I continue to have some reservations about various aspects of the Brown-Vitter bill, but I think the idea of imposing tougher capital restrictions on banks—especially the biggest ones—is sound and if anything Sens. Brown and Vitter didn’t go far enough in this regard.
Against them are, of course, the banks that don’t want to be subjected to these new regulations. The argument, naturally, is that tougher capital requirements will make it more expensive to lend and less lending will lead to less investment and therefore to less growth. Since this is the argument that gets made against essentially all regulatory proposals it’s easy for one’s eyes to glaze over and miss some of the uniquely ridiculous aspects of its application in this particular case. The whole point of having a Federal Reserve that conducts monetary policy is to create a situation in which the aggregate volume of lending and investment in the country doesn’t dependent on prudential regulation of this sort. If tougher capital rules had applied back in 2006 and that was creating “too little” lending, the Fed would have set interest rates lower. The difference would be in who lends. Applying Brown-Vitter rules would mean that some business that currently goes to the megabanks would go to smaller banks instead. That’s community banks if you want to be warm and fuzzy about it, and mid-major regional institutions if you want to be more realistic. Applying Brown-Vitter rules would also mean that some business that currently goes to the megabanks would instead take the form of companies directly tapping the bond market instead—just like Apple is planning to do under the current rules.
It’s actually this fundamentally benign aspect of Brown-Vitter that makes it so threatening to the megabanks. Precisely because it would be relatively easy for medium-sized banks and the bond market to pick up the slack, the tougher capital rules would be really hard on the megabanks who might end up needing to divest a lot of assets at unfavorable prices.