The development economists, they have now been shamed.

Now most development economists have been shamed by none other than Vikram Pandit, the chief executive of the Citigroup and who, in the Financial Times of October 26, is reported by Francesco Guerrera as saying “Under Basel, the ‘sweet spot’ business model for banks in the developed world will be to take retail deposits from mom and pop – small but stable customers – and lend only to big business and the wealthy. I do not believe this is the banking system we want”

Of course this is not the arbitrary regulatory discrimination we need, and I have been arguing against it since 1997 with for example a document I presented at the UN in October 2007 titled “Are the Basel bank regulations good for development?”. Unfortunately much of the development debate has been hijacked by baby-boomer development economists from developed countries and who cannot get it in their head that development requires a lot of risk-taking… and that therefore concentrating too much on avoiding bank failures will hinder the growth and the development of the economy.

As an example it suffices to read the Recommendations by the Commission of Experts of the President of the General Assembly on reforms of the international monetary and financial system chaired by Joseph Stiglitz. Nowhere in it do we find a word about the utterly misguided and odiously discriminatory capital requirements for banks imposed by the Basel Committee and which signify that a bank needs to have 5 TIMES more capital when lending to small businesses and entrepreneurs (100%-risk-weight) than when lending to triple-A rated borrowers (20%-risk-weight); and this even though the first are already paying much higher interest which goes to bank capital; and this even though no financial crisis has ever resulted from excessive lending to those perceived as “risky” as they have all resulted from excessive lending to those ex-ante perceived as not risky.

The Commission of Experts speak of increasing risk-premia but fail to notice that one of the reasons for that is the arbitrary regulatory risk-adverseness. It also speaks out against under-regulated and dysfunctional markets that fail to allocate capital to high productivity uses, without noticing that perhaps the major cause of markets being dysfunctional is often bad regulations, such as those issued by the Basel Committee.

Perhaps it is high-time economists from developing countries start to develop their own development paradigms; some of which might even help developed countries to keep from submerging.

And meanwhile, all you traditional development economists, put on your cones of shame.

A final question should Vikram Pandit now move to the World Bank?

It is very worrisome to see that Jacques de Larosiére does still not get it!

Sir Jacques de Larosiére in “Basel rules risk punishing the wrong banks” October 25 writes about the risk of the banks reducing “activities with modest margins such as lending to small and medium sized enterprises” If he wants to defend the small and medium sized enterprises then he should not forget that the primary reason for that lending having margins that are modest, relatively, is because the regulators allow other lending to occur with much less bank capital requirements… and of that truly odious discrimination he does not say a word.

He also writes that “The proposal to introduce an absolute leverage without taking into account the real risk of the asset is the most contestable element of the Basel reform, and would push banks to concentrate their assets in riskier operations.” This is pure nonsense as an absolute leverage does not mean that the risk of the assets are ignored, those risks are reflected in the risk premiums charged by the banks, and those risk premiums, higher interest rates, go straight to the capital of the banks.

In fact it was not having an absolute leverage level equal for all assets that drove the banks into an excessive lending or investment in what was perceived ex-ante as having no risk, precisely the place where all financial and bank crisis occur.

How worrisome and sad it is that a man of the statute of Jacques de Larosiére, now more than two years after the crisis detonated, does still not understand why it happened.

Is John Auther a closet-paper-money-bug?

Why would John Authers categorize the buying of gold as an “irrationality”, an act of faith, and thereby imply it is entirely rational to trust a piece of paper issued by politicians and marketed with what seems more of a slogan to them namely the “In God we trust”, Remember 1980: all that glisters is not gold” October 23. Could it be that John Auther is a closet-paper-money-bug?

Gold is not a substitute for stocks and properties… but it sure can come in as a handy complement in times when most countries seem to want to win the devaluation race?

Could we have avoided the crisis if Mandelbrot had gone to Basel?

Sir Christopher Caldwell writes how the recently deceased Benoit Mandelbrot “zeroed in on the besetting flaw [with financial] models that understated risk” and references The (Mis)behaviour of Markets a book that Mandelbrot co-authored with Richard L. Hudson in 2004, “Mandelbrot tips of the market”, October 23.

I do not have sufficient memory to recall it but it is very possible that it was the referenced book that, in October 2004, as an Executive Director of the World Bank, made me make a formal written statement that contained: “We believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”

The world could have benefitted incredibly from ascertaining the presence of skeptics like Mandelbrot at the Basel Committee for Banking Supervision. I am absolutely sure he would have been horrified at what its members were up to managing risks with truly faulty models and conceptions of the reality and tried his utmost to stop their regulatory nonsense in time.

But since even after its evident failure, the Basel Committee is not going back on anything, but is instead forging ahead and scaling it up, as if nothing has happened, now even wanting to tackle cyclicality and systemic risk, it is most likely that Mandelbrot would not have been heard at all by the self-sufficient scheming high-priests of the regulatory establishment.

Should we not have a serious man to man conversation with our bank regulating chaps at the Basel Committee?

Sir, if you and I were going to design some capital requirements for banks based on the risk of default of borrowers as measured by the credit rating agencies, would we use the default rates those credit ratings generally imply, or would we use the default rates suffered by the banks after the bankers received that credit rating information? I am sure you and I would agree on using the second alternative, since the first really makes no sense as it would imply that bankers do not take notice of the credit ratings, something that with the capital requirements based on these ratings, we are really making sure they do.

If we so then use the default risk for banks after credit rating information, would we also adjust our risk-weights to the fact that those perceived as riskier are charged much higher interest by the banks than those perceived as less risky? I am sure we would definitely consider that important risk mitigation factor and do so, since otherwise we would be perceived as foolishly assuming that all borrowers paid the bank the same interest rate.

But since we now know that our bank regulating chaps at the Basel Committee did nothing of the sort, they just used gross default rates unfiltered by the bankers applying their own credit analysis criteria, and they completely ignored the mitigation of a higher default risk provided by higher interest rates, isn´t it time we call them home so as to have a serious man to man conversation about what they are up to? I mean before they go on to tackle even much bigger problems like counter-cyclicality and systemic risk. I mean so as to inform them about the fact that they, in their own right, are becoming our greatest source of systemic risk.

 

I believe we should. Just consider the mess they did by making the banks stampede after some lousy securities just because these were rated triple-A; and all the small businesses and entrepreneurs who have seen their access to bank credit curtailed or made more expensive just because their odious regulatory discrimination against perceived risk.

A verse of a Swedish Psalm reads: “God, from your house, our refuge, you call us out to a world where many risks await us. As one with your world, you want us to live. God make us daring!”

“God make us daring!” That is indeed a prayer that the members of the Basel Committee do not even begin to understand the need for.

Psalm 288 Text: F Kaan 1968 B G Hallqvist 1970, Music Chartres1784

To help trade and other worthy of help, you first need to stop giving assistance to those who should not need it.

Sir, what sets trade, projects, small businesses and entrepreneurs into a clear competitive disadvantage for gaining access to bank credits is not really that there are capital requirements for banks when lending to them, it is only natural banks should be required to have capital, it is the incredibly low capital requirements allowed the banks to have when lending to others, such as the public sector, housing, or those blessed with triple-A ratings.

In “Impact of Basel III: Trade finance may become a casualty” October 19, as reported by Brooke Masters and Patrick Jenkins we read Simon Gleeson, partner at Clifford Chance, the law firm, arguing “An enormous number of letters of credit are guaranteed by a form of government support, which should mean they carry a zero per cent risk rating”, while the real question should of course be: why the lending to triple-A rated governments have a zero percent risk rating and occurs therefore with zero marginal capital requirements for the banks?

Why should any bank lending for the purpose of buying a house have lower capital requirements than bank lending to that small business which might create a job so that someone can afford to buy a house?

If you really want to help trade, projects, small businesses and entrepreneurs to gain access to bank credit you need to level the capital requirements for all… besides why should the strong triple-A rated public and private clients needs more help than what they are already getting in the market?

Though Martin Wolf has doubts, I am absolutely 100 percent certain!

Sir, Martin Wolf asks “who can confidently state that it must be better to rely on relaunching a private credit boom than on higher public investments? “Britain and America seek different paths from disaster” October 20.

Well I can with total confidence state that it is much better to rely on relaunching a private credit boom than to rely on higher public investments. That is, of course, as long as that private credit boom is free to grow according to what the market indicates and does not have to grow according to where the bank regulators want it to grow with their discriminatory risk-weights and capital requirements for banks... and which precisely caused bank credit to finance overpriced housing while making it much more difficult and onerous for the productive agents of the markets, the small businesses and entrepreneurs to access bank credit.

Let me also assure Mr. Wolf that to keep on financing public investments with bank credits for which there are zero capital requirements, will only increase the slope and the slippery of that slippery regulatory slope where regulators have placed us. And I have absolutely no doubts about that either!

With their “Risk-Weights” it is the regulator who is taking the load off the books of the banks.

Sir, in reference to all being written about that “distasteful” behavior of banks of putting much of their exposure off the books, you should perhaps consider the following:

When the regulators used (and use) a risk-weight of only 20% to reflect the risk-weighted value on the books of banks of for instance lousily awarded mortgages to the subprime sector that manage to hustle up a triple-A rating, it was (is) the regulator who is taking 80% off the balance sheet(books)of the banks.

When the regulators used (and use) a risk-weight of only 0% to reflect the risk-weighted value on the books of banks of loans to a sovereign rated triple-A, like the US or UK, it was (is) the regulator who is taking 100% off the balance sheet(books)of the banks.

Sincerely, I doubt the banks could have managed that kind of disappearance acts on their own.

Basel regulations are also bad for developed submerging countries.

Sir, Michael Taylor holds that “Basel III is bad news for emerging economies” October 15. He is right and I have been arguing so for years at the World Bank at UN and in many other places, since Basel I and II already contained plenty of bad news.

But what we more recently found out was that these regulations were equally bad for developed countries and which, because of them, have now been converted in submerging countries.

Any bank regulation that penalizes risk-taking so much as to force banks to finance only what is perceived ex-ante as having a low risk of default, belongs only to societies who have called it quits.

Why is not the existence of counterfactual bank regulations of interest to the Financial Times?

There is a very curious issue with current bank regulations and about which I have written hundreds of letters to the Financial Times but strangely enough, at least to me, they do not seem at all interested.

I am referring to the fact that since all financial bank crisis in history have resulted from excessive investment or lending to what is perceived as not risky, and no crisis has, naturally, ever occurred from excessive investment or lending to what is perceived as risky, the current only tool in the toolbox of the Basel Committee, higher capital requirements when risks are perceived as low and vice-versa is totally counterfactual.

In fact those capital requirements increased so dramatically the returns on equity for the banks when investing or lending to triple-A rated securities or clients that they stampeded after the triple-As, and went over a subprime cliff.

In fact those capital requirements discriminate so odiously against those perceived as of higher risk that they are making the access to bank finance much more difficult for the small businesses and entrepreneurs, precisely those clients whom banks most should help as they have little alternative access to capital, precisely those clients of banks on whom society so much depends for growth and job creation.

In fact the only truly invisible hand at work was that of the scheming banking regulators messing around with capital-requirement-risk-weights… under the table.

I ask don’t you agree with that what I describe is worthy of more commentaries? Why then is not a word of it reflected by the “Without fear and without favour” Financial Times?

Of course other media should also take it up but as you can see from this blog I have invested many efforts in having the Financial Times echoing my small and tiny though sometimes a bit noisy voice.

Most of the letters to FT I refer to you find in this blog under the label of "subprime banking regulations".

Is the Basel Committee simply insane?

Sir in “An Explanatory Note on the Basel II IRB Risk-Weight Functions" of July 2005 posted by the Basel Committee we read “Interest rates, including risk premia, charged on credit exposures may absorb some components of unexpected losses, but the market will not support prices sufficient to cover all unexpected losses.”

And since we then cannot see the Basel Committee taking in account the “risk premia” charged by the markets because of perceived differences in risk, when calculating the risk-weights used for the capital requirements of banks, we find us facing the distinct possibility that the Basel Committee completely, 100%, ignored the markets.

If so that would explain how they could have so counterfactually stimulated the banks so much to invest or lend to what is perceived as having low risk, like what is rated triple-A.

If so, since the higher interest rates they need to pay would then not count for anything that would help to explain why the regulators so odiously discriminate against those perceived as “risky”, like the unrated small business and entrepreneurs.

And if this is what the Basel Committee really did… then it is simply insane!

Start by controlling the blind runaway fear shown by the bank regulators

Sir, Alan Greenspan is absolutely right in that “Fear undermines America’s recovery” October 7. But instead of complaining about market fear and market risk-premiums, he should attack what really caused the crisis and so much stand against us getting out of it, namely that stupidly blind fear that bank regulators showed, when they ordered banks to have 5 times as much capital when lending to small businesses and entrepreneurs, than when lending or investing to anything related to a triple-A rating.

That is the blind runaway fear that first must be controlled.

FT, for the umpteenth time, it was not deregulation it was bad regulation.

Sir, in “A fresh approach” October 4 you write: “The recent global crisis, also rooted in an excessive faith in deregulation, removed any vestigial credibility from the view that markets always work best when left to themselves”.

I am amazed. Do you not yet know that this crisis was provoked directly by regulations which allowed banks to leverage their equity 62.5 times to 1, or more, when investing or lending to anything related with a triple-A rating? Is this what you call deregulation? I just see it as extremely bad regulations. Do you truly believe the markets would have allowed banks to leverage the way they did if left on their own design? Of course not! Just look at how they keep the unsupervised hedge funds in a much tighter leash.