Free markets were set up to go bad, because of bad bank regulations.

John Thornhill writes: “The global financial crisis of 2008 exploded the ideology that markets always deliver the goods” “Three game-changing ideas to shape the post-pandemic world” Life and Arts, May 30.

Sir, that is the problem, because that is exactly what all those against free markets want us to believe. 

The 2008 crisis resulted from huge exposures to securities collateralized with mortgages to the subprime sector in the USA, turning out risky. 

And those huge exposures were a direct result of: Regulators allowing European banks and US investment banks to hold these securities, if these were rated AAA to AA, which they were, against only 1.6% in capital; meaning banks could leverage their equity an amazing 62.5 times. 

Securitization, just like making sausages, is the most profitable when you pack the worst and are able to sell it of as the best. If you can sell someone a $300.000 mortgage at 11 percent for 30 years, which was a typical mortgage to the subprime sector, and then package it in a security that you could get rated a AAA to AA, so that someone would want to buy it if it offered a six percent return, then you would pocket an immediate profit of $210.000. 

The combination of those two temptations proved irresistible.

Don’t help bank regulators get away from being held accountable for their mistakes by politicizing the issue.

Sir, Gillian Tett commenting on Ben Bernanke, Henry Paulson and Timothy Geithner comments on the 10-year anniversary of the Lehman Brothers collapse writes:“Critics on the right complain that markets have been hopelessly distorted by government meddling” “European banks still have post-crisis repairs to do” July 20.

Frankly, you do not have to be from “the right” to “complain that markets have been hopelessly distorted by government meddling”

In 1988 bank regulators, based the risk weighted capital requirements for banks they were introducing on the nonsense that what was perceived as risky was more dangerous to our bank system than what was perceived as safe. With that they dangerously distorted the allocation of credit to the economy… and caused the crisis.

Would the Lehman Brothers have suffered the same collapse had not the SEC authorized it in 2004 to follow Basel II rules, and it could therefore (just like the European banks) leverage 62.5 times with securities backed with subprime mortgages, if these counted with an AAA to AA rating issued by human fallible credit rating agencies. Of course no!

But here we are a decade later and this major flaw of current bank regulations is not even discussed. What especially excessive exposures to something perceived decreed or concocted as safe are banks in Europe, America and elsewhere building up only because of especially low capital requirements, and which will guarantee, sooner or later, especially large crises? That should be the concern.

But, come to think of it, it could be that Ben Bernanke, Henry Paulson, Timothy Geithner and Gillian Tett, still believe in the story the Basel Committee told them, perhaps because they want so much to believe that a fairy could make banks safe and still be able to serve the economy. 

@PerKurowski

Regulators gave banks great incentives to smoke around drum barrels marked “empty”, and to stay away from drums marked “full”.

Gillian Tett writes “before 2008 the big banks spent a great deal of time fretting about issues that seemed obviously risky — hedge funds or highly leveraged companies — but tended to ignore anything that seemed safe or boring, such as AAArated mortgage-backed securities” “What the Hopi culture teaches us about risk” June 23.

Sir, if you go to my TeaWithFT blog and click on Gillian Tett, you will find that over the years I must have written her at least 100 letters explaining that what is perceived as risky, drums marked “full”, is never as dangerous than what’s perceived as safe, drums named “empty”. 

But, if a 70 year old paper by US fire-safety inspector Benjamin Lee Whorf, based a lot on Hopi Native American culture, is more convincing to Ms. Tett than my arguments, so be it.

My real complaint though is that Ms. Tett only refers to what bankers did, and does not mention the fact that bank regulators, on top of it all, with their risk weighted capital requirements, allowed banks to smoke (leverage) much more around drums named “empty”, than around drums named “full”. 

So when Ms. Tett writes: “In theory, this danger has now receded: banks have been trained to take a more holistic view of risk and to question whether even AAA ratings are always safe”, let us not forget that with Basel II, regulators allowed bank to leverage a mindboggling 62.5 times if only an AAA to AA rating was present. Since that besserwisser regulatory mentality still prevails, and risk weighting derived incentives still exists, unfortunately I do not share the hope that dangers have receded. New dangerous “absolutely safe” always lurk around the corners.

And Sir, come on, we have European central bankers who told banks “You can smoke as much as you like around that 0% risk weighted drum named Greece”; and they have still not been made accountable for that… and, between you and I, you FT is not entirely without blame for that.

PS. The sad complement to this analysis is that what regulators decreed as drums marked “full”, and made banks stay away from, includes entrepreneurs and SMEs, something which must erode the dynamism of the economy. 

@PerKurowski

Why do FT reporters refuse to implicate regulators and their risk weighted capital requirements for banks in the 2007-08 crisis?

Sir, Patrick Jenkins writes: “As a correspondent in Frankfurt in the early 2000s, I saw first-hand how a sector that had grown fat on government-supported AAA credit ratings, turned hubristic. The situation was at its worst — and most dangerous — after the EU pressured Berlin to end the government guarantee regime in 2005. That ruling prompted the banks to raise three years’ worth of money in the bond markets within a matter of months. It gave them vast investment resources to deploy just at the time when Wall Street and the City of London were aggressively pushing complex collateralised debt obligations underpinned by sub-prime mortgages and other nominally safe, but ultimately toxic, products to anyone that would buy them”, “The role of dumb money in Carillion’s crash”, January 18.

Amazing! Jenkins does not mention the fact that in June 2004, with Basel II, the Basel Committee approved a risk weight of only 20% for all private sector debt rated AAA to AA. That, with a basic capital requirement of 8%, meant banks needed to hold only 1.6% in capital against what was so rated; which meant the banks could leverage a mind-blowing 62.5 times with such assets.

It was pure regulatory lunacy! And the same loony regulators are still at it. How FT’s journalists and experts can keep so mum on the role of dumb and irresponsible regulations escapes me.

Jenkins refers to “complex collateralised debt obligations underpinned by sub-prime mortgages and other nominally safe” What a BS. These were AAA rated securities, that was what the market and bankers saw.

In January 2003 the Financial Times published a letter I wrote and that ended with: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.”

PS. FT, Jenkins, do yourself a favor. Go to all banks that had any involvement with Carillion and carefully research how much capital they held against exposures to it, before the blow-up. And ask to have a look at their equity requirements’ minimizing sophisticated risk-models, or at any “superficial credit analysis” … and don’t just naively believe anything they tell you.


@PerKurowski

Parent regulators, not even aware they were the ones blowing the bubbles, shamelessly put all the blame on their toddler banks when these burst.

Sir, Tim Harford writes: “As any toddler can attest, it is not an easy thing to catch a bubble before it bursts” “Forever blowing bubblemania” January 13.

That is entirely true. But though we should not expect our toddlers to know it, parents are fully aware that the bubbles their dearest are chasing, were blown up by them, in the clear expectation that these would burst, or delightfully disappear in the skies.

Harford concludes in that “It’s very easy to scoff at past bubbles; it is not so easy to know how to react when one may — or may not — be surrounded by one”

Not entirely true, because that should not excuse the case of parents not even being aware they’re blowing bubbles.

In the western world, regulators, for instance, by allowing banks to leverage their equity so much when financing residential houses, are, no doubt about it, blowing up a house credit bubble that will surely blow up in our face… even though we cannot exactly know when that will happen.

When with Basel II in 2004 regulators allowed banks to leverage a mindboggling 62.5 times their capital, only because an AAA to AA rating was present, it should have been clear to them that they were blowing a bubble. Seemingly they did not. Worse, when then the AAA rated securities backed with subprime mortgages exploded in their face, they should have been able to put two and two together, but no, they put all the blame on the banks, the toddlers in this case. Even to the extent of describing the excessive bank exposures to AAA rated assets, or to sovereigns like Greece who with a 0% risk weight they had decreed infallible, as an irresponsible excessive risk-taking by bankers. They should be ashamed!

PS. Like Harford’s senior colleague I was also very skeptical about Amazon’s valuation. In April 1999 I wrote in an Op-Ed that Amazon had “joined the rank and files of ‘tulipomanias’” Yes, I admit, it is now worth much more than it ever was at that time. That said, and though Amazon is now way more than about books, I still suspect that, long term, because of: “‘shopping agents’ will permit clients to quickly compare one company’s prices to those of its competition, which would seem to presage an eventual fierce price wars, would create an environment that is not exactly the breeding ground for profits that back the market valuations we are now observing”.

But then I also assumed institutional “efforts aimed at prohibiting any monopolistic controls of the Web”, and in this perhaps I could have been way to naïve.

@PerKurowski

Is banking regulation unfinished business? You bet, risk weighted capital requirements are still used

Sir, I have not read Tamim Bayoumi’s “Unfinished Business” yet, so for the time being I have to go on what John Authers writes in “A fresh way to learn from the financial crash” October 2.

From what I see the book seems in much like another example of Monday morning quarterbacking. For instance when it states “In early 2007 anyone in Wall Street would have said that naive European banks were the most enthusiastic buyers for dubious debt securities” we must really ask what is meant by qualifying European banks as naïve? These were AAA rated securities, these were the type of securities that their own regulators had just in 2004 with Basel II authorized the to leverage 62.5 times to 1 their capital with.

What we had (and still have) is amazingly naïve bank regulators… who for instance still allow banks to use their own models, as if banks were not interested in generating the largest risk adjusted returns on equity, something that, because of regulators, is nowadays foremost done by minimizing capital requirements.

It also says: “the US widened the collateral that banks could use in repo transactions [this] rule encouraged them to create mortgage-based securities, and “game” rating agencies into giving them undeserved strong ratings”. But that is wrong, or at the most, just a minor cause of the disaster.

Anyone who has taken time as I did to understand what had happened (I passed exams for real estate and mortgage intermediation licenses in the US for that purpose) would be clear on the following. The profit potential in securitization is a direct function of the quality difference between what is put into the securities, and what comes out. To be able to feed the sausage with subprime mortgages yielding 11 percent, and then because of AAA ratings be able to resell these (to Europe) at 6%, was a profit opportunity to big and juicy to miss.

Finally Authers comments: “Meanwhile, models resting on assumptions disproved during the crisis are still in use. There is indeed unfinished business.” Indeed, the risk weighted capital requirements are still used.

Sir, the first of about 50 letters I have written to John Authers since July 2007, more than a decade ago, ended with: “This all is lunacy and we are being set up for even bigger disasters and it must end, before it ends us. We need urgently to punish the regulators, at least on the count of being very naive.”

But clearly someone in FT did not want to hear my arguments, or at least not these coming from me.

@Per Kurowski

Do subprime borrowers or investors in mortgages benefit from securitization? No, now all profits go to intermediaries

Sir, Ben McLannahan, with respect to securitization of subprime mortgages quotes Julian Hebron, head of sales at RPM Mortgage with: “Making credit available to borrowers who are subprime is national policy and it is an important part of economic growth” “Financial crisis: 10 years on: The return of subprime” September 2.

Q. Do the subprime borrowers get any interest reduction from having their mortgages securitized, such reduction that could make these mortgage a safer investments for those investor who acquires these at lower rates? A. No!

Convincing risky Joe to take a $300.000 mortgage at 11 percent for 30 years, packaging it in a security, and then with a little help from the credit rating agencies convincing risk-adverse Fred that this mortgage is so safe that a six percent return is adequate, allows that mortgage to be sold for $510.000.

The $210.000 profit is now shared in it entirety by those originating the subprime mortgage, those packaging it, and those obtaining the excellent credit rating for the resulting security.

If that is “an important part of economic growth” that merits being part of a national policy, I don’t get it. Do you Sir?

If for instance 70% of those profits were paid back to those borrowers who lived up to their obligations, that would indeed imply a different and much more positive incentive structure.

Is that not something like for which cooperatives are often intended but not always achieve?

@PerKurowski

How did the world get into such a mess, and will it happen again? Here is why, and yes, as is, it will happen again!

Sir, Patrick Jenkins quotes Lord King — now a professor at the LSE and New York University with: “it was inevitable that a crisis was going to occur… The banking system as a whole was very highly leveraged. It had on its balance sheet a large volume of assets that were very difficult to value and no one could work out what the exposure of one individual bank was” “Financial crisis: 10 years on Where are we now?” September 2.

“How had the world ended up in such a mess — and has enough been done to stop something similar happening again?”, asks Jenkins.

First: The crisis resulted from: Basel II of 2004 allowing banks to leverage capital (equity) more than 60 times if only there was an AAA-to AA rating presents or if the exposure was to a friendly sovereign, like Greece. 

Jenkins writes “When the 2007 crisis broke, fingers of blame were pointed in all directions…. at policymakers for presiding over an environment of low interest rates and lax regulation” Lax regulation? No! Extremely distorting regulations. Had banks not been regulated by means of risk weighted capital requirements for sure some other crisis could have happened… but not that one that is here referred to.

Second: Since the risk weighing of some capital requirements is still used that guarantees that sooner or later, some safe-haven, like that of sovereign debt, will become dangerously overpopulated. Add to that the fact that risky bays, like SMEs and entrepreneurs, will not, as a result have sufficient access to credit, which will debilitate the real economy… and you can only come to the conclusion that, yes a crisis of the same nature is bound to happen again.

How can we stop it! To begin by removing all those who had something to do with current bank regulations because, as Einstein said: “No problem can be solved from the same level of consciousness that created it”.

To not debilitate the banks with fines and go after those responsible for any misbehavior would also help.

What would I do? Impose a straight 10% capital requirement against all assets; and if that puts a too big squeeze on bank capital, I would go a Chilean route of having central banks take on loans in order to capitalize the banks; and thereafter prohibiting banks from paying dividends before those shares that would have a preferential dividend have all been repurchased from the central banks. But that’s just me.

@PerKurowski

The financial packaging / securitization process includes an evil incentive

Sir, Patrick Jenkins in the Spectrum special “Financial crisis: 10 years on: Where are we now?” September 1 writes: “So great was investors’ appetite for these high-yielding MBSs and CDOs that mortgage companies lowered their underwriting standards to feed the securitisation sausage machine.”

Yes and no! First these MBSs had the additional quality of being rated by the credit rating agencies as very safe, AAA in many cases; and so in fact offered extremely high risk-adjusted yields, which made their great attractiveness perfectly logical. Naturally many investors would fall for these.

But then we have the problem with the securitization process itself. If you package something safe and sell it of as something safer, the profits are much smaller than if you manage to package something very risky and are able to sell it off as safe. So “mortgage companies lowered their underwriting standards”, not only because of the demand, but also because that allowed the original mortgages to carry higher interest rates, and so the profits of the packaging team would be larger larger. Here is how I have described that on my blog for more than a decade.

“If you convinced risky and broke Joe to take a $300.000 mortgage at 11 percent for 30 years and then, with more than a little help from the credit rating agencies, you could convince risk-adverse Fred that this mortgage, repackaged in a securitized version, and rated AAA, was so safe that a six percent return was quite adequate, then you could sell Fred the mortgage for $510.000. This would allow you and your partners in the set-up, to pocket a tidy profit of $210.000”

@PerKurowski

Should not regulators know that what is perceived safe has the largest potential of being what’s dangerous for banks?

Sir, John Authers writes: “In January 2007, credit was priced on the assumption that virtually all US sub-prime mortgages (to people with poor credit histories), would be repaid in full. House prices were already falling. Several subprime lenders went bankrupt in early 2007, with no great effect on credit prices. Banks felt obliged to stay in the market”, “Warning signs existed during decade before credit crunch” July 7.

Of course signs of distress in the housing markets were already seen. In August 2006 you published a letter I wrote to you in response to an editorial titled “Hard edge of a soft landing for houses”.

But to say that these credits were based on some direct assumptions or knowledge about subprime mortgages is blatantly wrong. It was strictly based on the AAA ratings that credit rating agencies issued to many of the securities backed with mortgages to the subprime sector.

And Sir, when with Basel II of 2004 regulators had authorized banks to leverage their capital 62.5 times when investing in what carried an AAA rating, but only 12.5 times when lending to for instance SMEs, there were absolutely no incentives to question such ratings. Banks did not feel obliged to stay in the market they loved it.

It all comes back to one of the fundamental mistakes made by current regulators, namely that of believing what is perceived as risky to be more dangerous to the banking system than was is perceived safe.

@PerKurowski

To restore real accountability in finance we must start with the bank regulators

Sir, Jonathan Ford writes: “Since the financial crisis, bank shareholders have borne pretty much the whole cost of cleaning up the reputational and legal damage done to the sector... the case must be focused on individuals simply to restore a sense of personal responsibility to finance. Bankers have escaped prosecution partly because of the law itself. There was nothing on the statute book to prohibit the mismanagement of big financial institutions.” “Restoring individual accountability in finance is worthy goal” June 26.

One reason for why that so necessary holding to account has not happened, might be the fact that the bankers “herded into the dock to face the music” could argue the following:

“Your Honor! Our regulators, those who explicitly or implicitly support us, those who tell governments and citizens they have everything under control, with Basel II in 2004, explicitly authorized us to leverage our capital 62.5 times or more whenever an AAA to AA rating was present, like the case of the securities backed with mortgages to the subprime sector, and to leverage even more with sovereign debt, like Greece.”

Sir, if there ever was a need to shame some in relation to the 2007/08 financial crisis, that would be its instigators, namely the Basel Committee and their bank regulating colleagues. Instead, like Mario Draghi, they were promoted.

@PerKurowski

If bank regulators in Brussels imply for instance an AAA credit rating for Greece, should Esma not also fine them?

Sir, Nicholas Megaw and Chloe Cornish report that the European Securities and Markets Authority has fined Moody’s for “negligent breaches” of the credit rating agencies regulation “Brussels slaps €1.2m fine on Moody’s” June 2.

As Jim Brunsden and Guy Chazan reported on June 1, Brussels applies a zero risk weight to the European sovereigns. That of course can only be compatible, according to the standardized capital requirements of the Basel Committee, with the absolutely clearest AAA credit ratings.

AAA is clearly a nonsensical credit rating for many European sovereigns, like Greece, and so the question remains should Esma not fine also those European bank regulators in Brussels?

@PerKurowski

FT, when banks have less capital against assets, how can you be sure their capital positions have strengthened?

Sir, Thomas Hale and Richard Blackden write: “The weakness this month comes in spite of stress test results on Friday from the European Banking Authority, which showed banks’ capital positions have strengthened over recent years”. “European bank shares fall in brutal start to August” August 2.

Yes, if we are to use the regulators’ risk weights, one could say “the capital positions have strengthened over the recent years. But why should we? The risk weights of 20% given by regulators to AAA rated securities and sovereigns like Greece were not that correct. 

The real truth is that, unfortunately, the real gross undistorted capital position of banks, the assets to equity leverage, has, according to EBA, deteriorated from 19.2 to 23.8 to 1.

​

@PerKurowski ©

Venezuela, and the world, is in need of a clear definition of what are odious credits and odious borrowings.

Sir, you write “China, which has loaned Caracas more than $65bn in return for oil deliveries, potentially has a big role to play. Having extended some of these loans’ maturities, officials in Beijing said that they hoped “Venezuela can properly handle” its current situation” “The ice finally begins to crack in Venezuela” May 19.

For me there are odious credits and odious borrowings, and you can bet Britain would never ever, or at least not currently, be allowed to take on public debt in such a non-transparent way, as when China lent money to the 21st Century Socialism.

You write: “A lack of basic goods and medicine has led to protests and lootings. Shortages of foreign currency, prioritised to pay overseas debts, have forced a 40 per cent drop in imports in the past year”

Who are these powerful foreign creditors that force the government to prioritize paying debt over securing food and medicine to its people? Could they be the same vagabonds that have ruined the country and are now set on to re-ruin it?

Should the creditors and or their advisors, knowing what the government was doing, have lent to Venezuela only because the risk premiums were attractive? And if so, should they have a right to be repaid?

I am not by far implying that something similar was the case in Venezuela, but, only to make the point, let me ask: Should one financing the cremation ovens of Auschwitz have a right to be repaid?

In the world there is much need for a sovereign debt restructuring mechanism but, if that is going to make us citizens any good, before entering in the notion of odious debts, it must clearly define what is odious credits and odious borrowings.

By the way, if such a definition had existed, and could have applied to odious mortgages such as those that ended up in AAA rated securities, then you might have saved yourself from the 2007-08 crisis.

PS. Are those recommending investors to lend to a country that has made no merits to receive credit, only because the rewards are high, not de facto pimping a country?

PS. Any government having to pay 3% more for public debt than the one paying the least, should not have right to contract debt.

@PerKurowski ©

The “risk” appetite that caused the 2007-08 crisis was for AAA-rated securities, residential mortgages and sovereigns.

Sir, Laura Noonan quotes Bank of England’s Andrew Haldane with: “I think the risk culture, not just from the regulator but from financial firms, is much different [than before the crisis], the risk appetite is much diminished.” “WEF group issues urgent call for fintech forum” April 19.

What risk appetite before the crisis? Was there any excessive exposure to something that was not perceived, decreed or concocted as safe? No, of course not!

In Basel II regulators assigned a 35 percent risk weight to residential mortgages; AAA-rated securities backed with mortgages to the subprime sector carried a 20 percent risk weight; and the risk weight for sovereigns rated like Greece, hovered between 0 and 20 percent.

Now, soon a decade later, regulators seemingly still think that ex post realities and ex ante perceptions are the equivalent. They keep on thinking that the expected is a good basis for estimating directly the unexpected.

The worse risk to a banking system derives from excessive exposures; and those excessive exposures are always built up with something ex ante perceived as safe… but which ex post could perhaps be risky. And that is currently made much worse, by the fact that those “safe exposures” require the banks to hold the least capital.

So NO, in terms of dangerous excessive exposures to “the safe” I would, contrary to Haldane, hold that the real appetite for real bank risk has not stopped growing for a second, it has even accelerated. 

Sir, again, for the umpteenth time, in Basel II the regulators set a 150 percent risk weight for assets rated below BB-. How on earth can anyone justify that assets that when booked carry a below BB- rating, are riskier for the banks than all other 100 percent and below risk weighted assets?

And how is it that, even after the evidence of the 2007-08 crisis, they still believe so? It is mind-boggling to me… and it should be to you too Sir.

Something is truly rotten in that mutual admiration club we know as the Basel Committee for Banking Supervision.

@PerKurowski ©

Securitization is useful, but not when it is driven primarily by differences in capital requirements for banks

Sir, Alexander Batchvarov writes: “It is claimed that securitisation was one of the main causes of the financial crisis because it was complex, performed poorly and lacked transparency.” “It is time to ditch the ‘toxic’ tag for the sake of Europe’s economy” March 24, 2016

There are deggrees of possible toxicity that are a direct function of how much the securitization process increases the perceived safeness of what is being securitized.

And in this respect what turned out to be really toxic, was not the securitization of relative safe 30 years fixed rate mortgages to the prime sector, but of home equity loans, subprime loans, Option ARM loans, and similar risky affairs.

But even these “risky” underlying loans would not have morphed into truly toxic securities, had it not been for the regulatory benefits awarded to them by means of risk weighted capital requirements for banks.

For instance Basel II assigned a risk weight of only 20 percent for securities rated AAA to AA- , which with a basic capital requirement of 8 percent, meant banks could leverage their equity with these securities a mindblowing 62.5 times to 1 (100/1.6). Those incentives distorted the whole process.

The moment when a securitization, for instance of SME loans, generates a lower capital requirement than non-securitized bank loans to SMEs, that introduces a distortion in the allocation of bank credit that can be very profitable for the banks, but generates little value for the SMEs.

And so if Batchvarov, head of international structured finance at BofA Merrill Lynch Global Research, wants to emphasise proper use of the securitisation technology for the benefit of the broader European economy, he should begin by favoring the elimination of the risk weights differences which cause bank capital requirement differences between what is ex ante perceived as safe and what’s perceived as risky.

And, by the way, that would not increase European financial instability, since there never ever are excessive dangerous bank exposures to something ex ante perceived as risky… that dishonor belongs entirely to what is perceived as safe.

PS. There is something fundamentally dangerous with securitization

@PerKurowski ©

Why is real fear of credit risks not as transitory as fear of terrorism?

Sir, Tim Harford writes about when recalling a flight taken after “watching the Twin Towers of the World Trade Center collapse on television”, he was “in a state of mortal fear”, but how that fear seems so foolish to him now. And that’s because “each year an American citizen has a one in 9,000 chance of dying in a motor vehicle accident, and… Even in 2001, the chance of an American being killed by a terrorist was less than one in 100,000”, “Nothing to fear but fear itself?” November 14.

Harford then argues: “Perhaps the true impact of terrorism is psychological… The terrorists’ best hope lies in provoking and overreaction. Too often they succeed”

Absolutely. And the question then is: What terrorism impacted our current bank regulators into believing so much that those who are perceived a risky credits cause more damage to our banks, than those who perceived as safe can turn out to be very risky?

The worst part of that belief is that seemingly it is not as transitory as Harford argues fear to more normal terrorism to be. Today, years after the explosion of what was considered safe by regulators, like AAA rated securities and loans to Greece, we still have much higher capital requirements for banks against what is perceived as risky than against what is perceived as safe.

@PerKurowski ©

Those who have no business interfering should not be allowed to use that a consequence was unintended as an excuse

Sir, Robin Wigglesworth writes: “Overlaying safeguards on an immensely complex financial system may have the unintended consequence of making it more intricate and therefore more fragile” "Regulators seek ways to stem fragility caused by hyper-fast trading", November 7.

Again there is that reference to “unintended consequence” which seems always ready to serve as an excuse for any kind of dumb and mindless interfering. An example:

Never have bank crises resulted from lending out too many umbrellas when it rained, they have all resulted from lending out too many umbrellas when the sun was shining radiantly.

But nevertheless bank regulators decided that, in order to make banks safe, they had to give them even more incentives to lend out the umbrella when the sun shines and to take it back hurriedly when it looked that it might rain. And so they imposed credit-risk weighted capital requirements for banks; more risk more capital – less risk less capital.

And of course the result was excessive bank exposures to what was perceived as safe, this time aggravated by banks holding specially little capital against it… was that an unexpected consequence?

And of course the result is excessive few bank exposures to what is perceived as risky, like SMEs and entrepreneurs, something very dangerous for the real economy… is that also an unintended consequence.

And then the regulators decided that a few human fallible credit rating agencies were going to decide on the riskiness of credits.

In January 2003, in a letter published in the Financial Times I wrote: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds”

And yet many present the ensuing disaster with the AAA rated securities backed with mortgages to the subprime sector in the US as an “unintended consequence”. Have they no shame? Are we so dumb we allow them to get away with that?

@PerKurowski ©

Those creating regulations that can be cheated provide the cheaters competitive advantages.

Sir, Michael Skapinker writes: “Devising a system to detect when a car is being tested surely required planning, expertise and a specific decision. It must have required forethought. It is not something you can drift into through incrementally deteriorating behavior”, “Volkswagen, its software and the psychology of cheating” October 1.

Indeed and we must blast Volkswagen for doing that. But, is it not also the responsibility of regulators to make absolutely certain that cheating cannot happen? Otherwise they will be providing the cheaters with a competitive advantage to win over those who do not cheat. At the end of the day, though Volkswagen needs to be punished, severely, let us not forget that it all happened thanks to lazy regulators who thought it was enough to regulate and no would cheat or game it.

Exactly the same happened when bank regulators allowed banks to hold very little capital against what was perceived as absolutely safe, and the securities backed with lousy mortgages to the subprime sector were dressed to the nines, wearing false AAA ratings.

@PerKurowski

Alan Greenspan is either blind to what caused the financial crisis 2008, or does just not want to admit it

Sir, I refer to Alan Greenspan’s “Higher capital is a less painful way to fix the banks” August 18.

Greenspan has either no idea about what happened, or does just not want to admit it. Suppose the base capital requirement had been the 30% he speaks of instead of that basic 8% required in Basel II. What would that have meant in terms of effective capital requirements using the risk-weights of Basel II. Banks, when lending to prime governments with a 0% risk weight, would then have had to hold, just as today, zero capital. Banks, when investing in AAA rated securities, or getting a default insurance from an AAA rated company, to which a 20% risk weight applied, would then need to hold 6% in capital instead of Basel II’s 1.6%; while for loans to SMEs and entrepreneurs risk-weighted 100% they would then be required to hold 30% in capital instead of the 8% they must currently hold.

Would that have created more or less distortions in the allocation of bank credit? No way Jose! The current crisis has resulted much more from the existence of different capital requirements than by their standard level. Just reflect on the fact that all assets that caused the crisis have in common they originated very low capital requirements for banks compared to other assets. To fix the banks, much more important than the size of the basic capital requirement is getting rid with of the risk-weighting.

Greenspan is also guilty here of serious misrepresentation. He writes: “Bank equity as a percentage of assets, for example, declined from 36 per cent in 1870 to 7 per cent in 1950 because of the consolidation of reserves and improvements in payment systems. Since then, the ratio has drifted up to today’s 11 per cent.” The 36 percent in 1870 and the 7 percent in 1950 was bank equity based on all assets, while today’s 11 percent is based on risk weighted assets… and are therefore absolutely not comparable. Besides, analyzing bank equity without considering other security factors, like reserve requirements that have fluctuated considerably, cannot tell the whole story.

FT, may I suggest you ask all experts writing on capital requirements for banks the following two questions, before allowing him space in your paper:

First: Why are the bank capital requirements, those that are to cover for unexpected losses, based on the perceptions of expected losses?

Second: Why do you believe government bureaucrats can use bank credit more efficiently than the private sector, as your risk weights of 0% and 100% respectively de facto imply?

If they can’t give you satisfactory answers to those questions do you FT really think they have the necessary expertise to opine on this issue?

@PerKurowski