Goldman Sach's ceo, Lloyd Blankfein, and its president, Gary Cohn, are out with their annual letter to shareholders. The sentence that most caught my eye was this: "Given that much of the financial contagion was fueled by uncertainty about counterparties' balance sheets, we support measures that would require higher capital and liquidity levels." This explanation sheds some light on what puzzled me back in December, when H. Rodgin Cohen, who represents a lot of financial institutions, said regulators should require tougher capital requirements. I said back then, "After all, nothing is stopping the banks from increasing their capital requirements or upping risk controls internally on their own, without a government mandate."
What Mr. Blankfein and Mr. Cohn are now saying is that their desire for higher capital requirements isn't related to concern about their ability to control Goldman's risk-taking ("Please, Mr. Government, supervise me more closely, allow me to borrow less money, and force me to take less risk"), but their ability to assess and judge the risks of their counterparties, the other firms they are doing deals with.
It sheds some light, but it's still not entirely satisfactory, in my view. Mr. Blankfein and Mr. Cohn are smart guys, and they have lots of other smart people working for them (which is why those smart people get paid a lot of money). If Goldman has doubts about its counterparties' balance sheets, it has plenty of options available to it. It could buy insurance to hedge against the possibility that the counterparties will default or fail. It could decide not to trade with the counterparties it has doubts about. It could encourage the counterparties to shore up their balance sheets. It could reduce the level of exposure to the risky counterparties. But measuring and managing uncertainty and risk is part of the value bankers provide. It's a core service that you'd think they'd want to excel at, rather than something they'd want to subtract from the equation by getting the government to make everyone failure-proof. It's one thing for some elderly retail depositor to ask the FDIC to protect her from risk by guaranteeing bank deposits. But the idea that the government needs to run around setting capital requirements to protect Mr. Blankfein and Mr. Cohn from the risk that their counterparties might go under or get in a liquidity crunch seems a bit odd. Let them protect themselves.
I realize that other people have other views of the capital requirements question; I don't want to belabor the issue more than I already have (see here, here, here, here and here). If I'm missing something, let me know. But I just don't see it.