Treasury Wants Stronger Capital Base For Banks But Plans Are Vague

The Treasury wants to make banks, particularly large ones, increase their capital bases and improve their liquidity. In a statement, the department said, “Capital requirements for all banking firms should be increased, and capital requirements for financial firms that could pose a threat to overall financial stability should be higher than those for other banking firms.”

The Treasury wants to make the entire banking system more conservative, at least from the standpoint of the compositions of balance sheets. What the Treasury does not want to do is propose the exact standards that it believes are appropriate. It is may want to leave that to Congress to figure out, but no one is saying. Even a 14-page document from the department covering its views on bank capital is unusually vague.

The broad statement about capital raises an issue over which the banks will put up a terrible fight. Higher capital bases mean lower earnings. In a perfect world, investors would understand that and give banks a pass on their quarterly numbers. The world is not nearly that perfect and bank investors will rue the day that the Treasury began to push the initiative.

One of the curious parts of the Treasury’d broad request for these changes is that it does not define what it means when it says that banks that “pose a threat to overall financial stability should be higher than those for other banking firms.” Goldman Sachs (GS), a bank based on the government’s view of institutions, may be extremely unlikely to face liquidity problems. Citigroup (C) may have a much more risky balance sheet. The Treasury does not define which firms are big enough to be held to higher standards. Are they the ones which have already been put through the government’s stress test mechanism? Or is it a larger or smaller group? The systemic risk that any one bank poses to the system is nearly impossible to calculate. It becomes even more difficult when a dozen or more banks have to be evaluated for their stability.

The other curious part of the Treasury’s proposal is that it is based on an entirely artificial and whimsical timeline. The department proposes that “a comprehensive agreement on new international capital and liquidity standards should be reached by December 31, 2010 and should be implemented in national jurisdictions by December 31, 2012.” The problems of risk involving bank capital are probably more immediate now than they will be a year or more from now, especially if the economy continues to recover. The risks were much greater a year ago than they are now, in all probability.

The weakness of a great many of the financial regulatory programs put forward by the Administration is that they are phenomenally vague. They are not really any better than a trial balloon. The best example of this may be the framework that has been suggested for creating a “super regulator” to oversee the financial markets. Treasury has suggested that a great deal of that authority be passed to the Federal Reserve, but the Fed has no specific plan for how it would fulfill this new role or whether it is actually the arm of the federal government which would be the appropriate one to do the job.

The financial and credit crises may nearly be over. There are still likely to be sickening episodes of huge bank write-offs ahead. Most will be due to toxic assets still held by some firms and to commercial real estate and consumer credit defaults. The government may even have to bailout another large bank. It is not likely that the entire banking system will have to be save again as it was late in 2008.

The further Congress and the public get from the disaster of nearly a year ago, the less important making permanent changes to prevent a repeat of it will seem. The goal of having new regulations in place by the end of next year is not realistic. Other priorities like the burgeoning deficit and what is likely to be prolonged high unemployment will have taken the center of the stage.

Treasury has not done itself any favors. The department says it has identified a serious problem and that it has a few suggestions about how these might be solved. It appears ready to leave the real thinking and the real work to someone else.

Douglas A. McIntyre