How do you get 27 countries with different cultures and political systems, often at different points of the credit cycle, to agree on a reform plan for the global financial system?
Answer: By watering it down.
After years of lobbying by banks, politicians and even some financial regulators, the Basel Committee announced Sunday that it would allow an array of equities, corporate bonds, and residential mortgage-backed securities (yes, remember those) to be counted toward Basel III's Liquidity Coverage Ratio. Too-big-to-fail banks and their numerous supporters, especially in Europe, have already been cheering.
Every year that passes, politicians, bankers and even some financial regulators forget how illiquidity helped the 2008 financial crisis spread like wildfire from Wall Street to Main Street and from the U.S. to the farthest reaches of the globe. With every part of Basel III that is gutted, we are increasingly back where we were at the eve of the crisis.
The bankers had argued that the stricter requirements of the originally proposed LCR would have constrained credit availability. But there is no guarantee that a weaker LCR will embolden banks to lend more. Given the amount of liquidity that monetary authorities in the U.K., Europe, and the U.S., have injected, banks have had plenty of opportunity to lend to the real economy.
Given how quickly the 2008 credit crisis turned into a liquidity crisis, one of the biggest improvements in Basel III was supposed to be the inclusion of a liquidity buffer which was completely absent in Basel II.
The first part of the liquidity standards is the LCR, requiring banks to demonstrate they have sufficient high-credit-quality, very liquid, unencumbered assets to survive in a period of stress for at least 30 days. ("Stress" scenarios would include unexpected significant withdrawals of deposits, lines of credit, or other wholesale funding vehicles.) The original suggested start date for the LCR was 2015 while many other enhanced and new buffers were supposed to start this year.
The second part of the liquidity standards is the Net Stable Funding Ratio, which will probably be the next point of focus for the Basel Committee. Its purpose is to establish a minimum acceptable level of stable funding over a one-year time frame, based on the liquidity characteristics of a bank's assets and activities, and to insure that long-term assets are funded with at least a modicum of stable liabilities.
For the LCR, the numerator, until Sunday, consisted of Level I assets: Cash, central bank reserves, and sovereign and supranational securities which are assigned a 0% risk weight under the standardized method (in other words, they had to be rated AA to AAA).
Even before it was softened, a problem with the LCR was that even if a sovereign security was not in the upper echelon of ratings, it could still be considered a Level I asset as long as it was denominated in the sovereign's own currency. Given the current fiscal condition of a number of European countries, it was already questionable how liquid these securities really are. Level II assets – sovereign, supra, corporate, and covered bonds that were rated AA-minus – could also be part of the numerator with a 15% haircut.
Under the revised LCR announced Sunday, the numerator can also include corporate bonds rated BBB-minus to A-plus; unencumbered equities; and residential mortgage-backed securities.
At least these assets have what some would consider a significant haircut (25% for the mortgage bonds, 50% for the others). But it is important to remember how volatile and illiquid even highly rated sovereign securities can become, not to mention the above assets. Also, yet again, the market will be relying on public ratings that are paid for by the issuer – a conflict of interest that led to dicey securities receiving high grades during the boom years.
If the price of mortgage securities can plummet 50% in the blink of a computer screen, how is that "liquid?"
The Basel regulatory mantra persist being save the banks above all and do not care one iota if everything else goes under.
http://teawithft.blogspot.com/2013/01/basel-keeps-tightening-noose-around.html
Emphasizing sovereign instruments was a bad idea as we discovered how risky Greek and Italian and Spanish sovereign instruments could become. Anyone willing to bet that those are the only nations that will have sovereign risk issues in the future? So the Basel folks responded by adding some other instruments. But, they have potential risk problems, too. We come to the recognition that liquid instruments are liquid until they aren't. How about some AAA mortgage securities? Can you get any safer than that? It seems in this world there is risk everywhere, and the Basel liquidity rule writers seeking safe and highly liquid instruments are chasing chimeras.
FDIC insurance premiums, and regulations to stabilize the economy and family finances when banks misbehave, reduced potential profits. To attract deposits above FDIC-insured limits, banks had to set up a parallel "insurance" scheme, now known as "repo". The more things change, the more they stay the same, and the financial crisis in a nutshell was a classic run on the banks' repo sides.
Actual bankers here will likely dispute my simple analysis with a bunch of technical stuff, but I think honest bankers will agree it's a fair description of the situation to use when talking to the layman.
In a just system, repo depositors and banks would have ended up bald! And given the level of abuse of privilege, maybe even headless. In the unjust system we have, government instead has torn Main Street's hair out by the roots to make elegant wigs for Wall Street. By covering up all those bald heads, which would have served to mark the miscreants for public derision, we have radicalized our politics to a point that US sovereign debt was downgraded by the very ratings agencies who cooperated with the fraud (and I use that term advisedly due to the massive list of settlements entered into by mega-banks).
I agree with Sheila Bair - complication in regulation simply invites higher levels of gaming. If I had my way, a financial crisis would serve as prima fascia evidence of widespread fraud (heck, it has always turned out to be the case after years of sorting through the mess!) and result in immediate nationalization of the whole banking system until every transaction is investigated and unwound.
And suppose the only clearing and settlement system allowed for any financial transaction were through the Federal Reserve. All the "proprietary information" dodges that delayed resolution of counter-party fears would've been moot, as the Fed would be entitled to every speck of information under its confidentiality rules.
@BankerBud
I remember proposals to establish direct government lending for the "needy" in service of the idea that home ownership would help stabilize communities. It was the bankers who howled about unfair competition for a market they red-lined habitually. Sorry, no sympathy here! But there is, indeed, a right way to do business. The problem is that it isn't as profitable as Wall Street wants.
I don't sell homeowners repairs they don't need, or cut corners on quality to increase my profit margins. My prices are not low, but I'm often called back to redo work folks had done on the cheap that didn't solve the underlying problem I warned them about. Neither do I dump paint thinner out on their lawns, or bury rubbish in their gardens, or leave termite-attracting trash in the crawl space they'll never enter. Many of my competitors do all of that.
All I want is my banker to treat me the same way. Not one ever has.
"Today I made and appearance downtown.
I am an expert witness, because I say I am.
And I said, 'Gentleman....and I use that word loosely...I will testify for you; I'm a gun for hire, I'm a saint, I'm a liar - Because there are no facts, no truth, just data to be manipulated.
I can get you any result you like....what's it worth to ya?
Because there is no wrong, there is no right; And I sleep very well at night;
No shame, no solution No remorse, no retribution.
Just people selling t-shirts just opportunity to participate in this pathetic little circus
And winning, winning, winning' "
Richard Isacoff
isacofflaw@msn.com
Assuming that only public debt is "good debt" (the paradigm of the original formula) was as misleading as the cornerstone of the original Basel accord dating back to 1988 which asigned a zero risk weight to sovereign debt. As we know, the latter did have a significant impact on portfolio composition and the balance sheet problems banks are facing as a result of the current sovereign debt crisis are - at least in part - also a result from false regulatory assumptions. Where to "draw the line" in terms of eligibility and which haircuts should be assigned, is a different but indeed valid question.