A European banking union should not discriminate between European sovereigns.

Sir, in “One small step for European mankind” June 30, you subtitled it with “The lethal sovereign-bank embrace begins to be pried loose”. 

Hold it there, not so fast, the most lethal part of that sovereign-bank embrace, is that which allows banks to leverage much more its equity when lending to a sovereign perceived as “safe” than when lending to one perceived as “risky”… something which neither sounds much compatible with having a European banking union. 

If those regulations are not changed, they will only doom all the European banks to end up with dangerous obese exposures to the last perceived safe haven in Europe, probably Germany.

And what about conceit in journalism?

Sir, Gillian Tett writes correctly that “Libor affair exposes big conceit at the heart of banking” June 29, but there might equally be some big conceit going on at the heart of journalism. 

Two questions: What is the most important dollar reference rate… the risk free US Treasury rate or Libor? And, who has effectively manipulated those rates the most, Barclays the Libor rate, or the bank regulators the US Treasury rate by means of allowing the banks to hold these instruments with less capital than other assets? 

Clearly, in terms of its significance, the manipulation of the US Treasury “risk free” rate has been much more significant than whatever Barclays can have done to Libor but that, Gillian and her colleagues at FT decided to ignore, with much conceit.


Should not an anthropologist be about the most humble of all professionals? 

And when regulators manipulate interest rates, is that ok?

Sir, when regulators set the capital requirements for banks based on perceived risks, even though these perceived risks are already priced in by the bankers in the interest rates, they are though perhaps unwittingly, effectively manipulating the interest rates. The direct consequence of it is that those officially perceived as not-risky, have to pay much less in interests than what would have been the case without this distortion, and those officially perceived as risky need to pay much more… and all for absolutely no good reason at all. 

And so when reading “Barclays fined a record $450m” for manipulating interest rates, my first thought was, “well done, but where can the “risky” small businesses and entrepreneurs also sue the regulators for all the monstrously excessive interests they have had to pay over the years? 

Simple calculations indicate to me that a not-rated bank client, exclusively on account of this odious regulatory discrimination, has to pay about 270 bp (2.7%) more in interest rates when compared to an AAA rated bank client… or, like now, in times of extremely scarce bank capital, suffer the consequences of being excluded from access to bank credit.

Europe needs to eliminate the subsidy of the “risky” to the “safe”.

Sir, Martin Wolf gives a good but incomplete analysis in “Look beyond summits forsalvation” June 27. 

Like all others intellectual prisoners of the bank regulatory pillar of capital requirements based on ex ante perceived risk, he fails to understand how all the banks are currently condemned to end up gasping for air, and capital, on the last officially deemed safe-havens in town, Bundesbank and US Treasury, more sooner than later. 

As a result he also fails to understand the artificially imposed regulatory subsidies that the “risky” European countries pay to the “safe”, by means of the much lower interest rates the latter must pay when compared to what would have been the case absent these regulations.

Bank regulations are beset with nanny populism

Sir, Nick Clegg in “Be alive to the risks and rewards of a banking union” June 27, states “We have put in place a bank levy, weighted towards riskier activities”. That is pure unadulterated bank regulatory nanny populism, as it implies that the government, ex ante, knows more than the market and the banks about which are the riskier activities, ex post. 

To know how wrong that is it suffices to see what caused the current crisis, namely excessive pure vanilla investments and loans to what was considered officially as not risky and therefore required minimum capital of the banks. 

Mr. Clegg, and all of you other intellectual prisoners of the current bank regulations paradigm, please do not forget that market and banks already clear for risks and so when a regulator does that too, he only produces dangerous distortions.

Credit rating agencies are just only other weathermen

Sir, imagine the old Mark Twain banker, he who wants to lend you the umbrella when the sun shines but wants to take it back as soon as it seems like it is going to rain. That banker would clearly be taking notice of what the weathermen had to say, to set the interest rates, the amounts of the loan and the other terms.

But what would happen if the regulators also told the banker that if the weatherman spoke of sun his bank was required to hold little capital but, if of rain, it had to hold more capital?

Obviously that would doom the Twain banker to choke on sunny expectations (AAAs and infallible sovereigns), and avoid possible rains (small business and entrepreneurs) like the pest… only to find out, too late, that weather reports are not always accurate.

Patrick Jenkins writes “Rating agencies still so relevant they need regulating” June 26. If he had understood the horrible consequences of the excessive and outright unmerited relevance given to the credit ratings, when deciding the capital requirements for banks, he would not be arguing for regulating these agencies but on reducing their relevance. Is the weathermen regulated?

PleaseFT, read the letter I wrote and that you published January 11, 2003

The correlation between the problem loans of banks and the lower capital requirements is 1

Sir bank regulators caused the current financial crisis by allowing banks to hold very little capital, for what was ex-ante officially perceived as not risky, and are deepening it by requiring them to hold more capital when there is none to be found.

Victor Mallet and Miles Johnson should really have titled their article “The bank that broke Spain” June 22 as “The Regulators that broke the bank that broke Spain” For how long will FT turn a blind eye to the sad fact that the Western World is drowning in seriously undercapitalized Bankias?

The Great Bank Retrenchment to the Last Safe Haven is on full speed ahead and so all our banks seem doomed to end up trampled to death on the shores of the Bundesbank and US Treasury.

What does Michel Barnier know about fairness?

Sir, Michel Barnier, the EU commissioner overseeing financial services calls on US authorities to apply regulations fairly, “The US must not seek to override EU regulators” June 22. Frankly, what does Michael Barnier, and other regulators know about fairness?

The regulators forced those perceived as risky and who therefore already had to pay higher interest rates, had less access to bank credit, and needed to accept harsher terms for their borrowings, to be additionally discriminated against, by means of causing higher capital requirements for banks than what is the case when banks lend to those officially perceived as not risky.

If that is not unfair what is? Especially when considering that no bank crisis ever has resulted from excessive exposures to what was perceived as risky, as these have always, except when pure fraud was present, resulted from excessive exposure to what had been believed to be absolutely not risky. 

And by discriminating that way so unfairly against the risky, the regulators themselves caused the current crisis, which is something they would have known had they dared to run a simple regression between the real current bank loan problems and their lower capital requirements, as it would have shown a correlation of 1.

Why do bank regulators subsidize Germany’s borrowings and tax Spain’s?

Sir, I refer to your “Eurozone weights another palliative” June 21, and many other writings referring to the increasing interest rates on some European sovereign borrowings.

The capital requirements for banks when lending to Spain, is much larger than when these lend to Germany, why? Is the risk differential not already imbedded in the rates? Is not the interest rate spread between those borrowers higher than they would be in a free market? Is this not counterproductive? Why does Germany receive a regulatory subsidy while Spain has to pay a regulatory tax?

Lacking a sufficiently large safe haven the Eurozone needs to stop its retrenchment.

Sir, Wolfgang Münchau, in “What happens if Angela Merkel does get her way”, June 18, asks “Why should citizens leave their money in local banks, when foreign investors are pulling out and when even the EU is making preparations to impose capital controls?” Indeed, why? But, worse so, why should they do it when bank regulators in Europe, by means of the capital requirements for banks based on perceived risk, have for a long time been ordering a European retrenchment to safety, foolishly believing that to be possible? 

It is of course the whole Eurozone that is in danger, as there is no way the Europe would find a sufficiently large safe haven for all. And this is why I have often found reason to mention that perhaps the Eurozone should not concern itself so much solely with Greece, Spain, Italy and Portugal, but more proactively try to find a more general solutions, based for instance on a Euro II, or a Euro-North and a Euro-South.

That could perhaps provide it with the tools to get out of this horrendous mess, detonated by bank regulations which among other allowed European banks to lend to Greece leveraging their equity a mindboggling 62.5 to 1... a mess made so much worse by now requiring they reduce to a 12.5 to 1 leverage or less that same exposure.

Mr. Sir Mervyn King and Mr. George Osborne, here is a much better proposal!

Sir I refer to Martin Wolf’s “We should not pin our hopes on Britain’s plan A-plus” June 16. 

Why should not those not creditworthy who want to borrow not be allowed to compete for access to bank credit on the same regulatory terms than those who are creditworthy but do not want to borrow? That is a question that Martin Wolf should try one day to answer, as currently the banks are required to hold more capital when lending to the risky than when lending to the not risky. 

This issue of discriminatory bank capital requirements is ignored over and over again, by those who feebly believe, even after all current evidence against such nonsense, that the best thing to do is to make sure that already risk adverse bankers avoid taking any ex ante deemed high risks. It is truly sad to see what a brave society can reduce itself to, when it allows its nannies to reign supremely. 

Instead of a temporary banking funding scheme such as is proposed by Mervyn King and or George Osborne I propose that regulators urgently calculate any individual bank´s capital to total assets ratio, and ask for it to apply a capital requirement that increases ever so slightly on any new asset it acquires… until reaching some basic goal. That way they would be able to put the banks on a stronger footing to lend, with much less distortion.

On the current banking reform plans, I feel more like crying.

Sir, First question: What is worse, a general systemic bank crisis that destroys the economy, whether inside or outside a ring-fence, or that taxpayers need to pay for some of the losses of that crisis? Clearly the occurrence of the systemic crisis is the worst since the latter is just a consequence, and the taxpayer would still have to pay in so many other ways. 

Second question: What caused and is causing the current crisis, bad lending and investments by the banks, or too little bank equity. Obviously the first, since if all bank lending and investment yielded a positive return for the bank, in theory there would not even be a need for bank equity. 

Third question: What really caused the current crisis, excessive lending to what was officially perceived as not risky, or excessive lending to what was officially perceived as risky? Clearly the first, because the bank exposures to what ex ante is perceived as risky, are of course, as usual, very small. 

Fourth question: What does Martin Wolf believe caused the excessive exposures to what was ex ante officially deemed as not risky, and that he believes has now been solved so much that he gives “Two cheers for Britain´s banking reform plan” June 15? I don´t know, but if asked he would probably give me a rundown of all macroeconomic structural imbalances. See also next post "Mr. Wolf think he´s understood the problem with risk-weighted bank capital. He has not!"

But I do know that what caused the banks to indulge excessively in “safe” exposures was the fact that when doing so banks were allowed to have much less capital, meaning much more leverage, meaning much more return on bank equity, than when lending to or investing in the already scary risky. 

And since we have yet to hear the regulatory authorities even acknowledging the problem with that silly bank capital discrimination based on perceived risks which have already been discriminated for before, when setting interest rates and deciding on the amounts, I find no reason to cheer, much the contrary I feel like crying. (Especially since I have explained this to Mr. Wolf in about a hundred letters, and he was also a member of the Independent Commission on Banking)

Mr. Martin Wolf think he´s understood the problem with risk-weighted bank capital. He has not!

Sir, Martin Wolf in “Two cheers for Britain´s banking reform plans” June 15, states that rejecting a general rise in bank equity “makes almost everything depend on risk-weighted capital: a fallible, even intellectually fraudulent, concept, as the Independent Commission on Banking´s final report”. And so one could think Mr. Wolf has now finally understood the problem with risk-weighted bank capital. Unfortunately, not yet! 

The ICB report states: “Risk-weighting has merit in principle but inevitable imperfections in practice. For example, the low risk weights attributed to some sovereign bonds have clearly been inconsistent with the market’s view of the likelihood of their default. So there is a strong case for capping total (un-weighted) leverage too, as a backstop.” And this basically means that ICB thinks the problem with the risk-weights is that these could be wrong. But that´s not it, it is much more intellectually fraudulent than that! 

The use of the risk-weights based on perceived risk is wrong even if the weights are perfect, even if they are consistent with the market views, because these perceived risks have already been cleared for by the banks (by means of the interest rate, amount exposed and other terms) and so forcing that risk perception to also affect the capital of a bank, dooms the banks to overdose on perceived risks. 

If you really want to have correct risk-weights for bank capital then these would have to be calculated based on how bankers react to perceived risks. And then, at least according to Mark Twain´s “a banker lends you the umbrella when sun shines and wants it back when it rains”, you might find instead a need for higher capital requirements for banks when the perceived risk of default of the borrower is low than for when the perceived risk is high.

Europe! Stop your regulators from playing risk managers… that is too risky

Sir, Niall Ferguson and Nouriel Roubini, in “Germany is failing to learn the lessons of the 1930s…” June 9, also fail themselves when not including the necessity of dismantling bank regulations that had the regulators playing risk managers handing out discriminating risk-weights which determined the final capital requirements for banks.

Had for instance a German bank, when lending to Greece, been required to hold the same 8 percent in capital it needed when lending to a German unrated small business, instead of a paltry 1.6 percent, implying an authorized leverage of 62.5 to 1, you can be sure that Greece would never have been able to borrow as much as it did.

How sad Europe is still being analyzed by looking at the facts using the wrong hypothesis… and therefore its crisis has not yet been fully understood.

It is of no use pouring water on a drowning plant

Sir, Samuel Brittan writes “You don´t need to be a lefty to support Krugman” June 8. Of course not! But, supporting aggressive government spending to remedy a recession produced by a crisis before eliminating the cause for it, is just throwing fairly good money after really bad. 

This crisis resulted from the imposition of capital requirements for banks which discriminated based on perceived risk, and created obese bank exposures to whatever was officially deemed as not risky and anorexic exposures to what is officially deemed as risky… and that discrimination is still in full effect.. especially when bank capital is more scarce than ever.

The “risky” borrowers should also complain about discriminatory bank regulations

Sir, Shahien Nasiripour and Tracy Alloway report on the concerns of some large US banks with respect to some new capital rules because these “will hurt them relative to overseas competitors” “Fed set to announce capital proposals”, June 7. 

These banks are of course in the perfect right to object any sort of discrimination, but, when will the Financial Times dedicate one single analysis to the discrimination that many borrowers are subjected to, when their bank borrowings give cause for a higher capital requirement than the borrowing of others? 

Does FT really think that a loan to a small business or an entrepreneur, he who already has to pay a higher interest rate and can only access a smaller loan than those who have officially been declared as “not risky” is correct, and does not create distortions? 

If you only report the complaints of the big banks… you are assisting them in becoming too big. 

If FT had complained in time about the fact that a UK bank was required to have 8 percent in capital lending to the grocery down the corner but only 1.6 percent if lending to Greece then perhaps we would not be in the current mess. Who knows? 

The article also reminds us that Jamie Dimon, chief executive of JPMorgan Chase, has decried the new Basel III rules as “anti American”, or un-American as it is usually expressed. But, again, that begs the question, if the American banks, according to Basel II and III, need to hold more capital when lending to American small businesses or entrepreneurs than when lending to foreign sovereigns or corporations deemed as not risky, is that not equally anti American?

Unions don’t work based on discrimination

Sir, you and others write about “Banking union and the euro’s future” June 6, without even referring to the disunion effect discriminatory capital requirements have. 

If you really want to start a banking union then you should start by allowing all banks to be required to have the same capital when lending to each other… and the same goes of course, for all lending to sovereigns. 

At this moment a Spanish bank needs for instance to hold much more capital when lending to Spain or to a Spanish bank that when lending to Germany or to a German bank, and that only stokes the eurozone fire.

PS. This was written before I knew of the Sovereign Debt Privilege that assigned all eurozone sovereigns a 0% risk weight even if they were taking on debt denominated in a currency that de facto was not their own domestic printable one. That was even crazier than Basel I or II.

When compared to irrational regulatory exuberance, the usual market one seems like small fry.

Sir, John Kay refers to an “implausible faith in the markets”, which clearly exists, and which is clearly dumb, but which, unfortunately, is surpassed by an implausible faith in the regulators, “Only market evangelist can reconcile Jekyll with Hyde”, June 6. 

Let us just look at one example. Basel II established that banks were required to hold 8 percent in capital when lending to an unrated small business, 1.6 percent when lending to a sovereign rated like Greece was recently and zero percent when lending to a truly “infallible” sovereign, like for instance Germany. 

And that meant that banks were allowed to leverage their equity 12.5, 62.5, and infinitely to 1, and with that regulators who with much hubris thought themselves capable to act as the risk-managers of the world, considered they had eliminated bank crisis forever. Has Mr. Kay seen any type of irrational market exuberance that surpasses this irrational regulatory exuberance?

The truth is the best anti-panic agent.

Sir, Martin Wolf is correct writing that investors who are buying “bonds at current rates are indicating a deep aversion to the downside risks”, “Panic has become all too rational” June 6. 

But, how he can he ignore the fact that the officially safe havens are also being crowded by banks forced there, by regulators, because parking their liquidity elsewhere would require them to have more of the currently so scarce bank capital? 

The best way to eliminate panic is to shine light on what has caused the emergency… but seemingly some cannot find it in themselves to do so.

Fooled by the nominal interest rates, Mr. Summers asks the government to fall for another type of teaser rates

Sir, Lawrence Summers is just another economist fooled by looking only at the nominal low interest rates for government debt of some “infallible” sovereigns, “Look beyond the interest rates to get out of the gloom”. Those interest rates do not reflect real free market rates, but the rates after the subsidies given to much government borrowing implicit in requiring the banks to have much less capital for that than for other type of lending. 

If the capital requirements for banks when lending to a small business or an entrepreneurs was the same as when lending to the government… then we could talk about market rates. As is, to the cost of government debt, we need to add all the opportunity cost of all bank lending that does not occur because of the subsidy… and those could be immense. 

Mr. Summers even suggests that governments should issue debt to buy government buildings it currently rents… and to me that sounds like tempting the government to fall for another type of teaser rates. 

PS. It is amazing that the Financial Times has not made an issue yet of the current interest rates not being what the market rates they are supposed to be.

All bank spreads are not alike

Sir, Michael Mackenzie, Ajay Makan and Nicole Bullock write that the spread on US consumer mortgages has widen over the last year when compared to that of Treasuries, “Mortgage rates fillip for banks”, June 4. 

Unfortunately, their analysis is flawed as it fails to take into account that all spreads are not alike, as to earn some require the bank to hold more capital than to earn others, and so in fact the complete opposite conclusion could be the valid one. 

In these days of scarce bank capital, had they run the figures on that which most generate capital requirements for the banks, namely the lending to the “risky” small businesses and entrepreneurs then they would have seen what borrowers are really hurting the most.