Regulators tell banks “Occupy what’s safe”; and so expel widows, orphans and pension funds, to handle what’s risky

Sir, Brooke Masters reports on how the Security Exchange Commission is making sure that private equity industry duly manages conflicts of interest and treats its clients fairly. “SEC enforcers must keep bearing down on private equity” August 27.

But Masters also writes: “Historically, PE clients have been highly sophisticated. So they are either well placed to decipher complex investment contracts or rich enough not to quibble about extra fees. But that is changing. Public pension funds are shifting more and more of their money into private equity as they chase higher yields. Pension fund managers are far less experienced with the sector.”

Why did this happen? When regulators, with their risk weighted capital requirements told banks they could leverage more, and therefore obtain higher risk-adjusted returns on equity with assets perceived as safe than with assets perceived as risky, they made banks occupy that area in which, without leverage, widows, orphans and pension funds used to dwell.

So see what they done. By trying to make banks safer they clearly made life for widows, orphans and pension funds much riskier. That is what happens when regulators regulate with no concern about the impact their regulations will have.

And the saddest part of it all is that it is all for nothing. Major bank crisis are never the result of excessive exposures to what is perceived as risky, but always the result of unexpected events or excessive leveraged exposures to what was ex ante perceived as safe, but that ex post turned out not to be.

PS. For the sake of our children and future pensioners, I pray we can reverse this, and that there are still some bankers out there who know how to be bankers, and not only how to be equity minimizers. 

@PerKurowski ©