Tuesday, September 13, 2011

Basel Is Not "Anti-American"

. Tuesday, September 13, 2011

I see (via Felix Salmon) that JP Morgan executive Jamie Dimon thinks the Basel bank regulations are "anti-American". I have no idea what he means by that, but my working understanding of the Basel regulations is that from a competitiveness standpoint they are generally beneficial to large American firms (like JP Morgan), and generally harmful to European and Asian firms. As Salmon puts it:

I have no idea what Dimon thinks is anti-American about the Basel standards, which are certainly in the interests of the United States. In fact, by all accounts it was the US which was pushing for stricter rules, and had to compromise with the laxer Europeans, whose banks are much less well capitalized right now. US banks, including JP Morgan with its “fortress balance sheet”, are very well placed to navigate through the Basel rules and come out strong and dominant on the other side.  
European banks, by contrast, will have to raise a lot of very expensive equity. And UK banks, if the Vickers proposals are adopted, will be much less formidable in the international arena than they are right now, with most of their assets ring-fenced and unavailable for merchant-banking misadventures.
There are two basic ways to think about regulations like the Basel accords. The first way is to think in terms of externalities and welfare: regulations restrict the ability of banks to act riskily, which prevents them from generating negative externalities that spill over into the rest of society during financial crises. Thus, new regulations represent a redistribution away from banks to society at large. I think this is the wrong view.

A better approach, in my opinion, is to think of regulation as altering the competitive landscape in ways that benefit some firms and hurt others, and benefit some in the broader society while hurting others. Large incumbent firms often support new regulations that function as a barrier to entry for potential competitors. Regulations can lock in the market dominance of existing firms. This is what Salmon is talking about when he writes that "US banks are well placed to navigate through the Basel rules and come out strong and dominant on the other side".

So why is Dimon opposed to them? It could be that he doesn't appreciate this dynamic, but that sort of ignorance would wreak havoc on the assumptions used to generate the rent-seeking model of regulation. So let's not go there.

My guess is that Dimon recognizes the advantages of Basel rents but think they are smaller than the benefits to his firm of having lower regulations. That is, since JP Morgan is already at a competitive advantage over many of its competitors, and with the European banking sector apparently on the verge of collapse, he may believe that he doesn't need to collect rents for his firm to be profitable. If that's the situation, then the regulations restrict Dimon's flexibility without providing any significant competitive benefit.

That doesn't mean Basel is "anti-American" of course. For one thing, the Basel system could lock in market dominance for large American firms long into the future. For another, US policy makers hope to create a more stable financial system through Basel, not just secure profits for American firms. Of course Dimon may have a shorter time horizon, in which case the long-run benefits of Basel would be enjoyed by someone other than him, while the costs of initiation and compliance are borne by him and his friends.

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Basel Is Not "Anti-American"
 
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