May 28, 2014

What can an insignificant ego like mine, even if absolutely right, do against significant egos, even when these are absolutely wrong?

What is perceived as risky never constitutes much real risk. What most drives a financial doomsday machine is what is perceived as absolutely safe; which is why risk-weighted capital requirements for banks based on perceived risks, which favors bank lending to “the infallible” is so absolutely dumb.

But unfortunately that seems too difficult to comprehend, for instance by Martin Wolf.

When he now begs for to “Disarm our doomsday machine” May 28, Wolf still shows no sign of having understood how dangerous the pillar of our current bank regulations really is. Why do I say so?

Wolf quotes Timothy Geithner saying “The safer the visible financial system is made, the greater the danger that the fragility will emerge somewhere less visible”, and connects that to the need of “preventing such obvious absurdities as the build-up of huge off-balance sheet positions in vital institutions. And though that might have some truth to it, the real fact is that currently it is the visible financial system that has been made dangerous, by trying to make it safe. For instance look at hedge funds and you will see that they never ever can achieve leverages similar to those authorized banks to have by regulators, if keeping to the “absolutely safe”.

No the best way to “disarm our doomsday machine” is to get rid of the distortions produced by risk-weighting, and to follow the simple rule of not procrastinating, meaning solving the problems while they are still small.

In May 2003, as an Executive Director of the World Bank I told bank regulators gathered to discuss Basel II “A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises. Knowing that “the larger they are, the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size. But, then again, I am not a regulator, I am just a developer.”

And though I am still not a regulator I still stand by that.

Mr. Martin Wolf. Currently we still have regulations which guarantee banks holding especially little capital when what is especially dangerous, one of “the infallible”, blows up. Disarm that AAA-bomb! Capisce?

The fact is that big egos can be just as dangerous as the tyranny of William Easterly’s experts.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.