August 28, 2016

Universities, especially tenured professors, sometimes neglect their vital social role as intellectual vigilantes.

Sir, I refer to Tim Harford's discussion of "Are universities worth it?" August 27.

I totally agree with Harford that universities generally produce a lot of local and global good vital for the welfare of society, though it behooves us never to ignore the possibility they could also generate some awful local and global bad.

But something Harford leaves out in his discussions, is that universities, most specially tenured professors, as intellectual vigilantes, have an important societal role to fulfill of alerting to stupid and dangerous ideas, like that of the credit risk weighted capital requirements for banks.

What are the causes of major bank crises?

1. Unexpected events, like major devaluations and natural disasters.
2. What was ex ante perceived as very safe turned out ex post to be very risky.
3. Shenanigans like unauthorized speculative trading or banks lending to their own directors or shareholders.

What did the regulators do?

They introduced credit-risk-weighted capital requirements: more ex ante perceived risk more capital - less risk less capital... re-clearing for basically the only risk that was already being cleared for, by means of size of exposure and interest rates.

For instance, they gave prime AAA to AA rated assets a 20% risk weight, while highly speculative almost broke below BB- rated, assets got a 150% risk weight...

As if banks would ever build up dangerous excessive exposures to what is below BB- rated.

And that has seriously distorted the allocation of bank credit to the real economy with disastrous consequences.

But have we heard sufficient finance professors protesting sufficiently against this the pillar of current bank regulations? Absolutely not! In fact their deafening silence on it, is one of the principal reasons why this issue is not even discussed.

Sir, it would be great if the undercover economist Harford would dare to do some research on the why of that silence. He could do that in his beloved Oxford or, if he feels more comfortable doing so, in some university of some other faraway town. (Cambridge?)

PS. Here is a more detailed aide memoire on the Basel Committee for Banking Supervision’s regulatory monstrosity.

PS. There are some academics who have protested these regulations but mostly in terms of the capital requirements being too low or in terms of the distortions these might cause of the balance sheets of banks. They are correct but my point is that the distortions produced in the allocation of bank credit by using different capital requirements, is even more important than these being too high or too low.

@PerKurowski ©