Banking dysfunction.

• Author: Grant, James
• Position: Essay

"Has anyone bothered to study the cumulative effect of all these things?" the chief executive officer of JPMorgan Chase reasonably inquired of the chairman of the Federal Reserve Board at a bankers gathering in Atlanta last June. The CEO, Jamie Dimon, was referring to the combination of cyclical hangover and regulatory constriction. The chairman, Ben Bernanke, replied, "It's just too complicated. We don't really have the quantitative tools to do that" (Grant and Masters 2011: 1).

Banking dysfunction is the subject at hand. For what ails us, I am about to blame modern regulation, the asphyxiating philosophy of modern regulation, the bankers themselves, the pure paper dollar, manipulated interest rates, and the human condition. Concerning bank capital, I favor just enough but not too much, the exact amount best blown to people who have not been elected to Congress. It isn't the lack of capital that's put the American banking system behind the eight ball; it's a shortage of capitalism.

A Shortage of Capitalism

Let us be clear: on Wall Street, there was never a capitalist Eden. There was, however, an era of capitalist clarity in which the owners of the banks and investment banks not only reaped the profits but also bore the losses. Insolvency, in the case of a nationally chartered bank, meant a capital call for the stockholders, the proceeds earmarked for the depositors and other senior creditors.

It was, after all, the investors' bank, not the taxpayers'. Before the coining of the Fed and especially the Federal Deposit Insurance Corporation (FDIC), and even up until the time of the codification of the doctrine that some banks were too big to fail, safety was a valuable banking franchise. The Chemical National Bank, the descendant of which combined with Chase Manhattan in 1995 to make today's JPMorgan Chase, made a lucrative business of it (Lowenstein 1990). However, what with Sheila Bair, Ben Bernanke, and the Troubled Asset Relief Program (TARP), safety has become a virtue without a market value. "Let financial prudence pay again" is my one-sentence contribution to the financial reform agenda.

In his colloquy with Chairman Bernanke, CEO Dimon made the case that the tide of credit is receding. CDOs, SIVs, mortgage brokers, most exotic derivatives--the relics of 2007--are mainly gone, he pointed out. Dimon (2011) went on:

Fannie Mae and Freddie Mae are in the government hospital, higher capital and liquidity are already in the marketplace, we estimate more than double what it was before. There are tougher requirements--boards are tougher, risk committees are tougher, there's an oversight committee. Regulators, I can assure you, are much tougher in every way ... possible. One of the cores of the problem was mortgage underwriting--mortgage underwriting has gone back to what it was 30 years ago. I think it's a good thing, but there's no more subprime, no more Alt-A. And to top it all off, Dimon wound up, there's talk of higher capital requirements on the so-called systemically important financial institutions (SIFIs), or--let us call a spade a spade--big dumb banks.

Capital, especially big-bank equity capital, is today's hot-button issue: the regulators want more of it, perhaps 2 or 3 percentage points more (expressed as a percentage of risk-adjusted assets), to protect the taxpayers against the next cyclical pileup. Above all, declared Fed Governor Daniel K. Tarullo in a speech on June 3, 2011, let there be no more TARPs. As it is, Tarullo complained, the big dumb banks have no incentive to carry "enough" capital. By mandating a fat new slug of equity, he said, the regulators would be making the banks stronger, the banking system safer and the competition between big and small depository institutions more equitable. Is it not unfair that the too-big-to-fail banks can borrow more cheaply than the small fry not similarly favored? Well, then, tougher new capital requirements would return to smaller banks a bit of what the government took away from them when it...