September 23, 2017

That 2007-08 crisis resulted from excessive risk taking by banks, is a dead cat thrown on the table by regulators

Sir, Tim Harford writes: “bold lies have become the dead cat of modern politics on both sides of the Atlantic. Dramatic lies do not always persuade, but they do tend to change the subject — and that is often enough. It is hard to overstate how corrosive this development is. Reasoned conversation becomes impossible”, “The fatal attraction of cynical falsehoods” September 23.

The Basel Committee for Banking Supervision, with Basel II in 2004, and for the purpose of setting the capital requirements for banks, assigned a risk weight of 20% to the AAA rated and one of 150% to the below BB- ones.

Since an AAA rated borrower is very much less likely to default than a below BB- rated, at first sight this could seem reasonable.

But precisely because of these perceived risks, banks lend much more and at much lower interest rates to the AAA rated, and very little or nothing, or anyhow at much higher interest rates to the below BB- ones.

And therefore, when it instead comes down to what poses more dangers to bank systems, and if applying the same weights, it would be the AAA rated that carried the 150%, and the below BB- the 20%.

So, as a result of allowing banks to leverage 62.5 times, as long as an AAA rating was present, (or even more in the case of sovereigns like Greece), excessive exposures to “the safe” were created and a super-crisis exploded.

But then the regulators, friends and admirers lay on the table the argument of it all having resulting from excessive risk-taking by banks.

That surely has all the characteristics of a dead cat but, when one tries to raise this issue the regulators, and undercover economists, they all shut up like clams.

Sir, since risk weighting the capital requirements dangerously distorts the allocation of bank credit to the real economy, we can’t allow for that to go on, and so we must insist in getting that dead cat off the table.

Unfortunately it would seem you also want that dead cat to remain on the table