Fair Game: Two Senators Try to Slam the Door on Bank Bailouts

The legislation, called the Terminating Bailouts for Taxpayer Fairness Act, emerged last Wednesday; its co-sponsors are Sherrod Brown, an Ohio Democrat, and David Vitter, a Louisiana Republican. It is a smart, simple and tough piece of work that would protect taxpayers from costly rescues in the future.

This means that the bill will come under fierce attack from the big banks that almost wrecked our economy and stand to lose the most if it becomes law.

For starters, the bill would create an entirely new, transparent and ungameable set of capital rules for the nation’s banks — in other words, a meaningful rainy-day fund. Enormous institutions, like JPMorgan Chase and Citibank, would have to hold common stockholder equity of at least 15 percent of their consolidated assets to protect against large losses. That’s almost double the 8 percent of risk-weighted assets required under the capital rules established by Basel III, the latest version of the byzantine international system created by regulators and central bankers.

This change, by itself, would eliminate a raft of problems posed by the risk-weighted Basel approach. Under those rules, banks must hold lesser or greater amounts of capital against assets, depending on the supposed risks they pose. For example, holdings of United States government securities are considered low-risk and require no capital to be held against them. Securities or loans that are riskier require more of a buffer against loss.

There are many problems with this arrangement. First, the risk assessments on various types of assets rely heavily on ratings agency grades. In the housing boom, toxic mortgage securities carrying triple-A ratings were considered low-risk, too. As such, they didn’t require hefty capital set-asides.

We all know how disastrous that was. So chalk up this plus for Brown-Vitter: Eliminating risk-weights as part of a capital assessment means less reliance on unreliable ratings.

Risk-weighted asset calculations also give bankers a lot of freedom to understate the perils in their institutions’ holdings.

The bill prevents another type of fudging by requiring off-balance-sheet assets and liabilities and derivatives positions to be included in a bank’s consolidated assets. In addition, the capital cushion that a bank would hold under the bill is liquid and can absorb losses easily. This capital measure would be more transparent than the current system and could not be manipulated.

In a truly courageous move, Brown-Vitter would require United States financial regulators to abandon Basel III. An earlier version of Basel did nothing to prevent the financial crisis and encouraged banks to binge on leverage.

Taxpayers would not be the only beneficiaries in the Brown-Vitter bill. Community banks, which weren’t responsible for bringing the nation’s economy to the brink, would be operating on a more level playing field with the jumbo banks. These large institutions have lower financing costs than community banks because the market understands that regulators will never let them fail.

“This bill will inject more market discipline on the financial services industry,” Mr. Brown said in an interview on Thursday. “The megabanks have a choice to make: they can increase their capital or bring down their size.”

Brown-Vitter has other attributes as well. It would bar bank regulators from giving nondepository institutions access to Federal Reserve lending programs. And it would make it harder for bank holding companies to move assets or liabilities from nonbanking affiliates, like derivatives bets held at a brokerage unit, to the protective umbrella of the parent company that might be rescued by taxpayers in a financial disaster.

Thomas M. Hoenig, the vice chairman of the Federal Deposit Insurance Corporation, supports the bill. “It’s finally taking the discussion in the right direction toward improving the stability of banks and the financial system more broadly,” Mr. Hoenig said in an interview on Friday. Brown-Vitter would also put the United States in a leadership position on financial soundness, he added, which other countries could emulate.

Article source: http://www.nytimes.com/2013/04/28/business/two-senators-try-to-slam-the-door-on-bank-bailouts.html?partner=rss&emc=rss