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Fear Mongering, Wall Street Style

 February 19, 2010 11:45 AM

By James Kwak

Jason Paez points out this Reuters story on the claim that new banking regulations will require an additional $221 billion of capital in the industry as a whole. I would take this a little more seriously if the source for the estimate were someone other than JPMorgan Chase, or even if there were a non-JPMorgan source to back it up.

As it is, I think this counts as another "nice little economy you've got there" attempt at hostage-taking or, as Paez says, "a threat levied against the entire non-banking economy if we allow the ‘extreme' case (using the article's words) of regulation to pass." For one thing, I don't see how any analyst could have come up with any number, given that the regulatory proposals I have seen have no numbers in them. That is, they say things like "capital requirements for large firms should be higher" but don't say how much higher. (It's possible I missed something recent here.) So what could $221 billion possibly be based on?

[Related -How bank reserves make the gap between deposits and loans disappear]

Second, there's this gem from one of the JPMorgan "analysts": "In order to return to similar levels of profitability as per current forecasts, we estimate that pricing on all products (retail banking, commercial banking and investment banking) would have to go up by 33 percent." How many things are wrong with this statement? One, that Paez points out, is that the 33 percent threat assumes an oligopoly that is able to pass on all costs to customers. There is no magic law of economics that says that industries naturally return to some exogenously determined level of profits. (See, for example, our most famous chart, on the ratio of financial sector profits to total U.S. corporate profits; there's a better version in our upcoming book.) And there is no law that says that banks' 2007 profit levels are the ones that they are magically entitled to.Take 3/4 of those profit levels (what you get if you don't let prices go up by 33 percent) and you are still well above long-term historical averages.

[Related -Bank Stocks: The Misbegottenness of the Volcker Rule Truly Knows No Bounds]

Finally, there's a more substantive issue behind this self-interested fear-mongering. We just lived through a decade of excessive borrowing and excessive lending by a dangerously undercapitalized financial sector that resulted in a huge crash. We need more capital in the financial system. If that causes lending to drop because banks behave more carefully, then so be it. We should find a way to manage that transition as smoothly as possible (we want to avoid over-correcting on the downside), but we should want to get to a situation where we have a stable financial system and a sustainable amount of borrowing. That's good. If forcing banks to have higher capital ratios is the way to get there, that's also good



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