As if the “fiscal cliff” were not enough, banks of all sizes — and in turn the consumers and businesses that rely on their credit — also face the “Basel cliff.”
The Basel cliff is not a precipice in Switzerland, the beautiful country in which the city of Basel is located. Rather, the term refers to the potential economic fallout from the implementation of the Basel III agreement, an international accord that is supposed to make the international banking system more stable. Unfortunately, Basel III is likely to dramatically increase the costs of mortgages and small business loans while making the banking system less stable.
The U.S. plans to begin implementing Basel III as early as January.
The Basel rules are unusual for a number of reasons: their stringency, their complexity and — in a sign of hope — their unpopularity with many members of both parties. The entire Maryland congressional delegation, mostly consisting of liberal Democrats such as House Minority Whip Steny Hoyer and House Budget Committee Ranking Member Chris Van Hollen, recently wrote of their concerns in a letter to regulators at the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency.
The lawmakers stated, “We strongly encourage you to avoid needless complexity and consider the impact any new framework will have on traditional depository institutions that provide credit to consumers and small businesses in our communities.”
The Competitive Enterprise Institute (CEI), where I work, co-signed a letter to the Senate Banking Committee, along with groups representing many sectors of industry, including the U.S. Chamber of Commerce, the Property Casualty Insurers Association of American and the National Association of Home Builders. The letter argues that the Fed, FDIC and Office of the Comptroller “have failed to consider the impact of Basel III upon Main Street businesses.”
What’s more, given what we now know about our financial system’s vulnerabilities, it’s clear that Basel III’s logic is extremely unsound. Under the accord, a U.S. community bank would have to put up much less capital to buy a teetering European bond than it would to make a mortgage or business loan to a customer it has dealt with for years. As The Wall Street Journal noted in a recent editorial (subscription required):
“Their new rules encourage banks to load up on sovereign debt. This makes perfect bureaucratic sense, since the world’s governments have proven to be hands down the issuers with the most dishonest accounting. The FDIC’s own director, Thomas Hoenig, sees in Basel III the same complicated system for judging risk that failed in Basel II ‘but with more complexity.’”
Basel III also imposes one-size-fits-all standards without accounting for underwriting standards and the quality of a borrower. A bank making a mortgage with any type of balloon payment — or adjustable interest rate — may be required to carry 200 percent extra capital to cover the loan. Yes, in the past, subprime operators have made adjustable-rate loans to borrowers with bad credit, but community banks have also made adjustable-rate loans to borrowers with stellar credit.
Community banker Jim Purcell, the head of the State National Bank of Big Spring, Texas (and co-plaintiff, along with conservative seniors group 60 Plus, in CEI’s lawsuit against the Dodd-Frank bank regulatory overhaul), has already testified that Dodd-Frank had made it impossible to offer the stable mortgages he made for decades. However they feel about Dodd-Frank, both Maryland Democrats and Louisiana Republicans seem to recognize that this dash of Basel added to the already potent regulatory mix makes for a poisonous recipe for community banks.
One of the many lessons of the 2012 elections is that while conservatives should look for ways to limit government with bipartisan support, they should never let the left dictate the main agenda or issues on the table. Since Hoyer and Van Hollen have — to their credit — expressed doubt about the Basel regime, the House majority party should give them the opportunity to put those doubts to a vote as soon as possible.
There’s no reason that Congress can’t fix both the Basel cliff and the fiscal cliff during the “lame duck” session.
John Berlau is senior fellow for finance and access to capital at the Competitive Enterprise Institute.