Regulators have purchased the illusion of bank safety, by forbidding these to finance the risky future.

Regulators have purchased the illusion of bank safety, by forbidding these to finance the risky future.

Sir, I refer to James Grant’s “Low rates are jamming the economy’s vital signals” October 13.

When Grant writes: “What is new today is the overlay of officially sponsored bull markets on governmentally suppressed interest rates”, he is quite right.

And when he writes: “True prices are discovered, not administered. They are set in the open market…. The world should spare some censure, too, for the central banks’ manipulation of money market interest rates, their heavy-handed administration of longer-dated bond yields and their sponsorship of rising share prices. Just because the public servants do their well-intended work under the banner of the law does not make the results any less subversive”, he is also quite right.

Unfortunately, what Grant misses in order to make the public servants “subversive” activities much clearer… is what is most jamming the economy’s vital signals, namely the credit risk weighted capital (equity) requirements for banks.

That regulation allows banks to earn much much higher risk adjusted returns on equity when lending to what regulators, with immense hubris, feel can be designated as “absolutely safe”, than for what they, with equally immense hubris, feel can be designated as risky. And that, instead of negating the efficient market hypothesis like so many hold, included Nobel Prize winners, has impeded the efficient open markets to work.

Grant concludes: “Central bankers… have purchased short-term relief with long-term instability”. I wish not to argue with that but, as I see it, what central bankers and regulators have most purchased, is the illusion of bank safety, and this by paying the price of forbidding the banks to do what they are most supposed to do, namely to finance the risky future, hopefully with reasoned audacity… since otherwise, as we know, the present will stall and fall.

PS. Grant should also try to figure out how the fact that banks on loans to the "infallible sovereigns" need to hold much less capital than against anything else, subsidizes the "risk-free rate".