The Wall Street Journal reports that a key element of Basel III rules, its provisions on liquidity buffers, are about to be watered down. Note that many, including this blog, deemed Basel III to be too weak and flawed in many critical regards (see here, here and here for some examples; among other things, its preservation of flawed risk weightings, delayed implementation and undue reliance on moving derivatives to exchanges rather than questioning their use).
International regulators are poised to ease a core element of new banking rules that were designed to improve the safety of the financial system, with some regulators fearing that plowing ahead with tough new requirements could exacerbate the current European crisis, according to people familiar with the matter.
Following months of intense industry pressure, regulators say they now plan to make it easier for banks to comply with a key provision of new international banking rules that will require lenders to maintain sufficiently deep pools of safe, liquid assets—like cash and government bonds—that can survive market meltdowns and other intense crises.
Now, changes to the rules will allow a wider variety of assets—such as gold and equities—to count toward banks’ liquidity buffers, among other changes envisioned to soften the rules, according to people involved in the talks.
Equities? Gold? This is deranged. Remember the S&P at 666? How gold would swoon with no proximate cause on bad market days? Volatile assets are to be treated as liquidity buffers? A liquidity buffer doesn’t just mean you can sell it in a pinch, it also means you can sell it and have a fair degree of certainty as to what price it will fetch.
As traders put it, in stress times, all correlations move to one. And we see a tendency toward that even now, with global markets exhibiting a “risk-on, risk-off” propensity. During the crisis, you see markets seemingly unrelated to whatever the bad news of the day was take sudden nose dives. Why? It looked to be hedge fund margin calls. When a trade is pressed to raise cash, he is probably not going to sell a position in market that it already roiled if he can avoid it. First, he may believe (correctly) that if he rides the panic out, he has a winner, or at least can exit at a better price. Second, he may not get a bid on a trade big enough to solve his problem. A trader will instead, if possible, sell a position in which he has a gain, and that could be anything. And this pattern was one big way that selling propagated across markets.
What is the rationale for this barmy move? First, that a lot of banks may not be able to handle meeting this requirement by 2015, which is when the liquidity requirement kicks in (keep in mind Basel III is most germane for European and UK banks. The US never got around to implementing Basel II, although it did hew to some of its approaches, and US financial firms, led by Jamie Dimon, have made Basel III a political hot potato). Um, so tell me why regulators allowed banks to pay dividends and hand out handsome compensation to executives and staff? This is an admission of a gross failure of oversight, but of course, that’s not how its being presented. Instead, we get this:
“In current exceptional conditions, where central banks stand ready to provide extraordinary amounts of liquidity against a wide range of collateral, the need for banks to hold large liquid asset buffers is much diminished,” Bank of England Governor Mervyn King said Thursday in a speech at a black-tie dinner in London. “I hope regulators around the world will take note.”
Translation: Because central banks will now do whatever it takes to prevent banks from falling over, why do they need to worry about liquidity? Of course, we’ll put aside the fact that the ongoing “prop up the banks rather than fix them” is leading to a rerun of Japan, zombification of the underlying economies. And unlike the Japanese, the West lacks the social cohesion to share costs and take diminished living standards gracefully.
King may think he’s saying that Basel III should not be implemented now but he is smoking something very strong if he believes that. According to banks, there is never a good time to make life tough for them. When times are bad, like now, they claim it will hurt their ability to operate (the regulators also seem unwilling to accept that we need a smaller financial sector, and inflicting some pain on them while applying offsetting fiscal stimulus would be a much better approach). And when times are good, there’s no problem, so why should they be asked to change behavior? The banks have learned that the trick when things bad is to engage in delaying tactics so that media and public attention move on. For instance, they managed to forestall regulation in the wake of a 1994 derivatives crisis that destroyed more value than the 1987 crash by running the clock out.
The endgame has been clear. The banks learned that all they have to do is mutter darkly about armageddon when financial markets are rocky and the authorities will fold, pronto. As Richard Smith noted last year, when banks were pushing back against giving national regulators the authority to set bank capital standards higher than Basel III minimums:
The message that’s coming through loud, clear and confident from these media statements, and from the Eurolobbying against the Basel III rules, is this: bank capital and liquidity are not going to be problems for the banks. Instead, the politicians will fix it, which is to say, some angry taxpayers, somewhere, will fix it.