(1) Ratchet up capital requirements as banks pass certain asset-size thresholds. Citigroup, for example, should carry at least TWICE as much capital (on a percentage basis) as a plain vanilla community bank. Currently all the banks are treated equally from a capital standpoint.
I don’t agree with this one. The small banks pose a risk if there are regional and systemic problems in the system. The large banks only pose a risk when the problem is systemic. Many of the large banks who got TARP funds are starting to recover, but several of the small banks who got TARP funds are looking like they may never recover. Larger capital requirements would also place them at a disadvantage.. and you might start seeing the gaming of this by having bank holding companies… which hold ownership in smaller banks (sized just under the threshold)
(2) Re-define allowable banking activities. If you want to operate with FDIC insurance, there are certain things you just can’t do, including (a) proprietary trading, (b) investing in hedge funds and private equity, etc. etc.
(3) Place much greater restrictions on derivatives and Level 3 investment activities.
This is where I think most of the effort should be. I don’t think they should be prohibited.. but any bank capital involved in these activities can not be counted towards capital requirements. This includes not only capital invested in these activities but at-risk capital from these activities (i.e. CDS(s) have at-risk capital different from the assets used to purchase). I also feel that CDS(s) should be regulated as an insurance product.. which is what they really are. There are capital requirements that are associated with insurance products and if a bank decides to invest in CDS(s), the capital requirements could not overlap with the capital requirements for their banking activities.
(4) Require greater diversification within the loan portfolio (most the Big Banks were allowed to get over-concentrated in certain areas)
I don’t know if I necessarily agree with this. Small banks by their nature are very concentrated when compared to how the larger banks were stuctured. Much of the problem was due to the mis-pricing of risk on sub-prime. The fact that CDS(s) were not regulated as an insurance product contributed to this. I also think that the ‘banks’ need to re-evaluate their models… which seem to be primarily ‘momentum’ based as opposed to fundamentals. This pyramid collapsed when the greater fool could not be located (because the greater fool could not buy in – wages had not kept up with price increases). Up to then, all of the creative financing was to allow the greater fool to buy in at ever increasing prices.
