September 27, 2017

The correlation between assets that caused the financial crisis 2007-09 and the lowest bank capital requirements is 1

Sir, Martin Wolf writes, “Since 2013, eurozone output per head has been rising at much the same rate as in the US. The main explanation for this turnround, beyond the normal cyclical forces, has been the determination of the European Central Bank, under Mario Draghi, to do its job properly.” “Creative reform is vital for the eurozone” September 27.

Well the job is clearly not over. Until now what has been achieved is basically to kick the can down the road. I wonder what forthcoming generations will say about Wolf’s “properly” and Mario Draghi’s “whatever it takes”?

The correlation of assets that helped cause the financial crisis 2007-09 and those assets perceived, decreed (Greece) or concocted as safe, meaning those assets that generated the lowest capital requirements for banks is 1. Since Europe and much of the world insist in using the risk-weighted capital requirements for banks that distorts the allocation of bank credit to the real economy, a vital bank regulation reform is still pending.

That this reform has no been carried out is caused by regulators, like Mario Draghi, not wanting to accept, or let it be known, what stupid mistakes they made. And with a little help from their friends they threw the dead cat of the crisis being caused by excessive risk taking by the banks on the table.

Wolf refers to a proposal by Adam Lerrick of the American Enterprise Institute for “a scheme for mitigating the impact of asymmetric fiscal shocks” by means of transferring “yields on government bonds of vulnerable countries rise relative to the stronger ones.” That sounds reasonable, but I would suggest that should have to begin by eliminating the regulatory subsidies to sovereign debt, so that one is really clear about who is strong and who is weak.