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Big Bank Leverage Too High as Interest Rates Rise

July 7, 2017 (EIRNS)—Despite major reports by the International Monetary Fund (IMF) and Moody’s this Spring on the rising risk of widespread defaults on the U.S. corporate debt bubble, Treasury Secretary Steven Mnuchin’s recent "bank deregulation" recommendations to the White House included reducing the amount of capital banks must have relative to their assets—the "leverage ratio"). Under the Dodd-Frank Act, U.S. banks are supposed to have a 5% minimum capital ratio (20:1 debt leverage) by the end of 2018, while European banks are required by regulators to have just a 3% ratio (or 33.3:1 debt leverage). Lehman Brothers, when it went under, and other U.S. investment firms had been allowed to go to 36:1 debt leverage from 2004 until the 2008 crash they triggered. Federal Reserve Chairman Janet Yellen agreed with the Treasury recommendation.

A letter to the editor in the Walton, Missouri Sun newspaper reports that Federal Deposit Insurance Corp. vice-chair Thomas Hoenig, in a speech, warned against flirting with the European level, and said a much higher level than 5% is required. Hoenig reminds that the big banks lost, on average, more than 6% of their assets during the financial crisis, so having capital ratios of 5% or much less, they all became bankrupt.

In fact, in the most recent stress tests, five of the "big six" U.S. banks all had capital ratios significantly below even the 5% level when their derivatives exposures—very conservatively underestimated—were included. And Spain’s fifth-largest bank, Banco Popular, just went bankrupt and was bailed out after successfully "passing" similar stress tests.

U.S. long-term interest rates have just begun to rise significantly in response merely to Federal Reserve discussion of future actions. This rise is what the IMF’s Global Financial Stability Report, 2017 warned of when it said that the result could by 20% or more of U.S. corporations defaulting, so huge and unsupported is the corporate debt bubble. Meanwhile, American Banker reported July 5 that defaults are rising rapidly in two other categories of that bubble: credit card debt, and auto loans, both of which are securitized like the mortgage debt of ten years ago.