September 25, 2015
Sir, I refer to Gillian Tett writing about hedge funds and banks moving into the P2P sector, “The sharing economy is a playground for Wall Street” September 25.
Ms. Tett writes: “banks used structured investment vehicles and collateralised debt… to dance around tough capital rules”.
That ignores that the reason why banks can “dance around tough capital rules” is that there are different capital rules. If for instance banks needed to hold for instance the basic Basel II capital requirement of 8 percent against all assets, there simply would be no music to dance to.
And Ms. Tett writes: “the system needs to provide more credit to the economy, in order to boost growth… If you ask bankers why they are moving into P2P lending, some will point to the high returns they hope to earn (since the average loan commands an interest rate of around 13 per cent, margins are high).”
Does Ms. Tett really believe that loans at 13 percent, in an almost zero rate environment, will help boost growth?
And Ms. Tett writes: “if you think that the main goal of finance should be to create safe, clear rules for capital flows… then the arrival of banks and hedge funds [to P2P sector]… might make you weep”
Ms. Tett still does not understand what is going on. Risk weighted capital requirements give banks the incentive of being able to leverage their equity immensely when lending to those perceived safe; and which forces the “risky” to have to pay both a bankers’ risk premium and a regulator’s risk premium. The natural result is banks will lend dangerously much to the safe and dangerously little to the risky… and that is what should make us weep.
And Ms. Tett writes: “[Banks] also took advantage of cracks in regulatory structures to create products that policymakers could not easily monitor or control (it was unclear, for instance, who was supposed to oversee mortgage derivatives).”
What cracks? Basel II clearly spelled out that if a security was monitored by one of the few credit rating agencies, and obtained an AAA rating, then the banks could leverage 62.5 times to 1 their equity.
And Ms. Tett writes: “unlike the pension funds which were exposed to mortgage-backed securities in 2006, for example, the banks and hedge funds understand the dangers of credit losses.”
I am not sure I would agree with that assessment. Too many banks, especially European had no understanding at all of the dangerous amounts of credit losses that could happen if the demand for mortgages to be packaged in securities, exceeded by much the capacity to rationally finance the purchase of houses.
Sir, since January 2007 I have written you around 150 letters in reference to articles by Ms. Tett; and of course copied her. Most of them have to do with explaining why credit-risk weighted capital requirements for a bank is such a flawed and dangerous concept. Even if I assume she has not read one single of those letters, she should have learned more about it after so many years.
Ms. Tett as the expert in anthropology you are: What would have happened with humans had some Basel Committee nannies given them so much incentives to stay safe in their caves and not venture out into the risky world? May I advance the possibility they would have ended up extinguished in their safe caves?