Tim Geithner: Here's How I'm Going To Make Sure That Never Happens Again

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Tim Geithner with some good ideas on how to make it slightly less likely that the entire financial system won’t nearly collapse again.

Tim Geithner, FT: First, capital requirements for banks simply must be higher across the board. Bringing more capital into the banking system is vital. It is equally crucial to hold the largest, most interconnected institutions, whether or not they own banks, to tougher standards than others.

Second, the regulatory framework also should put a greater emphasis on higher-quality forms of capital that best enable financial groups to absorb losses. Consistent with this principle, during good economic times, common equity should constitute a large majority of a bank’s Tier 1 capital.

Third, capital requirements and accounting rules should be more forward-looking and should reduce the system’s pro-cyclicality. The capital regime should require banks to hold a larger buffer over their minimum capital requirements during good times, to be available in bad times.

Fourth, banks should be subject to explicit liquidity standards designed to improve their resilience in the face of runs by creditors and prevent the build-up of liquidity risk in the financial system as a whole.

Finally, we need to improve the rules used to measure risks embedded in banks’ portfolios and the capital required to protect against them, and put greater constraints on banks’ use of leverage to dampen volatility.

Strengthening capital requirements is an essential part of a broader effort to modernise our regulatory framework so that the financial system is strong enough to withstand the failure of large, complex institutions. That is the most effective way to prevent the world from re-living the events of last autumn. And that is the challenge we must tackle in London, Pittsburgh and beyond.

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These are all good ideas, though they are easier to suggest than to actually implement.  Once we’ve finally worked through this crisis, it will likely be at least 50 years before we get another one of the same magnitude.  But that time, regulators and Congress will have determined that we now know better, that our increased sophistication and regulation have made a crisis like this one impossible, and that it’s time to relax the rules so American companies can compete more effectively in the world economy.  And then the same thing will happen all over again.

Note, too, that these fixes wouldn’t have prevented the problems this time around, although they would have lessened them.  The capital requirements for, say, Citigroup, would have had to have been sky-high to prevent the bank from rushing to the government with hat in hand.

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