Regions

Capital is not US economy's savior - article

September 28
5:25 AM 2013

In a Reuters article, an analysis by a writer explained how the importance of capital as the savior of the US economy was merely an inflated principle. Writer Bethany McLean pointed out five arguments to prove her case in the article.

First, capital is not a physical mound of cash but is merely an accounting construct. Citing wealth opinionist Steve Waldman on his blog Interfluidity, she agreed with Waldman that financial security of banks based on capital ratios were merely speculation. "Thousands of estimates and arbitrary choices must be made to compute the capital position of a modern bank," Waldman had said. For example, she cited Lehman Brothers' healthy Tier 1 ratio at 10.7% and a capital ratio of 16.1% on May 31, 2008. The rates were cosidered a solid picture of a healthy financial institution until Lehman caught investors by surprise by filing the most largest Chapter 11 bankruptcy protection with USD613 billion in debt.

Her next two arguments were about risk. Banks retaining 5% of risk of loss in assets were chucked out of the window when serious lobbying had led to banks making an exemption to housing and industrial mortgages. The real estate and industrial assets were the very same ones who contributed to the financial crisis. Ergo, as McLean pointed out, there is no such thing as managing risk.

McLean proceeded to argue about the alignment of individual incentives to firm performance. New provisions of incentives to bank executives had allowed the retention of underperformers. According to an anonymous former senior bank executive, "The inefficiency generated by the current illiquidity of people moving now can not be underestimated."

McLean ended her piece emphasizing the difficulty of streamlining regulators. Quoting former Treasury secretary Hank Paulson on his piece in the Financial Times, government needs a bit of sweeping up their own backyard. He wrote, "It is clear that their overlapping jurisdictions, gaps in jurisdictions and authorities, uneven capabilities and competition among themselves created the environment in which excesses throughout the markets could thrive." 

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