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Larry Summers: Banks with high capital levels can still fail

Sam Ro
Managing Editor

Failing banks have been blamed for turning the 2007-2009 recession into a global financial crisis.

So, in the wake of the crisis came regulation in the form of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which required banks to maintain higher capital levels among other things.

Many folks have argued that the pendulum has swung too far, and that regulation has become so onerous that it’s harming the economy. Former Federal Reserve Chairman Alan Greenspan is among these folks, and he recently proposed doing away with most regulation and just raising the capital requirements of banks.

Former Treasury Secretary Larry Summers would also agree to a certain extent.

“I think the impulse [for] higher capital requirements, and higher liquidity requirements, and less rigorous detail around many different aspects [of financial regulation] probably is a legitimate one,” Summers said in an interview with Yahoo Finance’s Andy Serwer.

“On the other hand, Bear Stearns had a comfortably double-digit capital ratio, as judged by regulators on the day it failed. So did Wachovia,” he said.

An employee enters Bear Stearns in New York, March 17, 2008. (AP Photo/Mark Lennihan)

Bear Stearns and Wachovia were among the storied banks that either went belly-up or were folded into other more stable banks. During the worst days of the financial crisis, no bank seemed infallible.

“Regulators made a judgment that Citigroup was very adequately capitalized, that Bank of America was very capitalized weeks before it was necessary to intervene in those institutions on a substantial scale,” Summers noted. “So, I think there’s pretty clearly a problem with the existing concepts for measuring and adjusting capital. And you can have very — we’ve seen — you can have very high capital, and you can still fail.”

Summers argues that regulators need to monitor much more than just capital levels.

“I think you need to pay a lot of attention to liquidity, as well as capital, and that is an area that needs to be extensively regulated,” he said.

“And I think you do have to pay attention to the kind of risk taking that institutions are engaged in, because there’s no real way of measuring capital, except with regard to the risks that are being taken,” he added. “So, I’d go some distance with that.”

The bottom line is that there needs to be some middle path of regulation.

“And I’m not sure that we need a financial regulatory system that involves hundreds and hundreds of examiners being in major institutions every day,” he said. “On the other hand, the capital-only approach, I think the lesson of 2008 and the lesson of Bear Stearns, the lesson of many other institutions is that really doesn’t work.”

More from our interview with Larry Summers:

Full Interview: