Tuesday, March 31, 2009
Posted by: Jane Sasseen on March 31
Catching up after a busy day. I heard Alan Greenspan speak on Tuesday morning at a Brookings conference on the “Too Big To Fail” problem now vexing bank regulators.
In his roughly 15 minute talk, the former Fed chairman argued that current proposals by Treasury Secretary Tim Geithner and others to empower a “systemic risk regulator” to ferret out and manage risk throughout the financial system will not work. “If we put a regulator out there who is supposed to fend off systemic risk, that system will fail,” he said.
The reason, Greenspan said, is that such a proposal would require predictive capabilities that regulators, being human, simply don’t have. He warned the crowd of around 150 that there are some things regulators can do, and some things they can’t.
Under the "can" category, he argues, regulators can readily tell when investors aren't getting enough of a pay-off for taking higher risks. That's a simple matter of looking at yield spreads. But what they can't do is anticipate what will happen as a result.
"None of us can forecast," he said. "You can forecast when a system is underpricing risk. But you can’t forecast when it will erupt in a crisis."
Instead, Greenspan argued, the solution lies in boosting risk-weighted capital standards and enforcing them better. One way to reduce the risks of Too Big To Fail institutions, he says "is to somehow impose costs on them."
He points out that 10% wasn't always considered an adequate level of capital for banks. Historically, some needed to have capitalization as high as 50%; by the early 1900s it fell to 20% because the financial system got more efficient.
"I would argue that 13% or 14% (is needed) in today's market," Greenspan said. "The way to attack the Too Big To Fail problem is through capital."
He suggests adding a capital charge for regulatory purposes that would increase as the size of a bank goes up. That would eliminate the competitive advantage that acrues to banks perceived to be too big to fail, because that perception lowers their cost of capital."We’ve got a risk-based capital system; it would be easy to do, if we wanted to do it," he says.