May 15, 2013
What Libertarians Worry About When They Worry About Bank Regulation
Posted by David Zaring

The British government has praised the development of the Co-operative Bank, a member-owned institution that looks a little like an old school thrift, but that also provides funeral services, grocery shopping, agriculture - and, we'll let's just agree that it isn't exactly a model of a pre-Glass-Steagal institution.

However, like old-school thrifts, the bank is overcommited to the British housing market, and the result is that this alternative to corporate behemoth banking has had its credit downgraded to junk status (usually the death knell when you're talking about an institution that provides, and depends upon, credit), while the traditional banks start to produce profits.

So sad, too bad, banks die every month - but what if the government has been trying to prop up its golden child with regulatory forbearance?  It's everything you worry about when you worry about capital regulation:

Ian Gordon, an analyst at Investec Securities, said it was “curious that the bank was allowed to run with such weak levels of capital,” adding there was “an element of regulatory neglect” that represented a lesson for the new system.

Julia Black, a professor at the London School of Economics, said, “Supervision isn’t a transparent process, but I’m surprised it hasn’t already been required to hive off the bad loans or to set aside more capital.”

The dirty secret of regulatory forbearance - and Congress tries to legislate it away after banking crises, you can see as much in the hand-forcing provisions of both Dodd-Frank and FIRREA - is that it works.  Some day Citigroup will be much more profitable than it was during the Latin American debt crisis and the housing crisis, when the government could have shut it down.  But not requiring a bank to maintain its capital levels during bad times is also counter to the whole point of safety and soundness supervision.  We'll see if the forebearance suspicions save, or destroy, Co-operative. 

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