Lax Basel III Rules to Spur Further Bank Consolidation, Meaning More TBTF?

The “lax” is clearly a tad inflammatory, but tweaks in Basel III rules to allow dubious quality items like mortgage servicing rights as Tier I capital speak volumes. In addition, the various noises from policy makers makes clear that they aren’t willing to make banks raise capital level by much due to fears of the impact of lower loan availability on economic growth (more equity behind lending means higher lending costs, since equity is more expensive than debt). And with that not-very-strong starting point, the banks have pushed for even weaker rules.

Should this come to pass, Credit Suisse, via a Wall Street Journal story, is already predicting the outcome: more bank mergers. This is would be yet another example of the costs of not taking a tough enough line with banks (the 2009 example being explicit and covert bailouts, without forcing changes in top management and boards at the struggling banks, was diverted to a significant degree to record bonuses, rather than its intended aim, building up capital levels). The latest antiicpated bad outcome, per the Journal (hat tip Richard Smith):

Interesting, therefore, that analysts at Credit Suisse, have just published a research report entitled “Opportunity Knocks,” which sees a “blue-sky” 78% potential upside from current share price levels based on higher returns, lower-than-expected cost of equity and benign macroeconomic scenarios.

If the blue-sky background does indeed pan out and profits rise as bad loans decline, bank share prices will improve to the extent that they will start to have the confidence to start looking at acquisitions that are more than just the opportunistic ones seen post-crisis.

This will especially be the case if, as expected, the new Basel III capital rules are pitched at such a level that many banks turn out to have excess capital. Most bankers have enough sense not to talk about this openly just now, but acquisitions will be one way of spending the money. One assumes that in this new banking environment, acquirers will have to convince regulators that the resulting solvency position is more than adequate. Given the ability of bankers to destroy value for their shareholders this would seem to be fundamental.

We doubt many readers are of the “benign macroeconomic scenario” school, but this is classic bad incentives at work. I haven’t seen any international studies, but US studies of bank efficiency have consistently found larger banks to be slightly MORE costly to operate as asset size rises, once a not very high threshold is reached. So the widely touted rationale of cost savings is bunk; each bank in a merger could have achieved the same cost level on its own.

So why do deals like this continue? Because banks CEO pay is positively correlated with bank size. Empire building is a very profitable exercise for bank executives. And the top echelon of the acquired bank is bought off via golden parachutes.

The result is more TBTF banks, the last thing we want from a policy standpoint. But it looks like fear of taking the banksters down a notch is going to lead to more of the same, which is ultimately more looting of taxpayers.

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  1. Jim Haygood

    ‘If, as expected, the new Basel III capital rules are pitched at such a level that many banks turn out to have excess capital … acquisitions will be one way of spending the money.’

    As opposed to, say, lending. Capacity reduction through mergers and acquisitions is a valid strategy in low-growth and no-growth industries.

    In the meantime, with the final outcome of Basel III uncertain, bankers would be imprudent to go on a lending spree and then get caught short of capital. That would be a quick ticket to a lowball buyout by an acquirer who saved some ammo.

    Current and forecasted capital adequacy, I suspect, are more important constraints on lending expansion than the cost of debt funding — which implies that QE II would have only second-order effects at best.

    Are you listening, Ben?

  2. anonymous

    From the Pragmatic Capitalist: “…With revenues likely to slow and margin expansion likely peaking there is increasing risk of further defensive posturing from corporations. If the macro outlook deteriorates further (none of this even considers the very serious exogenous risks from China and Europe) the private sector balance sheet will further deteriorate as layoffs ensue.”

    Five-alarm fire time? My own reading of the political news suggests two things: a/ The WH is looking increasingly inept. Internal polls, I’m guessing, probably indicate an even bigger drubbing in November than public polls are predicting. b/ The right is going to be much much stronger and bellicose than in 94. Larry Sabato and others, I think,

    If the unemployment rate rises much more with the populist, xenophobic right in control of Congress, a whole lot of unpleasantness may coming down the road. I’m a union member and got bounced from two prominent left-wing sites last year for suggesting that jobs were much more important than hcr and for arguing that hurling accusations of “racism” at every critic would not win the day post-2008.

    Cap and trade, hcr, and the slew of porky bail-outs for Dem aligned special interests demonstrate bad judgment above all. How bad? Bush looks better to significant numbers of voters.

    It’s been a long time since I was out of work, but I can certainly recall the degradation rituals of lining up to apply for jobs and the soul destroying experience of hearing: “Thanks, for coming in. We’ll keep your application on file.”

    I get no sense, and I mean none at all, that the people who elected this doofus to fix the Bush economy have any idea what they’ve done to large numbers of the American lower and lower-middle class. Four straight years of Katrina for huge swaths of the American electorate. And now Sarah Palin and Beck are about to explain who is to blame using megaphones.

    Talk about your stormy seas ahead.

      1. anonymous

        Do the unemployed have to pay their all their own medical expenses out of pocket? I certainly hope not. We’re only seeing the tip of the anti-hcr iceberg at this stage, btw.

        Wait till November when the “this is how they spent your money” ads coming rolling out with cap and trade, hcr, and bail-out for bankers featured large.

        Dems understand the writing on the wall and are busy crafting ads to blame everything on Bush and the Republicans. These ads, dead-ender support for hope and change llc, and a very healthy and sensible skepticism towards Republicans are the only obstacles preventing a Dem wipe-out in November, a possibility I would not rule out, should the economic situation deteriorate further between now and the election.

        I’ve seen this movie before. Unions put a gun to the head of Dems and warn that hiring non-union workers for WPA style projects or freezing or reducing public worker union wages means no GOTV on election day, or worse.

        Cleaning up after Bush required real intelligence, courage, and vision. If that’s what we’ve been watching for the last two years, we’re in much more trouble than we think.

        The good news is that the occupant of the oval office is probably simply a second-rate thinker, just as his instructors at Occidental and Columbia determined. Regime change in November, a slight uptick in consumer confidence and the possibility of improved demand in the open window may lift America out of the slump.

        1. Tao Jonesing

          “Cleaning up after Bush required real intelligence, courage, and vision.”

          Obama and company have real intelligence, courage and vision. They have the intelligence to speak as if they intend to clean up after Bush. They have the courage to turn their backs on the people who got them elected (and even ridicule them) in order to perpetuate Bush’s policies. And they have the same neoliberal vision that has driven American politics since Reagan.

          And, yeah, we’re in for some trouble.

          1. anonymous

            Did you vote for Hope and Change LLC? Cause the folks who voted for this clown are the source of the problem.

            Where was the healthy debate over priorities among Dems in 2008-9? Cause all I recall were Sarah Palin jokes, “we won, you didn’t” hubris, and “tea-baggers coming to getcha” intellectual laziness.

            While Dem partisans were feeling real good about closing Gitmo (a truly historic moment in self-delusion) and reformulating excuses for necessary war in Afghanistan, Wall St and company were writing their own bail-out legislation.

            This is a Dem disaster. All of it. Dems had the opportunity and the mandate to do something different. Dems didn’t. It’s on them.

            Not a hint of contrition from any of them.

          2. Yves Smith Post author


            Are you out of your mind? There was TONS of debate in late 2008 and early 2009 on nationalizaiton. Your remarks are complete bunk. Even the not really liberal at all Krugman was calling for nationalization, and there was similarly tons of talk re how the Swedish handled their banking crisis (which was vastly more aggressive than anything Obama had the balls to do).

            When Obama picked Geitner and Summers to head his economics team, it was a clear bait and switch. He’d put Volcker in the spotlight during the campaign, marginalized him after the election.

        2. anonymous

          The Bob Rae of America. Professional malcontent James Laxer saw the same parallels in March, 2009:

          “It’s hard to recall this so many years later, but when Bob Rae brought the NDP to power in September 1990, there was a surge of hope in the province. The new premier literally threw open the doors at Queen’s Park and invited everyone into the Ontario legislative building for a vast party. Rae’s job approval ratings surged so that when his face showed up on the giant screen at the Sky Dome at a Blue Jays game, the crowd cheered.

          Rae was an articulate, personable young man who told people the truth in ways so different from the obfuscations of the Tories and the tortuous rhetoric the Liberals offered to defend the scandal-ridden government of David Peterson.
          …During a very difficult recession, Rae was trying to migrate to the political centre, a space which would allow him to expand his left-wing political base. Over his years in power, Rae tried a great many things to make this work. He brought in labour reforms that banned strike breaking and eased the path for the formation of unions. His government established an employment equity commission in 1991 and two years later it introduced affirmative action to increase the numbers of women, aboriginals, non-whites and disabled persons in the public sector.

          Rae’s government tried initially to sustain public spending to protect Ontarians from the recession and then did a U-Turn, drastically slashing spending to control the deficit. It ditched the plan to establish public auto insurance on the grounds that the economic climate was too negative and that the move would result in reduced employment in the insurance industry. In 1993, the government introduced its notorious Social Contract, which re-opened public sector contracts, froze the salaries of public sector employees and imposed “Rae Days”, unpaid days off for public employees which amounted to pay cuts. Key trade union leaders denounced the Social Contract as a betrayal.

          Much of labour was furious with Bob Rae. The people who made up the NDP’s left-wing political base were disillusioned. And at the end of it all, despite his years of courting business, the business leaders prepared to support Rae could have assembled in a telephone booth. What Bob Rae did was to stake out a position in the political centre to which no one wanted to go, neither left nor right. From “dead centre”, Rae led his party into the 1995 election and political oblivion.
          The problem for Obama is that many of his top officials are in bed with Wall Street. Treasury Secretary Timothy Geithner, to name one prominent case, has been a Wall Street enabler for years. Mentored by Clinton era Treasury Secretaries, Robert Rubin and Lawrence Summers, Geithner was named president of the Federal Reserve Bank of New York in 2003. He was critically involved in the sale of Bear Stearns, in the bailout of AIG and the decision to let Lehman Brothers go down.

          He was the principal architect of the Obama administration’s recent move to partner up with the private sector to buy up the toxic assets of Wall Street financial firms. The move, which was wildly popular on Wall Street, sparked a major stock market rally.

          Let’s be clear about one thing. While right-wing populist ranters such as Rush Limbaugh salivate about the evils of big government, there is nothing big financial firms and other top corporations love more than handouts of tax dollars to them. The Obama administration’s policy toward the financial sector, so far at least, has been to shovel out the money while leaving the private bankers in charge. The president is so afraid of nationalizing the banks, a policy favoured by economist and New York Times columnist Paul Krugman among others, that he is willing to run the risk of putting Wall Street back in the driver’s seat while leaving the tax payers stuck with a mountain of bad debts…

          Barack Obama is trying to stay right in the centre, just where Bob Rae tried to stay. He could pull it off. But his constant yielding to Wall Street, and his fear of being labeled a foe of free enterprise is making him pay a huge price, both in the nature of the stimulus and bailouts he is offering, as well as in putting on hold programs to help ordinary Americans with the health-care, education, housing, reconstruction of cities, and provision of jobs they so desperately need….”

        3. koshem Bos

          The only organization that still works honestly and courageously is the unions. They don’t bait and switch, they don’t wave the white flag when the first bank lobbying group shows up.

          Another fib is “Not a hint of contrition from any of them.” Half of Obama voters bemoan the promise that died. Not being one of Obama admirers, though I’ll never vote for the Republicans who openly try to hurt the country, even I was surprised by how bad Obama is. He is even more dysfunctional that W and Carter and that quite an “accomplishment.”

          1. anonymous

            First, union is a countable noun. I’ve belonged to more than five over the course of my working life. The LA Times is running an excellent series on the appalling LA Teacher’s union, a union that is far more interested in defending the rights of the worst teacher than providing children with a decent public education.

            There are so many professional teachers in my own family and extended circle, I’d have trouble counting them all. A routine bargaining position is to insist that union members suspend all after school or extra-curricular activities not explicitly covered in the contract.

            Your bizarre claims about unions suggest to me profound indifference to fact, ignorance, or dishonesty. Your offensive suggestion that Republican voters or politicians are actively trying to “hurt America” might or might not included Lincoln and Eisenhower. I suppose you have some sort of list of those not actively engaged in trying to make the poor more miserable.

            I’ve heard Gov. Christie speak and I expect he’s every bit as slippery as the next Dem or Republican politician, but he was spot-on when it came to dealing with the teacher making $ 83k who attacked Christie for freezing her income and asking teacher’s to kick in a tiny bit more to pay for their blue-chip pensions.

            I’m extremely pro-union. That does not mean I believe unions to be any more or less honest or effective as any other organization.

  3. Crocodile Chuck

    “Given the ability of bankers to destroy value for their shareholders……”

    hmm, heretofore I never appreciated the WSJ’s penchant for drollery and dry wit.

    ps wish I could put my hands on the McK Quarterly piece from the early ’90’s that pegged the breakpoint for economies of scale in retail banks: at $150M in assets (that’s millions, not billions)

  4. ChrisPacific

    Considering how handsomely TBTF strategies have been rewarded in the last few years, it’s hardly surprising that more banks want in.

    I’m sure the comment about negative economies of scale is valid if you include cost to taxpayers in the equation, but who’s going to do that? Certainly not the banks.

  5. anonymous

    Hi Yves. Your own attempts to move the mountain are memorable and stand out simply because next to nobody else was saying the same things as you. I recall your remarks about nationalizing the banks on at the start of the crisis and you were the lone voice in the wilderness. I respectfully suggest you’re extrapolating from your own position.

    Here’s the “debate” you think was taking place Josh Green in the Boston Globe today:

    “When Obama’s top advisers gathered in Chicago to devise an economic strategy just after the presidential election they largely agreed about what to do. Aggressive monetary and fiscal expansion had been the standard response to economic setbacks from the Great Depression onward. The question was, how aggressive should they be?

    According to an account last fall in the New Yorker, Romer, an expert on the Great Depression, modeled the effects of stimulus packages of $600 billion, $800 billion, and $1.2 trillion, and concluded that the largest one would be necessary to fill the expected output gap over 2009 and 2010. Economists outside the White House agreed. But Romer’s recommendation, deemed politically unfeasible, never got a proper hearing. Instead, two smaller measures were put forward, with Emanuel making the determination to go with a package of $675 billion to $775 billion. Politics trumped economics.

    Last week, the Congressional Budget Office published an analysis of what the stimulus has done. It calculated that the package has lifted GDP by between 1.5 percent and 4.1 percent and reduced the unemployment rate by 0.7 to 1.8 percentage points. In other words, the stimulus has worked — but not well enough to produce an adequate recovery.”

    On the back of Green’s reporting, I’ll go further and suggest that a wonk like Bill Clinton would have demanded to hear the dissenting view and would have insisted that Romer be given all the time she needed to make her case.

    Polls and politicking took precedence over debate and sound policy decisions. Cap and trade? Plenty of people question the entire premise of AGW, now conveniently re-christened as “climate change.” Cash purchased Big Pharma, Big public service unions and Wall St. at the Obama table. Green is a confirmed Obama supporter and suggests the great man really wanted to do the right thing, but was deceived by that Satanic Rahm, who somehow slithered into the garden.

    The salient line: “…In other words, the stimulus has worked — but not well enough to produce an adequate recovery.” That’s it. Romer’s plan might well have prevented the fantastic fun-filled times of record unemployment and a looming double-dip had a real debate taken place.

    I’d even go so far as to suggest a strong element of sexist bias on the part of Ben, Larry, Tim, and the other boys in the room. Just cause we listen to you carefully doesn’t mean the rest of roiling masses get your message.

    And the incessant accusations of “racism?” That tired canard isn’t winning Dems many arguments.

    This is a Dem created disaster which occurred because real debates about policy didn’t take place. If you want to get a sense of what else didn’t get seriously discussed, consider how much we’ve heard about building new nuclear plants from Dems. Yes, I know. The famous signing statement last year. Kind of makes my case.

    1. Anonymous Jones

      What a waste of time, space and words. Explain how the counterfactual would have been better. You can’t because you have no credible evidence that it actually would have been better. It doesn’t matter how hot the frying pan is if the fire is hotter. I don’t which is the frying pan and which is the fire, and you don’t either.

  6. charles

    “Lax” they are in quite many ways

    The B.I.S published this summer a couple papers, outlining the macro-economic costs, stating also that ‘the banks’owners should expect a redoubling of risks and a halving of the profits’. I found interesting Keiichiro Kobayashi, Senior Fellow at the Research Institute of Economy, Trade and Industry: “Bad debt is the root of the crisis. Fiscal stimulus may help economies for a couple of years but once the “painkilling” effect wears off, US and European economies will plunge back into crisis. The crisis won’t be over until the nonperforming assets are off the balance sheets of US and European banks.”

    This with in the backgoround a 2 trillion euros refunding need for the European banks by the end of 2012…

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