Friday, September 17, 2010

A Reminder On The Ineffectiveness of Basel Capital Requirements

George Melloan, a former Wall Street Journal staffer, made a useful point in his editorial which appeared in Tuesday's edition.

Entitled Basel's Capital Illusion, Melloan notes that, while more capital certainly won't be a bad thing for US and other large banks, nobody should infer that the new capital requirements will prevent any further financial sector problems.

That's because, as Melloan points out, the US financial meltdown was caused by government policies aimed at "affordable housing" beginning twenty years ago.

Though many in the federal government are loathe to acknowledge this fact, the private sector banks only followed the lead of Fannie Mae, Freddie Mac and numerous CRA threats in lending to questionable borrowers. Mortgage banks such as Countrywide, too, only followed in the wake of the GSEs' securitization of low-quality mortgages.

Melloan reminds us that none other than Bill Clinton waived the Basel requirements for Freddie and Fannie because they were engaged in implementing federal policies to encourage more people with lower incomes to become homeowners. He writes,

"This was a laudable goal that ultimately wrecked the housing and banking industries."

Between Alan Greenspan's Fed reducing interest rates to absurdly low levels, and holding them there, while the GSEs revved up the private financial sector's institutions to originate mortgages, upstream them to Fannie and Freddie, then distribute them as private-labeled MBSs, large volumes of toxic, low-quality mortgages came to pollute global investment markets.

New Basel accords won't prevent any of that sort of governmental policy mistakes from tanking our financial sector in the future.

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