August 30, 2013

The Financial Stability Board, one of the Great Distorters, goes at it again

Sir Brooke Master and Tracy Alloway write about how the Financial Stability Board is focusing on securities lending, like the “repo” market. “Shadow banks face fresh limits to trading” August 30.

The FSB wants to impose: “a minimum .05 percent haircut for corporate debt securities with maturity of less than a year – so a $100 security could be used to raise $99.50. Equities and securitizations made up of debt with durations of five years and longer would be hit by a 4 percent haircut” allowing consequentially these latter only to be able to raise $96 for each $100,

Here one of the great distorters goes at it again. Do they not understand that by differentiating between short and long term they are distorting how the markets will allocate financial resources.

Come on FSB, in general terms of stability, what is wrong with long term debt? In terms of needed liquidity... does not long term debt need that perhaps even more than short term debt?

And I sure hope that Mark Carney, the Bank of England governor, and the FSB chairman, was joking when he called the proposal “an essential first step towards… transforming shadow banking into market-based financing” If not… “Houston we’ve got a problem”

An absolute capital requirement for a bank, expressed in pounds, euros or dollars, is not a good idea.

Sir, Martin Sandbu, holds that regulators should require and publicise absolute capital requirements for banks, not as a fixed equity ratio, but in terms of an absolute level of equity expressed in pounds, euros or dollars “to be reached regardless of how the balance sheet evolves over the review period”, “Ignore the bluster from banks over capital requirements”. August 30.

Except for as a temporary emergency measure, that sounds like a bad idea.

That would make it even more impossible than now for the market to know what the real capital requirement for the banks is; leading to that many who could be interested in being shareholders in a bank would postpone their decision to invest; meaning that would place our banking system into the hands of some regulator’s risk-models (1.6 percent capital when lending to Greece?); meaning the regulatory risk weighting that so distort bank credit allocation in the real economy would only have found another way of express itself; meaning that banks would, for political purposes, sooner or later, would be need to conform with being "a friendly bank".

But, since an absolute level of equity de facto operates as an equity ratio making risk-weighing irrelevant for the bank, for a while at least, much better would be to go for a one and the same equity ratio for all banks that makes prudential sense... in my opinion the 8 percent basic capital requirement of Basel II which was a good number… until it got so risk-weighted down.

Of course then you need to help and support the banks to reach those capital levels that for many banks now seems only like having to reach for the stars.

August 29, 2013

Do not allow our banks to live in nontransparent exploiters paradise, and do not sell us any new bank regulatory voodooism

Sir, I refer to Tim Harford’s “Markets must force banks, like petulant toddlers, to grow up” August 29.

In it, with respect to the simpler rules that Bank of England’s Andrew Haldane has been championing Harford writes that “simpler rules would soon be exploited”. Absolutely, every rule is exploited but simpler rules are exploited in more transparent ways. Has not Harford seen the Basel III updates and the 16.000 and more pages of the only 50 percent completed Dodd-Frank act? Those really represent a nontransparent exploiters paradise.

And then Harford begin selling us some “equity recourse notes” (ERN) proposed by Jacob Goldfield, Jeremy Bulow and Paul Klemperer as the new miracle cure, writing that “banks will not be able to go bankrupt because it will always be possible to repay ERN holders”. Nonsense!

I would ask, what if all banks had held the ERN during the current crisis? Would that have made the consequences of the losses sustained in AAA rated securities and loans to Greece which resulted from regulatory distortions, any easier on the real economy? Not much! How the costs of misallocations are distributed might indeed have a lot to do with justice, but, in terms of the overall real economy, a loss from a misallocation is a loss, no matter what pocket it hits.

Sir, again, for the umpteenth time... why is society well served by allowing banks to earn higher risk-adjusted returns when lending to "the infallible" than when lending to "the risky"?

Scary stuff! Mark Carney’s speech evidences he still knows too little about the real economy.

Sir, Mr. Mark Carney, in his speech in Nottingham on August 29, 2013, which you commented on in "Carney toughens his dovishness" he said the following:

“The Bank of England has established a threshold for the capital base of the major banks and building societies after taking account of likely future losses, fines for past misconduct and prudent calculations of risk. That threshold, a capital base of 7% of their riskweighted assets and at least 3% of their total assets, must be crossed if the system is to be able to support and sustain the recovery”

And so Mr. Mark Carney, none less than the Governor of the Bank of England and the Chairman of the Financial Stability Board, believes it is ok to allow the banks to earn higher risk adjusted returns on their equity when lending to “The Infallible”, to the AAAristocracy, than when lending to “the risky”, namely the medium and small businesses, the entrepreneurs and the start-ups, because, as you should know by know, that is precisely what the risk-weighing of assets does.

With that he evidences again he has still knows to little about the needs of the real economy. For it “to be able to support and sustain recovery”, the “risky” risk-takers need to be offered access to bank credit in competitive terms. This is indeed quite scary stuff.

August 28, 2013

Much of our nations’ “desire and dreams” were killed in the laboratories of bank regulators

Sir, Luke Johnson quotes Professor Edmund Burke, from his book “Mass Flourishing” believing “that the ‘glorious history of desire and dreams’ has run out of steam”, “The small start-ups are as vital as the starts” August 28.

Of course it has. How could it not, with bank regulators who allow banks to finance the “absolutely infallible”, the AAAristocracy, against much less capital than when lending to the small risky start-ups… and which means that the banks will earn a much higher risk adjusted return on equity when lending to the former, than when to the latter.

As I had the opportunity to do in a letter yesterday I would also suggest Luke Johnson to compare today’s banking with how, in Mary Poppins, Mr. Banks and his colleagues describe their Fidelity Fiduciary Bank

If you invest your tuppence, wisely in the bank, safe and sound

Soon that tuppence, safely invested in the bank, will compound
And you'll achieve that sense of conquest, as your affluence expands
In the hands of the directors, who invest as propriety demands
You see, my friend. You'll be part of railways through Africa.
Dams across the Nile. Fleets of ocean greyhounds.
Majestic, self-amortizing canals. Plantations of ripening tea
All from tuppence, prudently, fruitfully, frugally invested.

We used to pray for in our churches “God make us daring!” Clearly our bank regulators never attended mass.

August 27, 2013

Mr. Peter Sands of Standard Chartered. The real "real economy" outside your bank offices is too important

Sir, Peter Sands, the chief executive of Standard Chartered comes out against a leverage ratio and in defense of the risk-based capital requirements for banks which, in its more advanced version, Basel II, has only been around us for less than a decade and already created the greatest crisis ever seen, “When it comes to banks, simplest is not always best” August 27.

Beside their simplicity I have always favored leverage ratios for two reasons. The first that it guarantees that the banks will have some capital when the risk-weights turn out to be wrong, which is in fact the only case when bankers and regulators run into deep problems.

Secondly and perhaps even more important, it does not distort the allocation of bank credit to the real economy. Current risk-weighing, which translates into banks earning much more risk adjusted returns on their equity when lending to the “absolutely safe”, than when lending to the “risky”, does only guarantee the former get too much credit at too low costs, and the latter too little at too high cost.

Banking must seem to be all for Mr. Sands, but he would do good remembering that the state of the real economy is even more important, not only for us all, but even for the safety of the banking system.

For instance Mr. Sands writes that “the leverage ratio… assumes lending to a start-up and an established multinational are equivalent risks”. Precisely! If Mr. Sand applied the correct interest rates, awarded the correct amounts of exposures, and set the correct terms of the contracts, these should be equivalent risks from the banks perspective, and which lead to undistorted and efficient credit allocation in the real economy. 

To end let me quote from what Mr. Banks and the Bankers sang us about banks, in Mary Poppins.

If you invest your tuppence, wisely in the bank, safe and sound
Soon that tuppence, safely invested in the bank, will compound
And you'll achieve that sense of conquest, as your affluence expands
In the hands of the directors, who invest as propriety demands
You see, my friend. You'll be part of railways through Africa. 
Dams across the Nile. Fleets of ocean greyhounds. 
Majestic, self-amortizing canals. Plantations of ripening tea 
All from tuppence, prudently, fruitfully, frugally invested.

Sir, let me assure you that risk-weighting will not only keep the banks away from those “prudently and fruitfully” investments in the real economy, but that there is also nothing "frugally", in leveraging 30 times to 1 or more. How sad Mr. Sands seems to look down on old British banking traditions.

August 23, 2013

All dollars paid in interests, should be worth the same when accessing bank credit.

Sir, Frank Keating, President and Chief Executive of the American Bankers Association, writes in response to Thomas Hoenig’s “Safe banks need not mean economic growth” of August 20, that “There is such thing as having too much capital”, August 23.

Keating argues, correctly, that “When regulators set rules, they should be surprised that banks naturally adjust to the incentives created” and also, equally correct, that “too often banks get blamed for making rational decisions based on the rules that have been set by their regulators”.

But what I do not agree with is when Keating sort of implies the debate on capital requirements should be among “the banking industry and regulators”. Banking is much too important for that.

Right now, those perceived as “risky” have much less opportunity to deliver a good return on equity to the banks, only because their borrowings give way to much higher capital requirements for the banks than what the borrowings of the AAAristocracy does.

And that means that a dollar paid by a “The Risky” medium or small businesses, entrepreneur or start-up, is worth less than the dollar of interest paid by one of “The Infallible”. And, sincerely, that so distortive regulatory discrimination, puts the real economy on track of having to regress, perhaps to even what it was in the times of black and white television.

The current huge needs of bank capital, which have resulted exclusively from the fact that so little capital was required from the banks on exposures considered as “absolutely safe”, is indeed a very urgent matter for all, banks, regulators, depositors and borrowers. But, instead of wasting so much time negotiating how much that capital increase should be, we should all be thinking about how to stimulate the mother of all bank capital increases, since the real economy, upon which the safety of the banks really depends in the long run, surely needs it.

In order for “Game Changers” to play out their role, the rules of the game need to be fair

Sir, Sir Samuel Brittan surprises us presenting the so simplistic view that “There is nothing wrong with the US economy that a measure of redistribution towards both the less well-paid and public services would not put right” “Yes, productivity matters – but it is not everything” August 23.

I would ask him, what about a little redistribution, in ‘the Home of the Brave’, of bank credit from the AAAristocracy to “The Risky”, to the medium and small businesses, the entrepreneurs and start-ups? Would that not be needed?

And, in order for that to happen, and I explain it again, banks must be required to hold the same amount of capital against loans to both groups, so that both groups stand an equal chance to deliver risk-adjusted rates of returns on bank equity.

While banks are allowed to hold less capital–equity, when lending to “The Infallible”, that is who they are going to lend to… and the real economy and the productivity will suffer as a consequence.

And that will happen no matter how much the US wants to capitalize on opportunities such as those presented by McKinsey in “Game Changers”. You see, in order for the “Game Changers” to play out their role, the rules of the game need to be fair.

August 22, 2013

Private innovation needs government help, but it also needs not to be blocked by regulators

Sir, of course nations need to be bold, and take risks, in order to have a better future. That is, or at least was, why we used to go to our churches and pray “God make us daring!

And so of course most of us would wholeheartedly support Marianna Mazzucato’s call for more government financed basic research; especially if this resulted from redirecting to it other governmental waste; and this even though we suspect the argument will, as usual, be exploited by those who 
just want to increase taxes, “Why private innovation needs government help”, August 22.

But, that said, the fact is that currently, if a bank lends directly to a innovation project, like the failed solar power company Solyndra in the US, then it is required to hold about 8 percent in capital, but, if it instead lends that money to the government, so that a bureaucrat can relend it to a Solyndra, then it has to hold no risk-weighted capital... which skews all too much in favor of the government.

I do understand the importance of Mazzucato´s call, but, frankly, to me, it is of secondary importance when considered in relation to the fact that bank regulators, with their risk-weighted capital requirements, are effectively castrating our banks, making them sing in fAAAlsetto.

August 21, 2013

“Why has the Fed given up on America’s unemployed?”, is a question that is at least a decade late

Sir, Adam Posen, the president of the Peterson Institute for International Economics asks, “Why has the Fed given up on America’s unemployed?”, August 21.

He should have asked that long ago, because when the Fed, as a bank regulator, accepted the thesis that banks could have much lower capital requirements when holding exposures to the “absolutely safe” AAAristocracy, than when lending to the “risky” medium and small businesses, entrepreneurs and start-ups, the Fed helped to impose regulatory risk-aversion, and thereby gave up on the risk taking needed to keep the real economy producing jobs.

The incongruency of current risk-weighted capital requirements shine s through again.

Sir, Tracy Alloway and Vivianne Rodriguez end their “US repo finance faces threat from new capital rules” August 21, by quoting a person familiar with the regulatory effort saying “Repo reform is about recognizing the risk in pricing those repo transactions… What we learnt in 2008 was that the risks were not fully appreciated and therefore not fully priced into the transactions.”

That leads to the following two questions: First, if admitting that by fully appreciating the risk, you can fully price the transaction, then why allow for different capital requirements based on different risks? Does that not just create distortions in the allocation of resources between different classes of risk?

Second, if you cannot fully appreciate the risks, is that no what the ordinary not adjusted for risk capital requirements should be there for?

August 20, 2013

FDIC, please go the full way, and rid the banking system of all distorting capital requirements based on risk-weights

Sir, Thomas Hoenig of FDIC should be commended for putting forward such level headed arguments for a higher cap on a bank’s leverage ratio, which would significantly increase the capital requirements for banks, “Safe banks do not mean slow economic growth”, August 20.

And I absolutely agree with the title, that is, if the increases to where the final capital should be, happens fast and is not the result of a long and protracted process. I would, if I was the state and had some bad conscience about having permitted banks have so ridicule little capital before, help them along in the capital increases with some tax benefit packages for their shareholders. This, especially if banks agree to take that cap even higher, say 10 percent. 

Where I disagree though with Hoenig is when he writes “we would also be using Basel risk-weighted capital requirements to complement the leverage ratio and thus mitigate the potential for arbitrage”. And that because some argue that, as a result of the cap, banks could load up on riskier assets.

First, Basel’s risk-weighing does not reduce the risk of the system. On the contrary, it helps to push banks excessively into the arms of what is ex ante perceived as “absolutely safe” assets, which are precisely those assets that have caused the greatest bank disasters.

And second, worse, neither does it reduce the potential for arbitrage. With the risk weighting, the only thing the regulator achieves is to influence the arbitrage process. And in doing so, by favoring the access to bank credit of the AAAristocracy over that of the “risky” medium and small businesses, entrepreneurs and start ups, the regulator dangerously distorts the allocation of bank credit in the real economy.

Hoenig ends writing “The US is a market economy, and we know that bank capital is a source of strength, not a burden”. Absolutely! But, if one has a market economy, he should also know that nothing is gained, and perhaps much lost, by decreasing the possibilities of banks to exercise the reasoned audacity we expect from them, and increasing their risk-aversion. This, most especially, in the Home of the Brave.

August 19, 2013

Yes, bad domestic credit regulations did the eurozone in

Sir, Martin Sandbu writes “the crisis in many euro countries has more to do with bad domestic credit regulations than with the capital imbalances between them… The bright side of this is that the euro is not as flawed as all that”, “Europe needs new fables as Dutch and Portuguese go off-script” August 19.

And he is absolutely correct because that is precisely what has been my thesis for many years now as you know. More than a year ago, when Sandbu was blaming the “crazy capital flows” I sent you, and him, a letter titled “Don´t kill the eurozone dream just because bank regulators failed” and with which I also included a copy of my earlier “Who did the eurozone in?” At that time though, Sandbu only accepted that “lax capital requirements” were just “a bit of the culprit.

And as recently as in June this year, I repeated to Sandbu the same argument in a letter titled “Europe, I am sorry, as long as credit cannot flow freely, you will not get out of the hole.”

PS. By the way, are you not supposed to reference who have earlier made to you the arguments you are making? Or are you only morally obliged to do so, when it relates to some PhD or to some of your inner circle. I mean, Martin Sandbu, the author of "Just Business: Arguments in Business Ethics" would appear as someone knowledgeable about these sort of issues.

August 17, 2013

Basel II and III demonstrate ‘a lack of ambition and a willful blindness to the future’

Sir, Stian Westlake opines that “we live in an age where businesses and governments seem gripped by a lack of ambition and a willful blindness to the future”, “The west desperately needs more madcap schemes”, August 17.

Indeed, “a lack of ambition and a willful blindness to the future” does well describe current bank regulations which, because of capital requirements based on perceived risk” allow for banks to earn much more expected risk adjusted returns on their equity when financing The Infallible, like the sovereign and the AAAristocracy, than when financing The Risky, like medium and small businesses, entrepreneurs and startups.

Those regulations have placed sort of a reverse mortgage on our economy, which allows us to extract as much as possible of equity from the old risk-taking, while at the same time making it too onerous for banks to help finance the new risky ventures that must occur, if we are to move forward... if our young are to stand a chance to find jobs.

What a sad reality. From praying “God make us daring” in our churches, we now have ended up with castrated banks.

August 16, 2013

Capital requirements for banks based on perceived risk, is an equal opportunities killer

Sir, Tim Hartford writes “The uncomfortable truth is that market forces – that is, the result of freely agreed contracts – are probably behind much of the rise in equality. Globalization and technological change favor the highly skilled”, “This is what sticks in the throat about the rise of inequality: the knowledge that the more unequal societies become, the more we become prisoners of that inequality”, “The idea of a free, market-based society is that everyone can reach his or her potential. Somewhere, we lost our way”, “How the rich are making sure they stay on top”, August 16.

That is indeed powerful depressing stuff, and I can’t say that I have even a fraction of the suggestions needed to get the world out of this predicament. 

But, one thing I am absolutely sure of. Capital requirements for banks, based on perceived risks that are cleared for by other means, and that so shamefully favor bank lending to “The Infallible”, the haves, the old, the past, those already favored by banks and markets, and thereby discriminates against “The Risky”, the not haves, the young, the future, those already discriminated against by banks and markets, does not help. Those regulations have nothing to do with a free market. Those regulations only potentiate the inequalities and represent an act of financial terrorism that strikes at the heart of the needs of a nation to take the risks to allow it to move forward.

August 15, 2013

Can the eurozone sustain its recovery? NO! not with the current bank regulators

Sir, banks are the main financial intermediaries in Europe and so let me ask you: 

Do you believe that telling the eurozone banks: “Go and make your returns on equity financing what is safe, like sovereigns and the AAAristocracy, and forget about financing the risky, like medium and small businesses entrepreneurs and start ups”, would allow you to harbor any hopes of a sustainable growth and unemployment reduction? 

I sure do not think so, but that is what bank regulators are de facto telling the banks, when allowing these to hold much less capital-equity, when lending to "The Infallible" than when lending to "The Risky".

And so, with respect to James-Fontanella-Khan’s question “Can the eurozone sustain its recovery?” August 15, the answer has to be “NO! Not with these bank regulators” 

Of course, if you throw some trillions on the street, and people run there to “clean” it up, and you count that as growth and employment, you will get some better news, for a while, but clearly not sustainable.

The “convenient myth” which supports current bank regulations, needs to be debunked.

Sir, Tom Braithwaite and Patrick Jenkins, in their analysis “Balance sheet battle”, August 15, refer to bank executives and some [regulatory] officials holding that “not using risk-weights when calculating capital requirements for banks can tempt banks to move towards riskier loans that earn higher returns but are more likely to result in losses.” 

Baloney! That so “convenient” for some banks myth, needs urgently to be debunked.

And for that we need first to understand that any “perceived risk” can be cleared for by bankers by the interest rate they apply, the size of the exposure and other contracting terms. 

And so the truth is that lower capital requirements, permitted for something perceived as “absolutely safe”, and which allows the banks to achieve a higher expected risk-adjusted return on equity on those assets, will only help to push the banks to create excessive exposures, while holding very little capital, to precisely that type of exposures which have caused all the bank crises in history, namely assets which were ex-ante perceived as safe but that ex-post turned out to be risk. And, if in doubt, just try to find one single major bank crisis that has resulted from excessive exposures to what was ex-ante, not ex-post, perceived as risky.

The different capital requirements based on perceived risk which so much favors the access to bank credit of The Infallible and thereby discriminates against The Risky, also completely distorts the allocation of bank credit in the real economy. What would for instance a regulator, in the US or in Europe, answer if asked: Sir, why are the capital requirements for our banks lower when they lend to a foreign sovereign, than when they lend to our national small business and entrepreneurs, those who have never ever set off a major bank crisis?

August 14, 2013

Bank regulators should never trust bank meteorology but prepare for when it fails

Sir, John Kay ends his “Spotting a banking crisis is not like predicating weather” August 16, mentioning “we are better at avoiding drizzle than financial crises”. I do not agree, the two events are not comparable.

First, if you listen to a report on bad weather, you might take shelter, but you cannot influence the weather. But, if for instance the IMF would suggest a probability of a crisis in the banking sector somewhere, it could help to make that crisis a certainty.

Then of course are the consequences. I am sure John Kay has found himself under a surprising drizzle many times, only that he does not remember it, because, unless it happens for instance during a wedding party on a lawn, it really does not mean so much. A banking crisis is, on the contrary, usually, unfortunately, a too memorable event.

Because it is relevant to the theme of banking and weather, and it further explains my arguments, I include below an extract from my opinion “The ‘Mistake’ that dares not speak its name”, which was published in The Journal of Regulation and Risk North Asia, Summer 2013.

Mark Twain wrote that: “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain”.

And the weatherman could predict sunshine or rain, and he could be right or wrong.

If rain was announced and it rained, no problem for the banker, as he had either never lent the umbrella or had already taken it back. If rain was announced, but the sun shined, the banker may have lost some good tanning opportunities, but that’s about all. If sunshine was announced, and the sun shined, there are of course no problems for the banker.

But, if sunshine was announced, and it rained, then the bankers would be in serious trouble. And this could be why Mark Twain also said: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so”.

PS. You can find the whole opinion here, and of the whole Journal here

August 13, 2013

Current capital requirements for banks guarantee “The Infallible” lots of credit, while “The Risky” get nothing.

Sir, I refer to Mr. David R Martin’s “Summers’ fiscal mindset makes him the best choice to lead the Fed” August 13.

In his letter Martin writes that “using monetary policy is like spraying a fine mist on a raging fire. Loose money is not directed at any particular sectors”.

That is not true, because in the best of circumstances, with a banking sector that functions, the water will mostly go the where the real economy needs and deserves it most to go. Currently though, because of capital requirements for banks which are much higher for what is perceived as “absolutely safe” than for what is perceived as “risky”, you are actually spraying The Infallible with bank credit, while making sure The Risky remain under extremely arid conditions.

Since I have not seen Lawrence Summers (nor Janet Yellen for that matter) giving any sign he understands the distortions in the real economy these regulations create, I cannot say I agree much with Mr Martin on his favored candidate to chair the Fed.

What is perceived as “absolutely safe” is the prime source of the unexpected which can cause bank crises

Sir, Roger Altman, referencing the “epic credit collapse of 2008 and the eurozone sovereign and debt banking crisis that began in 2010” writes “the message of history is the repetition of such crises and how the next one can occur at any time and from an unexpected source”, “Why the Fed needs Summer’s firefighting skills”, August 13.

And it is that part of “from an unexpected source”, which is precisely one of the most important things the next Fed chair needs to understand, in order to help correct totally dysfunctional bank regulations.

Currently the capital requirements for banks are much lower for what is perceived as “absolutely safe” than for what is perceived as “risky”. And these do not only distort the allocation of bank credit in the real economy, by discriminating in favor of The Infallible and against The Risky, but are also perfectly useless when it comes to increasing the safety of the banking system.

I have been trying for a decade now to get regulators to justify these capital requirements that I find to be dangerous and loony, but all the responses I get are in terms of “more-risk more capital less-risk less capital… does that not sound logical?

I am sorry, it is not enough to sound logical for us to bet our future on it, it has to be logical.

August 12, 2013

Regulators, stop the credit rating agencies from telling banks where it is safe to go. They haven’t a clue, as neither have you

Sir, Christopher Thompson quotes Bridget Gandy, managing director of Fitch “If you compel banks only to use a leverage ratio, the only way to be more profitable is to take more risks on the assets you have. You need to have balance between capital coverage of risk-weighted assets and leverage, risk is not just about size”, “Banks ‘need’ to cut €3.2tn of assets” August 12.

And that is precisely the type of mentality, which completely aligned with the mentality of the bank regulators in the Basel Committee, and which if allowed to prevail would guarantee that the €3.2tn of assets expected to be cut in Europe, would not be cut in the most economic efficient way, but only in accordance to its perceived riskiness.

And, as a direct consequence, Europe would end up with its banks stuffed with “absolutely safe” assets, which could be financed by other means, while it’s medium and small businesses, entrepreneurs and start-ups, those “risky” borrowers which might hold the best chances for Europe to return to sturdy economic growth, will be completely starved for access to bank credit.

A credit rating agency, incapable of looking around the corner to what might happen down the line, might be an extremely good agency for rating the creditworthiness of banks and borrowers this and the next quarter, but is extremely useless for rating the credit worthiness of anything some years ahead.

“The only way [for banks] to be more profitable is to take more risks on the assets you have” Yes Fitch, indeed… and what is wrong with that? The latest decades the way banks have become more profitable has only been by convincing the regulators they need to hold less and less capital on assets perceived as absolutely safe. And look what damages that has caused us.

No Fitch! I appreciate very much your credit ratings, and these will be used, but it is high time for regulators to stop you from telling the banks where it is safe to go, because, sincerely, you have not the faintest idea about it... as of course, neither have they.

Regulators did not worship at the altar of the new financial capitalism, they helped to build it

Sir, Philip Stephens writes that central bankers “failed dismally [in regulating banks]… during the years before the crash. Their mistake was – all would be well if markets were allowed to operate freely”, “Summers or Yellen? The best Obama can do is toss a coin”, August 12. 

And that is precisely the kind of misunderstanding of what really happened which impedes us to move forward.

The regulators, by means of Basel II stopped the banks from leveraging more than 12.5 to 1 when lending to those considered “risky”, like the medium and small businesses, entrepreneurs and start-ups, but allowed the banks to leverage their equity 62.5 times to 1, or even more, when lending to what was considered “absolutely safe”, like to the "infallible sovereigns" and the AAAristocracy. 

Frankly, does that have anything at all to do with allowing markets to operate freely? Of course not! Regulators did not worship at the altar of the new financial capitalism, they helped to build it, when an overdose of hubris led them to believe they could and should be the risk-managers of the world… and which is precisely that type of “invested with supernatural qualities” problem Stephens refers to.

The sad truth is that if central bankers are now the new masters of the universe, then we’ve got ourselves some really shitty masters, and we better watch up. Really, how can one feel comfortable with a Mario Draghi, who acting as the chair of the Financial Stability Board, saw nothing wrong in banks lending to Greece holding only 1.6 percent in capital/equity?

PS. If Obama heeds Stephens´ advice he better allow a very innocent hand to toss a very well examined coin, live in a TV show. Otherwise no one in this skeptical world would believe the outcome was in the hand of God… and even so.

August 11, 2013

Central Bank´s forward guidance has a ring of the blind leading the blind.

Sir, John Authers concludes his “BoE guidance signifies more work for investors”, August 10, writing: “The effect of the extra guidance from Mr Carney and other central bankers is to force investors to watch the economy more closely and make their own decisions”.

Indeed, though investors should always watch the economy and always make their own decisions, it now becomes even more complicated with forward guidance, because that is something akin to the blind leading the blind, and because therefore the investor now also needs to concern himself with what the central bank blind sees.

Like banks were forced to heed the opinions of some few credit rating agencies, which led many of them down the wrong path, are investors now supposed to heed the opinions of some few central bankers? Would we all not be better off, if central bankers would just shut their mouths up, and allow for a diversity of investors to guess what they might be up to? That at least sounds as leveraging systemic risks less.

And, if then a central bank guides you down the wrong path, what on earth is a poor investor to do?

Poor rich Oprah Winfrey should get herself a buyer-power-rating, issued by one of few big agencies.

Sir, I refer to James Shotter´s “Swiss image suffers after asylum row and Winfrey furore” August 10.

Poor rich Oprah Winfrey considers herself discriminated against because of how a certainly much poorer sales assistant in an upmarket Zurich boutique, dared to express the opinion that a ludicrous expensive handbag was too expensive, instead of perhaps increasing its price 50 percent as any much more able vendor would have done.

Frankly, this whole affair is so incredibly petty when I compare it to that other official discrimination which also originates in Switzerland, through the Basel Committee. That one establishes that even though “The Infallible” borrowers are already much favored in the markets, and “The Risky” much disfavored, that banks are allowed to hold much less capital when lending to the former, and thereby earn a much higher expected risk-adjusted return on its equity, than when lending to the latter.

I guess that if these bank regulators were asked, they would suggest that Oprah Winfrey equips herself with an AAA buyer power rating, issued by one of few formidable buyer-power-rating agencies.

Of course, the instinct of any normal ludicrous expensive handbags store owner, upon seeing an AAA buying-power-rating, would be to increase the listed price of the handbag, but I am sure that our Basel Committee regulators could also come up with a way of favoring these ultra rich buyers, and thereby discriminate against those who, immensely poorer, just want to feel like an Oprah Winter holding that completely unaffordable handbag in their hands for some seconds.

It is truly amazing how much we can hear about any discrimination based on color or other factor, when compared how little the officially sanctioned discrimination based on perceived risks are not even debated. Could it be because we are ashamed of having to admit to ourselves that we have changed from being risk-taking into risk-adverse nations?

In the name of my constituency, my granddaughter, I protest though: “Damn you Basel Committee… for having castrated our banks

August 10, 2013

Could it be that testosterone is not what it used to be?

Sir, Gillian Tett in “Central banking is still a man’s world” August 10, quotes the opinion that if Lehman Brothers had been ‘Lehman Sisters’…there would have been less testosterone fueled risk taking. And she also notes the absence of “sisters” in high post of the public sector.

She is on the wrong track. This crisis was not the result of an excess of testosterone fueled risk taking, but of a silly risk-aversion by bank regulators, who by means of their capital requirements, stimulated the banks to go where it was perceived as absolutely safe, like to the AAA rated securities, and to the “infallible sovereigns”, like Greece, and to avoid like pest what was perceived as “risky”, the small and medium businesses, entrepreneurs and start ups.

But, then again, it might also be that testosterone is not what it used to be.

What’s wrong with you FT? Are you daft? How many times do I have to explain it to you?

Sir, in “Three threats to Europe’s recovery” August 10, you write “Europe’s main problem remains in its banking system. Impaired balance sheets are preventing lenders from extending credit to businesses, choking off growth”.

What’s wrong with you? How many times do I have to explain it to you? The real and complete story goes as follows: Impaired balance sheets of banks, facing capital requirements which are much lower for what is perceived as “safe”, than for what is perceived as “risky”, are preventing lenders from extending credit to businesses and choking off growth.

And why are those bank balance sheets impaired? Because they built up too large exposures to what was perceived as risky? No! Because they built up too large exposures to what was ex ante perceived as “absolutely safe” but that ex-post turned out to be risky and so caught them standing there naked, with their pants down, and no capital to speak off.

And I tell you FT, there will never ever be a sustainable sturdy growth in Europe again, as long as bank regulators discriminate in favor of “The Infallible” and against “The Risky”. Europe was not built on dumb risk-aversion but on smart and daring risk-taking, call it reasoned audacity if you want.

August 09, 2013

Greece: “I am not going to pay you”. Europe: “Then you’re out of the eurozone”. Greece: “So what?"

Sir, Sir Samuel Brittan writes that “The theory behind the euro was that the single currency would act as a harmonizing force”, “Why the eurozone will come apart sooner or later”, August 9.

I do not agree. To refresh my memory I went back to an article I wrote on the eve of the euro titles “Burning the bridges in Europe”. Reading it I conclude that, as I saw it then, it was very little about harmonizing something, and a lot about forcing Europe on Europe.

Brittan also believes that the most likely outcome is for “one or more of the peripherals to leave the eurozone” and links it to when Argentina “severed a supposedly unbreakable link with the US dollar”.

Again, I do not agree. Argentina was using a peso convertible to dollars, but the sustainable seigniorage value of for instance a new Drachma, should be so low that at least Greece would prefer to keep on using the euro, without asking for permission, which it does not have to do, just like Ecuador uses the US dollar without asking the US for permission.

PS. And by the way remember that the Greece mess was mostly caused by the Basel Committee, and European bank regulators, who approved that banks could lend to Greece against only 1.6 percent in capital, meaning allowing these to leverage their bank-equity, when lending to Greece, a mind-boggling 62.5 times to 1. Neither the banks, like those of Cyprus, nor Greece, could or should have been expected to be able to resist such temptations.

Sir, do you know of any plans of the Englishmen reclaiming London?

Sir, since we see London being sold out to foreigners looking for refuge, let me ask your opinion. Should the Englishmen design a long term plan to reclaim London, or should they just move their capital and Queen elsewhere?

For instance, since you have a lot of antiques from Greece´s Athens in the British Museum, but now also many wealthy Greeks own much in London, do you see any bartering possibilities?

Yes, what a crazy world we live in… for instance its bank regulations, designed for our banks to avoid like pest “The Risky”, when we all know that it is “The Infallible” that constitutes by far the biggest threat to our banking system.

August 08, 2013

The state, instead of taking on more risks, should reorient its risk-taking, towards more basic research

Sir, from what I see from many letters, it would seem that Mariana Mazzucato’s “The Entrepreneurial State”, and Martin Wolf’s review of it, is unleashing a call for the state to run more risks on behalf of society.

Indeed, there is a big and unquestionable role for the state in helping to fund and carry out basic research, but, since the state takes enough risks already on behalf of taxpayers, like with fiscal deficits and quantitative easing, should not the real call be for the state to reorient its risk-taking?

And again I have to remind you. If a bank lends to a small private entrepreneur to carry out some risky research, it is required to have 8 percent in capital but, if it lends to the state so that the state performs exactly the same function, with tax-payer’s money, then the banks needs to hold zero capital. Frankly, is that not risking enough on the state’s capability for you?

August 06, 2013

Bank regulators insisting on playing risk managers for the world, evidences hubris and lunacy is still going strong.

Sir, it is indeed scary reading Brooke Masters reporting on a “Call to harmonise bank risk models”, August 6.

The average risk weight for sovereign corporate and institutional debt that European Banking Authority found in 35 big banks is quoted as being 35 percent with a standard deviation of 12 percent. This indicates how frightening badly capitalized most European big banks are.

In Basel II terms a 35 percent risk weight, applied to a generously defined 8 percent basic capital requirement, could indicate the average banks to be assets to equity leveraged about 35 to 1, and some even 55 to 1 and more.

But even scarier, is reading what EBA suggests. Bank regulators should not be risk-managers for the world and have no business concerning themselves with whether the models banks use to analyze their risk work or not. Their responsibility is to think exclusively in terms of what to do when risk-weights and risk-models do not function adequately. And, in this respect, the last thing regulators should do is precisely what the European Banking Authority calls for, which is “further moves towards harmonized rules for risk models”. That only guarantees to increase the systemic risk of many risk models being wrong at the same time. It is as if regulators have learnt nothing at all from this crisis.

All in all what the article indicates, is the need for a more simple leverage ratio type of capital requirement, which, since applied equally to all assets, makes it therefore more independent of risk models. That would of course also help to reduce the extreme distortions in the allocation of bank credit to the real economy introduced by capital requirements based on perceived risks.

Do not help banks play the liquidity card trying to avoid higher leverage ratios

Sir, Daniel Schäfer begins his “Fix the contradictory rules pushing banks to be riskier”, of August 6, with the question “Can regulations make banks less safe?” And the answer is: Absolutely!

The current crisis was entirely the consequence of bank regulations, primarily Basel II, which allowed banks to hold extremely little capital/equity when lending to or investing in what was perceived as absolutely safe; which meant that banks could earn amazingly high expected risk-adjusted returns on equity when lending to or investing in what was perceived as absolutely safe; which meant that banks went overboard lending to or investing in what was perceived as absolutely safe, like to “infallible sovereigns” and the AAAristocracy; and which finally meant that when the problems arose, like with loans to Greece or with investments in securities collateralized with lousily awarded mortgages to the subprime sector, the banks stood there completely naked without any capital/equity.

The leverage ratio is a tool now used to correct somewhat for the above described miss-regulation, and some banks simply do not like it since it requires them to hold more capital/equity.

From reading Schäfer’s article, it is clear some banks are playing the liquidity card in trying to avoid the threat of even higher leverage ratios, as those proposed for example by Thomas Hoenig of FDIC. I hope the regulators, and the press, do not fall for this dirty trick.

Liquidity for banks was usually provided by the central bank’s discount window, and all it took for the bank in order to access that window, was to have good assets, of basically any kind. The underlying problem with Basel III liquidity requirements, is that is does nothing to solve the problems of Basel II, but layers on new regulations which are also basically based on ex ante perceived risks, on top of the old capital requirements, and thereby distorts and confuses even more.

Schäfer also writes banks will now as a consequence of adjusting to leverage ratios have zillions less in government bonds and deposits in other banks, but the real question is, why should banks have zillions in this type of investments? And what about all the absolutely essential loans to “The Risky”, like the small and medium businesses and entrepreneurs that are not given precisely because of the absence of a non-discriminatory and all encompassing leverage ratio? That to me sounds like a much more important issue, in order to make the real economy less risky, and which is really the best way of making our banking system less risky.

August 05, 2013

There’s a call for more integrity in baseball? Great! But what about more integrity in bank regulations.

Bank regulators, by allowing banks to hold much less capital when lending to the infallible sovereigns or the AAAristocracy, than when lending to the small and medium businesses and entrepreneurs; effectively feed the former with bank borrowing testosterone, and thereby place the later in much worse competitive position than usual to access bank credit. 

State and private entrepreneurs are neither alike nor equal

Sir, I refer to Martin Wolf’s comments on Mariana Mazzucato’s “Debunking Public vs Private Sector Myths”, “The State is the real engine of innovation”, August 5.

In these Wolf writes “the state is also an active entrepreneur taking risks and of course accepting the inevitable failures”. This entirely fails to recognize that state and private entrepreneurs are neither alike nor equal.

Currently, under Basel II bank regulations, if a bank lends to a private entrepreneur, it needs to hold 8 percent in capital/equity, but, if it lends to the state entrepreneur, then it does not have to hold any capital/equity... zero!

Also if the private entrepreneur is unsuccessful in his undertaking he will suffer the consequences, while if the state-bureaucrat-entrepreneur wastes away taxes, he will most likely not suffer at all.

I do not understand how one can ignore those differences, and conclude that “the entity that takes the boldest risks and achieves the biggest breakthroughs is not the private sector; it is the much-maligned state”, and especially so when extremely little of public spending really goes to take bold risk to achieve breakthroughs.

To describe the financing of innovation as “a parasitic [system] in which the most loss-making elements are socialized, while the profitmaking ones are largely privatized”, is to completely confuse the losses incurred when lending to safe-non-entrepreneurial activities, such as financing real estate and sovereigns, with losses derived from investments in innovation. In fact, the socialized losses in innovation financing that most comes to mind, are those which originate in loans given to entrepreneurs by the state, like that to Solyndra.

We do of course not object to the state lending a much needed helping hand in basic research but, if it goes overboard doing so, that will only guarantee this will be abused by those entrepreneurs who specialize in the extraction of rents from the state.

Wolf concludes “The failure to recognize the role of the government in driving innovation may well be the greatest threat to rising prosperity”. Wrong! The greatest current threat is the silly risk-aversion imposed on banks by regulators who fail to understand what brought our economies to where they are. 

August 04, 2013

IMF does not understand the strongest headwind affecting sturdy economic growth and employment in Spain, and in Europe

Sir, I refer to Tobias Buck’s reporting “Spain’s return to growth will not ease jobless rate, says IMF”, August 3. 

Our economies have been torpedoed by bank regulations which allow banks to hold much less capital-equity for what is perceived as “safe” than for what is perceived as “risky”. And the effect of that is to allow banks to earn much higher expected risk-adjusted returns on their equity when lending to “The Infallible” than when lending to “The Risky”. And that completely distorts the allocation of bank credit in the real economy making it unreal.

And before this distortion is eliminated the chances to generate jobs in any sustainable way, in Spain or in any other country for that matter, are truly slim.

The big difference, between for instance Germany and Spain, is that Germany is still living on old risk-taking and has not yet had its safe-havens dangerously overpopulated, or is at least in blissful ignorance of it, while Spain has wasted away their banks financing “absolutely safe” real estate and ignoring lending to small businesses and entrepreneurs.

That the IMF has not been able to understand and much less raise their objections to this strong headwind against sturdy economic growth, created by dumb bank regulators, should shame its current professionals.

August 03, 2013

Fabrice Tourre has been duly scalped, but where is the SEC’s mea culpa?

Sir, I have no doubt whatsoever that the prime responsible for the current financial mess were dumb bank regulators. That’s is why I dislike so much reading when Tracy Alloway and Kara Scanell report “SEC elated after claiming Tourre’s scalp.” August 3.

The whole story can either begin with the little guy, the mortgage underwriter underwriting bad mortgages to the subprime sector; and those bad ingredients were then sold by underwriter bosses to security packagers, who packaged these bad mortgages into very bad subprime sausages; but who were are able to turn these into valuable delicacies, only because of the high credit ratings these received from human fallible credit rating agents. And then the story could end with those selling the sausages to the investors, and some of them, like Goldman Sachs, even taking bets on that these would make their buyers puke. And all involved in the bad sausage chain made huge profits… and should all be ashamed, some more than others.

Or the story can begin with bank regulators, the Basel Committee, who with its Basel II of June 2004 authorized banks to hold AAA rated sausages on their books against only 1.6 percent in capital (equity), which meant they authorized banks to leverage their capital a mindboggling 62.5 to 1 times with these sausages; and who with this created the irresistible profit motivations that induced all humans previously mentioned to break all the rules.

Fabrice Tourre’s own word “More and more leverage in the system, the whole building is about to collapse any time now” says it all. Those directly responsible for that leverage were the bank regulators. Without the explicit blessing of regulations which allowed it, the system would never ever have been able to leverage as much. And the SEC was all in agreement with is, as can be read in its Open Meeting records of April 28, 2004.

Yes, Fabrice Tourre and all others involved in the subprime sausage chain are guilty and should be held responsible. But, if we allow regulators to get away, feeling elated, without even a mea culpa, then we truly have not learned the lessons we most need to learn from this crisis.

August 01, 2013

Until the financial transmission channels are repaired, BoE’s monetary injections are wasted

Sir, Chris Giles hold that “There will not be a better time than now to spend some of the BoE’s monetary policy credibility in search of a more robust recovery”, “Carney has a chance to kick-start the weak British economy” August 1.

Wrong! Anytime after the financial transmission mechanism, demolished by capital requirements for banks based on perceived risks that have already been cleared for with other means, has been repaired, is better.

Meanwhile any monetary injections would mostly flow to dangerously overpopulate the havens officially considered as safe, and too little would flow to the risky actors of the real economy who most stand a chance of knowing what to do with those injections.

Hollywood would never allow a Basel III to be produced by those responsible for a Basel II flop

Sir Hans-Joachim Voth and Mauricio Drelichman refer to the worth of risk-sharing between investors and the governments who borrow, as well as the need for thick equity cushions to help banks absorb the losses and withstand the problems derived from government defaults, “Banks should learn from Habsburg Spain” August 1, 2013

Put that in the perspective of Basel II bank regulations which required a bank to hold 8 percent capital (equity) when lending to a “risky” citizen, but allowed banks to hold no capital at all, ZERO, when lending to one of the “infallible sovereigns”.

Total disaster had to be the result of such undue favoritism of the sovereigns and it should be obvious now that it was plain crazy to allow a bunch of silly bank regulators to regulate for the whole world in splendid and incestuous isolation.

But the looniest bit seems still to come… since we have mostly allowed the same regulators responsible for the Basel II flop, to produce Basel III using basically the same script, directors and actors. Neither Hollywood nor Bollywood would ever have done such a stupid thing.