Basel Accord’s expanded banking rules could tank Trump’s economy

Since Congress passed President Donald Trump’s “One Big Beautiful Bill” this summer, strong real-GDP growth has combined with minimal inflation, boosting American prosperity.

But one potential misstep could end this decisive, action-oriented administration’s hope of making the American economy great again — while losing the midterm elections and Republican control of the government.

The Trump team is oddly frozen over what to do about the so-called “Basel Accords,” rules developed decades ago to introduce capital standards into the then rapidly developing international banking space — but which instead arguably led the global economy into repeated disaster.

At issue is the proposed expansion of the Basel rules to American community banks.  

Developed between the mid-1970s and late ’80s, the Basel rules followed the surprise 1974 failures of two large but second-tier banks, one in the United States, the other in Germany.

Experts at the time attributed both collapses to recklessness in the rapidly growing but largely unregulated global financial trading markets.

In response, anxious bureaucrats did what bureaucrats do.

For the next decade and a half, coordinating through the Bank of International Settlement in Basel, Switzerland, central banks and national regulators . . . talked.   

While they talked, the markets saw no repeat of the 1974 scare.

Actually, President Ronald Reagan’s deregulated 1980s were so stable that economists now call those years “The Great Moderation.”

But at last, in 1989, 28 central banks and their partner regulators announced they had agreed on a plan.

They seemed particularly proud that the plan included strong new rules requiring banks to hold 8% bank capital against the sum of their outstanding loans.

Loans to major corporations (think Apple, Intel or Ford) would mean setting additional percentages aside — “risk weighting,” as it was called.

Home mortgages and loans to countries, whether unstable ones like Greece or behemoths like the United States, were considered riskless and required no additional capital to be held.

The equity capital mandate reduced lenders’ profitability, so the set-asides all but forced banks to load up their portfolios with loans in categories that required no additional capital: mortgages and national debt.

What could go wrong? We soon found out.

The early rules were rolled out in stages: Basel I (launched from July 1988 to the end of ’92) and Basel II (April 2008 through December ’12).

In practice, raising bank capital to 8% of loans outstanding was mostly achieved by reducing the volume of outstanding loans — which, by definition, meant reducing the nation’s money supply.

Milton Friedman taught that the US economy takes six to nine months to respond to movements in the quantity of money.

Considering that US banks were brought under the new rules in stages, biggest to smallest, it’s a good bet that Basel I was at least partially, and perhaps entirely, responsible for the 1991 economic downturn that cost President George H.W. Bush reelection and sent Bill Clinton to the White House.

And it’s a sure bet that, with so much money essentially mandated to go into the mortgage market, Basel I induced a mortgage bubble.

A few years later, the Basel II rollout triggered another downturn — and, in 2007-’09, the traumatic popping of that bubble.

The financial crisis and the Great Recession followed, as did the election of Barack Obama.

Now, the same group of regulators has proposed to extend the Basel rules.

It’s known as Basel III Endgame — and the Trump administration appears to be paralyzed.

“Experts” assure us that the Basel-mandated capital reserve rules make the banking systems safer. In theory they may be right.

But each new rollout has triggered a downturn, as misjudgments about the incentives that the rules created massively added fuel to the fire.

The Trump administration is in a stand-off over rolling out Basel III Endgame, which would extend risk-weighting algorithms developed by global “experts” even further.

Adopting it would mean hometown bankers sensitive to details of local life and business will no longer independently decide the financing available to small businesses and other local entities in the United States.  

If American local business financing is to be great again, we must return to our long-held respect for experience-informed practice.

In the wake of the 2008 financial crisis, Johns Hopkins economist Steve Hanke wrote that the new rules may “constitute a structural impediment to the supply side of the American economy.”

Trump should take note.

Does he really want to give global regulators the power to pull the trigger on the next Basel rollout in the next few months — just in time to roil the economy ahead of the midterm elections that will determine the future of his MAGA agenda?

The president and his astute Treasury Secretary Scott Bessent need to decide — and act now.

Clark S. Judge, a special assistant and speechwriter to President Ronald Reagan, is chairman of the Pacific Research Institute.