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This morning everyone’s a-buzz about "Basel III" capital raises that might be necessary:

Investors are concerned the Basel Committee on Banking Supervision will propose higher capital requirements when it meets today, limiting banks ability to lend. Europes biggest lenders are already facing losses on more than 134 billion euros of Greek, Portuguese and Spanish bonds, according to a Bloomberg News survey.

Numbers being thrown around are as high as 105 billion – for Germany alone.  That could be trouble.

But what’s not being talked about nearly so much is this:

Recent amendments to the Bear Stearns Rule have extended this subsidy to Fannie and Freddie. The Basel Committee decided to include the debt of Government Sponsored Entititesbureaucratic code for Fannie and Freddiein the definition of high quality liquid assets. Whats more, it also included mortgage-backed securities guaranteed by Fannie and Freddie in the definition.

Up to 40% of a banks liquidity reserve can be made up of GSE obligations, under the rules likely to be approved in the next few weeks. And while it is true that these obligations get a 15% haircut under the rules because they are considered Level 2 liquidity assets, compared with the cash, central bank reserves and sovereign debt that will now be considered Level 1 assets.

Oh that’s nice.

So now we have GSEs, which are formally not guaranteed on a perpetual basis and in fact have their "guarantee" due to expire in a year or so, and Basel III proposes to allow up to 40% of a bank’s "liquidity reserve" to be stashed in these instruments – which have no guarantee at all.

So what happens now?

Well, it will certainly put a floor under the price of these securities from a trading perspective.  But the capital losses, if any, are what they are.  They can no longer be made to disappear than you can make home prices in California go back to 2006 levels.

This is pure insanity, and is very likely to provide the precise set of conditions for the next collapse in the banking system, which at present appears to be on track for sometime around the end of 2011.

SOMEONE needs to call these people on the carpet and tell them to shove these sorts of "rules" up their backside.  "GSE" debt is only "money good" if it has an explicit government backstop – if not, it is no more "sound" than any other sort of corporate obligation – period!