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Hensarling on Capital Standards: Is There A Better Way?


Washington, Jul 23 -

 
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WASHINGTON- Financial Services Committee Chairman Jeb Hensarling (R-TX) delivered the following opening statement at today’s full committee hearing to examine capital standards. This hearing is the latest in a series focused on the impact the Dodd-Frank Act has had in the five years since it was signed into law:

I woke up the day before yesterday to an article in one of the Hill publications, Politico I think it was. It was dealing with Dodd-Frank since we have either celebrated or bemoaned the fifth anniversary of Dodd-Frank. The subtitle to the article was, “Suddenly Democrats are resisting any changes to the five year old financial regulation law.” The article goes on to say that a number of moderate Democrats are quite frustrated with that their leadership is preventing them from engaging in meaningful, bipartisan work on the issue.

I do not know the article to be accurate; it certainly feels like it from this position, from this chair. I just want to again say publicly what I have said privately to my friends on the other side of the aisle: the majority stands ready to work with you to clarify, to improve, to deal with any unintended consequences of the law. Both Mr. Dodd and Mr. Frank have previously indicated areas of the law they would work on to improve. I trust they continue to be Democrats in good standing. I would hope you could be a Democrat in good standing and work with the majority. I hope there is not a knee-jerk ideological reaction to anything that deals with Dodd-Frank.  Again, it certainly feels that way.

I guess to some extent there is good news because the topic of today, capital and liquidity, is barely mentioned in Dodd-Frank. There is a differentiation where Dodd-Frank empowers the regulators who already had  pre-Dodd-Frank to set prudent capital and liquidity standards. They provide for a differential for SIFIs but outside of that they are largely silent on the issue.

Regardless of what you believe to be the genesis of the financial crisis, I think we can all agree looking through the rearview mirror that clearly capital and liquidity standards were insufficient, to put it mildly.

Prior to the crisis, there were very complex risk-based capital standards in place, and in implementing these very complex risk-based capital standards, as we know, they were principally designed by the Basel Committee out of Switzerland. Regulators in both the U.S. and in Europe were essentially encouraged to crowd into both mortgage-backed securities and in sovereign debt. Think Fannie, Freddie, and Greek bonds. Thus, rather than mitigating financial instability as the capital standards were intended to do, it appears that Basel helped fuel the financial instability. Rather than containing risk, Basel helped concentrate it.

Since the crisis, U.S. banks have raised more than $400 billion in new capital and regulators have required institutions to maintain higher capital buffers. Again, under the authority they possessed pre-Dodd-Frank, I for one believe that generally this to be a good thing. But the capital standards that were already complex have become even more complex with Basel III. I do not necessarily believe this to be a good thing.

Again, relying on regulators to calibrate risk and predict future economic conditions according to highly complex models -- models that neither market participants nor regulators themselves fully understand -- clearly appears to be a recipe for financial crisis. We have seen the danger of one global view of risk.

So there are a number of questions this committee must explore. One, again, although capital and liquidity standards have increased post-crisis, do we really know by how much? How opaque do balance sheets still appear? How many items that were once off balance sheet will find their way back onto balance sheets? What amount of capital is the proper amount? Too much, economic growth can stall. Too little and too many failures could yet ensue.

So at today’s hearing, we will explore is there a better way?  For example, are we better off by measuring capital adequacy according to a more straightforward leverage ratio, which takes discretion away from the regulators and seeks to give greater weight to market forces in allocating resources and achieving financial stability?  Are there specific forms of capital – such as those that convert debt to equity in the event of pre-determined market triggers – could they promote greater market discipline and better risk management at large, complex financial institutions?  

To help us with these questions, we have assembled a panel of noted experts and I certainly look forward to hearing their testimony.

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