The US economy has just been through an unprecedented debilitating financial crisis and six years of economic stagnation. It did not have to turn out that way.
What the 2008 crisis exposed was a fragile underpinning of a highly leveraged financial system. Had bank capital been adequate and fraud statutes been more vigorously enforced, the crisis would very likely have been a financial episode of only passing consequence.
If average bank capital in 2008 had been, say, 20 or even 30 per cent of assets (instead of the recent levels of 10 to 11 per cent), serial debt default contagion would arguably never have been triggered. Had Bear Stearns and Lehman Brothers continued as capital-conscious partnerships, a paradigm under which both thrived, they would probably still be in business. The objection to a capital requirement of 20 per cent or more, even when phased in over a series of years, is that it will suppress bank earnings and lending. History, however, suggests otherwise.