August 17, 2015

Alan Greenspan is either blind to what caused the financial crisis 2008, or does just not want to admit it

Sir, I refer to Alan Greenspan’s “Higher capital is a less painful way to fix the banks” August 18.

Greenspan has either no idea about what happened, or does just not want to admit it. Suppose the base capital requirement had been the 30% he speaks of instead of that basic 8% required in Basel II. What would that have meant in terms of effective capital requirements using the risk-weights of Basel II. Banks, when lending to prime governments with a 0% risk weight, would then have had to hold, just as today, zero capital. Banks, when investing in AAA rated securities, or getting a default insurance from an AAA rated company, to which a 20% risk weight applied, would then need to hold 6% in capital instead of Basel II’s 1.6%; while for loans to SMEs and entrepreneurs risk-weighted 100% they would then be required to hold 30% in capital instead of the 8% they must currently hold.

Would that have created more or less distortions in the allocation of bank credit? No way Jose! The current crisis has resulted much more from the existence of different capital requirements than by their standard level. Just reflect on the fact that all assets that caused the crisis have in common they originated very low capital requirements for banks compared to other assets. To fix the banks, much more important than the size of the basic capital requirement is getting rid with of the risk-weighting.

Greenspan is also guilty here of serious misrepresentation. He writes: “Bank equity as a percentage of assets, for example, declined from 36 per cent in 1870 to 7 per cent in 1950 because of the consolidation of reserves and improvements in payment systems. Since then, the ratio has drifted up to today’s 11 per cent.” The 36 percent in 1870 and the 7 percent in 1950 was bank equity based on all assets, while today’s 11 percent is based on risk weighted assets… and are therefore absolutely not comparable. Besides, analyzing bank equity without considering other security factors, like reserve requirements that have fluctuated considerably, cannot tell the whole story.

FT, may I suggest you ask all experts writing on capital requirements for banks the following two questions, before allowing him space in your paper:

First: Why are the bank capital requirements, those that are to cover for unexpected losses, based on the perceptions of expected losses?

Second: Why do you believe government bureaucrats can use bank credit more efficiently than the private sector, as your risk weights of 0% and 100% respectively de facto imply?

If they can’t give you satisfactory answers to those questions do you FT really think they have the necessary expertise to opine on this issue?