Reviewing the NYT Room for Debate: Are Global Banking Rules ‘Anti-American’?

Last month, Jamie Dimon thrust himself into the national spot light by standing up against Basel III rules. His complaints come nearly a year after the new rules on capital requirements were passed-see my commentary from October 2010 reviewing the details of Basel III-but that doesn’t mean he is wrong that Basel III is a bad idea. I happen to thing that capital requirements encourage more risk than they prevent, as I explained in that op-ed a year ago, so it is encouraging to see someone of high rank in the financial community call BS on Basel III regulations. That being said, however, is Jamie Dimon right in his technical assertion that Basel III is anti-American?

At first glance, I would say no since American banks are much better capitalized than European Banks (and just look at the CDS rates on European banks prior to the EFSF expansion last week). Most American banks will not have a problem meeting the new Basel III standards early on since they have been holding high amounts of capital lately anyway. But Dimon’s claim is more focused on the fact that the way the risk weights will be measured to determine a capital requirement rate is not favorable to the United States (for instance, mortgage servicing rights will be counted against U.S. banks in a way that European authorities will not force financial institutions to consider).

So is he right? The NYT’s Room for Debate last week offered up several possible answers. Here is a quick review and critique of each:

Lynn Stout, corporate law professor UCLA

“Thanks to capital requirements, bank shareholders have to have at least some financial interest in the bank – some skin in the game – that they would lose if the bank went under. This means that bank shareholders (who get the profits when times are good) also have to suffer losses when times are bad. The result? More cautious banks that are less likely to make bad loans and investments and then fail, causing market disruptions and costly taxpayer bailouts… So Basel III may indeed slightly reduce the wealth of bank shareholders and bank executives. But it helps American banks – and their customers, and the America.”

This is far from a sensible approach. Shareholders and managers can have skin in the game through the process of ensuring particular liability in the case of failure. Capital reserves just give banks a number that creates the perception of safety as the bank does everything it can to game the system and lower its capital requirement commitment. A better approach would be to nail down a clear process for resolving companies without the FDIC or other taxpayer risk-that would make customers safe.

Peter Wallison, Senior Fellow, AEI

“The question Jamie Dimon is raising – not unlike the debates over civil rights enforcement in the U.S. – is whether ostensibly nondiscriminatory regulations now under consideration in Basel III may, because of regulations in the U.S., have a “disparate impact” on the largest U.S. banks… the big European and Asian banks with which U.S. banks must compete for capital will have sources of revenue that could make them more profitable than JPMorgan Chase and other large U.S. banks, with no allowance for home country restrictions that reduce their earning power.”

This is closer to the answer. If Basel III is not applied in a uniform manner across countries, there could be risk exposure by those with tighter definitions on risk. In that sense the rules could be considered anti-American. But to be consistent, we’d have to call as anti-America any regulation that increased the cost of American companies and reducing competitiveness with foreign firms.

Simon Johnson, business professor, MIT

The term “bank capital” is often poorly explained in the debate on this issue. It is just a synonym for equity – meaning the amount of a bank’s activities that are financed with shareholder equity, rather than debt. The advantage of equity is that it is “loss absorbing,” meaning that it takes losses and must be wiped out in full before any losses fall on creditors… But the real need for capital requirements arises from the social costs that a banking crisis can impose. […]

Requiring higher capital – more equity relative to debt – in U.S. banks is good for everyone. If some bankers complain and work hard to overturn these rules, they are the ones being anti-American.

The point here is not whether more capital is good for a bank or not. Of course the better capitalized a bank is, the higher the likelihood it can absorb losses. By who is to say that banks shouldn’t hold 90 percent capital relative to risks? If too-big-to-fail banks didn’t exist, then this wouldn’t matter as much. If a bank failed, then it failed. As a customer you should consider carefully who you give money to. As an investor you should watch carefully what institutions you invest in are doing with their business. Only if society has to pick up the pieces, does the government get a legitimate claim at setting capital requirements-so instead of trying to have bank world insiders set the standards (which they have failed at twice), end the TBTF system itself and leave capital requirements up to individual banks and their own shareholders to decide.

Steve Barlett, president, Financial Services Roundtable

The U.S. banking industry has responded to the crisis by increasing capital to levels not seen in over 70 years. Requiring even more capital and liquidity at this juncture would siphon needed funds away from businesses and consumers that could be used to stimulate economic growth and job creation. It would also limit access to credit for borrowers. It has been estimated that Basel III’s higher capital requirement for large banks would require banks to hold an additional $200 billion in capital – an amount that could otherwise be used to support over $1 trillion in lending.

The debate over whether more capital is necessary (not over whether it would make banks safer) should help us to see that the only way to get good capital requirements is to remove across the board, one-size fits all risk weights, and force the banks to consider their own capital needs. This may lead some banks to add more capital than right now, and others to reduce capital. As long as there were real ways of forcing the banks to be liable for their actions and potential failure, this would mean that we’d avoid artificially forcing the collection of too much capital. And that would be not just anti-American, but anti-Globe.

Nomi Prins, senior fellow, Demos

Proposed Basel III capital requirements and regulations are not anti-American… Here’s what’s anti-American: receiving extreme federal assistance, while the country is hosed, loan refinancing and foreclosure reducing negotiations are pitiful, and both private and public sectors can’t finance enough job growth to alter our horrific unemployment situation.

Herein lies one of the more problematic attitudes when it comes to considering banking regulations in general. The banks should not be tools of social change. The unemployment situation is a long-term structural problem. Sure, more lending to small businesses (assuming there is the demand for the loans) would create more jobs and anything the government does to prevent that is bad-but that doesn’t mean we should force the banks to do this nor should we expect that is going to turn the economy around.

Rather, we should recognize this is the lingering problem with bailouts. We rescued a group of companies that ran poor business models and should have failed and been kicked to the curb. And then we get upset when those same groups start to act more responsibly, even if it means less cash for debt hungry America. The irony is that if the banks were to turn the flood gates loose again with irresponsible lending and stockpiles of toxic debt, there would be widespread praise for the bank’s positive social attitude-only to see another crisis hit, more suffering, more bailouts, and more complaining all over again.

Russell Roberts, economics professor, George Mason University

The regulations are for insiders. You also don’t understand dairy regulations. They too were written for insiders. My claim is that the opacity of both is deliberate. Insiders don’t want it to be easy for normal people – outsiders – to know what’s going on… I do not believe it’s a coincidence that Basel I and II blew up in a way that enriched insiders at the expense of outsiders. To expect Basel III to yield a better result (now that we’ve supposedly learned so much) is to ignore the way the financial game is played. […]

Jamie Dimon is a crony capitalist. Don’t confuse that with the real kind. If he says Basel III is bad for America, you can bet that he means “bad for JPMorgan Chase.” Either way, he’ll have a slightly larger say in the ultimate outcome than the wisest economist or outsider looking in.

Prof. Roberts takes my basic view that the capital requirement system itself is broken a step further and notes that Dimon isn’t out for the fairest system around (or one that is dramatically more pro-American), but rather one that benefits his bank the most.

Douglas Elliot, business and public policy fellow, Brookings Institution

In the retelling, [Dimon’s] wording (“anti-American”) has been twisted a bit to claim that Basel III was “un-American,” with obvious overtones of jingoism and McCarthyism. I, personally, believe that Basel III is a big step forward for both sides of the Atlantic, but we must admit that we do not yet know for certain that he will prove to be wrong. There are many devils in the details and considerable uncertainties remain. The U.S. and the European Union are still formulating complex regulations to implement Basel III, and we will not know for sure how banking supervisors will act under those regulations until we see what they actually do. Europe’s banking systems differ in important ways from those in the U.S., so differences in implementation can matter even if the broad principles are the same.

This is, perhaps, the most sensible direct answer to the question. Is Basel III anti-American? Well, if we assume that there is going to be some capital requirement system (getting rid of it would be a huge change in policy) and look at the details of Basel III, then it very well could wind up creating disadvantages for American banks like JMPC once you get into the details.

The idea of capital requirements is not necessarily anti-American-it is more anti-Globe in that it doesn’t force the banks around the world to properly assess and take responsibilities for their actions.