New Fed Rules On U.S. Banks Could Hurt Recovery

Banks: The world's wealthiest countries are experiencing a financial crisis the likes of which haven't been seen in 80 years. So why does the Federal Reserve seem intent on ratcheting up the pain on U.S. banks?

With little fanfare from the general media, the Fed on Tuesday quietly announced it will force American banks to put aside more capital to cover their assets.

"The recent financial crisis showed that some financial companies had grown so large, leveraged and interconnected that their failure could pose a threat to overall financial stability," the Fed said in its statement.

Sounds wise — prudent, even. And in the best of times this would be a good idea. But this isn't the best of times.

The economies of both Europe and the U.S. are fragile as eggshells, with growth in both areas shrinking or well below potential. In Europe, unemployment has shot up to dangerous levels, while the level of hidden unemployment in the U.S., according to our IBD/TIPP Poll, is above 19% — 30 million Americans.

Banks, though many are profitable, feel constrained from lending to any but the best of customers right now. While it's true that commercial and industrial loans have rebounded smartly from the 2008 collapse, consumer loans are still well below their peak.

The concern is that banks adding to their capital reserves can't lend more. After all, you can increase capital only by issuing new shares or by calling in old loans. Volatility in the markets makes the first a nonstarter. Which leaves banks to trim their loan portfolios to get their capital ratios higher.

Why, of all times, is this being done now? In part, it's required by the post-crisis Dodd-Frank legislation.

It's also to conform to the Basel III accords, global bank changes painstakingly negotiated by the U.S., Europe and Asia over more than two decades. The goal is to make the global financial system less prone to crisis.

Not a bad idea. Except it hasn't worked. We've had multiple bank crises since the Basel deals were struck.

Why? Because of the way Basel is designed, some assets are considered less risky than others and thus require less capital to be put away. Before the last crisis, one of the "less risky" assets was housing, and we all know what happened there.

Massive government intervention in the housing market and Basel rules granting favorable treatment to housing encouraged banks to make big bets on real estate. When real estate fell, banks were left holding the bag — another example of government incompetence blamed on the private sector.

Even so, the Fed is forcing banks to raise capital based almost entirely on the fiction that the banks, not government, caused our financial crisis in 2008 and 2009. 2012 will be a make-or-break year for the U.S. economy. It would be a shame if a fledgling recovery is derailed by another mistake by America's banking regulators.