Thomas Hoenig and I have new commentaries expressing similar thoughts. Hoenig said,

We know from years of experience using the Basel capital standards that once the regulatory authorities finish their weighting scheme, bank managers begin the process of allocating capital and assets to maximize financial returns around these constructed weights. The objective is to maximize a firm’s return on equity (ROE) by managing the balance sheet in such a manner that for any level of equity, the risk-weighted assets are reported at levels far less than actual total assets under management. This creates the illusion that banking organizations have adequate capital to absorb unexpected losses. For the largest global financial companies, risk-weighted assets are approximately one-half of total assets. This “leveraging up” has served world economies poorly.

Read the whole thing. Then read my latest essay.

So what accounts for the low interest rate on long-term bonds, particularly those of the U.S. government? It is not “quantitative easing.” It is not a mysterious shift in preferences among savers. It is that banks, which enjoy enormous advantages in attracting funds from savers due to actual and perceived protection offered by governments, have a strong incentive to direct these savings into financial instruments that their regulators have designated as having little or no risk. Risk-based capital regulations may be ineffective at promoting bank safety. But they are plenty effective at allocating capital away from productive private investments and toward government bonds.

I also thought the Hoenig quote worth including in the essay.