For our grandchildren sake we must recover the “democratic capitalism” we inherited and lost too much of.
“We have inherited democratic capitalism from the struggles of our predecessors. We must reform and protect it for our descendants.” Martin Wolf, “In defence of democratic capitalism” FT January 21, 2023
Yes, indeed, but Sir, sadly, we’ve already lost too much of it. When I see bank capital requirements with decreed risk weights of 0% government and 100% citizens, I see Hitler/Stalin/Mao/Mussolini decreed weights… I see populism… I see the empowerment of an authoritarian bureaucracy autocracy… I see the dangerous and weakening distortion of the allocation of bank credit.
And that’s why, even to the point of obsession (as Wolf once mentioned) I’ve been fighting the risk weighted bank capital (equity / shareholders’-skin-in-the-game) requirements, first introduced 1988, as Basel I. These allow banks to leverage more their shareholders’-skin-in-the-game, and thereby earn higher risk adjusted returns on equity when financing what’s perceived (or decreed) as safe, than when financing what’s perceived as risky.
That de facto decreed the more creditworthy as more worthy of credit and the less creditworthy as less worthy of credit.
Wolf opines “It is possible for example to limit macroeconomic instability by reducing reliance on debt-fuelled demand and making the financial system more robust”. Yes, but for that Wolf must try to understand that what’s “safe” e.g., government debts and residential mortgages are more like demand-pushing-carbs while, what’s “risky” e.g., loans to small businesses and entrepreneurs, could be classified as supply-producing-proteins.
These regulations were sold as making our bank systems safer. What nonsense. The large exposures that have caused all major bank crises have always been built up with assets perceived (or now decreed) as safe, and never ever with assets perceived as risky.
The real reason for it all was confessed by Paul Volcker in his 1988 autobiography “Keeping at it”: “Assets for which bank capital requirements were nonexistent, were what had the most political support; sovereign credits and home mortgages… A ‘leverage ratio’ discouraged holdings of low-return government securities.”
Were those regulations agreed upon in a democratic way? Absolutely not. For a starter these should not be able to clear the American Founding Fathers’ US Constitution.
Wolf mentions his family’s history: “In May 1940, as the Nazis invaded the Netherlands, my mother escaped from the country in a trawler hijacked by her father, a self-made fish merchant. Her father, one of nine, asked all his wider family to join them on the journey to England. None did: they were all slaughtered in the Holocaust.”
The morning after, everything’s clear but, the night before, who was the real risk-taker, Martin Wolf’s grandfather or the other eight who stayed behind?
In the same way the morning after a bank crisis, what’s dangerous becomes crystal clear. But what’s usually forgotten by Monday morning quarterbacks, is that the large exposures that caused the crisis were built up with assets perceived (or now decreed) as very safe.
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