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DAVIES/SHILLER: The Bankers’ Capital War

DAVIES/SHILLER: The Bankers’ Capital War

PARIS – Almost everyone nowadays agrees that banks need more capital. Christine Lagarde chose to make it her first campaign as Managing Director of the International Monetary Fund. And conventional analyses of the financial crisis focus on the weak capital base of many banks, which left them with insufficient reserves to absorb the losses they incurred when asset prices fell sharply in 2007-2008.

Taxpayers, notably in the United States and the United Kingdom, were obliged to step in to fill that hole. The same disaster movie is now playing in the eurozone. We can only hope that the bankers are eventually rescued from the burning eurotower by Super-Sarkozy and Wonder-Frau Merkel – and that the Basel Committee of Banking Supervisors ensures that there will be no sequel.

The Basel Committee has proposed strengthening considerably both the quantity and the quality of capital in the global banking system. This would mean much larger core equity capital for all banks and a range of additional reserves – a capital conservation buffer, a countercyclical buffer, and a surcharge for systemically vital institutions – to be added by local regulators as they see fit. Unfortunately, the final implementation date for these new obligations has been deferred until 2019 – by which point a few banks might still be left standing.

In fact, the view that banks need more capital, while widespread, is not unanimous. Two notable holdouts are Jamie Dimon and Walter Bagehot. Dimon, the Chairman and CEO of J.P. Morgan, has been making his contrarian views known to regulators, most recently almost coming to blows, according to eyewitnesses, in a spat with Governor of the Bank of Canada Mark Carney, who chairs a group that is designing parts of the new regime.

Walter Bagehot is in no position to threaten Carney, or any other regulator. He died in 1877. But in his great work on finance, Lombard Street, published in 1873, he asserted that, “A well-run bank needs no capital. No amount of capital will rescue a badly run bank.” I expect that Dimon, who has steered Morgan through the crisis without the need for public support, would say “amen.”

Of course, regulators cannot easily require all banks to be “well-run” in Bagehot’s sense. So banks require capital as a backstop. It is not a bad substitute for perfect judgment, and at least it can be defined and measured. But how much capital is enough?