Can You Measure Bank Capital

There’s been a fair amount of discussion over whether it’s necessary to set a statutory limit to bank leverage or whether it’s okay to leave capital ratios at the discretion of regulators. Steve Randy Waldman says it’s essentially all irrelevant since we can’t accurately measure capital at large, diverse financial firms. For example:

On September 10, 2008, Lehman reported 11% “tier one” capital and very conservative “net leverage“. On September 25, 2008, Lehman declared bankruptcy. Despite reported shareholder’s equity of $28.4B just prior to the bankruptcy, the net worth of the holding company in liquidation is estimated to be anywhere from negative $20B to $130B, implying a swing in value of between $50B and $160B.

So what happened? Was is fraud? Waldman points us to the relevant section of the Valukas Report:

The Examiner did not find sufficient evidence to support a colorable claim for breach of fiduciary duty in connection with any of Lehman’s valuations. In particular, in the third quarter of 2008 there is evidence that certain executives felt pressure to not take all of the write‐downs on real estate positions that they determined were appropriate; there is some evidence that the pressure actually resulted in unreasonable marks. But, as the evidence is in conflict, the Examiner determines that there is insufficient evidence to support a colorable claim that Lehman’s senior management imposed arbitrary limits on write‐downs of real estate positions during that quarter.

So maybe a little fraudy—maybe—but not in a provably illegal way even after the fact. So will there ever be a way for regulators to know whether or not a bank is skirting the limits?