Just two years ago the second worst depression in history hit us. Recently we have started pulling ourselves out of it, albeit slowly. Looking around at the depression’s results, the question is almost begging to be asked, did we learn anything from the first one?
Many reasons are attributed to the cause of the Great Depression, from the infamous Black Tuesday, to economic policies, and bank failures. All of which lead to a nervous public that spent less and sent the world economy into a tail spin. While this was a seriously unfortunate event, the world eventually recovered.
Following this most recent collapse of the financial markets and newfound public support, regulators have taken several quick steps towards setting up new regulation. Basel III, a new set of international banking regulations, was instated September 12 and will be phased in within the next 8 years. The most controversial piece of legislation with this is the raise in the capital reserve requirements, which control how much money a bank must have on hand, and consequently how much money it can loan out.
While this is to create a cushion for the next financial recession in the hopes of abating it, how much of an impact can it really have? During the Great Depression the average reserve requirements were double what the Basel III is requiring and they had massive bank failures and liquidations. The fact is that banks are going to attempt to be as close to the reserve limit as possible as to maximize their own profits. So when someone withdraws money from the bank, the bank may have to take money out of a good investment, which hurts the bank and the person withdrawing. Not to mention there is now less money being re-circulated. That leads into the debate on liquidity. Yes, there is less money in the world economy. But, the consumers’ have more confidence and are willing to spend. In the end it is up to the consumers, who I believe will not spend without confidence.
Because of the greed of a few banks and their desire to squeeze out every last penny, government is forced to put in reserve requirements. What needs to happen is for the banks to regulate themselves. They need to have personal requirements that can be passed by in times of need. Fortunately, Basel III made an attempt at this and installed what they called a Capital Conservation Buffer. The buffer is not a requirement, but when the buffer is not in place, the ability of the bank to distribute profits is cut. Profiting being the main point of the banks (and all other companies), gives them an incentive to create their own buffer. I think Basel III took a very big step in the right direction with this action. The next step will be to create a system in which the government has no need to intervene and the banks are responsible enough to keep a reserve on hand.