were most likely to fail. the wave of losses, consumer foreclosures and business failures infected every element of the economy. the deleveraging process commenced as highly - leveraged financial institutions, working with highly - leveraged consumers and business, had insufficient capital to withstand the financial blows. increasing numbers of homeowners were unable to keep up with their mortgage payments, leading to higher defaults. mortgage defaults, in turn, sharply lowered the values of mortgage securities held by financial institutions. these losses led banks to attempt to reduce their leverage, which required rebuilding tangible capital and reducing total assets – thus reducing loans. this placed downward pressure on asset values, losses worsened and the vicious cycle of deleveraging worsened. homes and businesses were lost to foreclosure and liquidation, while unemployment climbed. the large increases in leverage over the past decade have wrecked havoc on our economy and are responsible for the sluggishness of our recovery. strong economic growth simply cannot occur if consumers and businesses must focus on rebuilding balance sheets instead of on increasing spending, production and hiring of new workers. once again we have learned that the double edged sword of leverage is a pro - cyclical weapon. constraining leverage today, the largest financial firms are showing a solid recovery. regional and community banks continue to show stress but problems may have peaked as they have worked to reestablish stable capital and leverage levels. the market appears to be correcting and leverage based on high quality capital is returning to more historic norms. in time credit will once again expand and the economy will improve. but it won ’ t be quick or easy. therefore, we must now turn to actions that will prevent the impulses of consumers, businesses, and financial institutions from assuming ever more leverage as the expansion becomes a boom. if we take action now, then when the next economic correction occurs there will be less devastation to our economy. if we don ’ t change policy now, then this crisis will be remembered only in text books and leverage will rise again and lead to another crisis. i strongly support establishing hard leverage rules that are simple, understandable and enforceable and that apply equally to all banks and bank holding companies that operate in the united states. as we saw in the years leading up to the current crisis, leverage tends to rise during economic expansions as investors and lenders forget their past mistakes and believe that prosperity will continue with no end in sight. straightforward leverage and underwriting rules are not procycl

##ical, so that as the economy expands and heats up, bankers must match increases in assets with increases in capital, which constrains reckless growth. thus, such rules would serve to limit growth beyond a prudent level by creating a counter - cyclical force that moderates booms and provides a cushion to bank losses when the next recession occurs. for an example of the power of a hard leverage rule, consider the impact on assets and / or equity of restricting bank holding companies to holding no more than $ 15 of tangible assets for every $ 1 of tangible equity capital ( chart 9 ). as i noted, at the end of 2007, the 10 largest bank holding companies held $ 34 of tangible assets for every $ 1 of tangible equity capital. if the maximum leverage ratio was 15 : 1, these companies would have had to reduce their assets by $ 4. 9 trillion ( 56 percent ), increase their tangible common equity by $ 326 billion ( 125 percent ), or some combination of the two. simple rules also provide examiners with the tools they need to prevent leverage from rising and underwriting standards from declining. without hard rules on leverage ratios and lending standards, bank examiners were disadvantaged in taking actions on rising leverage and declining loan - to - value ratios because bankers could correctly claim they were following supervisory guidance on capital levels, and their loan problems were very low, while profits were strong. finally, the rise in leverage in the last cycle was facilitated by the complexity of international risk - based - capital requirements. in particular, the basel i risk - based capital standards in place leading up to the crisis provided very crude measures of asset riskiness, which increasingly underestimated risk as asset markets deteriorated. banks also could arbitrage capital standards and raise their risk - based capital ratios by shifting assets to favorably treated off - balance sheet vehicles or exchanging assets such as prime mortgages for “ lower risk ” subprime mortgage - backed securities. the basel ii risk - based standards, which we were starting to phase in, would have enabled an even greater amount of leveraging to occur. these standards, which allow banks to use model - based risk estimates for many types of assets, actually suggested banks were holding too much capital in the months leading up to the crisis.