[quote=arraya]1) The first thing to realize is that the single biggest issue in the financial system is confidence in the system itself. I think we can all agree on that.
Spoken like a true banker;)
-Maybe if the banking system was sound then there would be more confidence.
[/quote]
I agree with this, however… let’s talk a little about what we’ve decided as a society regarding banking and what the trade-offs are.
The govt. could decide tomorrow that previous capital levels for banks were too low and that they should be twice as high. This would definitely make the banking system more “sound.” But would anyone like the consequences? I doubt it. Bank investors need to get an adequate return on their capital in order to invest their capital in a bank. If equity capital requirements were doubled – and I’m just using this as an example of where increased “soundness” from a capital standpoint gets us – then the return on equity would decline dramatically all else being equal. Therefore, interest rates (for lending) would have to rise dramatically in order for the banking business model to generate enough return to attract capital. Thus, as a society, we’ve decided to have certain capital levels and FDIC insurance, etc. in order to have a banking business model that attracts capital for lending at “reasonable rates” (whatever that means). We’ve also decided that in order to maintain this system we’ll have to plug the occasional hole in the system when we have a blow up (like now). So, the capital providers to banks are going to get their returns (in aggregate) one way or the other. It’s up to society – via our government – to decide the manner in which they receive these returns – lower rates and higher leverage, higher rates and lower leverage, lower rates and less regulation, higher rates and more regulation, etc. But one thing’s for sure: if the returns aren’t there, the capital won’t be there either.
Personally, in order to ensure that this madness doesn’t happen again, I’d tackle things from the regulatory side. A few suggestions:
(1) Restrict the size that banks can grow to. Make it a big number, but no bank should be large enough that its failure could cause irreparable harm to the system. We probably have about 10 banks that fit into this category right now. We should have zero. (There are actually size restrictions related to deposits, but only one bank in the country bumps up against them – BofA. Obviously, the size restrictions are way too large.)
[OK, the free marketers don’t like this one. But here’s the fact: that FDIC insurance is, in effect, a subsidy from tax payers to the banking industry (which flows back through to the tax payers, of course). So, the taxpayers – via the govt. – should be able to restrict the activities of those who are benefiting from their largesse. Sorry, that’s just the way it is.]
(2) Change the appraisal methodology for single family residences to reflect what the homes would rent for. In other words, underwrite homes as you would apartments. Perhaps some adjustments can be made for the tax benefit to the prospective owner, but otherwise let’s change the appraisal process to more closely reflect the economics of the transaction. If this single change had been put into effect in 2000 we wouldn’t be in this mess.
(3) Restrict the amount of construction and development exposure that a bank can have on its balance sheet relative to its equity. Regulators kind of do that now, but were WAY too lax.
(4) Set up an exchange for credit default swaps that’s regulated, so that the system knows where all of this shit is hiding and who is exposed.
(5) Set up a regulatory body for the investment banks and demand higher capital requirements and far greater transparency. If they’re going to have access to the Fed discount window, then they’re going to be regulated and they’re going to have to hold higher capital levels. This means lower profitability, but boo fucking hoo. The previous “high” profits were mostly fakery anyway.
If these changes had been enacted even 5-6 years ago, we wouldn’t be in this mess.
