October 08, 2017

No one but a PhD or an MBA could have come up with the foolish risk weighted capital requirements for banks

Sir, Philip Delves Broughton in his “The business school tradition feels like an outdated Grand Tour”, October 7, refers to a book I am just to begin to read, Mihir Desai´s The Wisdom of Finance.

In that book Desai, writes about “how many of his MBA students avoid risk in order to retain their ‘optionality’... a concept they had picked up from finance… [but] often remain in companies saying to themselves, ‘Why not stay another year and create more options for down the road?’; ending up frustrated. The tool that was supposed to lead to more risk-taking ends up preventing it.”

Sir, I am not sure an option-searcher has ever in him to be a real risk-taker. That normally belongs to those who just close their eyes and jump at any opportunities in front of them. But, that said, I sure know of a tool that produces just the opposite. It was supposed to lead to less risk-taking, but ends up causing much more of it.

I mean of course to the risk weighted capital requirements for banks. By giving banks the incentives to create excessive exposures, holding the least capital, to what has always caused major bank crisis, namely what was ex ante perceived as safe but that ex post turned out to be very risky, instead of reducing the risks to the bank system, it increased it exponentially.

Broughton also refers to a book by Will Dean, It Takes a Tribe, in which the author holds that entrepreneurs learn by doing, while MBAs fail by over-thinking. Will Dean is by far not the first to argue such a thing.

My daughter Alexandra, an art fanatic, on hearing my explanation about the mistake of the Basel Committee, pointed me to “The forger’s spell”, a book by Edward Dolnick about the falsification of Vermeer paintings. Boy was she right! 

In that book Dolnick makes a reference to having heard Francis Fukuyama in a TV program saying that Daniel Moynihan opined: “There are some mistakes it takes a Ph.D. to make”. And Dolnick also speculates, in the footnotes, that perhaps Fukuyama had in mind George Orwell’s comment, in “Notes on Nationalism”, that “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” 

I am very happy with the MBA degree I received from IESA in Caracas 1974; but that does not stop me from being extremely disappointed with all MBA and Finance Schools all over the world, for not having been able to see, and much less stop, those regulations that are so dangerously distorting the allocation of bank credit.

Dolnick wrote: “Experts have little choice but to put enormous faith in their own opinions. Inevitably, that opens the way to error, sometimes to spectacular error.”

All of which leaves me with the problem that seemingly no ordinary financial reporters either, like those in FT, can really come to grips with believing, or even daring to believe, that experts could be such fools.