May 07, 2018

Risk weights of 0% the sovereign and 100% to its source of strength, the citizens, is putting the cart before the horse

Sir, I refer to Professor Lawrence Summers’ “The threat of secular stagnation has not gone away” May 7.

Again, for the umpteenth time: Regulators allow banks to hold less capital against what is perceived safe, like houses and friendly sovereigns, than against what is perceived risky, like entrepreneurs. This allows banks to leverage more with the “safer” present economy than with the “riskier” future. 

And this allows banks to earn higher expected risk adjusted returns on equity when financing the “safer” present economy than when financing the riskier future, something which causes banks to give too much credit to the current economy, without giving sufficient credit to the future productive means that could generate a much needed debt repayment capacity. 

This has to result in the “slow productivity growth [and] unsound lending and asset bubbles with potentially serious implications for medium-term stability” which is of such great concern to Professor Summers. Why is this so hard to understand?

Why can renowned professors with so much voice, not be able to also understand that if you assign a risk weight of 0% to the sovereign, and one of 100% to the citizens, those who signify a sovereign’s prime source of strength, you are putting the cart before the horse? Are they too statist or, behaving like sovereigns with an après nous le déluge, just too indifferent about the future.