June 16, 2010
To Members of the H.R. 4173 Restoring American Financial Stability Act of 2010 Conference Committee
Washington, DC 20510
Re: Support Statutory Guidelines on Bank Debt and Capital
Dear Conferee:
The over 250 consumer, employee, investor, community, small business and civil rights groups who are members of Americans for Financial Reform (AFR) urge you to support provisions in both the conference base text and House-passed financial reform bill that would place statutory limits on financial institution leverage, or debt.
The unprecedented increase in leverage that began in the late 1990s was a major cause of the financial crisis. It began as regulators ignored the buildup in large banks’ off-balance-sheet positions and escalated in 2004 when the SEC used its regulatory discretion to relax the leverage ratio for investment banks from $12 to over $30 for each $1 of capital. This regulatory misstep underscores the need for statutory limits.
From 1997 to 2007, financial sector debt jumped from 64 to 114 percent of U.S. GDP, with financial sector profits (closely linked to leverage) rising to 40 percent of total corporate profits. Likewise, the market for repurchase (“repo”) agreements – the major source of funding for leveraged positions – rose from $788 billion in 2001 to $2.3 trillion in 2007. Just before the crash, some financial institutions had debt-to-capital ratios as high as 31-to-1, and the ratio may have been higher for those with extensive off-balance-sheet positions.
The obvious role of leverage in bringing on the worst financial crisis since the Great Depression clearly requires new rules that cannot be waived at the discretion of regulators. Yet even now, regulators argue that statutory provisions are not warranted – that they would likely undercut the competitiveness of U.S. banks in competing with foreign institutions. But this was the argument made when investment banks persuaded the SEC to use its regulatory discretion to raise the limit in 2004, and investment banks were the first to experience the vulnerabilities leverage created. While we believe new rules governing leverage will, in time, apply to all international institutions, we think each nation will need to address the problem in the context of its own legal and institutional framework. That is why we support the two provisions passed by the Senate and House that deal with leverage in ways that best apply to the U.S. system. They are:
- Representative Speier’s provision in the House bill, which would place a statutory minimum leverage ratio of $15 in debt for every $1 in assets on systemically risky institutions. The systemic risk regulator would retain discretion beneath this maximum debt level.
- Senator Collins’ amendment to the Senate bill would establish minimum leverage and risk-based capital requirements on a consolidated basis for institutions. One of its major advantages is that by raising requirements for the holding companies that own banks, it will ensure that the companies are a source of strength to their depository institutions and reduce the likelihood that government support will be needed.
These provisions are critical for reducing the probability of another major financial crisis and preventing the use of taxpayer funds to prevent widespread destruction to the economy. We strongly urge you to support both the Speier and Collins amendments.
For more information, please contact Heather McGhee, Demos, at (202) 559-1543 ext. 105 or hmcghee@demos.org.
Sincerely,
Americans for Financial Reform