For regulators to impose risk weights is antithetical to the American principle of treating all citizens equally.

Sir, Judy Shelton writes: “The Fed has adopted monetary policy decisions that channel low-cost funding to wealthy investors and corporate borrowers at the expense of people with ordinary bank savings accounts and retirees on fixed-income pensions. That is not only inherently political — it is antithetical to the American principle of treating all citizens equally.” “Trump is right to take aim at the ‘political’ Fed”. September 29.

That might be political or not, but let us not forget that the current financial mess derives from something not really political but simply dumb; the senseless distortion of the allocation of credit to the real economy caused by regulators imposing risk weighted capital requirements for banks. That began in 1988 with Basel I and really took off in 2004 with Basel II, and Basel III is in many ways worsening it.

Just looking at the risk weights of: 0% for the sovereign, 20% for the AAArisktocracy, 35% for residential houses, 100% for We the (unrated) People and 150% for the below BB-rated outcasts; and considering that credit risk is already cleared for by banks with interest rates and the size of exposure, should say it all. And if that’s not antithetical to the American principle of treating all citizens equally what is.

But since Judy Shelton is a member of the Trump economic advisory council, and Donald Trump has often been involved with casinos, let me explain it all in terms of betting. The underlying principle of any casino is that all bets have the same expected financial outcome, a small loss, which represents the profit of the house. But what would happen if regulators manipulated the whole betting process and declared that the winnings of the house would depend on how risky each bet was, with risk being determined by the odds?

For instance if any safe bet, like on color, or on a pair or an impair number, gave the casino a much higher expected profit than a bet on a “risky” single number, that casino would make huge profits, until those betting there found out, and then it would go out of business.

And that is what regulators are doing when allowing banks to leverage their equity, and the support they receive from society, differently depending on the perceived credit risk. Worse yet, when it comes to the big banks, those who were deemed able to run their own capital risk models, the regulators authorized the casino owners to do their own manipulations.

And that means that The Risky, like SMEs and entrepreneurs, have their access to bank credit much more severely curtailed than usual. And stagnation results.

Worse yet, all that distortion for nothing, because bank crisis never result from excessive exposures to something ex ante perceived as risky, these always result from unexpected events or excessive exposures to something erroneously perceived as very safe.

And to add salt to injury, these failed and risk adverse bank regulations that affect banks in The Home of the Brave, emanate from a Basel Committee and a Financial Stability Board dominated mostly by European bureaucrats.

@PerKurowski ©