12 years since, and yet the true cause of the 2008 crisis shall seemingly not be told

Sir, John Flint a former Before chief executive of HSBC writes: “Before 2008, regulators’ approach to conduct risk in banking was what they called “principles based” — deliberately light touch. It relied too much on banks’ abilities to govern themselves and it failed.” “Warning lights are flashing for Big Tech as they did for banks” November 30.

“principles based”? Yes, but tragically with risk weighted bank capital requirements based on a very wrong principle, namely that what’s perceived as risky is more dangerous to our bank system than what’s perceived as safe.

“It relied too much on banks’ abilities to govern themselves and it failed.”? No, it relied way too much on some very few human fallible credit rating agencies, a systemic risk.

“deliberately light touch”? If as Basel II allowed​, ​ banks could leverage a mindboggling 62.5 times their capital with assets rated AAA to AA, I would not call that a “light touch”, I would call it putting Minsky Moments on steroids.

“This time it is the technology sector rather than the financial that is leaving us all exposed.”

Sir, current bank capital requirements, 12 years since the 2008 crisis, are still mostly based on the expected credit risks banks clear for on their own; not on misperceived credit risks, 2008’ AAA rated MBS, or unexpected dangers, like COVID-19. Therefore, banks will again stand there with their pants down. A good job Sir?

@PerKurowski

Here a formal statement in 2003 as an Executive Director of the World Bank 

Here my brief explanation of the 2008 crisis

And here the 2019 letter I sent to the Financial Stability Board

Sir FT, do you, or our dear The Undercover Economist Tim Harford, have an explanation for what is a monstrous regulatory mistake?

Sir, I refer to Tim Harford’s “The Changing Face of Economics” December 19.

As an economist, if I were to regulate or supervise banks, I would mostly be concerned with bankers not perceiving the credit risk correctly. Wouldn’t you?

That’s why I cannot understand why so many economist colleagues, when acting as bank regulators, can be so dumb so as to bet our banking systems on that bankers will be able to perceive what is safe correctly. 

Let me explain it having bankers answering the four possible outcomes.

If the ex ante risky, ex post turns out safe = “Great News we helped an entrepreneur to have success”

If the ex ante risky, ex post turns out safe = “You see, that is why we lend them little and charge them high risk adjusted interest rates.”

If the ex ante safe, ex post turns out safe = “Just as we expected”

If the ex ante safe, ex post turns out risky = “Holy moly what do we now do? We lend it way too much at way too low interest rates”

But the regulators in the Basel Committee, in their Basel II of 2004, assigned risk weights of only 20% for what is so dangerous to our bank systems as what human fallible credit rating agencies have rated AAA, and a whopping 150% for what has been made so innocous, by being rated below BB-?

Sir, so do you, or our dear The Undercover Economist Tim Harford, have an explanation for what is clearly a monstrous regulatory mistake? 

Or is it that you, and our dear The Undercover Economist Tim Harford, out of sheer collegiality solidarity, both agree with such dumb regulations?

If so, let me assure you that when I studied economics, it was to learn and understand economics, not to join an economists’ union/mutual admiration club.

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

PS Tweet: I can understand a child believing that what’s rated below BB- is more dangerous to our bank systems than what’s rated AAA, and therefore assigning a bank capital requirement of 12% to the BB- rated assets, and only 1.6% to those rated AAA. But mature professionals?

@PerKurowski

Beware when issues, no matter how important, like climate change, become mostly discussed because of their distraction value

Sir, Martin Wolf, after taking on a history tour argues: “A positive-sum vision of relations between the west, China and the rest has to become dominant if we are to manage the economic, security and environmental challenges we face”. That said Wolf frets our chances our small “given the quality of western leadership, authoritarianism in China and rising tide of mutual suspicion”, “Unsettling precedents for today’s world”, November 27.

Indeed, use history to illuminate the present, but never allow it to hide it. In the same vein let’s also include the caveat of not using any of those challenges to distract us from other just as important issues, like the very delicate state of our financial system.

Consider the following facts: 

1. As a response to the 2008 (AAA securities) and the 2011 (Greece) crises, by means of QEs and similar, there were/are huge injections of liquidity. 

2. Since the distortions produced by the risk weighted capital requirements were not eliminated, our banks have dangerously overcrowded all “safe” harbors, like sovereigns and residential mortgages.

3. As a result the rest of market participants had to take to the risky oceans like highly leveraged corporates debts and lending to emerging countries.

4. To top it up plenty of other high debt exposures abound, e.g. student and credit card debts.

5. Finally there are huge unfunded social security and pension plans all around the world.

And I refer to ”distraction” because everywhere we turn, we find regulators and central banks frantically looking for excuses to talk about other things, so as not have to answer some basic questions like:

Why do you believe that what bankers perceive as risky, is more dangerous to our bank system than what bankers perceive as safe?

Do you understand that allowing banks to leverage differently different assets distorts the allocation of credit to the real economy?

Do you understand that the other side of the coin of decreeing a zero risk to sovereigns, just because they can print the money to repay, is that it implies bureaucrats know better what to do with bank credit they are not responsible for, than for instance entrepreneurs?

EU you assigned a zero risk to all eurozone sovereigns’ debts even though none of these can print euros. What do you think would have happened to the USA’s union, if it had done the same with its 50 states, even though none of these can print US$ on their own?

Sir, when an architect takes on a project, he usually signs a contract by which he assumes personal responsibility “for the facility and its systems' ability to function and perform in the manner and to the extent intended” Should not bank regulators sign similar contracts?

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

https://www.stimmel-law.com/en/articles/architect-responsibilities-and-disputes

@PerKurowski

What a pity Martin Weitzman did not chair the Basel Committee for Banking Supervision. If he had we would surely not have suffered the 2008 crisis.

Sir, Tim Harford when referring to an economic paper by Martin Weitzman on climate change classifies it as a “this changes everything” paper, leading him to conclude “extreme scenarios matter. What we don’t know about climate change is more important, and more dangerous, than what we do”, “How this economist rocked my world” September 14.

So I must ask why is it possible to understand that and yet so hard to understand the mistakes of bank regulations based on that what’s perceived as risky being much more dangerous to our bank systems, than what might be lurking behind that which is perceived as safe?

“The truly eye-opening contribution” — for Tim Harford — “was Weitzman’s explanation that the worst-case scenarios should rightly loom large in rational calculations.”

In January 2003 you published a letter in which I said, “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”. 

Sir was it not clear I was warning about big crises resulting from some human fallible credit rating agencies assigning a very safe rating to something very risky? Like that in 2008 caused by the AAA to AA rated securities backed with mortgages to the subprime sector? European banks and US investment banks, loaded up with because with those credit ratings they were allowed according to Basel II, to leverage their capital a mind-blowing 62.5 times.

Ten years later, when it comes to bank regulations, Martin Weitzman’s wisdom about “worst case scenarios”, is still blithely ignored.

PS. In April 2003, as an Executive Director of the World Bank, in a formal statement I wrote "Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market"

PS. My 2019 letter to the Financial Stability Board

PS. My 2019 letter to the IMF

@PerKurowski

Don’t keep adding bank regulations for what is ex ante perceived risky. It is what is ex ante perceived as very safe that should concern us the most.

Sir, I refer to Sheila Bair discussion of how much banks are to set aside in order to cover for loan losses. “Congress should stay out of new bank rules for loan losses” August 5.

Bair mentions, “that FASB wants to switch to a new rule, known by the name of “current expected credit losses” or “CECL.” That rule “says that banks should set aside enough to cover expected losses throughout the life of a loan, taking into account a wide variety of factors, including historic loss rates, market conditions, and the maturity of the economic cycle.”

Bair argues the new rule has two key benefits. “First, banks will start putting aside money on day one of each loan so when trouble hits — as it did in 2008 — they will not be trying to play catch-up with their reserves.” 

Really, what money would they have had to put aside for the AAA rated securities gone bad? What money would they have had to put aside for loans with a default guarantee issued by an AAA rated entity like AIG?

Then “Second, it should make bankers a little more cautious in their lending decisions, as they will have to account for likely losses when the loan is made, not kick the can down the road until the borrower is actually in arrears.”

That all has me concerned with that we might be adding a new layer of discrimination against the access to credit of the risky.

Those perceived ex ante as risky already get less credit and pay higher risk premiums. Those perceived ex ante as risky already cause banks to have to hold more equity against loans to them. 

If those perceived ex ante as risky must now also require banks to set aside reserves earlier than what is required for those perceived as safe, banks might stop altogether lending to the risky, like to entrepreneurs, and that will absolutely hurt the economy.

And Sir, it would all be for nothing, because major bank crises are never caused by excessive exposures to what was ex ante perceived as risky when placed on banks’ balance sheets. 

http://subprimeregulations.blogspot.com/2019/03/my-letter-to-financial-stability-board.html

@PerKurowski

To explain the 2008 financial crisis a two pieces puzzle could suffice.

Sir, Tim Harford writes, “Raghuram Rajan, when he was chief economist of the IMF, came closest to predicting the 2008 financial crisis. He later observed that economists had written insightfully on all the key issues but had lacked someone capable of putting all the pieces together”, “How economics can raise its game” June 29.

According to 2004’s Basel II, a corporate rated AAA to AA, could offer banks to leverage their equity 62.5 times (100%/(8%*20%)) with its risk adjusted interest rate, while one rated BB+ to BB-, or not rated at all, could only offer banks to have their risk adjusted interest rate leveraged 12.5 times (100%/(8%*100%))

Sir, I am not arguing whether it is better to be a hard or a soft economist but, any economist looking at that proposition and not seeing it would cause serious misallocation of bank credit, should either go back to school, perhaps to take some classes on conditional probabilities, or go out on Main-street, and learn a bit of what real life is about.

62.5 times leverage? What banker could dare resists that temptation and stay out of competition thinking, what if that AAA to AA rating is true?

PS. That leverage applied for European banks and US investment banks supervised by SEC.

@PerKurowski

As long the mistake that caused a crisis gets to be treated as one that shall not be named, it is doomed to become a Groundhog Day event.

Sir, Martin Wolf writes “financial regulation is procyclical: it is loosened when it should be tightened and tightened when it should be loosened. We do, in fact, learn from history — and then we forget”“Why further financial crises are inevitable” March 19.

Yes and no!

Yes, it is procyclical especially when allowing banks to leverage more with those who, thanks to good times are perceived as safer, and much less in bad times with all those that then are perceived as risky, which of course includes many former very safe.

No, we have not learned from history, because there is too many interested in putting a veil on the mistake with the risk weighted capital requirements. And there is too many who do not want to admit they fell for the populist that told them to relax, because they have weighted the risks.

Even though a leverage ratio has been introduced, the following Basel II risk weights that which evidences an absolute lack of understanding of the concept of conditional probabilities have not been changed, and this even after a crisis that exploded in AAA rated territory.

AAA to AA rated = 20%; allowed leverage 62.5 times to 1.

Below BB- rated = 150%; allowed leverage 8.3 times to 1

Also, the distortion the risk weighting creates in the allocation of credit to the real economy is mindboggling. Just consider the following tail risks:

The best, that which perceived as very risky turning out to be very safe.

The worst, that which perceived as very safe turning out to be very risky.

And so the risk weighted capital requirements kills the best and puts the worst on steroids… dooming us to suffer from a weakened economy as well as an especially severe bank crisis, resulting from especially large exposures, to what was especially perceived as safe, against especially little capital.

Wolf writes: “The bigger the disaster, the longer stiff regulation is likely to last. [But] Over time, regulation degrades, as the forces against it strengthen and those in its favour corrode.” I agree, but I would have to add something to it, namely, the bigger the disaster the more the running away from responsibilities… and accountability. 

@PerKurowski

The 2008 crisis had little or nothing to do with a tax bias in favour of debt finance

Sir, Martin Wolf discussing a system where for tax purposes “no deduction would be allowed for financial costs” writes “there would no longer be today’s bias in favour of debt finance, which creates significant risks to economic stability, as the financial crisis demonstrated.”“The world needs to change the way it taxes companies”

One could sure argue there should not be a bias in favour of debt finance, and that it has had an important role in creating excessive corporate debt, but to argue that it caused the financial crisis is clearly wrong.

Does Mr Wolf really think that all those in the subprime sector who bought houses on credit, and whose mortgages got packaged into ex ante AAA rated securities, which ex post turned out not to be AAA securities, and which set off the 2008 crisis, did so because of tax considerations?

And does Mr Wolf think that the reason banks held so little capital against these securities was that the dividends they were to pay were not tax deductible? Was it not that the US investment banks and the European banks were allowed to hold these AAA rated securities against only 1.6% capital?

@PerKurowski

Much needed bank capital reforms are hindered by bank lobbying, and by regulators unwilling to discuss their mistakes.

Sir, Benoît Lallemand, Secretary-General of Finance Watch writes: “European bank supervisors last year found ‘unjustified underestimations’ of risk in nearly half of the 105 banks they investigated” “Banks should submit to logic of reform on capital allocation”, March 6.

For those regulators who assigned a risk weight of 150% for what is so innocuous for our bank systems as what is rated below BB-, is not assigning a meager 20% for what could really endanger our bank systems, precisely because it is ex ante rated a very safe AAA to AA, a much worse ‘unjustified underestimations’ of risk?

Surprisingly Lallemand opines that “Risk-based capital measures could still serve their original purpose: as an internal instrument to guide banks’ capital allocation processes.

What? Where in all Basel I or II regulations has he seen stated their purpose was of being “an internal instrument to guide banks’ capital allocation processes”?

It is only the complete elimination of risk weighting that could “encourage banks to lend more productively because it would lessen the regulatory skew towards seemingly safe assets, which has done so much to deprive the real economy of capital, inflate housing and land prices, and feed financial instability.”

Because, even with a 5% leverage ratio, something Lallemand favors, keeping risk weighting would keep on distorting the allocation of bank credit on the margin, there where it matters the most.

Lallemand ends arguing, “that such reforms have still not happened is testament to the power of the banking lobby”. No, much more than that, it has been the refusal by bank regulators to admit their mistakes.

Would there have been any type 2008 crisis if European and American investment banks had not been allowed to leverage a mind-blowing 62.5 times with assets rated AAA to AA, or with assets for which an AAA rated entity like AIG had sold a default guarantee? The answer to that is, an absolute definitive, NO!

@PerKurowski

If only regulators had analyzed their risk weighted capital requirements for banks in terms of bets.

Sir, Tim Harford refers to Nassim Taleb, warning of “the ‘ludic fallacy’ — treating the unknown risks of life as though they were the known risks of a game of chance”, “Experimental living beats thinking in bets” February 17.

That is somewhat like when regulators treated the unknown risks in banking and set their risk weighted capital requirements. 

Harford also mentions Annie Duke’s recommendation “that we should always be willing to ask ourselves, ‘do I want to bet on that’ — it’s easy to be overconfident if there are no obvious consequences for being wrong. A bet forces us to think about the odds and the possibility that someone else may know better.”

Oh, if only our bank regulators have asked themselves: “Do we want to bet our bank systems on that what gets an AAA to AA rating, issued by human fallible credit rating agencies, is so safe we should only need to require banks to hold 1.6% in capital against such assets and so allow them to leverage 62.5 times with these?” Had they posed that question, the crisis resulting from excessive exposures to AAA rated securities backed with mortgages to the subprime sector would not have happened.

“We have risk-weighted the capital requirements for banks in order to make our bank system safer.” Someone has either played tricks on them or they are bluffing. The sad part is that so few dare to call them out on it. And, when I do that, many just brush me off with a “he’s just got an obsession”.

Though Harford accepts that “Thinking in bets is a rigorous and admirable habit” for many cases he favors “Thinking in experiments [as that] allows us to learn [and might be] less painful.

In case of bank regulations experiments are not needed. Just go out and look at all the crises and try to find one that was caused by excessive exposures to something perceived as risky when placed on the balance sheets of banks. None! Should that not tell you something about our unwillingness to learn when the lessons are hard to swallow? 

Sir, using Edward Thorp’s real casino risks, in banking, the Basel Committee represents “the crooked dealer” and the risk weighted capital requirements “the poisoned coffee” 

Casino games, like roulette, are all based on offering all possible bets exactly the same expected payout adjusted for their respective probabilities. If it was not so, no casino would survive. So it was in banking, until risk weighted capital requirements offered banks higher risk adjusted return on equity for what was perceived, decreed or concocted as safe (betting on a color), than for what was perceived as risky (betting on a single number). The consequence? Our bank systems will fail especially bad, by building up especially large exposures to what is especially perceived as safe, against especially little capital. The 2008 crisis, and Greece, were just canaries in that mine.

PS. Here is the current summary of why I know the risk weighted capital requirements for banks, is utter and dangerous nonsense.

@PerKurowski

The world’s banking systems are dangerously fragile, courtesy of inept and statist regulators.

Sir, Martin Wolf writes: “Should we be concerned about the state of the world economy? Yes: it always makes sense to be concerned. That does not mean something is sure to go badly wrong in the near future… It is the political and policy instability, combined with the exhaustion of safe options for credit expansion, that would make handling even a limited and natural short-term slowdown potentially so tricky.” “Why the world economy feels so fragile” January 9.

Sir, as you know because of the thousands of letter I have obsessively written to you on this subject, which you have equally obsessively ignored, I am absolutely sure something has been going very badly for a long time, and will explode… perhaps the sooner the better.

In April 2003, as an Executive Director of the World Bank, in a board meeting I said, "A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind."

Likewise, a world obsessed with allowing banks to leverage their capital immensely only because something is perceived or decreed as safe, is doomed to overload what’s “safe” way too much with debt, while, relative to that, financing what’s “risky” way too little. That will sure exhaust, sooner or later, any "safe options for credit expansion". That makes for a hell of a fragile bank system. 

Wolf writes, “The long-term credit cycle reached its denouement in the disastrous financial crisis of 2007-08.” 

That crisis was solely caused by excessive exposures to what was perceived as safe, mortgages to residences and AAA rated securities, against which investment banks in the US and all banks in Europe had to hold little capital. Did regulators wake up and change their risk weighted capital requirements, which are so idiotically based on the idea that what’s perceive as risky is more dangerous to our banking system than what’s perceived as safe? No! No real denouement there.

And then Greece exploded in 2009, and the fact that statist EU authorities had assigned all Eurozone sovereigns a risk weight of 0%, which allowed EU banks to lend to Greece against no capital requirement at all, which clearly doomed the not so well managed Greece to excessive indebtedness, does not even appear listed among the causes for its tragedy. No denouement there either. EU sovereigns are still risk-weighted 0%.

Sir, just look at houses. Easy financing made available by very low capital requirements turned what used to be homes into investment assets. All this while entrepreneurs, those who could create the jobs so that house owners can afford to service their mortgages and pay the utilities, were denied credit or charged higher interest rates, because of higher bank capital requirements. Just you wait till that easy financing stream stops and too many house owners wish to convert their houses into main-street-purchase capacity again. It's going to be hell.

@PerKurowski

Hercules Poirot, as a bank regulator, would be much more watchful of the “safe” than of the obvious risky.

Sir, Gillian Tett reminds us that “Any fan of Agatha Christie mystery books knows that distraction is a powerful plot device: if there was a commotion in the kitchen, detective Hercule Poirot would look for a body in the library, or other clues being hidden in plain sight, amid the noise.” “Federal Reserve attack is just a distraction”, November 30.

Indeed, but she could rest assure that Poirot, if cast as a bank regulator, would laugh at his current colleagues who show so much concern with what seems obviously risky, like when they in Basel II assign a risk weight of 150% to what’s rated below BB-, and so little about what seems very safe, like giving only a 20% risk weight to what’s rated AAA and is, therefore, if wrong, truly dangerous for the bank system.

Ms. Tett argues here that President Donald Trump “uses weapons of distraction more effectively than almost any leader before him”

She could be right but also, when GDP and inflation data are fraught with may uncertainties or outright errors, to hear the Fed discussing the “neutral rate”, could also be an intent to distract from the fact that they find themselves in that “dark room” deputy Fed chair Rich Clarida is quoted to have mentioned, and so that they therefore have not the faintest idea about what’s going on, and much less about what to do. 

Sir, when not knowing the answer to a question, proceeding to with a firm voice give an answer nobody is guaranteed to fully understand, also qualifies as a high quality distraction.

PS. That 20% risk weight of the AAA to AA rated, translated to a capital requirement of only 1.6% (8%*20%) which meant the banks were allowed to leverage mindblowing 62.5 times with such assets (100/1.6) which translated in to the cause numero uno for the 2008 crisis. 

@PerKurowski

Our banking systems have been made especially fragile, because of especially bad bank regulations.

Sir, Martin Wolf writes “The world’s economy and financial systems are fragile … the most important source of fragility is political… In country after country, populists and nationalists are in, or close to, power. Salient characteristics of such politicians are myopia and entrenched ignorance. Inevitably, they spread uncertainty.” “Politics puts the skids under bull market” October 17.

In April 2003, as an Executive Director of the World Bank I delivered a statement that contained the following: "A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind."

One of those “Best Practices” has been the risk weighted capital requirement for banks. These give banks incentives to create especially large exposures to what is perceived or decreed as especially safe, against especially little capital; making our banks, and the sector lending thereby favored, like sovereigns and houses, extremely fragile.

Populism? Sir, few things as brazenly populists as “We will make our bank systems with our risk weighted capital requirements because we sure know about risks. 

PS. Wolf, during the last annual meetings of IMF and the World Bank in Bali when interviewing Christine Lagarde, mentioned: “As a journalist I am paid to be skeptical”

But Wolf refuses to ask bank regulators about what they were thinking when they assigned a meager 20% risk weight to assets that because rated AAA represents great dangers to bank systems, compared to a whopping 150% for the so innocous below BB- rated. Sir, could it be you are not paying Wolf enough?

PS. In a similar vein during the interview Mme Lagarde said, “In IMF’s view capital flow management measures should: not be first order of priority, only be used in exceptional circumstances, not be a substitute for macroeconomic and macroprudential policies.”

So why does IMF keep mum about the risk weighted bank capital requirements? In a letter FT published in November 2004 I wrote: “our bank supervisors in Basel are unwittingly controlling the capital flows in the world.” Could it be that IMF still does not understand that that regulation distorts, controlling credit flows in favor of the “safe” present and against the “risky” future

PS. Ref the same interview: Trade protectionism? What neo-Bretton Woods Conference will be needed to help us get rid of bank regulations made to protect banks but that only endangers bank systems?

PS. Ref the same interview: Balance sheet vulnerabilities. Are not the consequences of central banks huge liquidity injections, with QEs, especially for emerging countries, precisely the same as those of the 1974 to 1981 recycling of oil revenues surpluses?

PS. Ref the same interview: Is the eurozone crisis over? “No!” says Mme Lagarde. After 20 years way too little has been done about solving the challenges of the euro and that, if not solved could bring EU down… and still Wolf categorizes his homeland Britain as “my idiotic country” because of Brexit.

PS. Ref the same interview: With respect to Greece, not a word was said about the EU authorities 0% risk weighting of Greece, which doomed it to its excessive public indebtedness.

@PerKurowski

Risk weighted capital requirements expelled many traditional bank risks into the shadows

Sir, Patrick Jenkins, when discussing regulator’s growing concerns for the growth of shadow banking”, lists some reasons for why policymakers bear some of the blame, among these the “regulatory crackdown on banks in the aftermath of 2008 may well have derisked those institutions by boosting equity, thus cutting leverage. But it displaced many of the risks to non-banks”, “Why policymakers are to blame for the shadow bank boom”, October 2.

Did they really “derisk” banks, cutting leverage as a result of “boosting equity”, or was it not a continuations of banks expelling that what perceived as risky required them to hold more capital, all because of the permanence of a portion of risk weighted capital requirements? My opinion is that it is much more the second option that is at play.

The moment risk weighted capital requirements were introduced then the risk adjusted return on bank equity no longer depended on managing a portfolio of risk intelligently, with help of savvy loan officers, but financial engineering came into place, because then much of the bank returns on equity would depend on having as little equity as possible.

And of course bankers loved it. The less equity there needs to be, the more is left over for their bonuses.

And where would that “risky” business then go? To the shadows of course!

Jenkins writes, “The relatively loose regulation of many non-banks means data on areas of risk, such as leverage, are scant.” Indeed but it is very hard to believe that in the shadows they would allow remotely as generous leverages as regulators allowed the banks in the sunlight… like 62.5 times to 1 if only an AAA to AA credit rating was present.

@PerKurowski

The priority of those who committed the mistakes that caused the financial crisis has been the cover up, not the corrections

Sir, Gillian Tett, similarly to like Martin Wolf wrote a couple of days ago, expresses surprise and concerns for the fact that so many things that were supposed to be corrected or at least bettered after the financial crisis seem worse today. She lists the level of debt and leverage, the market share of TBTF banks, the size of the shadow banks, and that no few bankers directly related to the crisis have been jailed. “Surprising outcomes of the financial crash”, September 7.

But how can one be surprised by so few corrections and betterments when those supposed to correct and better it remain being those who committed the mistakes, and have not been held accountable one iota for their mistakes? 

But how can one be surprised by so few corrections and betterments when in the aftermath of the crisis so many truths were classified as those that shall not be named, and consequently arduously silenced, like for instance:

Lack of regulations: Wrong! Total missregulation. Regulators for their risk weighted capital requirements for banks used the perceived risk of banks assets, those that bankers were already clearing for, and not the risk that bankers would perceive and manage the risks wrongly. They seemingly never heard of conditional probabilities.

Excessive risk taking: Wrong! It was the regulators excessive risk aversion that gave banks incentive to build up excessive exposure to what was perceived safe. Like allowing banks to leverage assets a mind-blowing 62.5 times only because some human fallible credit rating agencies had assigned it an AAA to AA rating.

Greece did it: Wrong! EU authorities did Greece in, when assigning a 0% risk weight to its debt. Is the statism implied in assigning a 0% risk weigh to the sovereign and one of 100% to the citizens discussed? No! There are too many interested in benefitting from crony statism for that.

Sir, Ms. Tett ends with “predictions are best presented with a dash of humility — and the knowledge that what does not happen can sometimes be even more significant than what actually does.”

Indeed but since “that what does not happen” could be much a result from a lack of questioning, to understand it could also require loads of humility from journalists. Capisce FT? 

@PerKurowski

The worse the mortgages packaged, the higher the potential of securitization profits was (is)

Sir, FT’s big read by Mark Vandevelde and Joe Rennison “The story of a house” September 6, leaves out two important facts:

First: Christopher Cruise, who ran popular courses in mortgage origination, is quoted with “You had no incentive whatsoever to be concerned about the quality of the loan or whether it was suitable for the borrower” 

But yes you did, only in a direction quite different than usual. The worse the borrower and the worse the mortgagor, the higher the potential of profits of packaging it in a securitization sausage bound for a high credit rating. All involved in that securitization would profit, immensely, except of course those who were being packaged into that sausage. Imagine, if that sausage obtained an AAA to AA rating, US investment banks and European banks were allowed by the regulators to leverage 62.5 times their capital with these.

Second: “Société Générale, the French bank, was one of those that took out insurance against a collapse in the value of Davis Square, buying exotic derivatives contracts from the insurance group AIG.”

That was not solely for insurance. Because AIG was AAA rated, whatever lower rated securitized mortgages it added its signatures to also gave the banks the possibility of a mindboggling 62.5 times leverage. 

Profit potential: 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

Sir, credit rating agencies using fallible humans did not stand a chance to get it right! 

@PerKurowski

September 2008 when the crisis bomb exploded is not as important as the dates when the bomb was planted

Sir, Philip Stephens writes: “The process set in train by the September 2008 collapse of Lehman Brothers has produced two big losers — liberal democracy and open international borders. Historians will look back on the crisis of 2008 as the moment the world’s most powerful nations surrendered international leadership, and globalisation went into reverse”. “Populism is the true legacy of the crisis”, August 31.

I agree with most of what Stephens writes, especially on how “central bankers and regulators, politicians and economists, have shrugged off responsibility” for the crisis. What I do take exception of is for the date of the collapse since much more important than when a bomb detonates, is when the bomb is planted. In this respect three dates come to mind. 

1988 when regulators announced: “With our risk weighted capital requirements for banks we will make our bank system much safer” and a hopeful world, who wanted to believe such things possible, naively fell for the Basel Committee’s populism.

April 28, 2004, when the SEC partially delegated their authority over US investment banks, like Lehman Brothers, to the Basel Committee. 

June 2004, when with Basel II, the regulators put their initially mostly in favor of the sovereign distortions on steroids, like for instance allowing banks to leverage a mind-blowing 62.5 times with assets that managed to acquire from human fallible credit rating agencies an AAA to AA rating. And EU authorities decided that all EU nations, like Greece should, in an expression of solidarity be awarded a 0% risk weight.

Populism? What’s more populist than, “We will make your bank systems safer with our risk-weighted capital requirements for banks”? 

PS. Here is somewhat more extensive aide memoire on the mistakes in the risk weighted capital requirements for banks.

@PerKurowski

The US 2008 financial crisis was born April 28, 2004

Sir, Janan Ganesh writes: “A financial crisis that was experienced as a fragmented chain of events is being commemorated as just one: the fall of Lehman Brothers, 10 years ago next month",” “Political distemper preceded the financial crisis” August 30.

That is only because the truth shall not be named. In the case of the United States, that crisis started on April 28, 2004 when the SEC decided that the supervised investment bank holding company ("SIBHC"), like Lehman Brothers, “would be required periodically to provide the Commission with consolidated computations of allowable capital and risk allowances (or other capital assessment) consistent with the Basel Standards." 

When the Basel standards approved in June 2004 included allowing banks to leverage a mind-boggling 62.5 times with any asset that have been assigned by human fallible credit rating agencies an AAA to AA rating, or had been guaranteed by an AAA rated corporation like AIG, the crisis began its construction. That in the European Union the authorities also included allowing banks to lend to sovereigns like Greece against no capital at all would only worsen the explosion.

Populism? What’s more populist than, “We will make your bank systems safer with our risk-weighted capital requirements for banks”? 

PS. Here is somewhat more extensive aide memoire on the mistakes in the risk weighted capital requirements for banks.

@PerKurowski

The US 2008 financial crisis was born April 28, 2004 – and different bank capital for different assets are worse than too little or too much bank capital.

Sir, I must refer to Janan Ganesh’s “Political distemper preceded the financial crisis” August 30, in order to make the following two comments:

1. “A financial crisis that was experienced as a fragmented chain of events is being commemorated as just one: the fall of Lehman Brothers, 10 years ago next month.”

That is only because the truth shall not be named. In the case of the United States, that crisis started on April 28, 2004 when the SEC decided that the supervised investment bank holding company ("SIBHC"), like Lehman Brothers, “would be required periodically to provide the Commission with consolidated computations of allowable capital and risk allowances (or other capital assessment) consistent with the Basel Standards." 

When the Basel standards approved in June 2004 included allowing banks to leverage a mind-boggling 62.5 times with any asset that have been assigned by human fallible credit rating agencies an AAA to AA rating, or had been guaranteed by an AAA rated corporation like AIG, the crisis began its construction. That in the European Union the authorities also included allowing banks to lend to sovereigns like Greece against no capital at all would only worsen the explosion.

Oops! The following part had nothing to do with Janan Ganesh, but all with Lex's "Bank capital: silly old buffer"

2. “Debates over bank capital resemble tennis rallies… On one side of the net you have the big global banks. They say they have plenty of capital and that forcing them to operate with more is a restraint on trade. Pow! On the other side are the regulators, who say more capital is better because you never know what losses you may have to absorb. Thwack!”

But there are some few, like me, who argue that much worse than there being much or little capital, is that there are different capital requirements for banks, based on the perceived risk of assets. Riskier, more capital – safer, less capital. In tennis terms it would be like judges allowing those highest ranked to be able to play with the best tennis rackets, and the last ranked to play with ping-pong rackets. And of course that distorted the allocation of bank credit.

Populism? What’s more populist than, “We will make your bank systems safer with our risk-weighted capital requirements for banks”? 

PS. Here is somewhat more extensive aide memoire on the mistakes in the risk weighted capital requirements for banks.

@PerKurowski

EU needs to find a president of the European Central Bank quite different from Mario Draghi… whatever it takes

Sir, you opine, “The most worthwhile tribute that European governments can make Mario Draghi, the president of the European Central Bank, is to find a successor who most closely replicates his attributes and has the best chance of continuing his success. There are few harder acts to follow in global policymaking than his. He has helped rewrite the central banking handbook, shepherding the euro through an existential threat from the sovereign debt crisis and the danger of a deflationary recession. “Next ECB chief should be in the Draghi mould” August 30. 

I disagree and believe that FT, at some point down the road, will have to eat up these words of praise for Draghi; who alsopreviously served as the Chairman of the Financial Stability Board from 2009 to 2011 and Governor of the Bank of Italy from 2005 to 2011.

Draghi, as a regulator, with the risk weighted capital requirements for banks was partt of the team that introduced a risk-aversion, which ignored all the valuable services banks provided, when acting as the societies’ designated risk-takers.

Draghi, as a regulator, ignoring conditional probabilities, supported risk weighted capital requirements for banks based on the perceived risk of assets and not based on how banks could manage those assets dependent on their own perceptions of risk. That distorted the allocation of credit, causing among other banks to fall over a precipice when chasing those AAA to AA rated securities they were allowed to leverage a mind-blowing 62.5 times with.

Draghi, as a regulator, was, is, a statist of first degree, for agreeing with risk weights of 0% for the sovereign and 100% for the citizen.

Draghi, as a European central banker, who must have known that the challenges the euro posed had not been taken care of, irresponsibly agreed when Greece was assigned a 0% risk weight, which caused its current tragedy.

What Draghi did in ECB, was just to act as the principal member of that kicking team that kicked the crisis-can down the road, willfully ignoring the fact that European grandchildren will suffer when that can begins to roll back on them.

Sir, in summary, the next ECB chief should know about the importance of risk taking, about conditional probabilities, should not be a statist, and should be able to refuse punishing a EU nation, like Greece, for the mistakes of EU authorities. 

So, whatever it takes, he should be very different from Draghi. I would hold that EU’s own chances of survival depends much on that. 

@PerKurowski