What if the State of Maryland USA, where I live, was treated by the Fed as Italy is by its EU bank regulators?

Sir, Tony Barber writes: “Paradoxically, as Italy’s debt has ballooned in size, it has become more manageable. Particularly over the past two years, the crucial factor has been European Central Bank support” “Reforms and ECB help are key to Italy debt sustainability” February 25.

Although already Maryland, as all other US states is already treated quite (too) generously by bank regulators, since it cannot print dollars on its own, the capital banks need to hold when lending to it, do at least depends on its credit ratings. 

Not so in the Eurozone. Though none of its sovereigns, like Italy, can print euros on their own, and independent of their credit ratings, the banks in EU can lend to all Eurozone sovereigns, against zero capital. Something much agreed by and pushed by Mario Draghi.

It’s been hard for me to understand, especially after Brexit, why FT has kept so much silence on this Eurozone’s sovereign debt ticking bomb.

@PerKurowski

For inflation, where the money supply goes, matters a lot too

Sir, I refer to Martin Wolf’s “The monetarist dog is having its day”, FT February 23.

Yes, the money supply impacts inflation, no doubts but, when it comes to how much, that also depends on where that money supply goes.

If central banks inject liquidity through a system where, because of risk weighted capital requirements, banks can leverage more, meaning easier obtain higher risk adjusted returns on equity with Treasuries and residential mortgages, than with loans to small businesses and entrepreneurs, does that not favor demand over supply?

It does, and you should not have to be a Milton Friedman to understand that sooner or later that can only help inflate any inflation.

Wolf holds that “Central banks must be humble and prudent” Yes, and that goes for bank regulators too.

“Humble” in accepting there are huge limits to their knowing what the real risks in an uncertain world are; and “prudent” as in knowing bank capital requirements are mainly needed as a buffer against the certainty of misperceived credit risks and unexpected events, and not like now, mostly based on the certainty of perceived credit risks.

@PerKurowski

Compared to more than three decades ago, what is the current leverage ratio of our banks?

Sir, Martin Wolf, in FT on July 12, 2012, in “Seven ways to clean up our banking ‘cesspit’” opined: “Banks need far more equity: In setting these equity requirements, it is essential to recognize that so-called “risk-weighted” assets can and will be gamed by both banks and regulators. As Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk. For this reason, unweighted leverage matters. It needs to be far lower.”Soon a decade since, are bank capital requirements much higher and really sufficient?

No! Though bank capital requirements are mostly needed as a buffer against the certainty of misperceived credit risks & unexpected events, in this uncertain world, these are by far, still mostly based on the certainty of the perceived credit risks.

Consequently, when times are rosy, regulators allow banks: to lend dangerously much to what’s perceived as very safe; to hold much less capital; to do more stock buybacks and to pay more dividends & bonuses. Therefore, banks will stand there naked, when most needed. 

The leverage ratio is also important because it includes as assets, loans to governments at face value, and thereby makes it harder for excessive public bank borrowers to hide behind Basel I’s risk weights of 0% government, 100% citizens. No matter how safe the government might be, those weights de facto imply bureaucrats know better what to do with credit they’re not personally responsible for than e.g., small businesses and entrepreneurs.

November 19, 2004, in a letter you published I wrote: “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector?” That this factor, in the face of huge government indebtedness, is not even discussed, as I see it can only be explained by too much inbred statism.

Before the Basel Committee Accord became operative in 1988, Basel I, banks were generally required to hold about 10 percent of capital against all assets, meaning a leverage ratio of 10.

Where do banks find themselves now? I know well it’s hard, and extremely time consuming, to make tails and heads out of current bank statements, but I’m absolutely sure most financial media, if they only dared and wanted, have the capacity to extract that information.

Should not such basic/vital data be readily available and perhaps even appear on front pages? It’s not! Why? Has media been silenced by capital minimizing/leverage maximizing dangerously creative financial engineers?

Sir, I’m not picking especially on financial journalists, the silence of the Academia, especially the tenured one, is so much worse.

@PerKurowski

How can you hold governments accountable, while their borrowings are being non-transparently subsidized?

Sir, Aveek Bhattacharya discusses various options to improve the productivity and effectiveness of public spending. “A future case for the ‘retro’ policy of public sector reform” FT February 18, 2022.

He fails to mention: Current bank capital requirements are much lower for loans to the government than for other assets. This translates into banks being able leverage much more their capital – and so making it easier for them to earn higher risk adjusted returns on equity when lending to the government than when lending to the citizens. That, which de facto implies bureaucrats know better what to do with credit they’re not personally responsible for than e.g., small businesses, turns into a subsidy of the interest rates government has to pay on its debts. Top it up with that the quantitative easing carried out by central banks is almost all through purchases of sovereign debt, and then dare think of what sovereign rates would be in the absence of such distortions.

Sir, if you really want to make your government more accountable, have them at least know what their real borrowing costs are.

Sir, in a letter you published in 2004, soon two decades ago I asked “How many Basel propositions will it take before regulators start realizing the damage, they are doing by favoring so much bank lending to the public sector?” Do you think this only applied to developing nations? If so, please open your eyes.

@PerKurowski

If we want public debt to protect citizens today and tomorrow, it behooves us to make sure it cannot be too easily contracted.

Sir, I refer to John Plender’s “The virtues of public debt to protect citizens” FT February 7, 2022.

Sir, as a grandfather I do fear debt burdens we might impose on future generations, but I’m absolutely not an austerity moralist. I know public debt is of great use if used right but also that the capacity to borrow it a reasonable interest rates (or the seigniorage when printing money), is a very valuable strategic sovereign asset, especially when dangers like war or a pandemic appear, and which should therefore not be irresponsibly squandered away.

In 2004, when I just finished my two-year term as an Executive Director of the World Bank, you published a letter in which I wrote “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage, they are doing by favoring so much bank lending to the public sector?”

1988 Basel I’s risk weighted bank capital requirements decreed weights of 0% the government and 100% citizens. It translates into banks being allowed to hold much less capital - being able to leverage much more, with loans to the government than with other assets.

Of course, governments, when their debts are denominated in the currency they issue, are, at least in the short-term and medium term, and in real terms before inflation might kick in, less risky credits. But de facto that also implies bureaucrats/ politicians/apparatchiks know better how to use taxpayer’s credit for which repayment they are not personally responsible for than e.g., small businesses and entrepreneurs. And Sir, that I do not believe, and I hope neither you nor John Plender do that.

Such pro-government biased bank regulations, especially when going hand in hand with generous central bank QE liquidity injections, subsidizes the “risk-free” rate, hiding the real costs of public debt. In crude-truth terms, the difference between the interest rates sovereigns would have to pay on their debts in absence of all above mentioned favors, and the current ultra-low or even negative interests they pay is, de facto, a well camouflaged tax, retained before the holders of those debts could earn it.

But of course, they are beneficiaries of all this distortion, and therefore many are enthusiastically hanging on to MMT’s type Love Potion Number Nine promises.

@PerKurowski