Jeb Bush Is Right on Bank Capital
During Tuesday's presidential debate, Jeb Bush offered one of the clearest policy proposals yet to emerge from the Republican field: Increase capital requirements to reduce the threat that big banks can present to the economy. It's a great idea.
Capital is often misunderstood, portrayed as some kind of rainy-day fund that banks must set aside, or as a sort of punishment for previous misbehavior. Actually, it's equity that banks get from shareholders -- money they can use to make loans and other investments. Unlike debt, it doesn't have to be paid back, so it has the advantage of absorbing losses. The more capital banks have, the more capable they are of taking the kinds of risks that make the economy dynamic.
Unfortunately, more than five years after the enactment of the Dodd-Frank financial reform legislation, banks' capital levels remain troublingly low. Several of the largest U.S. financial institutions have less than $5 in equity for every $100 in assets, measured according to international accounting standards. That means a net loss of 5 percent would be enough to render them insolvent. During the last financial crisis, in 2009, the International Monetary Fund estimated U.S. banks' losses on securities and loans would ultimately amount to more than 8 percent.
Such a thin capital cushion places the interests of shareholders at odds with those of society at large. In good times, using more debt, or leverage, boosts banks' performance -- measured as the return on equity. In bad times, shareholders risk only the meager amount of equity they've put in. Beyond that, the banks' losses become everyone's problem, as the distress reverberates through the broader economy and necessitates taxpayer bailouts.
Raising equity requirements would have benefits far beyond making the system safer. Consider, for example, the concern that Bush and other candidates expressed about "too-big-to-fail" institutions. By increasing shareholders' responsibility for risk, it could create an incentive for them to divide the banks into more manageable -- and potentially more valuable -- pieces. That, in turn, could render unnecessary much of the regulatory complexity that Republicans rail against.
More equity could also allow regulators to simplify rules that burden smaller banks, another important issue that Bush raised in the debate. Well-capitalized institutions that don't get involved in trading and derivatives shouldn't have to file lengthy reports sorting their assets into myriad risk categories or submit to examinations as frequently as others.
All told, the benefits of boosting banks' capital so outweigh the costs, the only question is: Why wait for the next president to do it?
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