When Basel III Met the Yankee Bubblemeisters

♠ Posted by Emmanuel in , at 1/11/2011 10:19:00 PM
In German, weltmeister is the world champion in English. But, when it comes to inflating asset price bubbles, perhaps we can relax the rules of grammar and syntax and declare our American friends the global bubblemeisters. Not being content with one housing bubble and its demise, let's just say the US in its own inimitable way is trying to inflate another one via shenanigans such as the $600 billion Fed bond purchase programme.

Now we come to another conundrum of international organization in the form of the upcoming Basel III macroprudential banking regulations. Interestingly enough, some of its framers propose including a mechanism for various countries to report that asset bubbles are afoot at home. In theory, the others would then be able to raise financial firms' capital requirements to guard against troubles in the said country spilling across borders via this early warning device.

It sounds great in theory, but what if the world's largest economy is so magnificently distorted already by, say, still-historically elevated housing prices as to preclude rational analysis in neat and tidy Basel III frameworks? Beats me, and nobody should be surprised to see the bubblemeisters push back at the global negotiating table for Basel III:
Banking regulators have quietly taken a major step towards harmonised global regulation by agreeing to raise worldwide capital requirements whenever an individual country declares a credit bubble. Part of the larger “Basel III” banking reform package, the “countercyclical capital buffer” heralds a step change in the way national banking regulators interact and is the first concrete example of “macroprudential” regulation that seeks to moderate the economic cycle.
In a nutshell, it works this way:
The agreement, struck last month, says that if a country decides its economy is overheated – based on the ratio of credit to gross domestic product – it can require banks within its borders to hold extra capital against potential losses. Regulators in every other country would have to follow suit and impose a proportional surcharge on their own banks, based on the size of those institutions’ exposure to the bubble country.
However, there are operational problems in verifying that the concerned developed countries apply these measures equally. There's a particularly large one that may feel it's being unfairly targeted based on its recent economic history. Its excuse is that their geographical spread is so large that so-called bubbles may be localized as to render such measures impracticable (as if Michigan compensated for Nevada circa 2007, but I digress):
Banking groups said they were concerned some nations would impose buffers more readily than others, creating an uneven playing field. They are also sceptical that once buffers are imposed, they will become permanent, either because regulators never cut them or investors react badly to a reduction.

“A country would have significant disincentives to impose the countercyclical capital buffer [because] ... the impact would likely be greater on its economy than on the banks,” said Greg Lyons, a US partner at law firm Debevoise. The US is said to be particularly reluctant because it would have to declare a country-wide bubble, even though there might be large variations between regions.
In essence, what if certain countries deliberately encourage such bubbles for short-term gain alike certain folks whose, ahem, "forward-looking perspectives" incorporate nearly infinite discount rates?