One Ply Look-Ahead
By Arnold Kling
Jacopo Carmassi, et al write,
the key to avoiding repeating this crisis is setting adequate capital requirements that cannot be circumvented for all intermediaries able to raise funds redeemable on demand at par. The simple way of doing it is to set capital requirements with reference to total assets, with no further distinction – 8% should be 8% in cash and equity, with no gimmicks allowed. All risks effectively borne by a bank, regardless of their legal attribution or geographical location, should be included in the asset definition, and accounting principles should be modified accordingly.
Thanks to Mark Thoma for the pointer.
The authors of this article understand the role that excess leverage played in the financial crisis. However, they have no feel for the chess game of financial regulation. If you went with a fixed ratio of capital to assets, regardless of the risk of the underlying assets, what move would the banks make in response?