Earlier this week, the Basel Committee announced that, not satisfied just with issuing edicts, it’s also going to send on-site examiners from Switzerland into the back rooms of banks around the globe. When the Tea Party gets word of this, we expect a new round of hysteria about “black helicopters” – the silent, whirring instruments of global hegemony Tea Party predecessors once feared from the United Nations. But just because this criticism of Basel is laughable, it doesn’t make the idea itself – supranational examiners – any more sensible. In our view, it’s yet another contribution to what we call complexity risk – the pile-up of gigantic rules and burdensome implementation requirements slowing recovery. This risk could, we think, be eliminated if regulators stick to simple, clear and enforceable precepts that bind banks and regulators alike.

As client know, we’ve been focused on complexity risk for some time, highlighting it when we’ve assessed daunting rules like the Basel III tomes and the U.S. proposals more distinguished by the hundreds of questions they pose than by the policy they craft. But, criticism is easy; a constructive alternative not so. Challenged by this, we tried our hand at one: a white paper posted today on our website (http://www.fedfin.com/images/stories/client_reports/complexityriskpaper.pdf).  This paper assesses key rules and their cross-cutting implications and unintended consequences. Then, it goes on to outline near-term solutions that, we hope, will strengthen global and U.S. financial-market regulation without unintended consequence or unnecessary cost. This white paper is an initial effort and we would be most grateful for comments and questions to inform our future work.

But, back to Basel’s black helicopters. The on-site exam program was announced Wednesday by the Basel Committee’s chair, Stephen Ingves. Mr. Ingves premises the platoons of global gumshoes on grounds that national and bank implementation of the rules to date has been, shall one say, spotty. True enough, with the prime example of this being, as he rightly says, the huge disparities in risk weightings that permit banks to claim that assets with blinking red lights all over them are safe and sound. But, are new on-site examiners piling in after the old ones have gone or, perhaps, sitting side-by-side with them to complicate supervision, the way to make regulatory-capital work? Not exactly, especially given the likely sharp differences of opinion on complex assets among all of the groups of supervisors set upon each bank. Based on the white-paper work, we have an alternative. We think it not only meets the Basel Committee’s goal – better cross-border governance of risk weightings – but does it one better by adding market discipline to the mix.

How? The idea is simple and, for it, we are grateful to Citigroup’s CEO, Vikram Pandit who thought of it first. As we see this concept, each bank would be required to take a benchmark portfolio of assets specified by regulators and disclose in a timely way how it sets the relevant risk weightings. The bank wouldn’t have to report its whole book of banking and trading assets and all of their regulatory capital – a release that would not only disclose too much proprietary information, but – more importantly – undermine the goal of transparency. So huge a release would be so difficult to parse that it would surely join all the other giant, impenetrable “pillar 3” disclosures mandated by Basel on the scrap-heap of prior tries at better market discipline.

This disclosure-based policy for comparative supervisory judgments on risk weightings could be done overnight – all it takes is supervisory decisions on benchmark assets, one that could be reached immediately and refined over time without any burden to banks or regulators. If banks don’t then disclose true risk weightings, this is a clear violation of a critical rule – telling the truth – and they should be summarily and harshly disciplined. If they do disclose the risk weightings they actually use (for pricing, not “compliance”) and the weightings are deemed wrong, the banks can fix the weightings quickly and errant supervisors that previously cosseted banks will be, we hoped, called on the carpet by the Basel Committee. And, if the Basel Committee doesn’t discipline anyone, the markets will.

This will work a lot faster than the planned on-site exams, which can only be implemented after yet another series of long meetings at Basel lightened only by some good wine. And, the benchmark disclosures can do this without the added cost or, worse, unintended consequences of still more complexity risk.

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