Wednesday, September 18, 2013

William Black says banks will game capital requirements.

William Black is a associate Professor of Law and Economics at the University of Missouri-Kansas City. He deserves a Nobel Prize for his anti-fraud investigations and crusades. However, I don’t agree with his claim that imposing decent capital requirements won’t work because banks will “game” the system. Reasons are as follows.

If banks were required to have about 20% of their liabilities made up of equity as distinct from deposits or bonds (as advocated by Martin Wolf, chief economics correspondent of the Financial Times) that would make it near impossible for a bank to fail.

Bill Black’s answer will be: “but banks will game that”.

My answer to Bill is: “OK just make the ratio 100% rather than 20%: would-be fraudsters will have a hell of job gaming THAT.”

You might think the 100% ratio is ridiculous. But as Messers Miller and Modigliani pointed out, banks’ funding costs are not increased when capital requirements are increased.

Second, there are numerous advocates of the 100% idea. For example there is John Cochrane.

Plus there’s Laurence Kotlikoff and Matthew Kline.

In short, Black's "game" point is another argument for the 100% figure.

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