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Ezra Klein gets geeky:

One of the pieces of the crisis that I hadn’t understood until recently, for instance, was the role that Basel II banking regulations played in the growth of the structured securities market. In essence, Basel II, which went into effect a couple years ago, held that a bank only had to keep half as much capital on hand for AAA-rated securities as for other types of assets. That created a huge incentive for banks to get more things rated AAA….

And that in turn made the creation of allegedly AAA-rated securities a growth industry.  If a bank holds a $100 BBB-rated security, for example, they’re required to maintain $8 in capital reserves to back it up.  However, if they ring up their friendly broker at AAA-rated AIG and buy a credit default swap on that bond, it’s suddenly rated AAA too and the bank only has to hold $1.60 in capital.  That $6.40 freed up, and with leverage of 20:1 that’s $128 available for productive investments in America, my friend!  What a bargain.

(Though it’s worth noting that European banks engaged in this kind of regulatory arbitrage at least as much as American banks.  Maybe more, in fact, which is why AIG ended up paying out so much money to Société Générale and Deutsche Bank.  American banks have gotten the lion’s share of the attention so far for their shoddy asset portfolios, which is fair enough since America was the focal point for the subprime crisis, but European banks were pretty eager consumers of regulatory shenanigans as well.)

In any case, there are plenty of reasons to be skeptical of Basel II, and among other things it goes to show the difficulty of setting international standards in the world of finance.  One of the reasons Basel II is weaker than Basel I is that every country has its own financial industry idiosyncracies, and every country wants banking accords to treat their particular idiosyncracies lightly.  Basel II did that, and then took things even further by allowing banks to use their own internal models for credit risk because, you know, internal models had proven themselves so sophisticated and reliable.  Oops.

On the other hand, the Basel II accords weren’t even published until 2004, and didn’t get adopted in most countries for several years after that.  As weak as Basel II is, the credit bubble and its associated financial rocket science far predates it.  I’m not really sure how far you can go in blaming it for our current meltdown.

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Fact:

In-depth journalism that investigates the powerful takes real money and is so damn important right now.But it doesn’t take a Mother Jones investigation to know that billionaires and corporations will never fund the type of reporting (like they do politicians) we do that exists to help bring about change. Instead, our mission-driven journalism is made possible by people power, and has been for 46 years now since our founding as a non-profit.

In “TITLE TK” Monica Bauerlein writes about the perilous moment we’re in, and why it’s so important that we raise $325,000 by the time November’s midterms are decided so we can be ready to throw everything we have at the big issues facing the nation no matter what happens. Please help MoJo’s people-powered journalism with a donation today.

$400,000 to go!

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