January 26, 2018

Martin Wolf, public borrowings are being subsidized by bank regulations

Sir, Martin Wolf discussing the UK government’s private finance initiative (PFI) and costs of capital writes: “A sophisticated counter-argument is that government borrowing enjoys an implicit subsidy from taxpayers. That represents an unpriced insurance contract… This subsidy makes government funding look cheaper. But this is an illusion. “Public-private partnerships have to change to be effective” January 26.

Illusion? Does Martin Wolf really think that if banks had to hold the same capital against sovereign debt, than for instance against loans to entrepreneurs, the interest rate on public debt would remain the same?

Or, in a similar vein, does Martin Wolf really think that if banks had to hold the same capital when financing houses, than for instance when lending to entrepreneurs, the price of houses would not be negatively affected?

Mr. Wolf: Do you really think it is the risks for the banking system that are being weighted in those capital requirements? If so, I am sorry to have to break the bad news to you, again, for the umpteenth time. The risks that are being weighted for are the risks of the assets per se, which is why regulator want banks to hold more capital against what is ex ante perceived as risky than against what is perceived as safe.

Which explains how they could assign a risk weight of only 20%, to what rated AAA could pose a terrible threat to our banks, and a whopping 150%, to what rated below BB- bankers won’t touch with a ten feet pole.

John Kenneth Galbraith, in his “Money: Whence it came, where it went” (1975) wrote: “What people do not understand, they generally think important. This adds to the prestige and pleasure of the participants” … and yes, Sir, “risk weighted capital requirements” sounds indeed so delightfully sophisticated… almost as much as “derivatives”.