Ezra Klein references David Brooks talking about how convertible bonds could help head off future asset bubbles and ought to be part of the financial reform discussion. Ezra notes that executing the idea would require similar structures to those already in the existing Senate bill. That’s not a coincidence, because this idea is already in the bill!
We've discussed extensively how the bill requires regulators to come up with new — though undefined — standards of prudential regulation, including higher capital requirements and lower leverage limits for large banks relative to smaller ones. The bill asks regulators to do the same thing for “contingent capital”: Create new standards that would allow non-bank financial firms and financial firms to issue debt or another security that converts to capital in the event of a regulator’s decision or another sign of increased systemic risk. Depending on what regulators think is best, this contingent capital requirement could take the form of the market-based Zingales-Hart proposal that Klein, and perhaps Brooks as well, think is smart, although I question whether basing any kind of decision as important as this on market movements is the best plan.
Obviously this is not the same as putting a contingent capital system in statute, but the complexity of creating this rule suggests to me that regulatory discretion is not the worst thing in the world here; there has been a lot of debate over how specific different standards should be, but it is clear this concept is on the mind of regulators and legislators and they are taking the initial steps to implement it.
— Tim Fernholz
