May 09, 2015

Shrink and Sage, in these days of skepticism, why are bank regulators so trusted and so obvious questions not asked?

Sir, Psychotherapist Antonia Macaro (The Shrink) and philosopher Juan Baggini (The Sage) ask “Which great thinker is most relevant today?” May 9.

In it The Sage writes: “Ours is a skeptical age, where old certainties have collapsed and no new ones have taken their place. Fewer people in the west now look to religious leaders for guidance but, following various disasters with drugs, pesticides and nuclear power stations, there seems to be at least as much distrust of scientists.”

And “The Shrink & The Sage”, they end by requesting suggestion for questions. Boy, do I have one for them.

Regulators have decided banks need to hold much more equity against assets perceived as risky from a credit point of view than against assets perceived as safe. Though more-risk-more-equity and less-risk-less equity might intuitively make some sense, it absolutely does not. This because never ever have major bank crises resulted from excessive exposures to what was perceived ex ante as risky, but always from excessive bank exposures to what was ex ante perceived as “safe” but which ex post turned out to be very risky.

And by favoring so much the access to bank credit of those perceived as safe, it also introduces a seriously dangerous distortion in the allocation of bank credit to the real economy.

But the members of this “skeptical age”, like journalists who should be on the forefront of skepticism, they do not want to ask why and seemingly they blindly trust regulators to know what they are doing. How come?

For instance Martin Wolf in July 2012 wrote that when "setting bank equity requirements, it is essential to recognise that so-called “risk-weighted” assets can and will be gamed by both banks and regulators. As Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk."

And yet Wolf is unable to take it from there and arrive at the only logical conclusion, which is that if equity requirements are to be based on the risk of assets then, for stability purposes, they should be 180 degrees the opposite… slightly higher for what is perceived as safe than from what is perceived as risky.

So Shrink and Sage… why in this “skeptical age” are questions not asked and scientifically failed bank regulators so trusted so as to keep on regulating banks even when they have failed?

In my blog you will find copy of all my hundreds of letters sent about this issue to FT and to their journalists and opinion makers for more than a decade. You can use it as evidence for what I am saying.