The Madness of a Model and its Unfounded Policy Conclusion

As the pending U.S. capital rules head into their own end-game, there is finally a good deal of talk about an issue long neglected in both public discourse and banking-agency thinking:  the extent to which higher bank capital rules accelerate credit-market migration.  Simple assertions that more capital means less credit are, as I’ve noted before, simplistic.  One must consider how banks reallocate credit exposures to optimize capital impact and, still more importantly, how the credit obligations banks decide to leave behind take a hike.  Now comes a new paper the Financial Times touts concluding that, thanks to shadow banks, “we can jack up capital requirements more.”  Maybe, but not judging by this study’s design.  Even with considerable charity, it can be given no better than the “very creative” grade which kind primary-school teachers accord nice tries.