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Bank of America Continues to Ignore Market View of Risk

Monday, 12 Sep 2011 | 10:39 AM ET
A Bank of America trader inside the NYSE.
Oliver Quillia for CNBC.com
A Bank of America trader inside the NYSE.

Bank of America's CEO Brian Moynihan once again laid out his company's plan to meet regulatory capital requirements and denied that the bank will have to issue new stock to raise capital. Bank of America can meet its requirements simply by retaining profits.

This has been the consistent line of the senior management of the bank for quite some time, even as the market has pushed shares of the bank down nearly 50 percent for the year.

Moynihan seems to view capital purely as a regulatory compliance issue. As long as the bank is in compliance with regulatory requirements, he's satisfied that it has enough capital.

What Moynihan misses is that capital requirements exist to support market requirements. They are supposed to make sure that banks have enough capital in good times so that when bad times descend, investors and counterparties don't panic about the financial condition of the bank.

But capital requirements can undershoot market requirements at times.

A bank fully in compliance with regulatory requirements can be judged to be too risky by the markets, which can refuse to extend business and funding to the bank on the basis of those fears.

Bear Stears had capital far in excess of the requirements going into the week it needed to be rescued, proving that regulatory capital can be insufficient. What's more, markets can raise questions about the quality of a bank's capital, requiring safer capital than the government. We saw this when many investors decided to focus on tangible equity rather than regulatory structures such as "Tier 1 Capital" in 2008.

Moynihan says that Warren Buffett's $5 billion counts as Tier 1 Capital. But the markets have largely ignored the investment, most likely because it looks a lot more like debt than capital.

There's no rule that says markets have to fund a bank just because it is in compliance with regulatory capital levels. Bank of America should start listening to the market—before it is forced to start listening.

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