Geithner Outlines Basel’s All New Boom-Bust Detonator
Reprinted with permission from EconomicPolicyJournal.com
It is also essential that the Basel agreements are implemented by national authorities in a way that generates a `level playing field’ in our increasingly integrated global financial system. We will engage our foreign counterparts to look for ways to ensure that that these agreements are implemented in a transparent and consistent way by supervisors in different countries.
We will also continue to explore innovative ways, such as the use of counter-cyclical buffers and contingent capital, to expand the capacity for the system to absorb unexpected losses without amplifying shocks to the system.
Note the use of scare quotes around “level playing field.” One wonders which staffer had to strike “LOL” from Geithner’s Kool-Ade-stained draft. And, while the term “innovative” out of the mouth of a regulator is enough to make the hairs on our neck stand on end, we’ll move on and explore just what are those counter-cyclical buffers. Felix Salmon writes:
When credit in an economy is growing faster than the economy itself, a countercyclical capital buffer kicks in, which essentially says that banks need to have more capital in good times. That countercyclical buffer won’t be set by the BIS in Basel; it’ll be left up to national regulators. But you can probably expect the UK, US, and Switzerland to enforce it up to the maximum of 2.5%.So when the economy’s booming, banks are going to need 9.5% common equity, 11% Tier 1 capital, and 13% Tier 2 capital.
Got that? Central banks create the boom bust cycle by printing money, which enters the economy through the banking system. If the economy “heats up” a “countercyclical buffer” will kick in to slow bank lending, as part of Basel III. But this “countercyclical buffer” could be done without all this Basel III mumbo jumbo by central banks simply slowing money printing. Since central banks target either interest rates or money supply growth, if the countercyclical buffer kicks in, it simply means that central banks will have to be more aggressive adding reserves to maintain a particular interest rate level or money growth level. Bizarre.As for protecting banks against a future crisis by these new capital levels, not a chance. Following the 1929 stock market crash margin requirements were boosted to 50% to eliminate stock market crashes, a lot of good that did.As long as central banks pump money into the system, the economy will be vulnerable at the points where that money goes first and since banks are the ones who put that money into the system, they will continue to be vulnerable to slowdowns in money growth. 10%, 12% and 13% capital levels will never be enough to protect them (especially when some of the assets are held in the form of Freddie and Fannie paper, not to mention sovereign debt of the PIIGS).
RATIOt=CREDITt / GDPt Х 100%
GAPt=RATIOt – TRENDt.
TREND is a simple way of approximating something that can be seen as a sustainable average of ratio of credit-to-GDP based on the historical experience of the given economy. While a simple moving average or a linear time trend could be used to establish the trend, the Hodrick-Prescott filter is used in this proposal as it has the advantage that it tends to give higher weights to more recent observations. This is useful as such a feature is likely to be able to deal more effectively with structural breaks…