Sunday, September 12, 2010

Breaking Down Basel III

Who really needs a college intern crunching out bureaucratic gobbledygook when Felix Salmon is around?

Salmon buys into a lot of elitist propaganda when its dished out, but he has done a damn good job of breaking down the Basel III agreement, here. Salmon's analysis is must reading for anyone interested in Basel III, but please ignore his effusive comments about the plan being "effective." As I have pointed out before, the plan is all about driving bankers to load up on sovereign debt and Fannie and Freddie paper.

In his analysis, Salmon only briefly mentions key  feature of Basel III, but this has to be the most bizarre feature:
When credit in an economy is growing faster than the economy itself, a countercyclical capital buffer kicks in, which essentially says that banks need to have more capital in good times. That countercyclical buffer won’t be set by the BIS in Basel; it’ll be left up to national regulators. But you can probably expect the UK, US, and Switzerland to enforce it up to the maximum of 2.5%.

So when the economy’s booming, banks are going to need 9.5% common equity, 11% Tier 1 capital, and 13% Tier 2 capital.
Got that? Central banks create the boom bust cycle by printing money, which enters the economy through the banking system. If the economy "heats up" a "countercyclical buffer" will kick in to slow bank lending, as part of Basel III. But this "countercyclical buffer" could be done without all this Basel III mumbo jumbo by central banks simply slowing money printing. Since central banks target either interest rates or money supply growth, if the countercyclical buffer kicks in, it simply means that central banks will have to be more aggressive adding reserves to maintain a particular interest rate level or money growth level. Bizarre.

As for protecting banks against a future crisis by these new capital levels, not a chance. Following the 1929 stock market crash margin requirements were boosted to 50% to eliminate stock market crashes, a lot of good that did.

As long as central banks pump money into the system, the economy will be vulnerable at the points where that money goes first and since banks are the ones who put that money into the system, they will continue to be vulnerable to slowdowns in money growth. 10%, 12% and 13% capital levels will never be enough to protect them (especially when some of the assets are held in the form of Freddie and Fannie paper, not to mention sovereign debt of the PIIGS).

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