Five years before Lehman Brothers imploded and crippled the global economy, mortgage giant Fannie Mae - which was facing rising defaults - tried to reassure investors that it had $47 billion in capital, considerably more than the $30 million required by law.
Fannie conformed to the rules but the rules didn't conform to reality. It sounds remarkable but five years after the crisis, the health of the financial industry is just as hard to determine, wrote Alan Davidson in The New York Times. A major bank or financial institution could meet every single regulatory requirement, yet still be at risk of a collapse.
The sprawling Dodd-Frank Act, which rewrote banking regulation in 2010, didn't resolve things as it kicked off endless rules-writing by regulators. The rules are confusing, which allows banks to sometime misrepresent facts.
Take capital-adequacy ratio, a measure of how much capital you need to back the risk of your assets. This is one number that makes clear whether a bank is prepared for a crisis; higher the better. Davidson randomly picked a recent Citibank report to SEC and found the bank reports several different measures, ranging from what appears to be a safe capital ratio of 17.26 per cent (implying the bank maintains a loss-absorbing buffer of $17 for every $100 of the assets it owns) to a potentially worrisome 7.48 per cent (with stops at 14.06, 12.67 and 8.7 per cent). The problem is not with the bank, but as financial experts say, in the rules themselves, which instruct banks to use complex formulae to calculate their leverage ratios, based on different definitions of capital and debt.
Confusion was central to the financial crisis; banks collapsed or needed bailouts, in part, because few trusted, or even understood, the information they provided about their health. In finance, though, complexity often means profit. Simplicity might be good for economics but it's lousy for Wall Street bonuses.
