News and Commentary
The Basel III international banking regulations instructed national regulators to enact countercyclical capital buffers (CCyB). These regulations would require banks to build up more financial resilience in good times and then allow them more flexibility in lean times. In March, the Fed voted to keep the CCyB at zero percent of a bank’s assets. With a very tight economy and easy (perhaps too easy) credit, this moment appears ripe for making banks issue more equity. The New York Times just reported on how this debate is taking shape within the Fed. Trump appointees Randal Quarles and Jerome Powell favor even further softening of capital requirements, while Obama appointees Lael Brainard and Janet Yellen have argued the Fed should consider now turning on the CCyB’s.
The Elizabeth Warren campaign released a memo on financial regulation. Armed with plans galore, she wants to combat abuses in corporate governance, to transform certain post offices into banks, and to break up our biggest financial institutions. There’s a lot in here. Some of it is commonsensical and some of it merits real skepticism. It is worth noting that in this torrent of reforms she devotes exactly one clause of one sentence to capital requirements. The document is primarily concerned with the “looting” performed by private equity companies or the amount of human capital sucked up by Wall Street. Promoting financial stability to prevent another crisis receives remarkably little attention.
Regulators have finally released their proposal to update the Volcker rule. Bloomberg predicts that the changes will do little to address Wall Street’s worries. (You can read more about the ambiguities of the Volcker Rule in Dan’s blog post here.)
New Research
A paper in CEPR makes the case that Value at Risk (VaR) regulation is insufficient to prevent financial crises. VaR regulation aims to assess the risk of an institution’s portfolio and scales the regulatory burden to match their exposure. However, mark-to-market accounting and fire-sale pricing mean that our measurements of risk will be poor predictors of the institution’s balance sheet in a financial panic. Here’s a useful summary.
Macro-prudential policy has been central to post-crisis plans for reform. When financial markets are running hot, regulations can be applied to prevent excessive expansions in credit; when the market is cooling off, some of those regulatory burdens can be removed. (The same idea motivates CCyB’s.) This article takes aim at that grand design. The unpredictable nature of systemic risk makes it inherently difficult for regulators trying to read the financial cycle; if it were obvious when a problem was coming, markets would not be subject to crises. Then, looking at these policies in action, their implementation has been far more open-ended and less rules-based than the elevator pitch for counter-cyclicality would suggest. (Case in point, our current CyCB are at zero percent despite the strong economy.)
A new paper traces the unstable trajectory of stock market integration across history. International equity markets were actually quite well integrated before World War One. Under the Great Depression, the World Wars, and the Bretton Woods system, integration ebbed, and only in the past ten years have we surpassed the integration seen at the turn of the last century.
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