What, exactly, does Greenspan want? A theme is that excessive leverage and risky banking were causes of the crisis, in line with the consensus of international financial officialdom. But the argument is not well-presented and, bluntly, Greenspan cannot make up his mind about the desirable level of regulation. As with far too many accounts of the years in question, the impression is given that the American banking system operated in 2007 with unusually low levels of capital and incurred losses that wiped out much of banks' equity. The point is of huge importance, since officialdom's justification for the capital-raising agenda over the last five years is that many banks did have losses similar to or larger than their equity. Let us check the facts. 

 

In the decades before 2007 the Federal Reserve did not supervise all of the American financial system, since the main business of the investment banks (Goldman Sachs, Morgan Stanley and so on) was to trade and underwrite securities. This business is not "banking" as usually understood, and Goldman Sachs and its immediate rivals were answerable not to the Fed, but to the Securities and Exchange Commission. The Federal Reserve has long compiled detailed numbers on the capital position and profitability of the US commercial banking system as such. For these banks Greenspan's (and international officialdom's) accusations of excessive leverage before the crisis are plain wrong. Moreover, the losses seen in the crisis were tiny relative to capital and at no point endangered the solvency of the commercial banking system. (The investment banks are different.)

Concern about US banks' capital adequacy long predates the Great Recession and in fact goes back to the early years of independence. It became urgent in the 1980s as a result of the Third World debt crisis. Although it may seem incredible relative to the situation today, the New York money centre banks had equity-capital-to-assets ratios under 5 per cent in the early 1980s. They were told to more than double their equity capital buffers. In the ten years to end-1997 the ratio of US commercial banks' equity to assets averaged 7.3 per cent and in the following ten it averaged 9.3 per cent. Just before the Lehman Brothers debacle itself the ratio was 10.1 per cent. 

In other words, the American banking system was less leveraged when the Great Financial Crisis intensified in autumn 2008 than it had been typically in the previous 20 years and much less leveraged that at the onset of the Third World debt crisis of the 1980s. Moreover, the losses suffered by the commercial banking system as a whole were minuscule relative to its capital. In fact, the official Fed data show only one quarter in the recent crisis period with a negative return on bank equity. It was in the third quarter of 2009 when the loss amounted to 1.01 per cent of equity. (Readers may blink, given the media hullabaloo about these events. But, yes, in the worst quarter of the supposed greatest setback to free-market capitalism since the 1930s, 99 per cent of the mainstream American banking system's capital was untouched.)