December 08, 2017

If bitcoin poses no threat because it’s perceived risky, why agree with regulations that hold lending to entrepreneurs is dangerous because they are risky?

Sir, I refer to your “Do not worry about bitcoin — at least not yet” December 8.

Of course while bitcoin are perceived risky they pose no major danger. What I cannot understand though is why you do not extend that same reasoning to bank regulations?

What if suddenly bitcoin holdings were suddenly in terms of safety rated AAA by credit rating agencies, and regulators allowed banks to leverage over 60 times with these? That would make these bitcoin really dangerous, as happened when Basel II allowed banks to leverage with AAA rated securities.

That leads me to comment: “A flawed blue print for reform of the Eurozone” also of December 8.

Sir, if it were up to me I would not allow any expert technocrats to come even close to any institution in the Eurozone, before having received a satisfactory answer on why their regulators want banks to hold the most capital against what is perceived as risky. As I see it, it is when something ex ante perceived very safe ex-post turns out to be very risky, that we would like our banks to hold the most of it.

For instance would you like your banks regulated by those who assigned sovereign Greece a 0% risk weights and German entrepreneurs 100% and thereby caused German banks to lend more to Greece than to their local entrepreneurs? I sure would not!

@PerKurowski

The Basel Committee’s bank regulators being replaced by an algorithm could be the best that could happen.

Sir, I refer to Gillian Tett’s “Self-driving finance could turn into a runaway train”, December 8.

Well human-driven banks are now not doing so well either. 

Any algorithm currently making credit decisions for a bank would do so based on maximizing risk-adjusted returns on equity, based on perceived risks of assets and on regulatory bank capital requirements regulations.

Where would it get the risk perceptions? Currently credit ratings… Who knows if in the future algorithms would also take over the credit rating functions… if these have not already done so?

Where would it get the capital requirements? Currently it get those from the Basel Committee’s standardized risk weights, or if the algorithm works for a sophisticated bank, from its own risk models.

So, if the algorithm does its job well, and works for a sophisticated banks, it would seem that in order to obtain the highest risk adjusted return on equity, its priority has to be creating the risk model that minimizes the capital requirement.

And if it works for a bank that uses the standardized risk weights, then it is clear it would not waste its time with what carries a 100% risk weight, like an entrepreneur, but concentrate entirely on those with much lower risk weights, sovereign 0%, AAA rated 20%, residential mortgages 35%.

So, with the risk weighted capital requirements it is clear that whether the banker is a human or an algorithm, we can forget about savvy loan officers… they will all be equity minimizers.

Of course, an entrepreneur can always offer to pay sufficiently high interest rates to overcome the regulatory handicap. But, would doing so not make him even more risky? With current regulatory risk aversion we should cry for the future real economy of our children.

Sir, in 2003, at the World Bank’s Executive Board (before Nassim Nicholas Taleb had appeared on the scene to discuss fragility) I stated: "A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind."

So, I guess you can you imagine how much I fret us humans falling into the hands of a final conquering algorithm.

Or having to suffer the consequences of the systemic risks resulting from banks using fewer and fewer human bankers… with probably higher bonuses to the remainders.

By the way since the replaced bankers used to pay taxes, will we at least be able to tax those algorithms?

But, come to think of it, if an algorithm substituted for bank regulators that could be great news. I mean any half-decent algorithm would be able to figure out that what is really risky for our bank system is not what is perceived as risky but what is perceived as safe.

And any half-decent algorithm would also require an answer to the question of “What is the purpose of banks?” And I suppose no regulator would dare tell it, “Only to make the maximum risk adjusted returns on equity” 

@PerKurowski

December 06, 2017

Some might see Donald Trump’s bankruptcies as a weakness, but others, especially in America, as a symbol of go-get-it strength.

Laura Noonan, Patrick Jenkins and Olaf Storbeck write: “Deutsche Bank has been one of Mr Trump’s longest-standing and most supportive lenders, extending him hundreds of millions of dollars in credit for real estate deals and other ventures despite his history of bankruptcies.” “Deutsche Bank hands over Trump files to Mueller probe of Russian influence” December 6.

Sir, the way it is phrased might reflect some profound cultural differences. Is it really “despite Trump’s history of bankruptcies”, or could it precisely because of it, that Deutsche Bank could be interested, as that would indicate business opportunities?

Let me quote the following from “The Wisdom of Finance” by Mihir A. Desai, 2017, Chapter Seven “Failing Forward”:

“Until 1800 [in America], borrowers who could not service their debts were moral failures. As a consequence, imprisonment was common for debtors…

Failure would be redefined away from moral failing or a sin and toward a more natural consequence of risk taking with the 1800 act. [The first bankruptcy law]… the new republic desperately needed risk takers, and punishing them so severely froze commerce in the late 1790. If the young country was to flourish, failure had to be redefined, and the moral stigma associated with it had to be lessened.”

Sir, after current regulators, with their risk weighted capital requirements, for soon three decades now, have exacerbated the normal risk aversion of our bankers… I would argue we currently are also in desperate need of risk takers. God make us daring!


@PerKurowski

More food for the hungry and less food for the less hungry sounds logical and decent, that is unless the hungry are obese and the less hungry anorexic.

Sir, Martin Wolf writes: “More equity capital would make banks less fragile.” “Fix the roof while the sun is shining” December 6.

That is only true as long as we get rid of the distorting risk weighted capital requirements for banks. Though “more risk more capital - less risk less capital” sounds logical, that is unless “The Safe” get too much credit and “The Risky” too little. If that happens, both banks and the economy will end up more fragile.

Wolf writes: “The world economy is enjoying a synchronised recovery. But it will prove unsustainable if investment does not pick up, especially in high-income economies. Debt mountains also threaten the recovery’s sustainability”. Let me comment on that this way:

First: “a synchronised recovery” is a way to generous description of what is mostly a QE high that has just helped kick the crisis can down the road.

Second: The investments most lacking in the “unsustainable if investment does not pick up” part, is that of entrepreneurs and SMEs, those which have seen their access to bank credit curtailed by regulators. It is high time we leave the safer but riskier present and get back to the riskier but safer future.

Third: The “Debt mountains [that] threaten” are either those for which regulators allow banks to hold much less capital against, like sovereigns and residential mortgages; or those consumer credits at high interest rates that dangerously anticipate consumption and leaves us open to future problems.

Sir, let me again make a comment on Wolf’s recurrent recommendation of “Public investment to improve infrastructure”. He usually argues this in order to take advantage of the very low interest rates. That ignores that those low rates are not real rates but regulatory subsidized rates. If banks had to hold the same capital against loans to sovereign than against loans to citizens, and if also central banks refrained from additional QEs, I guarantee that the interest rates on public debt would be much higher.

Besides, given the fast technological advances, we do not even know what infrastructure will be so much needed in the future so as to be able to repay the loans, instead of just burdening more our grandchildren.

@PerKurowski

December 03, 2017

When being rightly suspicious about making algorithms powerful let us not ignore that powerful humans could be very dangerous too.

Sir, Tim Harford, agreeing with Hayek holds “Market forces remain a more powerful computer than anything made of silicon.” “Algorithms of the world, do not unite!” December 2.

But when regulators decided to replace the risk assessments of thousands of individual and diverse bankers, with those produced by some few human fallible credit rating agencies; and then allowed banks to increase their bets on these ratings being correct, for instance with Basel II allowing banks to leverage a mindboggling 62.5 times if only an AAA or an AA rating was present, we would have benefitted immensely from having some algorithms indicate them this was pure folly.

Because, in the development of such algorithms, it would not been acceptable to look solely at the risks of bank assets as such, but would have required to consider the risk those assets posed for the banks.

And as a result the algorithms would not have allowed banks to leverage more with safe assets than with risky, that because only assets perceived as very safe can lead to the build up of such excessive exposures that they could endanger the whole bank system, were the credit ratings to turn out wrong.

An Explanatory Note on the Basel II IRB (internal ratings-based) Risk Weight Functions” expresses: “The model [is] portfolio invariant and so the capital required for any given loan does only depend on the risk of that loan and must not depend on the portfolio it is added to.”

And the explicit reason given for that inexplicable simplification was: “Taking into account the actual portfolio composition when determining capital for each loan - as is done in more advanced credit portfolio models - would have been a too complex task for most banks and supervisors alike.”

Sir, algorithms are precisely designed to combat such complexities.

Yes, “Facebook and Google have too much power” but so did the regulators; and with their risk weighting of the sovereign with 0% and citizens with 100%, Stalin would have been very proud of them.

@PerKurowski

December 02, 2017

What cultural insight could anthropologist Gillian Tett, or any neo-Cannibal Club colleague of hers give in order for me to better understand bank regulations that seem so loony?

Sir, Gillian Tett, commenting on Marc Flandreauan economic historian’s 2016 book “Anthropologists in the Stock Exchange”, writes about the “Cannibal Club, a so-called anthropological society that, its members hoped, would explore far-flung cultures in order to uncover what made humans tick” “It is primitive to ignore what links finance and social science” December 2.

When Tett refers to that “By the middle of the 19th century, much debt was turning sour due to defaults, corruption and fraud (some perpetrated by British swindlers who misled investors about opportunities on offer). Sovereign loans in places such as Venezuela kept delivering nasty shocks.” I would then have liked very much to be able to ask those anthropologists whether if all, or any, of those failed financial assets had been ex ante considered risky. 

Today I would also like to ask any neo-Cannibals why they think current bank regulators could want banks to hold more capital against what is perceived as risky? To me that is a mystery. Is it not when something perceived ex ante as very safe turns out ex post as very risky, that one would really like banks to have the most of it?

On Venezuela’s defaults, Tett suggests “thinking about this historical link between capital markets and culture, and between finance and social sciences” I would add the fact that Venezuela’s main export revenues, oil, currently 97% of these are centralized in its government. If that’s not enough to know that things will, sooner or later, go utterly wrong, I do not know what is.

@PerKurowski

To allow banks to regain public trust and better serve the UK economy, begin by explaining how their regulators distorted banking.

Sir, you write about “the highly concentrated nature of the UK system, which is dominated by a handful of large institutions, with balance sheets skewed towards mortgage lending and other forms of consumer finance” and of a popular resentment of banker’s pay, “Corbyn’s calculated ‘threat’ to the banks”, December 2.

Banks’ balance sheets are skewed towards less-capital or very high risk-premiums, like lending to the sovereign, mortgage lending and other forms of consumer finance

Banks’ balance sheets are skewed away from what requires holding more capital and cannot afford to pay too high rates, like SMEs and entrepreneurs.

If you required banks to hold as much capital for all their assets as they must hold when lending to SMEs and entrepreneurs, then the story would be much different.

If you allowed banks to hold slightly less capital against loans to SMEs and entrepreneurs than against all other assets, that would more than compensate for the lack “of community banks or Sparkassen”; and introduce such economic dynamism that it could more than help you to confront any Brexit difficulties.

If banks needed to hold more capital in general, and therefore needed to compensate shareholders more, then there would be less available space for current abnormal banker bonuses. Ask Sergio Ermotti how much he has to thank regulators for his bonuses.

So, how to ensure that the banking sector can regain public trust and better serve the needs of the UK economy? Sir, why not begin by explaining what the bank regulators have done. We can of course not ask the bankers to explain that.

Oops, but that would mean you would have to explain why you have silenced my soon 2.700 letter to you on this, and that could be too embarrassing for one with your motto.

A brief aide memoire

@PerKurowski

December 01, 2017

Martin Wolf, a country needs its elites to inspire much more the “possible” than to preach the “impossible”.

Sir, in “Way back Home”, about his World War II days, we hear Rod Stewart singing: “we always kept the laughter and the smile upon our face. In that good-old-fashion British way with pride and faultless grace”.

And then we read Martin Wolf, reciting six impossible, not one possible, and ending with: “The EU holds the cards and it knows it holds the cards…The UK is no longer its 19th-century self, but a second-rank power in decline”, “Six impossible notions about ‘global Britain’’ November 31.

How utterly depressing!

We saw when Holland got smacked with the Dutch disease, and instead of just taking it laying down, they forgot about manufacturing, and decided to become the distributors of Europe… (at least that is the version I have been told)

Just days ago, November 29, in “Challenges of a disembodied economy” Martin Wolf discussing Jonathan Haskel’s and Stian Westlake “Capitalism without Capital: The Rise of the Intangible Economy” was illustrating the huge changes the world was going through, when for instance “Apple, the world’s most valuable company, owns virtually no physical assets. It is its intangible assets — integration of design and software into a brand — that create value.” In such a new world, is really the UK dependence on EU the same as previously seen? Does anyone really know what cards one holds nowadays? 

The day after Brexit, Britain will not be very different from EU, it will mostly be sharing the same old and new problems as EU and, unless Britain decides that is not to happen, there is nothing that eliminates the possibility of Britain’s relations with EU being more intensive and better than ever. A divorce, though it might be traumatic, does not mean the divorcees cannot get along splendidly.

Does that mean the Brexit road is easy rosy? Of course not, but there is a vital need for Britain, and for Wolf, to stop lamenting so much, and get down to work at doing the best, not out a bad situation, but out of an for everyone unknown situation.

Like when Rod Stewart’s song ends with hearing Churchill reciting: "We shall fight on the beaches. We shall fight on the landing grounds. We shall fight in the fields, and in the streets. We shall fight in the hills; we shall never surrender." 

PS. To begin with you should reverse having surrendered your banks to dangerous risk aversion, and eliminate the loony risk weighted capital requirements for banks

@PerKurowski