June 01, 2015

The next crisis will have the same origin as the last, too much bank exposure to what is blessed as safe by regulators.

Sir, Avinash Persaud writes: “Exotic assets, and the crippling losses that big and indispensable financial institutions suffered after buying too many of them, bore much of the blame for the last financial crisis. The next one might have a more paradoxical cause. Instead of being overexposed to assets of dubious provenance, many of the same institutions may be buying too many of the assets that the authorities deem safe.”, “The assets made combustible when regulators call them ‘safe’” June 2.

What “Exotic assets that bore much of the blame for the last financial crisis” is Persaud talking about? Where has he been? Was it not AAA rated securities, loans to Greece, any assets backed by default guarantees issued by an AAA rated like AIG, loans to the real estate sector in Spain, and similar “safe assets” that caused the crisis? Every single one of these problematic assets had one thing in common, namely that bank were allowed to hold very little equity against these because these were perceived as safe.

But Avinash Persaud is absolutely correct when he ends stating: “In the popular narrative, the financial crisis was caused by the willful wrongdoing of the banks. Regulators should know better. In financial markets, risky behavior is less often born of recklessness than of a false sense of safety.”

I wonder though if he will dare to honestly extrapolate from what he is saying… and understand that current capital requirements for banks should perhaps be higher for what is perceived as safe than for what is perceived as risky? And then dare to state that current bank regulators have been 180 degrees wrong?