Economix Blog: Multinational Corporations’ Support for Big Banks Is Not Persuasive

Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

Large multinational nonfinancial companies waded into the debate over too-big-to-fail financial institutions this week, coming down strongly on the side of very large global banks. Specifically, the Business Roundtable, a group representing big nonfinancial companies, sent a letter to the leadership of the House Financial Services Committee and the House Ways and Means Committee arguing in favor of including financial services in any potential new trade agreement with Europe (known as the Transatlantic Trade and Investment Partnership, TTIP, pronounced T-tip).

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The rationale is that “the negotiations will provide an opportunity to address market access barriers that keep U.S. businesses from enjoying full opportunities in Europe.”

And the letter comes from the International Engagement Committee and the Corporate Governance Committee of the Business Roundtable, a distinguished group of executives. It will carry weight.

There are three reasons to worry a great deal about the thinking behind this intervention: the motivation, the facts and the implications for our ability to limit systemic risks.

First, the explicit intention of this letter includes resisting further attempts at strengthening cap requirements for the United States financial system, like the legislation proposed by Senators Sherrod Brown, Democrat of Ohio, and David Vitter, Republican of Louisiana. The letter includes this statement:

The “Brown-Vitter” legislation and other contemplated proposals threaten to place significant new burdens on the largest U.S. banks, unilaterally imposing a new regulatory regime while leaving E.U. financial institutions unaffected.

The reasoning is that higher capital requirements would hurt American banks and therefore hurt nonfinancial activity:

The end result of these proposals would be to give large European and Asian financial institutions a serious advantage against their U.S. competitors, while increasing regulatory dissonance between the United States and the E.U.

The implication, as I read the letter, is that the United States should tie itself more closely to European banking practices, on capital and regulation more generally.

But the point of the Brown-Vitter proposal is precisely to make the financial system safer, by requiring larger buffers of loss absorbing equity financing. As Anat Admati and Martin Hellwig point out in their book, “The Bankers’ New Clothes,” more equity reduces the risk of financial distress. Financial crises cause huge damage to the nonfinancial sector, and this is exactly what happened in 2008 and the years that followed.

Ask yourself this question: had the United States more fully adopted Basel II – the international capital standards preferred by Europe – in the run-up to 2007, would its problems now be bigger or smaller? Under Basel II, banks were allowed to have less equity funding and more leverage (i.e., more debt relative to their balance sheets). Thank goodness that Sheila Bair and her colleagues at the Federal Deposit Insurance Corporation resisted efforts by the Federal Reserve Bank of New York and others to fully adopt the European way of calculating and regulating capital.

Unfortunately, leading nonfinancial corporate voices seem to have forgotten that lesson.

Second, there is a problem with the basic facts in the Roundtable letter. These representatives of big nonfinancial companies assert that if, for example, American banks were forced to become smaller, this would put American nonfinancial companies at a disadvantage relative to European and Asian nonfinancial companies.

The United States is home to only three of the largest 20 global banks, ranked by total assets; if those banks were significantly downsized or altered via these proposals, European and Asian competitors would be much better positioned to handle major, complex global transactions that smaller, regional U.S. financial institutions simply cannot handle.

But if big banks are measured on a comparable basis – for example, by converting American balance sheets from GAAP (the Generally Accepted Accounting Principles, used in the United States for financial reporting) to the International Financial Reporting Standards, or I.F.R.S., used in Europe – the United States has the largest three banks in the world (JPMorgan Chase, Bank of America and Citigroup).

Differences in accounting standards may sound technical, but this is just about comparing apples to apples. Thomas Hoenig, vice chairman of the F.D.I.C., has done a great service by providing the numbers on this basis. I agree with Mr. Hoenig that I.F.R.S. is the best basis for this comparison.

Asked for its sources and definitions, the Business Roundtable responded with a statement that said it used “conventional industry rankings,” which I believe are flawed.

Measured properly, JPMorgan Chase is already much larger than its nearest foreign competition (a balance sheet of nearly $4 trillion, compared with the largest European banks, which are under $3 trillion) and Bank of America is nearly as big. If JPMorgan Chase and Bank of America are pressured to shrink to the level of their European competitors, what exactly would the broader American economy lose?

Third, consider the deeper logic implied in the Business Roundtable letter. The euro-zone economy is a mess, and its financial sector is a disaster — in part because equity capital fell to dangerous levels and has not been rebuilt, and in part because the European regulatory and private-sector application of “risk weights” has completely broken down. Sovereign debt within the euro zone is still considered to be low or zero risk, despite all that we have observed over the last five years.

The idea that the United States should associate itself more closely with this completely failed approach to bank regulation boggles the mind.

If financial services are included in TTIP, this would completely tie the hands of American regulators, including the Federal Reserve and the F.D.I.C.

Existing international agreements – for example, the Basel III accord on capital – are not good, but at least these only set a floor on what American regulators can do. And the latest indications are that the Fed – with much prodding from the F.D.I.C. – will set a limit on financial-institution leverage that is lower (i.e., a tougher restriction on how much such companies can borrow) than required under Basel.

But if such details were put into a trade agreement, in all likelihood a ceiling would be set on bank equity capital, severely limiting the ability of American officials to respond to financial risks as they materialize. The Federal Reserve, among others, should resist strenuously any attempt to include financial services in TTIP.

It is with good reason that capital requirements and core regulatory issues for financial services are not usually part of such trade agreements. The nonfinancial sector – along with everyone else – really does not need big banks to blow themselves up along European lines at any point in the foreseeable future.

Article source: http://economix.blogs.nytimes.com/2013/06/06/multinational-corporations-support-for-big-banks-is-not-persuasive/?partner=rss&emc=rss