January 17, 2015

Bank regulators and central bankers owe Greece and Germany some explanations and apologies.

Sir, I refer to Gillian Tett recounting what happened in a meeting of central bankers last year in Switzerland, “Why Europe owes a debt to history” January 17.

It says: “To many Germans and other northern Europeans present, it seemed outrageous – if not immoral – for anyone to suggest that Greece’s debts be written off… ‘How can you forgive debt when a country has an official retirement age of 50?’ an official said”.

That is absolutely the wrong question, the right being: “How on earth could you lend so much to a country that has an official retirement age of 50?”

By means of allowing banks to lend to sovereigns holding much less equity than when lending to citizens, the whole Basel Accord… I, II and III, have been inducing banks to lend too much to “infallible” sovereigns.

Basel II of June 2004 explicitly stated that, if a bank lent to a sovereign rated as Greece was at that time, it needed to hold only 1.6 percent in equity against such loans; meaning that it could leverage its equity more than 60 to 1; meaning that if it thought it could make just half of a percent margin onthose loan, it would be able to obtain more than 30 percent return on equity a year. 

I have heard that reality was even worse than Basel II, as seemingly European banks were allowed to lend to Greece, and the other European sovereigns, against zero capital… meaning infinite leverage… meaning infinite expected returns on equity.

Clearly without such regulatory lunacy Greece, and other sovereigns, would never ever have been able to rack up so much debt. Therefore it is bank regulators and central bankers who owe Greece and Germany some serious explanations and, foremost, many truly sincere apologies… to say the least.

Let us hear those mandarins telling Europe “Forgive us, we had no idea of what we were doing”... and then let’s see if Europe forgives them... their sin of hubris.

The other side of odious debt is odious credit.