The good points in Treasury’s Dodd Frank reform priority list – in particular, acknowledging that cranking up regulatory capital requirements made the corporate bond market a LOT less liquid, and therefore prone to crisis – are overshadowed by one piece of truly head-shaking stupidity.
Treasury seems to have forgotten – or perhaps it never understood (or, more likely yet, just wants to cut its pals at the once and future wards of the state on Wall Street a break) – that it was all that super-senior synthetic CDO crap, requiring nearly no regulatory capital, that blew banks apart when the ratings firms realized their models were all wrong in 2007-08.
Banks stuffed to the gills with that gilded manure – they couldn’t sell it, after all, initially because it yielded zilch and later because no one wanted to catch a falling knife – were suddenly insolvent when the three blind mice began their panicky widespread ratings downgrades and the squillions of super-senior crammed in banks’ attics suddenly started requiring – yup – lots of regulatory capital.
This proposal is doubly idiotic, since it assumes that investors will want to buy this stuff when it is declining in value, just when those investors themselves are scrambling to sell their own liquid assets to meet the true bogeyman of the crisis, the promised panacea that turned out to be the virulent contagion that spread the trouble from one basket of eggs to the next and pushing asset class correlations inexorably, painfully, toward 1 – the magic of collateral and margin calls.
From the FT:
The report seeks to soften bank capital requirements for securitised products, lowering some calculations in line with international recommendations. It also suggests the highest quality layers, or “tranches”, of debt should count towards banks’ liquid assets able to be sold in a crisis to raise cash, helping them meet another international regulatory requirement.