Last Friday, Donald Trump told the Wall Street Journal that he believes new rules crimp credit availability.  On Monday, the Journal printed an article voicing the regulatory rebuttal, laying out data substantiating statements from Chair Yellen, Vice Chair Hoenig, and others that credit is fine and capital hasn’t much to do with it even if it isn’t.  I’ve found myself in the middle of a debate that’s grown from important to critical in the wake of the President-Elect’s statement.  In recent research and a speech shortly before the election, I’ve argued that higher capital per se doesn’t necessarily mean safer finance and that capital rules do, in fact, adversely affect credit formation, especially when considered in concert with other rules and accommodative monetary policy.  Here’s why.

Those who believe that more capital doesn’t lead to less credit formation base this in part on the belief that banks can raise capital not by diluting current shareholders at higher cost, but rather by retaining earnings instead of distributing them to investors.  As Tom Hoenig said on Thursday, retained earnings are working capital that can be put to use for credit formation.

As we’ve noted in our research, the problem with this hypothesis is its assumption that investors are patient.  They probably should be, but they aren’t.  Equity investors want one of two things:  dividends or higher equity prices.  Retained earnings work against them on both counts.  Obviously, any earnings that are retained aren’t doled out as dividends or repurchased stock, sacrificing one form of investment pay-out.  Secondly, retained earnings – in part because of their cost to dividend income – adversely affect stock prices.  A recent study shows how dramatic the fall of large U.S. bank equity prices has been since the crisis.

At its core, return to investors is return on equity and the more equity, the less return.  The only way to make more capital comport with more credit is to lower the cost of capital enough to compensate investors for the dilutive effect of more capital.  Low market capitalizations demonstrate that investors are in fact not willing to pay for the privilege of owning big-bank stock, driving up the cost of capital and forcing banks to conserve it for fewer assets that then support less credit formation.

When banks cannot raise more capital at costs investors are willing to bear, they have no choice but to allocate the balance-sheet capacity their capital will bear so that profit is maximized to the greatest degree possible.  Here, the regulatory framework becomes particularly problematic because some of the capital rules tax assets regardless of risk and these rules then run into the liquidity ratios that demand large holdings of low- to no-risk assets with no diminution of required capital.  Combining this with accommodative policy means that large banks must hold far more of their balance-sheet in high-price, low-yield assets – $2.4 trillion at last count on U.S. bank books, a 74 percent increase over the past three years for the five largest U.S. lenders.  Some of these government-securities holdings are attributable to recent deposit inflows, but these would ordinarily be put into loans and instead are not.  Ultra-low rates mean not only that banks are turning down deposits, but also that the types of credit formation that contributes most importantly to economic recovery are next to impossible taking new capital requirements and reduced balance-sheet capacity into account.

Even the Journal article touting credit creation includes a boatload of caveats.  These include the fact that the fastest growing loan sector looks anemic when measured against GDP growth – that is, banks are making more large corporate loans than they did, but not anywhere near as many as needed to support economic growth.  FRB research cited in our studies demonstrates a link between higher capital and unemployment that may help to account for this.  It is also likely that large-bank credit to large corporations reflects an underlying flight-to-quality trend across the financial system in which banks lend only to the lowest-risk customers, again a phenomenon with adverse employment and income-distribution impact.

And, despite the good credit news the Journal lauded, it concedes that loans for start-up small businesses are in scarce supply and non-jumbo residential mortgages that can’t be sold to the agencies are non-existent.  In our work on income inequality, we find that these two forms of credit are particularly critical for wealth accumulation, which is of course vital to sustained economic growth.

One can pick one’s data to prove anything.  I have a lot of data I believe justifies assertions that credit formation is struggling in the U.S. and that high bank capital is meaningfully linked to it in predictable, demonstrable ways.  On the other hand, Neal Kashkari’s TBTF “cure” concludes that capital is so perfect a good that it can be mandated virtually without limit because financial stability marches in lockstep with how much capital big banks are forced to bear.

We can argue these points all day long and lots of conferences have and will.  The real answer is that none of us knows for sure and therefore that financial policy – monetary and regulatory – is a game of trade-offs that should be judged incrementally and with humility.  Causation is complex and even the most public-spirited official with the best data is still making no more than an educated guess about the right balance of financial stability versus macroeconomic growth.

Voters last week said this balance is tilted against them – rigged some said.  They’re not wrong – all of the best guesses the Fed has made since the crisis have combined with broader fiscal-policy, demographic, and other trends to make the rich richer, savings impossible to accumulate, and loans very, very hard to get.  Lots more regulatory capital will only make matters worse in the near term even if one believes the U.S. financial system might be made safer thereby.  What we learned last week is that bad short-term results have profound political impact with even more destabilizing effect than the best analysts with the most data could ever have anticipated.