One Man’s Opinion: Do US Banks Still Pose A Systemic Risk To The Economy?

Legendary investor Warren Buffet thinks US banks are out of the woods. In a recent interview with the Bloomberg, Buffet said he guarantees US banks will not get the country in trouble as capital ratios are huge and the excesses on the asset side has been largely cleared out.

Neil Barofsky, a former inspector for the Treasury’s Troubled Assets Relief Program and a Bloomberg Television contributing editor, begs to differ and believes large US banks still pose systemic risk to the economy.

There’s a difference between things being improved and sufficient, said Neil, adding the bank capitals today are much better than they were at the heart of the crisis, and the banks and the government gets some credit for pushing that. But that’s not to say it’s sufficient.

If you look at how much capital they actually have after considering the complex risk-weightings and the non-tangibles that count as capital, and then if you consider the more aggressive way that Europe counts as capital for its banks, you still are looking at leverage ratios of 33-to-1; Lehman-type territory. So it’s good that there are higher capital ratios, but to say they won’t cause trouble is a bridge too far, Neil observed.

One of the arguments for Buffet’s optimism is that US bank ratios are much better than the rest of the world, including Europe because of tougher capital requirements. Neil said US ratios are much better even if you make an apples-to-apples comparison because US allows more netting of derivatives when calculating assets than Europe does. But being better does not make the US safe, he noted. People like Tom Hoenig, vice-chair of the FDIC say we should have 10 percent of tangible equity as capital ratio and we have 3.3 percent now, Neil added.

When asked to define the sufficient capital ratio that will make banks safe, Neil said academic research shows capital should be 20-to-30 percent of assets to be safe when you have institutions of the size and character of what we have. Though that would not prevent another meltdown, they would put the system at a much safer plane, he observed. Institutions are still too big and they still enjoy implicit guarantees, so there’s still more that needs to be done on the capital front, he added.

When Warren Buffet talks about how banks have gotten rid of troubled assets, there’s no way we can really know that, he added. There’s so much capacity with these banks, it’s almost impossible to say where those risks are. Considering the recent London whale episode, it’s possible that even the CEOs don’t know where those risks are hiding, he noted.

At this point in time, no bank is at the precipice of bringing the economy down, but most of the big banks are capable of doing that, he observed. An external shock can push them off the cliff pretty quickly given how thin their capital is, even if it is much better than it was in 2008, he concluded.

You can watch the video here.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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