To pay taxes directly to your government, in your own name, no matter how small, should be a human right.

Sir I completely agree with Mr Serge Desprat´s letter of September 29 titled “Poorest may benefit from paying tax”, written in response to John Authers´ “Romney´s gaffe highlights difficulty of avoiding cliff” September 29. 

It is an absolute shame how much in taxes are paid by the poorest, for instance through sales taxes or, in my country Venezuela, by having their rightful share of oil revenues retained by the petro-dictator in turn, without any of those taxes being credited to their names, so as to allow them the feeling they have contributed with their nation, and that they have indeed a right to also hold their government accountable for what it did, with their own money.

“My tax paradise: (Nothing as powerful against tax havens as tax heavens)”

In Spain, I would half, at least, the capital requirements for banks when lending to risky small businesses and entrepreneurs.

Sir, if Spain cannot target too much its fiscal budget on growth and job creation, then it must allow others to do so. In your “The many crises confronting Spain”, September 28, you hold that “some of the non-budgetary measures – such as energy liberalization and educational reform should bring about a healthier Spanish economy once the crisis is over” “Once the crisis is over”, is of course good but clearly not sufficient. 

No, if I was responsible for Spain I would immediately half, at least, the capital requirements bank need to hold when lending to “risky” small businesses and entrepreneurs, those who stand the best chance of being the creators of the next generation of Spanish jobs. 

And that I would do in the knowledge that bank lending to these “risky” have never ever created a major bank crisis, only excessive lending to the “absolute safe” like real estate, AAA rated clients and “infallible sovereigns” has cause that. 

And just the fact of explaining the true causes of the Spanish crisis, namely that bank regulators allowed the banks to lend excessively to the “not-risky” without much bank equity, could also help to create the understanding required for the consensus needed.

A question from a humble reader to any of FT’s brilliant economists, on how banks assist in an efficient economic resource allocation.

Sir, undoubtedly FT must be interested in the banks assisting in allocating resources in an efficient way. In this respect, I would humbly request that you ask some of your great economists, like for instance Martin Wolf and John Kay, to answer the following: 

Let us suppose a bank with only two types of clients, those perceived as fairly “risky” and those perceived as “absolutely not risky” 

And then let us suppose there are two different types of capital requirements for banks methods: 

The first, let us call it the pre-Basel method, which requires the bank to hold 8 percent in capital against any loans to any of their clients. 

The second, let us call it the Basel method, requires the banks to hold 8 percent in equity for loans to those considered “risky”, but only 1.6 percent against loans to the “absolutely not-risky” 

I ask this because it would seem to me that, in the first case, banks would allocate their funds in accordance to what produces the largest risk-adjusted return to them on their equity, but, in the second, they would allocate their funds in accordance to whatever produces the largest risk adjusted return equity for the particular bank equity which regulators have decided should be held for that particular  asset… and, frankly, both methods can’t be correct from an economic efficient resource allocation perspective 

I, as you must be aware of by now, believe that the “Basel method” seriously distorts the resource allocation process, by dramatically increasing the possibilities of returns on bank equity for what is officially perceived as not-risky... and thereby dooming our economies, which for instance need their "risky" small businesses and entrepreneurs to have access to bank credit in competitive terms.  

But, since FT’s economists have absolutely refused to concern themselves with this issue during so many years, no matter how many letters I sent them, that could indicate that they know something that I, also an economist, do not know. Please, help me, what class did I miss?

PS. In case it is easier for your economists to understand what I am talking about with numbers, here are some very simple. 

Suppose that the banks would, during pre-Basel method days, have set the interest rates in such a way that the loans to the “risky” and to the “absolutely not risky” produced an expected risk adjusted margins of 1 percent. This would then have provided the banks with an expected 12.5 percent return on its equity (1/.08) on any of the loans. 

But, with the Basel method, and using the previous set interest rates, though the expected return on equity for lending to the “risky” would remain the same 12.5 percent, the expected return on lending to the “absolutely not risky” would now be a mindboggling 62.5 percent a year (1/.016). 

That would of course mean that banks could lower, by much, the interest rate charged to the “absolutely not risky”, or needed to increase, by much, the interest rate charged to the “risky” in order to provide them with the same return their equity as the "not-risky". Whatever, but, pas la même allocation de ressources.

Those with medical preconditions should fret, as Lord Turner and other bank regulators want to regulate insurers.

Sir, Brooke Masters and Alistair Gray report that “FSB committee turns its attention from banks to insurers” September 27, and they write that “the industry representatives present came away hopeful that their worst fears about the plans would be averted”. 

Yes, but perhaps those who really need to fret are the “risky” insurance risks, like those with medical pre-conditions, because if regulators, like Lord Turner, would apply the same principles when regulating insurers as they do when regulating banks, the insurance company would be required to hold more capital when insuring the “unhealthy-risky” than what they would need to hold when insuring the “healthy-not-risky”. 

And that would of course mean that those qualified as “healthy-not-risky” would see their premiums lowered and those perceived as “unhealthy-risky” would see their premiums go up, precisely like what happened with the interest rates charged by banks to those officially perceived as “not-risky” and “risky”.

Excessive regulatory risk-aversion caused the excessively risky bank lending to the “not-risky”.

Sir, Jacques de Larosiėre writes “The crisis has shown that bank failures are not related to specific structures but to excessive risk-taking”, “Do not be seduced by the simplicity of ringfencing” September 27. We need to carefully analyze the real meaning of “excessive risk-taking”, as a lot of dangerous confusion prevails in the debate.

First, it is absolutely clear that none of current bank failures have anything to do with excessive exposures to what was perceived as “risky”. Instead all failures were related, as is ordinarily the case with bank failures, to excessive exposures to what was perceived as “not-risky”, like AAA rated securities, real estate in Spain or “infallible” sovereigns like Greece. 

What was different this time though, and what makes this crisis particularly severe, is that the banks, like never before, were authorized by regulators to leverage their equity immensely, when holding those dangerous assets perceived as “absolutely not risky”. 

And so, in this case, any excessive risk-taking of banks was caused directly by the regulators excessively wanting the banks to avoid the “risky”, and they did so, stupidly, by stimulating the banks to take excessive risky high leverages exposures to what was officially perceived as “not-risky”. 

Sadly the above has not been yet understood by those who so simplistically equate a bad result with taking an undue risk. Sometimes, quite often in fact, a bad result is due from excessively avoiding taking risks.

What’s wrong with variation in banks’ risk estimates?

Sir, Brooke Masters reports on a “Wide variation in banks’ risk estimates” September 26 and I cannot but ask… what’s wrong with that? 

Is the one single standard risk estimate applied by petit bank regulatory bureaucrats supposed to be better? Like their 0% for UK, 20% for Greece and 100% for a small business? 

Markets are not about consistent risk estimates, they are all about different risk estimates. And so, NO! Set one single capital requirement for all bank assets, and then allow the banks, and the markets to do their own very varied risk calculations.

The eurozone might be better off fixing its banks the Chilean way

Sir, it is completely counterproductive for the economy if banks can comply with harsher capital requirements by switching to holding assets which require less capital. That is an aspect amiss in Philipp Hildebrand´s and Lee Sachs' “The eurozone should fix its banks in the US way". September 25. 

To have the ECB propose purchasing bank equity in order to blackmail private investor into increasing their bank equity while Basel II or III´s discrimination based on perceived risk is still in effect, does simply not work. 

Set instead a fix capital ratio for any asset, like 8 percent, for loans to infallible sovereigns the same as for loans small businesses, and then you will get some real action. 

If that would require too much capital then perhaps ECB, and Europe, could benefit from doing something along the way Chile did during its monstrously large bank crisis 1981-1983. Excluding for some foreign exchange considerations, those Chilean actions were in summary based on: 

a. The purchase of risky loans by the Central Bank by means of long term promissory notes accruing real interest rates and with a repurchase obligation out of the profits of the banks' shareholders before those promissory notes came due, plus some limitations on the use of their operative income. 

b. There was a forced recapitalization of the banks and in which any shares not purchased by current shareholders, would be acquired by the Central Bank, and resold over a determined number of years. 

c. And finally there was also an extremely generous long term plan for small investors to purchase equity of banks. 

The above, together with some strong revisions of bank regulations, helped to set Chile on a track that Europe would currently envy.

Basel III is dead because it is just as wrong as Basel II or even worse.

Sir, Brooke Masters writes that “Time is running out for the opponents of Basel III" as “it has been nearly two years since regulators from 27 countries struck a landmark banking reform deal aimed at preventing future financial crisis.”, “Basel naysayers delve into detail in battle to dilute reforms", September 29. That is sheer nonsense. 

If the "deal struck" had any chance to prevent better a future financial crisis then that could be correct, but, as it stands, it can only result in causing the repeat of another financial crisis, precisely because of the same reasons as the current. In Basel III, not only do capital requirements for the banks remain as in Basel II determined by the ex-ante perceived risks, favoring any assets officially perceived as “not risky”, and discriminating against assets deemed “risky”, but now, to top it up, the liquidity requirements will also do so.

I agree completely with those who want simplified rules and banks to rely exclusively on a “leverage ratio” and to that effect I have written some couple of hundred letters to FT over several years, which were all simply ignored in the name of I do not know what. 

But the real reasons for the need of change have not surfaced yet, basically because they are too embarrassing for those responsible, but they will, sooner or later, and you can bet on that. 

What happened? Bank regulators, scared witless by the possibility that bankers would expose themselves too much to assets deemed as “risky”, something that bankers never or very rarely do, created huge incentives for banks to concentrate on assets that were, ex ante, perceived as “not risky” and, in doing so, they fomented an incredible dangerous highly leveraged bank exposure to the “not risky”, something which has us already placed over the brink of disaster. 

You do not create jobs, or a sturdy economy, based on favoring the access to bank credit of the “not-risky” more than it is already favored, and thereby making it harder and more expensive for the "risky", like small businesses and entrepreneurs to access the bank credit they need. If you do so, your economy will become flabbier and flabbier, day by day, until it completely breaks down. Capice?

Why do development banks not understand that risk-taking is the oxygen of development?

Sir, you dedicate a Special Report on “The Future of Development Banks” September 24. 

As a former Executive Director of the World Bank (2002-2004), knowledgeable about many developing banks, and with over 30 years experience as a strategic and financial consultant for medium and small enterprises in a developing country (Venezuela), I again must reiterate that I find it extraordinary that development banks have not reacted against bank regulations which by favoring those perceived as “not risky” discriminate profoundly against those perceived as “risky”, like small businesses and entrepreneurs. 

Risk taking is in my mind the oxygen of any development, and I cannot therefore conceive a development path that goes through helping the “not-risky” to get ampler and cheaper access to bank credit than they would have without regulatory interference, and the “risky” to get scarcer and more expensive access to bank credit. 

For development banks to develop their possibilities to help in developing they need to embrace the “risky”… the “not risky” are sufficiently embraced anyhow.

To me, Mario Draghi is one of the regulatory devils in the eurozone drama.

Sir, Wolfgang Münchau believes Jens Weidmann’s fears of that Draghi and ECB, with an increase in the monetary supply, and the purchase of government debt, will medium term doom Europe to a great inflation, are unwarranted; or, the risks of that happening, given the crisis, are acceptable. And that is why he holds that “Draghi is the devil in Weidmann’s eurozone drama” September 24. 

I reiterate my opinion that stimulating the economy with any sort of injection, before making substantial structural changes to the economy, so as to give ground for credible hope that these injections will be productive, is an irresponsible waste of scarce fiscal and monetary policy space. And, those changes have simply not happened. 

Bank regulators, among them Mr. Mario Draghi, wanted the banks to avoid lending to the “risky” so much, that they ended up leveraging the banks very dangerously to the “not-risky”. And, pitifully, the regulators have still not understood what they did wrong. 

Any injections without a reversal of the capital requirements for banks based on perceived risk which discriminate against the” risky”, will only mean that the economy gets to be flabbier and flabbier. This is so because so many of the economy’s productive growth possibilities are to be found exclusively in the hands of the “risky”, like the small businesses and entrepreneurs. 

And so, even though I do not know all of Mr. Weidmann’s arguments and thinking, Mr. Münchau should by now know that, at least to me, Mr. Draghi is indeed one of the bank regulatory devils in the eurozone drama. And that I know without the need of reading Faust.

Must Michele Obama explain the causes and dangers of obesity to Ben Bernanke and bank regulators ? And to FT?

Sir, in your “Bernanke’s gamble is no free lunch”, September 22, you mention the possibility of QE’s diminishing returns, which would lead us into uncharted waters. Of course, QEs, and other stimulus, are dangerous, if not productive and self-sustainable. It is as easy as that. 

Sadly though, the QEs and other more traditional stimulus are now all bound to be unproductive, since banks, because of the way they are regulated, will mostly re-channel any new funds into holding assets perceived as “not-risky”, as these do not require from the banks much of that now so very scarce bank equity. 

What is missing in the debate, and FT's silence on that is almost embarrassing, is the fact that an economy needs “risky” loans to generate both its vitality and its flexibility. Inducing our banks to take cover in what is ex ante deemed as “not-risky”, only guarantees a type of economic flabbiness as well as a structural fragility. 

It is all like sending the kids out to play telling them “You can only eat the pastries ("infallible" sovereigns) and the well certified by your Aunt Moody hot dogs (AAA-rated), because I do not really know who cooked the vegetables (small businesses and entrepreneurs)”. 

Sir, must we call on Michele Obama to explain to Ben Bernanke and bank regulators (and FT) the causes and the dangers of obesity? 

For the umpteenth time, please understand that we need those perceived as “risky” to have access to bank credit, on terms free of regulatory discrimination.

Witless risk-adverse bank regulators are unwittingly destroying our economies. We urgently need regulators and bankers capable of "reasoned audacity"!

Is the financial transmission mechanism muddled? Yes, that is to say the least.

Sir, Gillian Tett writes that the “bigger worry is that the benefits of QE3 are so unclear, because the transmission mechanism is so muddled”, “Beware the high costs and psychology of America’s QE3.” September 21. 

And Tett reports on Richard Fisher, head of the Dallas Fed saying: “Nobody on the [Fed] committee… really knows what is holding back the economy. Nobody really knows what will work to get the economy back on course. The very people we wish to stoke consumption and final demand by creating jobs and expanding business investments are not responding to our [Fed] policy initiatives as well as theory suggests”. 

Muddled transmission mechanism indeed! How could it not be so when capital requirements for banks favor so much the lending to those perceived as “not-risky” and thereby discriminates so much against those perceived as “risky”. 

But I know for sure what is at least an absolute sine qua non to get the economy back on track, and that is getting rid of those discrimination based on perceived risks, and which almost amount to a class war waged by the “not-risky” against the “risky. 

It is the action of the “risky” which normally builds the muscles of an economy. Those “not risky” slowly, or fast, over time, most often turn into flabby fat. 

And Gillian Tett should know this after all the letters I have sent to FT, and to her, explaining the above. But, then again, as she recently wrote in “An internet free for all read by none” September 15, “People are clustering into tribes… only reading information that reaffirms their pre-existing social and political world view”, and, since I do not really belong to her mutual adoration tribe, she might not even have read my letters. 

PS. As I am putting together a Stupid Bank Regulations 101, for the benefit of those who like Martin Wolf do not get it, perhaps Gillian Tett would also like to take advantage of it.

Our economies, now turning very flabby, will soon fall into a permanent falsetto... unless

Sir, in Martin Wolf in explaining “The puzzle of the UK´s falling labour productivity” September 21 advances the possibility of one cause, suggested by Ben Broadbent of the Bank of England’s Monetary Policy Committee, namely that of “misallocation of capital dues to a defective financial system”. Wolf accepts it but does not believe it to be very important. 

Of course, if he cannot get a grip around the concept that allowing banks to leverage their equity more when lending to the “not-risky” than when lending to the “risky” introduces incredible distortions in the economy, and guarantees a flabby economy, he cannot think of it as important. 

The fact though is that funds are flowing to what is perceived as safe, and away from what is perceived as risky, in all Western economies, as a consequence of mindboggling stupid bank regulations. 

In this context, the small efforts to make up for the failings, like the one Wolf states he has proposed, namely that the government should insure the tail risk on bank lending to small and medium enterprises, are almost laughable. What he actually saying is that, insure the tail risk for these risky borrowers and then you might define them as “not-risky” and allow them access to bank credit in the same terms as those currently considered as “not-risky”. And that is not the way to go about correcting the mistakes made. 

Our economies, UK’s included, are castrated by the capital requirements for banks based on perceived risks, and, if nothing is done urgently about that, they might soon fall into a permanent falsetto.

PS. For the benefit of those who like Martin Wolf do not get it, I am trying to put together an introductory course, a 101, on the issue of Stupid Bank Regulations

The animal spirits, at least those of the banks, are not free to roam as they should.

Sir, Jesse Norman, a conservative MP in UK, writes that the recovery from a balance sheet recession, with a difficult process of deleveraging which reduces both demand and the effectiveness of monetary policy, requires not merely savvy economics, but a feel for animal spirits from policy makers”, “Britain has the political capital to boost investment” September 20. 

How I would like to sit down with Mr. Norman and explain to him how the capital requirements for banks, based on perceived risk, not only caused the explosion that brought us the balance sheet recession but, because this foolish regulatory discrimination, against what is perceived as risky, like the small businesses and the entrepreneurs is still well and alive, it also fundamentally hinders any recovery. 

Hopefully he finds time to read about it in my blog that contains my hundreds of letters, over many years, that I have written to FT on this issue, but that FT has preferred to ignore.

In the “Home of the Brave” the banks should not be induced to play it foolishly safe

Sir, James Bullard writes that after the large shock suffered by the US 2008 and 2009 “Patience is required to meet the Fed’s dual mandate”, of containing inflation and promoting employment September 20. 

It appears that Mr. Bullard believes that shock to be exogenous. I on the contrary am sure that the mega-shock was the natural result of capital requirements for banks based on perceived risks, which dramatically distorted the economy, in the US and in Europe. 

And those capital requirements are still distorting and do still discriminate against the “risky”, like the small businesses and the entrepreneurs… and, let's be honest, who can expect generating a new generation of jobs that way? 

No, if the Fed was truly serious about fighting unemployment, then it would requests that the capital requirements for banks had more to do with that objective, like basing it on potential-of-job-creation ratings, instead of on purposeless credit risk ratings, most especially since the perceived credit risks are already cleared for by the banks with other means. 

No, if the “Home of the Brave” wants to get out of a downward spiral, it cannot allow bank regulators to continue to induce the banks to play it foolishly safe. To do so, that would indeed be to inflict permanent damage on the US economy (and exactly the same, or even more, goes for Europe).

Before going after the titans of Wall Street, we need to go after the petit bureaucrats of bank regulations

Sir, John Kay ends an article that includes many truths about bank regulations with “the only sustainable answer to the issue of systemically important financial institutions is to limit the domain of systemic importance. Until politicians are prepared to face down Wall Street titans on that issue, regulatory reform will not be serious.” “Take on Wall Street titans if you want reforms” September 19. 

Yes, but, the systemically important financial institutions grew to be systemically important institutions, much with the help of bank regulators who, I do not really know with what authority, decided that banks could hold many assets against little or no capital, as long as these assets were perceived as “not-risky”. 

Had for instance Basel II decided that banks would need 8 percent of capital for any asset it held, we might still have systemically important financial institutions, but their systemic importance would be just a fraction of their current. 

And since there has been about five years since the crisis began, and current bank regulators have still not admitted the simple truth that their capital requirements based on perceived risk distort the markets, before we hit the titans of Wall Street down, we have to hit the petit bureaucrats of bank regulations who believe themselves titans in risk management down. 

John Kay also wrote that any capital target “will be gamed by those who observed the letter rather than its spirit”. Yes that is true, that is a fact of life, but, let us at least not have petit regulators also trying to simultaneously game the markets with their silly risk-adverse risk-weights. 

Frankly, who authorized bank regulators to do to our banks what they did?

Might Martin Wolf have too many “not risky” friends and too few “risky”?

Sir I completely share Martin Wolf’s concerns about “1930s…economic catastrophe with long lasting political results” “Bernanke makes an historic choice” September 19. And to that effect let me just reference the letter I wrote titled “The monsters that thrive on hardship haunt my dreams”, and that you so kindly published on the last day of 2009. 

But it is precisely because of it that I do not agree with any injections of any sort of stimulus, before we have eliminated the regulatory taxes on access to bank credit for those perceived as “risky”, and which result from the regulatory subsidies given to the access to bank credit to those perceived as “not risky”. That discrimination waters down any long lasting effect of QEs and fiscal stimulus, and is therefore basically setting us up for a monstrous inflation. 

I just cannot understand how Martin Wolf can keep silent, year after year, about the distortions produced by petit bank regulators, when setting their risk-adverse risk-weights which determine the capital requirements for banks. Or, is it that Wolf has too many friends among the “not-risky” and too few among the “risky”? If so, perhaps he should divulge his conflict of interest. 

Frankly, who authorized bank regulators to do to our banks what they did?

We must stop petit bank regulatory bureaucrats from distorting the markets with their risk-weights

Sir, George Magnus opines that “Draghi’s bond-buying plan is economically unsound” September 18. I fully agree with him but for a reason he does not mention, or is perhaps not even aware of. 

Most of those funds that ECB’s “outright monetary transaction” generate more sooner than later, will flow through a banking system that has become regressive, as a consequence of bank capital requirements based on risk. 

If regulators are not willing to allow the funds to flow where these could be most productive, but insist on these flowing to where they ex-ante believe these to be safer, they completely ignore the role of the market… and that is as economically unsound as it comes. 

We must urgently allow the market decide without some petit bank regulatory bureaucrats distorting its functioning by assigning, quite haphazardly, the risk-weights which decide how much capital each bank needs, and, with that, who in this bank capital scarce world, gets the loans.

Professor Summers still lives in blissful ignorance about our most urgent “magneto” problem.

Sir, Professor Lawrence Summers writes that “short run increases in demand and output would have medium to long term benefits as the economy reaps the rewards of what economists call hysteresis effect”, and that this calls for more public investment, “Britain risks a lost decade unless it changes course”, September 17. 

I can only understand that as a result of him still being in blissful ignorance of current bank regulations, which artificially favor access to bank credit, solely on the basis of being perceived as not-risky, and thereby makes the access to bank lending to those perceived as risky, like small businesses and entrepreneurs, scarcer and more expensive than normal. 

When will Professor Summers get to know that those regulations represent in fact the most urgent “magneto” problem that needs to be fixed, in the UK, in the rest of Europe and in America for our economies to run? Before that, any public investments based on deficit public budgets, and any lose monetary policy for that matter, can only threaten to further flood the engines and consume what’s left of scarce fiscal and monetary policy space.

No more QEs and fiscal stimulus. Bet on a bank stimulus for the “risky”, in America and in Europe

Sir, Wolfgang Münchau writes on “Why QE would be the right policy for Europe, too” September 17. Since I do not feel Bernanke’s QE is correct either, I cannot agree with this. 

It is high time to forget about any QEs and or fiscal stimulus, decided on an implemented by bureaucrats at a long distance from the real markets, and which have only consumed scarce monetary and fiscal space, with very little sustainable to show for it. 

Instead we need the banks to direct those stimulus flows to where these are most needed and could be the most productive. And this, governments can do, without asking anyone’s permission, or worry about any unconstitutionality. All it takes is that they instruct the bank regulators to drastically reduce the capital requirements for banks when lending to what is perceived as risky small businesses and entrepreneurs. 

Would this be reckless? Not at all, or at least much less than when allowing the banks to hold very little when lending to what is perceived as not-risky, precisely the type of exposures that have always been behind any major bank crisis.

If a new QE is politically mistimed I do not know, but it sure is still economically mistimed

Sir, I refer to your “Bernanke’s latest round of easing”, September 16, where you comment on Romney arguing on Bernanke bailing politically out Obama. 

I do not know if this latest QE is mistimed because of political reason, I do not really care about that, but what I do know, is that not only the latest but the all the former QEs, and fiscal stimulus too, have been mistimed because of economic reasons. 

Having had frequent experiences in workouts, I know you do not inject any fresh funds into any failed project, until you at least believe you have made the changes required for its success. And, as far as I know, central banks and governments, confronting the crisis begun in 2007, have been wasting away immense monetary and fiscal spaces, like if there was no tomorrow, without imposing any sort of changes in then economy. 

As an absolute minimum, central banks and governments should have eliminated those ridicule regulations that make it so hard and expensive for those perceived as “risky” to access bank credit, like the small businesses and entrepreneurs… precisely those who generates the jobs that Bernanke now says he cares so much about.

A wicked question for the candidates for governor of Bank of England

Sir, as you write, finding a governor of all the talents required to run the Bank of England, is indeed an extraordinarily important and formidable task, September 14. 

But that is under normal circumstances. Currently though, given the difficulties with the banks, even more important and urgent than that, is to find a better regulatory paradigm. And for this purpose, I would begin by asking each candidate for governor, the following simple question: 

When do banks most need capital, when the risky turn out risky, or when the “not-risky” turn out risky?

And then follow it up with a “So?”

We need more widows and orphans as shareholders of our banks

Sir, the capital of my homeland (Caracas, Venezuela), used to, for over a hundred years, have its electricity needs well serviced by a private company run by electrical engineers, and its shareholders were mostly widows and orphans. But then came the financial engineers and took it over, and leveraged it to the tilt, and the consumers were not longer its prime focus of interest, the speculative shareholders were. How we wish we could have the old company back. In this particular case that seems impossible because it has since then been taken over by the Petrostate. 

I mention this because John Gapper, though mentioning “the targets for returns on equity” leaves aside the issue that different shareholders might have different targets, “The financial incentives to behave badly will endure” September 13. For instance, if capital requirements for banks were substantially increased, that would of course diminish the returns on bank equity, but that could also help to make banks safer investments, and with that attract the widows and orphans who could be happy with lower but safer returns. 

As a client of any utility, whether electricity or banking, I would like its shareholders to be widows and orphans, and so should the regulators.

Let us welcome John Kay’s awakening. Better late than never! Let us now hope he wakes up completely

Sir, John Kay, refers to “Goodhart’s law”, from the 1970s, which states that “any measure adopted as a target loses the information content that appeared to make it relevant. People [bankers] change their behavior to meet the target”, “The law that explains the folly of bank regulation”, September 12. 

Well, if that law was known, one could have presumed someone would have alerted the bank regulators about that, when they in the Basel Committee were concocting their capital requirements for banks targeted based on perceived risks. Where was Charles Goodhart, and those who knew of his law, when we needed him? 

The fact though is that in this case it was even worse, forget about “changed behavior” because when regulators set their capital requirements, they even ignored the initial behavior of bankers when reacting to the perceived risk, and which of course ignored the fact that bankers already had a propensity to go for the “absolutely not risky”. And, in doing so, they doomed our banks to a crisis larger than ordinary bank crisis. 

But now at least John Kay writes about the Basel Committee’s “irrelevant” “conclaves”, held “to give politicians and the public a sense that something is being done while enabling banks and regulators to go on doing what they have always done”. But, honestly, that Kay can do so without the slightest word of “sorry”, after he in the midst of this monstrous crisis has himself, for years, blithely ignored Goodhart’s Law, is sort of sad. 

That said, let us welcome John Kay’s awakening, better late than never, and let us hope he now wakes up completely. 

PS. In http://teawithft.blogspot.com/search/label/John%20Kay you will find the letters I have written in response to John Kay’s articles.

If prudent finance requires partnerships, why then are not regulators also made liable for bank losses?

Sir, when Basel II states that banks need zero capital when lending to an infallible sovereign and 1.6 percent when lending to slightly more suspect sovereign or private AAA ratings, what does that say with respect to shareholders of the bank? The answer is that for all practical purposes the regulators feel that for that business the shareholders are not really needed. 

And that is why when I read Martin Jacomb’s “Prudent finance requires a return to partnership” December 12, my first reaction was… do we then need credit ratings for the partners?, and my second, should the not bank regulators also be partners of the banks they regulate? They assign risk-weights too, don't they? 

Frankly, before thinking about how to create partnerships able to shoulder the too big to fail, we should be thinking to make shareholders at least 8 percent important, for any type of bank business.

Europe needs an urgent explicatory mea culpa from Mario Draghi and colleagues.

Sir, Martin Wolf, in “Draghi alone cannot save the euro” September 12, writes the following: 

“But the risks of a breakup [of the eurozone] cannot be eliminated. If these are to disappear, citizens of debtor countries must see a credible path to growth, while citizens of creditor countries must believe they are not throwing money down a bottomless pit… Is there any way the ECB on its own could make it more credible that the eurozone will last?” 

Yes there is. Mario Draghi could do a mea culpa, and explain to Europe how he, and his regulator colleagues, messed it all up by distorting the markets with their capital requirements for banks based on perceived risk, which helped create and finance much of the existent “bad equilibrium”. 

That regulation made the banks run for the “absolutely-no-risk” areas, because there was where they could leverage their equity the most, and this not only caused some fairly safe havens to become dangerously overpopulated, like Greece and real estate in Spain, but also stopped small businesses and entrepreneurs from accessing bank credit at competitive rates. 

And then so as to explain how much they understand how wrong they did, he should ask his regulating colleagues, to start looking in at capital requirements for banks with a purpose, like based on job creation potential ratings. 

Then Europe would know why it all went so wrong and therefore be able to believe in why it can be saved… but, again, that of course requires a fair dose of humility from Mario Draghi and colleagues. 

The Fed is actually stopping the money from flowing where it, and we, most need it to flow.

Sir, Ruchir Sharma writes “The Fed can print all the money it wants – but it cannot dictate where it will go” “For a true stimulus, the Fed should drop QE3” September 11. 

Actually it is much worse than that, since the Fed, by means of capital requirements based on perceived risks imposed by their colleagues, the bank regulators, is dictating where money, or at least bank credit, should not flow, which is precisely where we and they would most want and need it to flow… to small businesses and entrepreneurs. 

Get rid of the distortions produced by bank regulators with a lot of hubris playing risk managers of the world and then perhaps a QE3, or better yet a helicopter drop, might actually have a chance to work.

Mr. Draghi is just naturally scared, shooting into the dark night.

Sir, “Why has Mr. Draghi done it?” asks Gideon Rachman with respect to ECB’s announcement of “unlimited” purchases of bonds, “Democracy is the loser in the struggle to save the euro” September 11. 

The real answer is of course Mr. Draghi is scared, as we all should be of course, but, because he does not really understands what is happening, he has no other option than to massively and blindly shoot into in the dark night. 

Again, I repeat anyone who does not understand the extent of distortion and damages produced by the capital requirements based on perceived risk does not know how we got here or how we get out of it. 

 And yes, if democracy is going down the tube, so is transparency. Article 32 of the Regulations of the European Financial Stabilisation Mechanism, ESM, states: “The archives of the ESM and all documents belonging to the ESM or held by it, shall be inviolable.” 

Does Europe really have to step back into the dark ages in order to go forward in the 21st Century?

Interest rates are low, but the ratio of rates to the “risky” over the rates to the “infallible” is probably the highest ever.

Sir, John Authers quotes Deutsche Bank’s market historian Jim Read on us “entering the unknown” with respect to the interest rates being “so low, for so long, for so many”, and he writes in UK “the base rates are at the lowest in 318 years, “London property market cannot avoid mean reversion” September 10. 

Absolutely, but those are the rates for those in the center rated absolutely safe, those so much favored by accommodating capital requirements for banks. If he wants to see a quite different story, he should look at the ratio between the interest rate charged to the “risky”, those living in the periphery, like small businesses and entrepreneurs, divided by the interest rate charged to the officially “infallible”, and he might then find that ratio larger than ever. 

If the current mean, which has resulted from these capital requirements is to revert to some historic standard then regulations should also conform to a historic standard. 

Authers also writes “Bank of England’s balance sheet is its biggest, compared with the size of the UK economy, since the records began in 1830”. But, to get a real grip on the true monstrous size of that balance sheet, he should perhaps also include how much QE all those commercial banks, acting almost as quasi-branches of the central bank, have provided to government’s treasury, because that requires little or no capital of them.

Give back to markets the role of risk management for the world which the bank regulators usurped

Sir, Robin Harding and Chris Giles when reporting on the current travails of central bankers they quote Donald Kohn of Brookings Institute saying “something deeper going on” referring to “something structural [that] has changed to hold back growth”, "Not so different this time", September 10. 

I guess you know what I am about to say. Yes! That “something deeper going on”, is the incredible discrimination in favor of what is perceived as “not-risky” and against what is perceived as “risky”, and which is present in the current capital requirements for banks based on perceived risk. 

Of course these central banker’s don’t know what to do, their instruments are all wrong, they have no idea of what the real market rates would be for the debt of their "infallible" sovereigns, if banks needed to hold as much capital than when lending to the more fallible citizens. 

Never before have bank regulators taken upon themselves the role of playing risk managers of the world. We need that role to be given back urgently, to the markets.

An essential part of the narrative on the eurozone crisis is withheld, among others, by FT

Sir, Wolfgang Münchau, in “Why Weidmann is winning the debate on policy”, September 10, writes the following: “The German public has bought into the narrative that the crisis was caused by profligate southern European and consumers who had wasted the first decade of their membership of the eurozone indulging in a debt financed housing and consumption boom. It is a false morality tale, mostly devoid of economic reasoning. But this has not stopped it from becoming the dominant narrative. Not enough politicians, certainly not enough journalists and commentators are pushing against this narrative” 

And I ask again why is it that FT resists to present my argument of that this crisis was doomed by the regulators, some of them Germans, to happen? The fact is that for instance a German bank, was allowed to lend to a Greece holding only 1.6 percent in capital, making it possible for it to leverage its equity 62.5 to 1 with Greece´s risk-adjusted returns, while, when lending to a German small business or entrepreneur, it was required to hold 8 percent in capital, meaning it could only leverage its equity with those risk-adjusted returns, 12.5 to 1. If you do not think that this fact is an essential part of the real narrative of what has gone wrong, I just do not understand you. 

(Would it really hurt the FT´s ego so much acknowledging that little me, who has written hundreds of letters to you about it, was correct, and so that you prefer to shut up about it? Poor Europe... with friends like that)

Defining the purpose of banks, would be good regulatory behavior

Sir, Bradley Fried writes that when the Commission of Banking Standards resumes it work, it needs to look at the human behavior of the bankers, “Banks have to learn to compete on good behavior”, September 10. And he is more right than he imagines. 

Had for instance regulators been as perceptive about the behavior of bankers as Mark Twain, with his their wanting to lend you the umbrella when the sun shines and take it away when it rains, they would never have come up with such daft regulations as their capital requirements for banks based on perceived risk. Or, if they had still used perceived risks, then perhaps they would have set these totally opposite to the current ones, the lower the perceived risk the higher the capital requirement. 

But let us hope bank regulators also learn to compete on good behavior, and come understand that, when you regulate something, it is good behavior first to define its purpose. 

FT, do the “not-risky” need additional help accessing bank credit and the “risky” need to be hindered more?

Sir, do you really think that giving those perceived as “not risky”, like those rated AAA, regulatory assistance in their access to bank credit, and which of course translates into hindering the same more for those perceived as risky, like a small business, is an acceptable and worthy distortion of the market? 

Apparently you do, that is unless you have not yet been able to understand, what capital requirements for banks based on perceived risk does.

Are you, FT, Ok with this?

Sir, are you Ok with Article 32 of the Regulations of the European Financial Stabilisation Mechanism, ESM, which states the following: 

“The archives of the ESM and all documents belonging to the ESM or held by it, shall be inviolable.” 

Is that not taking Europe back, fast, to the dark ages?

And why did FT mostly ignore also this for about a decade?

Sir, what Mr. Robin Monro-Davies tells you in his letter “Making Basel III look like a doodle” September 8, is what I have been telling you for about a decade and which you basically, for reasons I cannot understand, decided to ignore. 

I greeted regulators during a workshop at the World Bank on Basel II in May 2003 with a “I congratulate you, we can already begin to see how Basel II is forcing bank regulators to make a real professional quantum leap. As I see it, you will have a lot of homework in the next years, brushing up on your calculus—almost a career change.” 

And I have also often warned about “Solvency II” taking the “Basel II” route.

And why did FT mostly ignored this for about a decade?

Sir, what Mr. Keith Phair tells you in his letter “Caveat Emptor should be everybody´s maxim”, September 8, refers precisely to something I have been telling you for about a decade, and which you basically, for reasons I cannot understand, decided to ignore.

A prominent and important FT journalist interviewed invisibly on my empty chair?

Sir, I recently sat down a prominent and important bank regulator invisible on an empty chair and made him some questions. And I am sort toying with the idea of now inviting a prominent and important FT journalist, to do the same. I tell you why. 

Over the last decade I have been writing literally hundreds of letters (over 700) to the Financial Times referring to the fact that the current capital requirements for banks, based on perceived risks, constitute a formidable and dangerous source of distortion of the markets, to such an extent that it can even be blamed for the current crisis. 

Why distortion? Setting the risk-weights which determine the capital requirements for the banks, in a quite arbitrary way, means that the regulator is, in a very non-transparent way, intruding in how the market evaluates risks. That they for that purpose use the same risk perceptions which are cleared for by not blinds bankers makes it so much worse, as that only guarantees that the banks will overdose on the perceptions of risk. 

Why dangerous? Because by giving the banks additional incentives to search out the “not-risky”, that will cause a dangerous overpopulation of the safe-havens. And also because by giving the banks additional incentives to stay away from what is officially perceived as “risky”, the banks will not perform adequately their role of allocating capital in the markets. 

But you the Editor, and the journalists in FT, have for all practical purposes been totally silent about this. I have been told by one of you that I am just too monothematic, which if you look at all my letters is really not true, but, even if so, that would be something much less serious than your monothematic silence. 

When I hear one of you described as an “uncompromisingly pro-market columnist”, but he is still incapable of understanding and much less defending the market against this really unauthorized regulatory intrusion, I do not know whether to cry, or whether to believe that he is just too dumb to get it, or whether he has his own agenda.

Yes, occasionally, someone in FT refers to some of my arguments, but then, always in a very partial way. 

Imagine what could have happened to bank regulations, Basel III and other, if FT had helped to give me voice, earlier, in time. Can you imagine how much buildup of dangerous exposures to what was perceived as absolutely safe could have been avoided? Can you imagine how much better use we could have given to that scarce fiscal and monetary policy space that is being consumed so fast? 

Why was I and my arguments censored this much by a paper that so bravely announces in its motto "Without fear and without favor"? 

Dumb bank regulatory nannies… talk about a real hazard!

Sir, James Mackintosh in “ECB bazooka faces peripheral tests” writes about ECB’s recent “grand plan to save the euro” and of the moral hazard “that Spain or another beneficiary fritters away the savings from cheaper financing in order to please voters”. 

The hazard of that moral hazard is relatively small when compared to the hazard of having banks regulated by nannies who do not understand what they are doing. 

When a regulator allows a bank to have less capital, only because a borrower is perceived as “not-risky”, he is effectively, de facto, discriminating against those perceived as “risky”, like the small business and entrepreneurs. And, discriminating against the access to bank credit of these so needed “risky” risk-takers is, more or less, a death sentence to our economies.

FT, your protégé Draghi, before any audacious gamble, should dismantle overly-cautious-nanny bank regulations

Sir, in your “Mario Draghi’s audacious gamble” September 7, you write: “The eurozone’s financial market is fragmenting. The wide divergence of rates between different countries is raising fears that the monetary policy mechanism may be broken.” 

That is correct, but again you do not mention how current bank regulation, with its capital requirements based on perceived risk, fragmented the markets, and is now responsible for the widening of interest gap between those countries officially perceived as absolutely safe and those as “risky”. 

For those regulations, your protégé Mario Draghi is very much responsible, and so before any “audacious gamble”, he would do much better dismantling those really dumb overly-cautious-nanny regulations.

The euro-battle will only weaken the whole eurozone (and the rest of the world too)

Sir, John Plender points correctly to the nasty realities of a credit-debtor relationship, in “Only the weakest will triumph in the euro battle” September 7. That is of course a slight exaggeration of his, since he knows there is no real triumph for the weaker either. 

The eurozone got messed up because their bank regulators gave banks excessive incentives to lend to what was perceived as “not-risky”, like Greece or Spain’s real estate sector, and the eurozone cannot now get out of the crisis because their bank regulators now give the banks excessive disincentives to not lend to what is perceived as risky, like Greece or Spain. 

And if the major creditors, those for the time being the last standing “not-risky”, the stronger, think they can get away with regulatory discrimination against the risky, the weaker, at no cost for them, then they’re just dumb. 

It might well be that “The reality is that the ECB’s new initiative may prove to be just another transfer to distress debtors” but the fact is that this is not only about redistribution within Europe as it can also be, if badly handled, about the general impoverishment of the whole Europe (and the rest of the world too).

And what if an expelled Greece insists in using the euro?

Sir, Ralph Atkins discusses that the “Fear of a Greek exit could strengthen Draghi’shand” September 6. 

Again the possibility that Greece defaults, the others get mad and expel Greece from the eurozone, but Greece keeps on using the euro, is not discussed. Why? To me that sounds as the most reasonable proposition, so that Greece does also not lose what it has left marketing a hard to sell neo-drachmas. 

And why is so little discussed about making the best out of all those funds held by Greeks outside Greece? Is it that it would have been preferably that those funds had been lost too?

We need solutions not solely based on finance ministers and central-bankers

Sir, Michael Steen reports “All eyes and ears on Draghi over bond proposal” September 5.

Sincerely why should the solution to the current crisis come down exclusively from ministers of finance and central bankers? Especially when it was the bank regulators they appointed who messed it all up? 

Sincerely any solution, without major economic structural changes occurring, among other in bank regulations, will only be kicking the can further up the slippery slope.

We need to think urgently about how for instance manage to channel the private Greek savings, which luckily have not also been lost, into solutions more helpful than the buying of location-location-locations in London. 

On a recent Labor-With-No-Jobs-Day, I speculated about an idea that could be good for Europe, and for America to explore and here below is the link:

http://teawithft.blogspot.com/2012/09/theres-economic-war-raging-out-there.html

There’s an economic war raging out there, so we need ministers and bank regulators with vision, not janitors and nannies!

Sir, Josef Joffe’s “Merkel’s case of good politics and bad economics” September 5, makes a solid case for buying gold and go to church and pray (and perhaps buy a gun) 

What can I say? There’s an economic war raging out there and we need our finance ministers and bank regulators to be men of vision, not janitors or nannies! Has anyone seen a Lord Keynes lately? 

Personally, and not as a Lord Keynes by any means, but as a simple consultant with quite a lot of workout experience, on a recent Labor-With-No-Jobs-Day, I thought that the following could be a good idea for Europe and America to explore: 

There is currently a tremendous scarcity of bank capital, and all fresh capital raised is going to plug holes instead of generating the new business needed… and so we are in dire need of traditional bank capital, not that silly modern stuff. 

In this respect I would gladly contemplate granting a 15 years full exoneration from corporate and dividend taxes, to whatever bank capital is raised by a banks that agrees to hold 15 percent in capital against any asset, no matter how safe or risky it might seem. 

There is a world of productive risk-taking waiting out there to get our youngster their generation of good jobs… let’s give them a chance. 

I would love to see 500 billion Euros (dollars) in this type of fresh bank capital...which could be leveraged into over 3 trillion Euros (dollars) in loans which do not discriminate based on perceived risks more than what they should ordinary do in a free market. 

That could mean a fresh start for our economies and a full-stop to that other war our current bank-nannies are waging against the "risky".

Bank regulators should keep it simple, and not allow complexity to distract them from their real business.

Sir, as you know by now, I agree completely with the need for simplifying bank regulations, like recently suggested by Andrew Haldane, and now also strongly supported by Sebastian Mallaby, “Regulators should keep it simple”, September 5. 

But, my reasons for doing so, are not really because the issues are too complex, and the data is too hard to gather, but because the regulators have no role playing risk-managers to the world, and thereby risk adding distortions to the markets; their role is to prepare for when complex risk-management fails. 

Look at what happened! Bankers react of course to the perceived risks, by means of interest rates, amounts of exposure and terms of loans, and so, when too creative busybody regulators came along and used the same perceived risks to set their capital requirements; the whole banking sector overdosed on perceived risks… and so now we have a crisis because of obese dangerous bank exposures to what was perceived as absolutely safe, and anorexic bank exposures to what was officially perceived as “risky”, like small businesses and entrepreneurs. 

There is an economic war raging, so we need ministers and bank regulators with vision, not janitors and nannies!

Mr. Draghi, nothing good comes from distorting the markets

Sir, Wolfgang Münchau, in “Here is my one piece of advice for Mr. Draghi” September 3, writes “the banking sector intermediates the imbalances that have arisen in the real economy”. 

Is Mr. Münchau really sure about that? The way I see it the regulators, with their capital requirements for banks based on perceived risk, and their risk weights, both create and intermediate more than the banks the imbalances in the real economy. 

Can you for instance think of what would happen if a German bank needed to hold the same amount of capital when lending to a small business in Greece than when lending to the German government. 

My advice for Mr. Draghi, without any doubts, would be to stop his colleagues the bank regulators from distorting the markets, since nothing good can come of that.

The bankers are what bankers always have been… not so bank regulators.

Sir, in “Changing Banking” September 3, you hold that “banks need to behave more responsible”. Of course, who would argue with that? But the subject you avoid touching with a ten foot pole, is that bank regulators too, must behave much more responsibly. 

Just as examples they are irresponsibly regulating the banks without having defined a purpose for the banks and they have irresponsibly appointed themselves as risk managers for the world, doling out risk weights here and there, which determine the capital requirements for the banks and which so dangerously distort the markets. 

No! The bankers are what bankers always have been… not so the bank regulators. 

PS. Yesterday I managed to sit down a prominent and important bank regulator in my chair, though he remained invisible and quite silent 

http://subprimeregulations.blogspot.com/2012/09/a-conversation-with-prominent-and.html

Yes, Basel III has to be thrown out the window, in its entirety, current bank regulators too

Sir, Brooke Masters, September 1, reports that Andrew Haldane, at Jackson Hole, made a “Call for simpler bank oversight” which “would require an about-turn from the regulatory community from the path followed for the better part of the past 50 years”. 

As you must know by now, even though you quite diligently have set your mind on ignoring it, I have for almost a decade held that bank regulators are not just some few degrees wrong, but 180 degrees wrong, and so I cannot but agree with Haldane. 

His argument is in line with that of mine that holds that, by accepting to engage banks through complex regulations, the regulators have acted less as regulators and more as risk-managers… which does not make any sense, since a regulator’s prime responsibility is to prepare itself for when risk-management fails. 

But there are of course many more reasons to throw Basel III, and the current Basel Committee regulators too, out of the window. Unfortunately, no matter how wrong one can prove them to be, getting rid of it and them is no easy task, especially when even a Financial Times want to treat them with kid gloves.