Larry Summers urges savvy thinkers not to blindly accept that banks are now safer because they are better capitalized.
“There is distressingly little evidence in favor of the proposition that banks that are measured as better capitalized by their regulators are less likely to fail than other banks,” he recently explained in a Washington Post blog.
He offered five suggestions to avoid another banking collapse.
“First, it is essential to take a dynamic view of capital. The stress tests introduced by the regulatory community represent a welcome recognition of the need to take a dynamic view of capital,” he said, but fears the “inadequacies of the stress test procedures.”
“Second, a crucial challenge for financial regulation going forward is assuring prompt responses to deteriorating conditions that do not set off vicious cycles. Markets were sending clear signals of major problems in the financial sector well in advance of the events of the fall of 2008 but the regulatory community did not even limit bank dividend payouts, even after the experience at Bear Stearns, which had been deemed very well capitalized even as it was failing,” he wrote.
Third, regulators need to be attentive to franchise value. “Regulatory costs are an especially large issue for smaller banks since there are almost certainly economies of scale in compliance functions. There is also the crucial point that incomplete regulation which discriminates against banks in favor shadow banks may by undermine financial stability in two ways. First, shadow banks may become loci of instability. Second, weakening the franchise value of regulated institutions may make their insolvency more likely,” he said.
“Fourth, bankers may be more right in their concerns about increased costs of capital and its effect on lending than economists usually suggest. There is every reason to suppose that bank capital costs have increased as a consequence of regulation, and that this may to some extent have reduced credit flows,” he wrote.
“Fifth, it is high time we move beyond a sterile debate between more and less regulation. No one who is reasonable can doubt that inadequate regulation contributed to what happened in 2008 or suppose that market discipline is sufficient to contain excessive risk-taking in the financial industry. At the same time, not all regulatory expansions are desirable and in some contexts tougher regulation can be counterproductive for financial stability if it reduces profitability without offsetting benefit, if interferes with bank diversification, or if it causes regulators to become overly identified within regulated institutions,” he wrote.
For his part, President Donald Trump said he is actively considering breaking up giant Wall Street banks, giving a push to efforts to revive a Depression-era law separating consumer lending and investment banking.
“I’m looking at that right now,” Trump said in a recent interview with Bloomberg News in the Oval Office. “There’s some people that want to go back to the old system, right? So we’re going to look at that.”
During the presidential campaign, Trump called for a “21st century” version of the 1933 Glass-Steagall law that required the separation of consumer lending and investment banking. The 2016 Republican party platform also backed restoring the legal barrier, which was repealed in 1999 under a financial deregulation signed by then-President Bill Clinton.
A handful of lawmakers blame the repeal for contributing to the 2008 financial crisis, an argument that Wall Street flatly rejects.
Trump officials, including Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn, have offered support for bringing back some version of Glass-Steagall, though they’ve offered scant details on what an updated approach might look like. Both Mnuchin and Cohn are former bankers who worked for Goldman Sachs Group Inc.
(Newsmax wire services contributed to this report).
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