In 1988 the banking regulators from 20 leading industrial nations of the International Monetary Fund met in Switzerland and created Basel I to create a common set of banking standards by setting risk based capital standards, and assigning degrees of risk.
But the Japanese banks were bragging about their compliance when they tanked in the 1990’s.
So they created Basel II. Standards were toughened to include trading in securities and derivatives. All of this seemed irrelevant in stopping the meltdown of 2008.
The international banking tumult of 2008 was not a result of insufficient rules or even primarily of noncompliance with the rules. Banking is perhaps the world’s most regulated major industry. As in Japan in 1990, the imperatives of politics simply overrode what the rule makers and rule enforcers were trying to accomplish, turning their labors to dust.
The 2008 crisis resulted when the Fed-created credit bubble collapsed and soaring housing prices deflated as well. To promote “affordable” housing, Bill Clinton had excused the two giant government-sponsored housing finance agencies, Fannie Mae and Freddie Mac, from normal banking rules, allowing them leverage ratios far in excess of the limits on ordinary lenders. Banks were forced to write risky mortgage loans, a large number of which were then folded into mortgage-backed securities that Fannie, Freddie and others sold internationally with triple-A ratings.
This business seized up, crippling banks throughout the world, when holders began to realize that the assets that backed the securities, home mortgages, were going under water at an alarming rate. One of the great ironies of our times is that the two strongest defenders of the Fannie-Freddie shell game, Chris Dodd and Barney Frank, are now in charge of reforming banking regulation.
The better solution is clear rules, commonly understood financial prudence, and control of debt. Yet our current government administration, which practices none of this, proposes to fix our financial system. I have yet to hear a peep out of Congress taking any responsibility for our financial mess. This will only increase the likelihood or repeating or worsening the next crash.