I admit “is the global financial system safer” is a trick question.  Answering it requires two pieces of knowledge:  what are the two time periods being compared and who has the financial system been made safer for.

If you look at the global financial system before the financial crisis and compare it to today, the financial regulators would claim it has been made much safer for taxpayers as the risk they will be called on to bailout the financial system has declined.  Recall these are the same financial regulators who said the financial system was safer in the run-up to the global financial crisis and whose job is dependent on making such assertions.

So what do these financial regulators think has happened since the financial crisis to justify the conclusion the financial system is safer for taxpayers?  They have written 100s of complex financial regulations.  Each regulation carefully designed to reduce risk and create a barrier between losses in the financial system and the taxpayers.

No regulation embodies this idea more than the new Basel III capital regulations.  Underlying Basel III is the idea if banks have more book capital to absorb losses, this reduces the chances taxpayers will be called on to bailout the banks or the financial system.

As I discuss in Transparency Games, this wonderful theory about the use of bank capital only has one small problem.  As shown first in the case of Continental Illinois, then with the savings and loans, and most recently with the 2007 financial crisis, on their own, regulators will never require banks to recognize their losses.

Why?

In describing why regulators created the policy of Too Big to Fail, the OCC’s C. Todd Conover said regulators fear the “unimaginable consequences” of a large bank failure.  There is nothing that says a large bank has failed liked making it recognize its losses and using its book capital to absorb these losses.

If regulators won’t require banks to use their book capital to absorb losses, then the taxpayer is not safer as they still face the same chance of having to bailout the financial system.

However, the taxpayer could be made safer if the banks were required to provide transparency.  Then, market discipline on both the banks and the regulators would force the banks to recognize their losses before the regulators could turn to the taxpayers for a bailout.

Of course, making the financial system safer for taxpayers by pushing the banks to provide transparency is just one of the benefits of the Transparency Label Initiative™.