Tags: Partnoy | Fed | bank | rules

U of San Diego's Partnoy: Fed's Bank Rules Likely to Spark Next Fincl Crisis

By    |   Friday, 06 March 2015 07:00 AM

Frank Partnoy, professor of law and finance at the University of San Diego, isn't too enamored with the Federal Reserve's proposed rules to boost bank capital.

"It is usually hard to spot regulatory mistakes before their effects are felt. But one is happening in plain view right now," he writes in the Financial Times.

"When the next banking crisis strikes, critics will look back and ask what went wrong. In answer, they will probably point to the Federal Reserve's proposed new rules on bank capital."

The problem is a rule for the eight banks the Fed deems systemically important that requires them to have "an intricately calibrated quantity of extra capital," Partnoy argues. "The goal is a good one: reduce the likelihood of these banks defaulting on their debts."

But the result won't be pretty, thanks to convoluted rules, he notes. "They will create incentives for banks to manipulate their financial statements, hide risks and engage in dysfunctional strategies — much like those that doomed Lehman Brothers and brought the financial system to the brink of collapse seven years ago."

The Fed has drawn complaints from economists across the political spectrum that its effort to make banks safer since the 2008-09 financial crisis hasn't improved matters at all.

The critics note that the biggest banks have only grown bigger since the crisis, perhaps making them even more "too big to fail" than before the crisis.

So what should be done instead?

"Instead of encouraging big banks to play games with their accounts, regulators should offer them a simple bargain: drastically increase your capital and in return we will exempt you from the most onerous regulations," Partnoy contends.

"This would not be a soft option; the capital requirements would be stringent, perhaps double what the Fed currently requires," he adds.

"Let us hope Fed officials recognize the perverse incentives their proposed rules would create, and that this leads them to consider a simpler alternative. Otherwise, bankers will once again run circles around the Fed and history will repeat itself."

Elsewhere on the Fed front, Brian Wesbury, chief economist at First Trust Advisors, says there's no need to audit the Fed. "An audit, unless the word is used in a very broad sense, would be redundant and basically irrelevant," he writes in a commentary.

So what should be done?

"What [the Fed] needs is more responsible and effective oversight from Congress, a smaller balance sheet and less ability to interfere with private business decisions," Wesbury states.

The Fed's balance sheet has ballooned to $4.5 trillion through more than six years of quantitative easing. The constitution puts Congress in charge of overseeing monetary policy.

"The easiest way out of this mess is for Congress to force the Fed to sell its assets and limit the Fed's power to bank oversight, not bank management and macro-prudential policy tools. Don't audit the Fed, don't create conspiracy theories, but reign in the overreach," Wesbury argues.

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Frank Partnoy, professor of law and finance at the University of San Diego, isn't too enamored with the Federal Reserve's proposed rules to boost bank capital.
Partnoy, Fed, bank, rules
Friday, 06 March 2015 07:00 AM
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