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The Tier 1 capital level is used together with a risk-adjusted measure of a bank’s loan portfolio to determine a capital adequacy ratio (CAR), or the ratio of the capital level to the loan base adjusted for risk. Investment analysts and bank regulators monitor the CAR ratio for banks to evaluate safety and to compare banks. The Tier 1 capital and CAR ratio received publicity in the media in postcrisis coverage of big banks like Bank of America, JPMorgan Chase, Morgan Stanley, Goldman Sachs, Wells Fargo, and Citigroup. The Tier 1 capital level was also one of the ingredients in the “stress testing” conducted by the Federal Reserve.
Based on the Federal Deposit Insurance Act, the law governing deposit insurance (see #45 FDIC), banks must have a Tier 1 CAR of at least 4 percent. Institutions with a ratio below 4 percent are considered undercapitalized, and those below 3 percent are significantly undercapitalized—but most investors and industry experts feel that a level closer to 10 percent is really adequate. Aligned to this thinking, in July 2013, the Federal Reserve Board recommended that the Tier 1 minimum for the eight “globally significant” U.S. banks be raised to 6 percent—and also a
Why You Should Care
Unless you’re in the banking business or are a bank investor, you don’t need to calculate Tier 1 ratios. But if you see a report that a major bank’s Tier 1 ratio is declining, that bank may be in trouble—about to cut its dividend to shareholders, or about to raise capital by selling more shares in the markets (both bad for investors). As a depositor, there probably isn’t much to worry about, because depositors only lose what is not covered by FDIC insurance, and after equity investors lose.
39. DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT OF 2010
It often takes crisis to bring change in American politics, and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 is a crystal-clear example. “Dodd-Frank,” as it is more casually known, came to us as a direct consequence of the Great Recession. Introduced by Senate Banking Committee Chairman Chris Dodd and House Financial Services Committee Chairman Barney Frank in 2009, the bill became law in 2010 and is aimed mainly at consolidating and strengthening regulation in the financial services industry.
What You Should Know
The new law brought sweeping changes to the investment, financial services, and consumer finance industries, many of which are too detailed and focused on industry internals to matter to most, unless you work in the industry. Much of the new law’s provisions aim at avoiding or reducing the risks and regulating transactions central to the causes of the Great Recession. A new “Financial Stability Oversight Council” assesses risks and stresses, and provides for the Federal Reserve to more closely supervise “too big to fail” bank holding companies, giving us the “stress tests” occasionally reported in the news. An “Office of Financial Research” compiles data on the performance and risks of the financial system, and presents it to Congress, among others. New rules streamline the liquidation of banks, savings and loans, brokerages, and other financial institutions. The law beefs up reporting requirements for Registered Investment Advisers, and sets up new rules—and possibly a new regulatory body (still to be determined)—for hedge funds.
Importantly, the law as passed re-establishes the “Volcker Rule,” separating commercial and investment banking operations, and restricting what banks can invest on their own accounts (so called “proprietary trading”). The law also called for new regulation and standardization of the trading of credit derivatives, especially credit default swaps (see #69 Credit Default Swap). New rules give greater authority to the Securities and Exchange Commission (see #44 SEC) on a number of fronts, including the establishment of a “whistleblower bounty program” to encourage discovery of unfair securities practices. New oversight is now given to the credit rating agencies—Standard & Poor’s, Moody’s, and Fitch—to prevent conflicts of interest and other practices that led to the misrating of credit securities before the crisis. Finally, Dodd-Frank established the Consumer Financial Protection Bureau, adding new and centralized regulation to financial products and services, including new disclosure requirements and educational materials, and putting former Harvard professor and outspoken consumer advocate, and now Massachusetts senator, Elizabeth Warren, in charge.
Why You Should Care
The far-reaching Dodd-Frank legislation should curb many of the excesses that caused the Great Recession, and also serves to centralize authority and regulation. That helps lawmakers (and you, if so interested) know whom to go to in order to understand the latest of what’s happening in the industry, where the risks are, and to ensure compliance. For most of us, it’s a security blanket to know that the government is watching, and that many critical areas in the financial industry are no longer reminiscent of the “Wild Wild West”—there’s a new sheriff in town.
CHAPTER 5
Government and Government Programs
Whether or not you like the presence and cost of government, it plays a huge role in today’s economy. Governments provide money and monitor its supply, but go way beyond to create and implement various policies and programs to influence the economy, fix the economy, spend critical resources, and make it better for all of us.
Government agencies regulate economic activity, providing safeguards and a fair and level playing field for economic transactions to occur. Certain bodies of law, like bankruptcy law, create fair ways to dissolve failed economic entities, ultimately facilitating the sort of risk-taking necessary to make the economy work in the first place.
Want to understand the role and importance of the government in the economy? Just try to picture what it would be like without government. We would have no universally accepted currency, and no supervision and regulation of the markets and other economic activity—and no reallocation of resources to public programs and infrastructure, like roads and airports—that make the greater economy work.
40. U.S. TREASURY
It’s good to know where our money comes from and who’s managing it. Today, it’s sort of a joint venture between the Federal Reserve, our central bank, and the U.S. Department of the Treasury.
The Treasury department is part of the executive branch of the U.S. federal government and reports to the president. While the Federal Reserve (see #30 Federal Reserve) was created in 1913, the Treasury has been with us almost since day one, being created by Congress in 1789 to manage government revenue and currency.
What You Should Know
The Federal Reserve and the U.S. Treasury work together to create and implement money and monetary policy. The Federal Reserve is more the “brains” of the operation, deciding what policies to put into place with regard to employment, prosperity, and price stability; the Treasury is more “working man,” in place to carry out the programs.
The Treasury prints, mints, and monitors all physical money in circulation, including paper and coin currency. The U.S. Mint and the Bureau of Engraving and Printing are part of the Treasury. In addition, the Treasury is responsible for all government revenue generation through taxes—the Internal Revenue Service is part of the Treasury. Beyond raising money through taxes, the Treasury also raises money by creating debt securities—bills, notes, and bonds—to sell to the general public, banks, corporations, investment funds, and so forth.