Edward Lotterman

Utter nerve! Gall! Chutzpah! Shamelessness!

Even with multiple thesauruses, it’s hard to describe the level of cynicism in modern corporate communications.

This rant is prompted by recent propaganda from Goldman Sachs alerting the world about threats small businesses face from proposed new capital adequacy standards for banks. If implemented, the Wall Street behemoth tells us, there will be a capital crunch crippling small businesses’ ability to operate and expand.

Well! Thank God someone still stands up for the little people, protecting us common folk from inept and crushing regulation by unelected bureaucrats and central bankers.

Yeah, that press release really tripped my trigger. Perhaps because I had just gotten yet another email from “Farmers For Free Trade — a “grassroots advocacy group” dating from 2017 when Donald Trump initiated trade wars with China and our neighbors to the north and south.

I still interact with farmers back home and I have not met one in six years who ever heard “Farmers For Free Trade” much less joined it. An internet search unsurprisingly reveals that 99% of this “grass roots” movement’s funding comes from the large grain trading or ag processing industry companies and associations.

True, the subject of the Goldman release, the Federal Reserve’s proposed Basel III Endgame to modify regulatory capital requirements for U.S. banks, along with rising interest rates, could theoretically crimp small-business borrowing and in turn stifle growth. But when deciding who the real victims would be, consider the source.

Manipulation of public opinion to shape public policy to one’s own benefit, what Nobel-winning economists call “directly unproductive, profit-seeking (DUP) activities,” by big finance and business and their PR agencies, employs many thousands. And it enrages me on an equal-opportunity basis.

I actually agree with the policy stance of the “Farmers” group — Trump’s trade wars, perpetuated by President Joe Biden, have harmed our economy. I just detest the method. But the cynicism of mega-banks passing themselves off as champions for Ma and Pa Kettle is particularly outrageous in both method and substance.

Yes, of course, credit availability for small businesses is vital. But there is no credible evidence that new capital standards for banks will harm that.

That the “warning” comes from a large Wall Street firm that never was a commercial bank until 2008, when it hurriedly changed its charter to be able to get more bailout funds “to stabilize its capital situation” is galling. Goldman was one of the eight largest U.S. banks especially favored in the George W. Bush administration’s Troubled Asset Relief Program during the Great Recession. The government used that to directly pump money into banks via the purchase of preferred stock in them.

Then, along with many other busted companies holding securitized mortgages, Goldman was allowed to sell these shares to a holding company set up by the Fed. Even that aid was not enough. In 2016, Goldman admitted that it had intentionally lied about some securities they sold into TARP and agreed to pay a $5 billion penalty for their fraud.

Someone should have gone to jail for this. After all, there were over 800 felony convictions after the 1980s Savings and Loan scandal. The 2007-09 collateralized debt debacle made S&L problems look like tiddlywinks. But that is water under the bridge.

Where is the economics in all this?

Start with the issue of bank capital standards. “Capital” for banks and other businesses is the money paid in by owners plus any past profits not paid out. This is different from bank “reserves” which are the fraction of deposits not loaned out.

Reserves are needed to protect “liquidity,” a bank’s ability to always have cash on hand when customers withdraw from their accounts. Banks are financial intermediaries. They take in deposits from saving customers and lend most, but not all that money, to borrowing customers. They are legally obliged to give depositors their money on demand but cannot similarly demand repayment of loans. In normal economic conditions, things even out, so they do fine with the cash cushion called reserves.

Remember the classic Christmas movie “It’s a Wonderful Life”? Jimmy Stewart’s George Bailey character donates his personal funds as capital during a run on his small-town lending institution; later, he contemplates suicide when a large chunk of capital goes missing. That wouldn’t have happened if he had been required to maintain a level of capital reserves.

Capital or “equity” is needed to protect solvency or soundness. Again, a bank accepts deposits and makes loans. If a mass amount of borrowers fail to pay a loan, or their collateral goes bust, as happened in the run-up to 2007-09, does the bank have enough of its own money, its capital, to still pay all depositors? Hence the required levels of capital.

The Fed was set up in 1913 to address liquidity. Federal Deposit Insurance was instituted in 1933 to protect depositors in case of insolvency.

The collateralized debt debacle showed us that existing institutions to protect liquidity were barely adequate. Rules to protect solvency plainly were not. Eight big banks would not have gone scurrying to the Fed for an unprecedented bailout if they had maintained adequate capital.

But the problem existing today is that they still do not want to do that. For any given amount of operating profits, the ratio of profits to equity or capital will be higher if the amount of that capital is lower, hence if left on their own, banks would want to retain as low a level of capital as possible. Hence government or the Fed must demand an adequate amount to protect the economy.

Yet banks compete internationally. If one country allows its banks to operate with lower capital levels, those will have a competitive edge over ones from countries requiring higher capital reserves. There was near-universal agreement after 2009 that capital requirements needed tightening. National regulators eventually agreed on how and when.

A key problem is that banks do vary in the riskiness of loans they made and in the stability of their deposits. The old rules that capital had to be the same percentage of total assets for everyone lacked flexibility. It favored risk-taking banks over prudent ones.

So regulators, including the Fed, called for “stress tests,” mathematical simulations of a range of financial market situations, to determine how much risk particular large banks faced. These tests would have to follow standardized criteria. The total level of capital required for any particular large bank would depend on these stress tests.

Furthermore, there was a particular set of very large banks, the failure of any one of which could push the world financial system into a tailspin. These “Global systemically important banks (G-SIBs),” which include Goldman Sachs, face a “capital surcharge” or higher capital requirement which is tailored to the situation of each of the banks.

These new rules, shorthanded as “B3E,” were finally announced in July 2023, more than a decade after the need for them was obvious. So now the fat cats are howling. And their howls include floods of cynical, self-serving crocodile tear press releases about how the new rules will dry up loans for small businesses.

This brings us to a second economic point, that of “rent seeking,” or the shopping around of a particular grievance to whatever friendly authority would alleviate it.

Yet despite the hand-wringing over B3E, nothing did as much harm to small businesses and households as the mess created by the same large financial firms in the speculative lending of the 2000s, during which regulators stood by idly. The Fed and other regulators have adequate tools to ensure credit availability to all levels of businesses on a more level playing field than we had before.

And one hopes there is a special place reserved for the cynics who try to scam public opinion.

Related Articles

Real World Economics: Grains of truth about U.S. ag trade

Real World Economics: Will our creative intellect work to destroy us?

Real World Economics: Bonds are in the news. But what exactly is going on?

Real World Economics: America’s natural bounty became its destiny

St. Paul economist and writer Edward Lotterman can be reached at stpaul@edlotterman.com.