BREAKING: Bank Rules JUST Changed, Here's What You MUST Know

The country's big three bank regulators are making big changes to the bank rules. Now this is supposed to be in response to concerns over function of the treasury market with the April basis trade blow up fresh on everyone's mind, so the government is going to rejigger capital and leverage ratios in order to ostensibly free up bank balance sheets, big bank balance sheets, or at least that's the official story. The idea is that in times of trouble like April, with a tweak to something called the SLR, banks will have more space to therefore step into the market and it won't create the dysfunction and breakdown that we all saw. And it all sounds really great, but it's the same useless theater these quantitative measures have been all along. The real purpose is to make it seem like authorities are on top of everything, when in reality the reason why quantitative measures exist in the first place is because they're not. The actual reason why basis trade went so wrong in 2025, like March of 2020, is the same one which gave us the basal rules in the first place all the way back in the 1980s. Banks aren't really banks, at least not as most people understand them, and that includes regulators. These are complex institutions, not simple warehouses storing cash and making loans from the vault. From any government standpoint, the question of how to monitor, let alone regulate these things, let alone try to influence their behavior, it's far from straightforward. It is quite fittingly a complete mess. The Eurodollar system itself had come face to face with that mess 50 years ago when a bank failure in Germany nearly shut down the entire global reserve network. And from then on the race was on to try to figure out a way to keep an eye on what the modern banks were really doing. What authorities originally came up with back in the 1970s was to set up a system which would have rewarded, and I'm not even kidding, gossip. The sad part is gossip would have stood a far better chance of providing useful information than something like these quantitative ratios. Lowering the SLR commitment from the banking sector really isn't going to change anyone, any bank's behavior. This isn't really about the treasury market either. It's the fact that no one in position of authority, therefore the public, really knows and understands what it is these banks do, why they're not even banks. The idea here that we're all supposed to just swallow is that governments can and do influence bank activities. Not just influence, but heavily influence them. Here we are once again worshiping the SLR to further that faith. They had tried to sell the same fairy tale to the world a couple of decades ago, except by October 2008 it was clear that it wasn't working. In fact, the SEC chairman at the time, Christopher Cox, said the rapid collapse of Bear Stearns during the week of March 10, 2008 challenged the fundamental assumptions behind the Basel standards and the other program metrics. At the time of its near failure, Bear Stearns had a capital cushion well above what is required to meet supervisory standards calculated using the Basel framework and the Federal Reserve's, quote, well-capitalized standard for bank holding companies. The fact that these standards did not provide enough warning of the near collapse of Bear Stearns, and indeed the fact that the Basel standards did not prevent the failure of many other banks and financial institutions, is now obvious. But here's the thing. Why wasn't it obvious before then? Where did these Basel standards come from that they functioned and performed so poorly? Now before we get back to the rest of today's video, I want to tell you about today's video sponsor. We talk all the time on this channel about the dangers the world is facing, trying to come to grips with the aftermath of the pandemic and the lockdowns, the difficulties associated with the supply shock and price illusion, not to mention still living in the shadow of the 2008 crisis. To put it mildly, there's a lot of systemic uncertainty. Now I've recommended gold as a store value hedge for years. In fact, it's the ultimate error hedge. While gold prices are at an all-time high, price appreciation isn't the only way to profit. You can earn a yield on gold, paid in gold, without selling your metal. When the price of gold increases, so does the cost to store it and insure it. Don't lose money owning gold, earn a yield on it instead. And Monetary Metals allows you to earn up to 4% on your metal in their gold leasing program. And you start earning that 4% yield immediately upon funding your account. The yield you earn is paid in ounces of physical gold or silver, which you get in addition to any price appreciation from gold and silver during the year. So join the thousands of investors earning interest in physical gold and silver every month with Monetary Metals. There's a link in the description of this video that has all the information that you need. We thank Monetary Metals for their sponsorship. And now back to the rest of this video. And of course, after 2008, rather than try to answer those questions, authorities just invented new quantitative measures. The supplementary leverage ratio, which we're talking about here in 2025, was invented in 2014 as part of Basel 3. So you know its purpose straight away was and remains to try to clean up after the mess of Basel 1 and Basel 2, and how those had failed spectacularly. The SLR forces banks to hold capital against all of its assets, including those that are off balance sheet or where the firm has some partial exposure that's not otherwise captured by some of the pre-existing metrics. Most importantly though, unlike prior capital ratios, there's no weighting to the SLR. All assets are treated the same, so banks can't effectively hide leverage in regulatory capital relief or arbitrage any more than they did before. So whereas Basel 1 or Basel 2 considered a treasury or something very equivalent to it, very differently from say a low quality mortgage loan, Basel 3 no longer cares what the loan or the bond is. They all count the same way and mean the same capital treatment no matter what. And this is a somewhat understandable overreaction given the shortcomings of the previous quantitative rules. But is the issue here the set of quantitative measures or is it the entire idea and theory behind quantitative measures themselves? In other words, is it in the execution of the theory in which measures do the best job or is the entire point of trying to quantify a complex institution's complex behavior in a single simple standard way, is it just folly? In very big picture terms, the prior Basel rules were seen as too loose and therefore easy to engineer and manipulate. Which by the way, that was the real purpose of something like credit default swaps, this regulatory capital relief. So naturally, the regulatory pendulum would swing to the other side or appear to swing to the other side in the opposite direction to the failures of the crisis period. So if Basel 1 and Basel 2 were too loose with their capital ratios, which were unable to properly identify and capture the true amount of leverage that these banks were using, then supervisors simply invented leverage ratios. And a decade after they were invented and implemented, they're now being seen as too tight. Even though like the previous set, they don't actually matter all that much. The reason why the new rules are considered too tight is that banks don't want to lend. Dealers won't don't want to do dealer things like they used to. So economists and policymakers are, as they always do, confusing correlation for causation. The lack of lending and lowering of dealer capacities far predate Basel 3 or even Dodd-Frank. Bank behavior changed on August 9, 2007. Ironically, just a few days after Basel 2 was fully implemented. No one blames those rules for hampering and constraining bank balance sheets during the crisis because, as Christopher Cox was saying, they didn't seem to really matter. No one blames those rules for hampering and constraining bank balance sheets during the crisis because, as Christopher Cox admitted, they didn't seem to matter one bit. But as public banking supervisory officials at the Fed, the FDIC, and the OCC, if the official explanation is that bank rules got to be too tight in the wake of the crisis to try to fix the deficiencies of the first set, then they have to be loosened again, which is just what the government's three bank regulators have done and said here in 2025. In fact, as Michelle Bowman, who's the Federal Reserve's vice chair for bank supervision, wrote in a note accompanying the release of these details on the SLR changes, she said, quote, the proposal will help to build resilience in U.S. Treasury markets, reducing the likelihood of market dysfunction and the need for the Federal Reserve to intervene in a future stress event. We should be proactive in addressing the unintended consequences of bank regulation. And so they're going to, in effect, lower and loosen the SLR, something called the ESLR, which we don't really care about. The details don't really matter. But essentially, these revisions would reduce holding companies' capital requirements under the rules to something like 3.5% to 4.5%. It really depends on the calculations, from around 5% where they are currently. And bank subsidiaries would see their requirements lowered to the same range after being around 6%. So if your idea is that bank capital ratios, which we know don't matter, are constraining dealer activities, therefore limiting dealers in their capacity to act in situations like the Treasury market basis trade blow-up, then lowering capital ratios would free up dealers to enter into the Treasury market to make sure that everything stays quite orderly. However, if capital ratios or leverage ratios or any of these quantitative measures don't actually matter because they came from a place of complete ignorance about bank activities to begin with, then this is all just performative theater. And that raises a ton of questions, starting with, why do authorities keep slapping these various quantitative ratios together? Why do they have to keep doing this, keep changing them? Why are they so ineffective in the first place? Like with the modern Federal Reserve, the euro-dollar evolution changed the way banks operated. So of course, it would have to change the way that governments attempted to police them. To begin with, there's no money in euro-dollar networks except as bank ledger money. Prior rules that were set up were set up to govern physical cash and reserve, which increasingly didn't apply to most of these circumstances, least of all in any binding way. And Paul Volcker found this out the hard way at the end of the 1970s. So as you might imagine, there were a number of new challenges to a common global ledger money currency from the national perspective of all these various regulating bodies. Moving these ledger money dollars all over the world created all sorts of potential risks. For one thing, how might disputes be reasonably and efficiently settled? What about monitoring banks from on the other side of the world because they have the ability to impact operations of banks in your local area? Euro-dollar banks had already gone about setting up their own internal frameworks, what we call today financial utilities, things like chips, that were designed for more than simply clearing payments. Given the international nature of this entire monetary enterprise, it was one thing for members of the New York Clearing House Association, which is the trade group responsible for chips, to sign on to messaging and payment rules. Back in those early days, and chips was set up in 1970, on an otherwise uninteresting morning in June of 1974, we started to see some really big early cracks in this monetary arrangement. And so suddenly the euro-dollar world would have to come face to face with these potential fracture points. On the 26th of June 1974, a mid-sized German bank that hardly anyone had ever heard of, a company called Bankhaus or Bankhus Herstadt, had been closed by regulators in that country. Now Herstadt had been very active in London trading, meaning euro dollars, and not simply taking in euro-dollar deposits and arbitraging the spread between offshore and New York dollar markets. This mid-market German firm had become a relatively significant player in derivatives transactions, mostly currency forwards, and in dollar denominations. And those derivative activities had come to the attention of authorities in England, as well as Germany, from as far back as 1971. So here we had a German bank on the brink of default in dollars from derivatives over in London. I mean, that was the euro-dollar in a nutshell. And so already you can see why bank regulators have been basically outmatched from the beginning. But it also created a problem of time, which is one reason why Herstadt is remembered to this day. And by time, I mean time zones. Through a combination of really Clouseau-like errors, everything from flight delays among regulators to heavy traffic in the morning trying to get to the offices of Herstadt, German government supervisors wouldn't be able to officially shut down the bank until 4 30 p.m. local time, which was smack in the middle of trading 10 30 a.m. in New York. So what followed was a mess when Chase Bank, as Herstadt's sponsoring bank at CHIPS, attempted to protect itself by halting outgoing payments from Herstadt's ledgers on its books, even as it was still accepting incoming payments. Now that everyone was fully aware of the time zone problem, the New York clearinghouse added recall provisions to its member rules, which would have allowed New York banks to essentially cancel payments that had been technically settled the prior day, which basically undercut the whole point of something like CHIPS, a real-time gross settlement interbank network. So over three consecutive days in early July 1974, CHIPS was basically a ghost town. It almost completely shut down, which threatened the entire global monetary and financial order, because by then the euro dollar system was the reserve currency. So with CHIPS failing to provide timely processing, the euro dollar market itself, the euro dollar system, became nearly non-negotiable. Borrowing rates skyrocketed, and often funds were unavailable even at those quoted prices. And so the activities of one small bank in Germany had come to threaten the entire global currency system, even if hardly anyone knew what it really meant. But it was serious enough that in September of 1974, all the major countries' bank regulars got together and said, what do we do about this to make sure that something this big never happens again? So on September 10th of that year, the group of 10 and their central bankers, they issued a statement, a joint statement, which promised, quote, to intensify the exchange of information between central banks on the activities of banks operating in the international market, and where appropriate, to tighten further the regulations governing foreign exchange positions. And then a couple months later, in December 1974, at the monthly meeting, the G10 central bankers then created an informal committee, which was chaired by George Blunden, who was the head of supervision for the Bank of England, which began meeting in Basel, Switzerland, and whose, quote, main objective was to help ensure bank solvency in liquidity to this new international banking framework. And in order to accomplish this, in the wake of Herstatt, they had to, again, quote, give particular attention to the need for an early warning system. So where would this early warning system come from? How would they do that? Gossip. There was simply no way for regulators in one country to figure out what a foreign subsidiary of a local bank might be doing in a complete other country. And this wasn't just about Herstatt, by the way. There was other affairs in 1974, including the thing with Israeli-British Bank, all of which further exposed the serious potential deficiencies in a now truly global banking environment. What seemed like the easiest way, and maybe it was the only realistic way, was for regulators to try to coax out information, even if it was in the form of informal rumors, out of overseas traders in order to begin to put together a list of who might need further local regulatory attention. As Blunden himself said, they saw few other options. Quote, the only possible and useful kind of international early warning system would result from the establishment of contacts for the purpose of confidential exchanges of relevant information picked up by their own national warning systems. Now, as you can imagine, I hope, this was not popular among either bankers or bank supervisors. As another of the G10 committee members, this one from France, admitted, it was hard for him to imagine that information based simply on rumors, or even on accusations, could be transmitted to the supervisory authorities of other countries. So bankers might not have liked it, but who cared? What better way to gain keen and useful insight than from those doing business and intimately familiar with the operations of the Eurodollar world? Who else would know of the real nature behind Herstet's short dollar book than those on the other side of that short dollar book? It's one thing to see a number on a call report or a balance sheet statement. It's entirely different when your own money is on the line item below it. But rather than pursue this, the world's bank regulars decided to chase instead that other developing fad from the 70s and into the 1980s. They would go quant. They would come up with a bunch of quantitative measures which would distill a complex bank's operations down to a couple of ratios. They all began to presume they didn't need details or inside information. They could just put together a couple of mathematical measures. It was the apex of hubris. And none of them truly understood what banks were doing, so essentially they set about inventing a lazy shortcut. They could put bank assets into a couple of rough buckets, and they thought that would suffice to monitor these increasingly complex institutions, which resembled and acted like the bank's governments imagined less and less over time. Right on up to The Eurodollar had essentially created an arms race of knowledge and information, which left governments perpetually behind. And so those governments invented all kinds of forms and spit out any number of numbers and ratios, but yet never really knew and still don't to this day what any of it actually meant. The gossip system would have at least provided authorities with an expert set of guides rather than arbitrarily chosen mathematical guidelines that were all too easily overcome by lawyers, accountants, and yes, derivatives. Okay, but that was the basal capital ratios. Did the updated SLR fix everything? Well, maybe let's ask Switzerland. Bank regulations, they're neither tight nor loose. They're applied and then evaluated entirely based on circumstances. Banks were expanding rapidly and therefore doing more and stupider things, just like human nature under Basel 1. Was that because of Basel 1 and being too loose? No. Regulators had no idea what was going on. But once the banking system was forced to confront the stupidity starting in August 2007, quite naturally it essentially stopped. And so the tightness that followed during the crisis as well as long afterward, it wasn't because of Basel 3. That didn't show up until years later. This constant appeal to quantitative bank measures that is intended to prove that governments are on top of everything ironically is only proof positive they're not. If they really wanted to know what modern money banks have been doing all this time, officials really should have been paying bankers under the table, off the books, to gossip. And even then it wouldn't have been enough. If you go back through all the historical documents and details from the 2008 crisis, what you find is that in specific cases like Lehman Brothers, banks couldn't stop talking about the case. They couldn't stop talking about Lehman Brothers and they couldn't stop talking about Lehman to authorities. But authorities wouldn't listen. And they wouldn't listen because they thought their quantitative ratios had everything covered. There is a parallel story to the evolution of banks and bank regulations and the forced evolution of the Federal Reserve into its interest rate targeting regime, and that's in the video link below. As always, thank you very much for joining me. Huge thank you Eurodial Diversity members and subscribers. And until next time, take care.