My alternative is to encourage new lending by lowering capital
requirements at the margin. Tell banks that loans issued after
September 1, 2009, require half the capital of similar loans issued
before September 1. Some banks are in such bad shape that even with
those lower capital standards they will not be able to make new loans.
Fine. You don’t want those banks to grow. But other banks have room to
grow, and you want them to grow more than they would under the existing
As with changing accounting rules, lowering capital requirements
ultimately exposes the government funds that insure banks to more risk.
That is the flaw in the idea. However, there has to be some risk
exposure to tax payers for any policy that encourages bank lending.
Here is more. One question I have is how to calculate the existing capital for the very worst, most insolvent, and most corrupt banks. You don’t want them making loans to their uncles, so to speak. Would requiring 1/2 capital discriminate usefully against such banks or would it in fact select for their relative expansion? Or do we have this problem in any case?
Via Brad DeLong, here is a summary of the Dodd plan. It sounds like an improvement over the Paulson plan.