January 10, 2018

The financial-elite’s reluctance to ask bank regulators for clear explanations, seriously threatens the west’s liberal democracy and global order

Sir, Martin Wolf asks and answers: “What has created sharp (and usually unexpected) slowdowns? The answers have been financial crises, inflation shocks and wars” “The world economy hums as politics sour” January 10.

Indeed, but currently our economies are also suffering a slow but steady state slowdown as a consequence of the insane risk weighted capital requirements for banks, which were created in the name of making banks more stable. It all boils down to the following:

If a “safe” AAA rated offered a correct risk adjusted net interest margin to a bank, a loan to it could, according to the Basel Committee’s Basel II of 2002, be leveraged 62.5 times but, if that correct risk adjusted net interest margin was offered by a “risky” unrated entrepreneur or an SME, then a loan to these could only be leveraged 12.5 times.

As a direct result bank credit has been used to finance “safer” present consumption; to inflate values of mostly existing assets; and way too little to finance “riskier” future production.

In summary it amounts to having placed a reverse mortgage on our past and present economy, in order to extract all of its value now, not caring one iota about tomorrow, and much less about that holy social intergenerational contract Edmund Burke spoke about.

But Wolf could argue that this is evidently not true because: “Yet the world economy is humming, at least by the standards of the past decade. According to consensus forecasts, optimism about prospects for this year’s growth has improved substantially for the US, eurozone, Japan and Russia”

Sir, it’s all a debt financed economic growth. Like a family having a great Christmas by racking up debt on their credit cards. How much of the enormous recent growth of debt everywhere has gone to finance future builders like entrepreneurs and SMEs? The answer is surely a totally insignificant fraction.

Wolf here anew identifies threats: “The election of Donald Trump, a bellicose nationalist with limited commitment to the norms of liberal democracy, threatens to shatter the coherence of the west. Authoritarianism is resurgent and confidence in democratic institutions in decline almost everywhere.”

Sir, sincerely, what is all that compared to the fact that the world’s financial elites, either because it is not in their interests, or because lacking self confidence they are afraid they might have overlooked something, do not have the gut to firmly ask regulators: “Why do you want banks to hold more capital against what has been made innocous by being perceived risky, than against what is dangerous because it is perceived safe?”, and not accepting any flimsy nonsensical answer veiled in sophisticated voodoo technicalities.

Martin Wolf has moderated numerous important conferences on financial regulations, but not one has he dared to ask that simple question. Could it just be because he is scared he would then not be invited again as a moderator? Or is it that he just doesn’t get it.

And Sir, you have really not been living up to your motto either. Shame on you!

PS. And all that risk adverse regulations for nothing, since, as I have told Wolf and FT time after time, major bank crisis, like that of 2007/08, never ever result from excessive exposures to what is ex ante perceived as risky.