SAFE Banking Act, What it Does in 2D

Let’s talk about the SAFE Banking Act. First up, what does it do? Well, it caps deposits at 10% of total deposits, non-deposit liabilities at 2% of GDP for banks and 3% of GDP for non-banks. Huh? Let’s put it on a 2d graph:

Banks take in money, and lend out money. The riskier the money they take in, the more likely it is you’ll have a bank run. On the y-axis we have the amount of deposits a firm has. Because of FDIC insurance and the federal reserve window, deposits are fairly sticky, even in a crisis (have you worried about a bank run?). This bill would reinforce that one bank can’t have more than 10% of the total deposit base, which is around $800 billion.

But what about non-deposits? What about liabilities like obligations in the repo market and other shadow deposits, deposits very subject to bank runs? That will be on our x-axis. The SAFE Banking Act would limit this to 2% of GDP for banks, and 3% of GDP for non-banks. Right now that is about $280 billion, and $420 billion respectively.

Notice that this axis is where the shadow banking run happens. This is where banks take on debt to use for lending that isn’t deposit based. So why not at least put a ring-fence around how large this can get for any single firm? This can at least put some sort of limit on how interconnected a firm can get into the capital markets, so if our other regulatory efforts fail we at least have some boundaries on the damage.

A lot of people say “Lehman wasn’t that big!” and it is true compared to the even larger firms. (Though it was a massive firm.) But the bigger firms were all shadow banks that also have a giant deposit base. So even though other firms may have been bigger, since their liabilities were far less riskier the damage was more contained.

Let’s take a look at who this would effect:

Remember the idea of two problems with size: something like Wells Fargo which is huge but not a shadow banks, and something that has huge exposures in the shadow banking market but wasn’t that big. And then there is the problem of both, which is what we face.

A lot of people are against a size cap because they think there isn’t a problem with “too big” per se. The size cap people are way ahead of this critique, which is why we’ve all been pushing for a cap on liabilities that aren’t relatively safe deposits.

Again, if you really believe Basel III is going to solve this, run with it. I’d encourage you to leave a link with a story about Basel III negotiations going well, because I’ve never heard any. (If you like having nightmares, start reading the lobbying letters on Basel III. My god.) And we are putting all of our eggs in this basket.

e21 has a critique of the SAFE Banking Act, where among other things they bring up that the leverage cap wouldn’t have done much. But remember the leverage ratio people are talking about when they mention Lehman passing is net leverage ratio. The SAFE Banking Act would be total leverage ratio, and it would move it from the current 3% to a new 6%. (That’s 16.67:1.)

On this definition, the banks were definitely leveraged following a 2004 SEC report. A graph from Boston Fed shows this:

Remember to deleverage a firm of that size would cause a firesale on the assets, which would increase leverage again in addition to tailspinning the market. So it’s very, very difficult to get this down once it is this inflated (as we all learned from Lehman in 2008).

So getting a hard rule around the size of your shadow banking enterprise, as well as a hard rule around the leverage a massive firm can take. What’s not to like?

Mike Konczal is a fellow with the Roosevelt Institute.