Will Davos 2018, again ignore the financial weapon of mass destruction concocted by the Basel Committee populists?

Sir, Gillian Tett when commenting the concerns that will be expressed at the 2018 Davos meetings writes “The biggest perceived danger of 2018, in terms of impact, is that somebody uses weapons of mass destruction”, Holy moly! and ends with: “keep a close eye on what Davos is not worrying about enough this year: that pesky matter of global finance, particularly in places such as China.” “Populist swing alarms financial titans” January 19.

My concern though is that the technocratic and hubristic populism, proclaimed by the Basel Committee will again not be denounced in Davos, perhaps because doing so might be deemed ungentlemanly or ungentlewomanly behavior in such fine surroundings.

I refer of course to their promise that distorting bank credit with risk weighted capital requirements for banks will make our banks safer.

Higher capital requirements for what’s “risky”, has caused among other that millions of entrepreneurs, those on which so much of our economic future depends, have seen their credit applications rejected or not even received by banks.

Lower capital requirements for what’s “safe”, has among other, helped to fuel house prices which has overloaded that sector with mortgages that, within a future subprime economy, seem impossible to service.

And let’s not even talk about what the 0% risk weight awarded to sovereigns has done in terms of statism and of blurring the risk free rates.

Sir, no doubt about it, the risk weighted capital requirements for banks, is a weapon of financial mass destruction.

Did we not see it explode with AAA rated securities that banks were allowed to leverage 62.5 times with?

Did we not see it explode in Greece with sovereign debt that European regulators allowed their banks to hold against no capital at all?

If a regulator is incapable to provide a clear answer to: “Why do you want banks to hold more capital against what has been made innocous by being perceived as risky, than against what is dangerous because it is perceived as safe?” should he not be fired Sir?

http://theaaa-bomb.blogspot.com

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

PS. On the same page Philip Stephens writes:” The World Economic Forum and the Davos crowd pride themselves on their globalism has set itself the fearsome task of mapping “a shared future in a fractured world”. “Trump, Davos and the special relationship”. The risk weighted capital requirements, which favor refinancing of the “safer” present over financing the “riskier” future, is fracturing the world and causing the future to produce less and less of what could be shared.

@PerKurowski

Martin Wolf insists on turning a blind eye to the Financial Instability AAA-Bomb armed by the Basel Committee

Sir, Martin Wolf writes: “it has to be possible for the financial system to cope with changes in asset prices without blowing up the world economy… An essential part of achieving this is deleveraging and in other ways strengthening intermediaries, notably banks.” “Central banks alone cannot stabilise finance” October 25.

What did the Basel Committee for Banking Supervision do, for instance with Basel II?

They assigned risk weights of 0% for AAA rated sovereigns, 20% for AAA rated private sector, 35% for residential mortgages and 100% for the unrated private sector.

That, with a basic capital requirement of 8%, translated into banks being able to leverage their capital (equity): limitless with AAA rated sovereigns, 62.5 times with AAA rated private sector, 35.7 times with residential mortgages and 12.5 times with the unrated private sector.

Major bank crisis never ever result from excessive lending to what is perceived as risky. These, with the exception for when some major unforeseen events occur, always result from excessive exposures (credit bubbles) to what is ex ante perceived as safe, but that ex post turns out to be very risky, often precisely because too much credit has been given to it.

So considering that this regulation implies telling banks to go to where for the system it is the most dangerous, while holding the least capital, it must truly be classified as a bomb against financial stability. In 2009, in sad jest, I set up a blog titled The AAA-Bomb.

And oh if the only thing that bomb produced was financial instability. But no, it also produces economic weakness, by negating the “risky” the access to credit they need in order to keep the economy going forward. We finance much more the building of safe basements in which our jobless children can live, than those “risky” who could have a better chance to provide them with the jobs they need to move to their own upstairs.

And don’t tell us that if a bank can leverage much more with the “safe”, and thereby obtain much higher expected returns on equity with the “safe” than with the “risky”, it will keep on bothering with lending to SMEs or entrepreneurs. Of course it won’t. The risk weighted capital requirements for banks have turned our savvy know-your-client loan officers into dumb equity minimizers.

With respect to “deleveraging and in other ways strengthening intermediaries, notably banks” Wolf now opines “That has indeed happened, but not, in my view, nearly enough.”

Well of course not! How could that be, when even Martin Wolf himself has played a great role in silencing the existence of that bomb… that about which I have written to him more than 400 letters and to FT in general more than 2.500.

Finally Martin Wolf writes about “the failure of governments to address the many frailties that still lead to financial excess. The central banks did their job. Unfortunately, almost nobody else has done theirs”

What? Look at the major role central bankers like Paul Volcker, Mario Draghi, Jaime Caruana, Mark Carney, Stefan Ingves and many other have had or have in the area of banking regulations. They, by ignoring the distortions in the allocation of bank credit to the real economy these regulations caused, have wasted most of the stimulus they have been injecting with their quantitative easing and low interest rates.

Sir, since getting rid of the risk weighted capital requirements for banks is not even mentioned here by Wolf, and you yourself can be considered a partner in the silencing of me, I guess this letter will also be added to the silenced ones… but of which I of course keep a record… here on the web.

PS. Come to think of it, should not central bankers even recuse themselves when it comes to bank regulations?

PS. Truly, FT's lack of curiosity amazes me

PS. Sir, click if you want an aide mémoire on the mistakes

@PerKurowski

Wow! Did someone from Kremlin infiltrate the Basel Committee for Banking Supervision to seed bad advice?

Sir Courtney Weaver and Kathrin Hille report from Moscow that “Yevgeny Fyodorov, a deputy for the pro-Kremlin party United Russia… claimed US consulting and audit firms were working under the orders of their governments and could cause ´real damage´ to the Russian state by purposefully giving out bad advice.” “Duma hits back with proposal to ban Big Four auditing firms”, July 30.

Oh boy! That is precisely what I, in jest, implied in a blog of many years ago, when I suggested that a disappointed and revenge wanting Kremlin retiree, Carlos Molotov Pavlov, had infiltrated the Basel Committee for Banking Supervision in order to seed advice that would bring down the banking system of the west.

We used to drill for the A-bomb threat… but got hit by the AAA-bomb.

Sir, I belong to that generation that Gillian Tett refers to and who in the 50s and early 60s crouched under tables preparing for the A-bomb threat, “From fire drills to firearm drills” May 31,

50 and some years later I am now wondering what drills could be useful for a society in order to avoid that kind of AAA-bomb the Basel Committee launched at our banks, when they allowed these to leverage their shareholder’s equity a mindboggling 62.5 to 1 times (or infinitely in the case of sovereigns) only because something got an AAA credit rating issued by humanly fallible credit rating agencies.

What can an insignificant ego like mine, even if absolutely right, do against significant egos, even when these are absolutely wrong?

What is perceived as risky never constitutes much real risk. What most drives a financial doomsday machine is what is perceived as absolutely safe; which is why risk-weighted capital requirements for banks based on perceived risks, which favors bank lending to “the infallible” is so absolutely dumb.

But unfortunately that seems too difficult to comprehend, for instance by Martin Wolf.

When he now begs for to “Disarm our doomsday machine” May 28, Wolf still shows no sign of having understood how dangerous the pillar of our current bank regulations really is. Why do I say so?

Wolf quotes Timothy Geithner saying “The safer the visible financial system is made, the greater the danger that the fragility will emerge somewhere less visible”, and connects that to the need of “preventing such obvious absurdities as the build-up of huge off-balance sheet positions in vital institutions. And though that might have some truth to it, the real fact is that currently it is the visible financial system that has been made dangerous, by trying to make it safe. For instance look at hedge funds and you will see that they never ever can achieve leverages similar to those authorized banks to have by regulators, if keeping to the “absolutely safe”.

No the best way to “disarm our doomsday machine” is to get rid of the distortions produced by risk-weighting, and to follow the simple rule of not procrastinating, meaning solving the problems while they are still small.

In May 2003, as an Executive Director of the World Bank I told bank regulators gathered to discuss Basel II “A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises. Knowing that “the larger they are, the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size. But, then again, I am not a regulator, I am just a developer.”

And though I am still not a regulator I still stand by that.

Mr. Martin Wolf. Currently we still have regulations which guarantee banks holding especially little capital when what is especially dangerous, one of “the infallible”, blows up. Disarm that AAA-bomb! Capisce?

The fact is that big egos can be just as dangerous as the tyranny of William Easterly’s experts.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.

Bank regulators, the Basel Committee, created a nuclear bomb, Basel II, the AAA-bomb, which exploded,

Sir, John Kay writes with respect to financial regulations that “Shorter, simpler, linear chains of intermediation are needed, and loose coupling that gives every part of the system loss absorption capacity and resolution capability.”, “The design failures that lead to financial explosions” November 13. I could not agree more.

And with respect to his nuclear simile let me just note that in 1999, in an Op-Ed, I wrote:

“The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system”.

And indeed, with Basel II, they fabricated a bomb; I have called it the AAA-bomb.

Do not let Lord Turner, FSA, FSB, or any bank regulator set the flight plan for a helicopter drop.

Sir in “Helicopter money”, October 14, you refer to Adair Turner, Lord Turner, head of Financial Service Authority suggesting the “helicopter drops” of newly minted money something you define as the “nuclear option” of monetary policy. He should be ashamed. 

The only reason we very well might now need a general helicopter dropping of money, is because all huge moneys previously injected were dropped in the wrong spot. Lord Turner, FSA, and their regulatory colleagues made certain, by means of their sissy capital requirements for banks based on perceived risk that all new money got routed towards “The Infallible”, and none of it to “The Risky”, like to the small businesses and entrepreneurs who could have put it to so much better use. 

If there is to be a helicopter drop, please don’t let regulators set the flight plan, I trust any helicopter pilot to do that much better on his own. 

A “nuclear option”? Forget it! Here the real nuclear device used, was that AAA-bomb bank regulators exploded in the midst of our financial system.

PS. My 2019 letter to the Financial Stability Board 

And FT too clings to blissful oblivion... Shame on you!

In November 1999, in an Op-Ed in the Daily Journal of Caracas, I wrote the following: “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause its complete collapse” 

And January 2003, while being an Executive Director of the World Bank (one of 24) you, the Financial Times published a letter I sent you which ended with: “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 in 2007 the Big Bang happened, not because of an A-bomb but because of the AAA-bomb, those capital requirements for banks that orders reasonable bank equity when the perceived risks of default are high, but allow for unreasonably low bank equity when the ex-ante perceived risks are low. 

But now, Sir, in October of 2012, you end the editorial “Markets cling to blissful oblivion” October 6, with “Liquidity… cannot alone fend off the guns trained on our economies”… but you still insist, God knows why, on being oblivious to the fact that the most dangerous gun trained on our economies, are the regulatory distortions caused by capital requirements based on risks, and as weighted by bank regulatory bureaucrats. 

Shame on you!

It was the firemen who, unwittingly, planted and incendiary AAA-bomb in our banks

Sir, John Gapper in “The banking firemen won´t prevent fires breaking out” July 26, mentions the need for bank supervisors to prevent banks from taking excessive risks…” 

Again I must remind him that this was not a crisis because of “excessive risks”, but a crisis that resulted from an excessive trust by regulators in the perceptions of risks, and of an excessive importance given also by regulators to these perceptions in the capital requirements for banks, when they ignored that these risk perceptions were already cleared for in so many other ways. 

Gapper refers to “Most supervisors admit they were too lax in the past… their job was to identify risks, and bring them to the attention of bank executives, but not tell them what to do.” Precisely, the problem though, is that these regulators have not yet understood that with their risk-weights that define the capital requirements they are, de-facto, telling a banker what to do. 

And so, in this case it was the firemen who, unwittingly, planted and incendiary AAA-bomb in our banks… and the firemen are still out there stoking the fire with their revised risk-weights.

Hollywood would never have allowed Basel III after the Basel II magna flop

Sir, Kishore Mahbubani writes “Now we know that bankers produced no economic value. Instead they produced financial weapons of mass destruction that almost destroyed the world… European bankers… ignoring common sense… lent money to Athens on the assumption that Greece was as solvent as, say Germany”, “To become rich is great but to pay taxes is glorious”, October 21. 

That shows precisely what happens when the whole truth is not allowed to surface. It was the bank regulators who, when they allowed the banks to leverage differently their equity, by means of capital requirements based on ex-ante perceived risk, Basel II, which created what I have called the AAA-bomb… a truly massive weapon of mass destruction. 

It was those regulations which allowed banks to stock up on Greek sovereign debt against only 1.6 percent capital, a leverage of 62.5 times, while at the same time forcing banks to hold 8 percent when lending to small businesses or entrepreneurs, a leverage of 12.5 times, which gave the incentives to created the huge exposures to where all bank crisis occur, namely where the risk is ex-ante perceived as almost non-existent. It was those odiously distorting regulations that short-circuited the markets… and still keeps these from functioning. 

And because this is silenced, we allow the same producers of the failed Basel II, to produce Basel III, with only minor changes in the script. Friends, Hollywood would never allow such a thing. No, to be able to hold bank regulators accountable, that is what would be really glorious.

Even the safest haven could become dangerously overcrowded

Sir, Richard Milne’s “Beware of safe havens when seeking next financial crisis” July 28, makes reference to the truth that “Risky assets do not cause crises. It is those perceived as being safe that do” and to the immense regulatory bias in favor of the “not-risky”, especially the good sovereigns and the triple-A rated, and against the risky, like the small businesses and entrepreneurs.

(Mr. Milne must know, because of the emails he has received, that those arguments is part of the criticism that, at no irrelevant personal cost, I have for many years voiced quite lonely about the bank regulations that came out of Basel II. In this respect I must say that I am indeed surprised and disappointed that he makes no reference to that in his article. Had I been a PhD from his own Alma Mater, he would not have dreamt of ignoring me.)

His analysis is quite accurate and so I guess the cat is out of the bag. How on earth can the bank regulators explain what they did pushing dangerous “safe assets” and, especially, how can they defend that they mostly want to insist in doing just the same?

That said the article fails to point out the real fundamental mistake committed by the regulators and which is that they blithely ignored the fact that the markets already clear for the safe-haven perception when it sets the risk adjusted interest rate. And so, when the regulators also based their capital requirements for banks on exactly the same safe-haven perception, they turned what is a natural and reasonable pursuit of a safe haven, into an unnatural and unreasonable stampede in search of a safe and profitable haven… and even the safest haven can turn into mortal traps, if they become overcrowded. Milne mentions “Follow the debt” as to where investors should be looking for trouble. I have since 2003 told regulators “Follow the AAAs” as to where the next bank crisis will be.

Milne quotes Professor Geoffrey Wood of Cass Business School calling the “push by regulators for banks to own sovereign debt” as “premeditated theft”, but in my AAA-Bomb blog I have for a long time called that sheer communism.

Finally what Milne also fails to point out, perhaps because the implications are so frightening is that, given that huge regulatory bias in favor of sovereign debt, we really do not know what the underlying real interest rates of public debt are… and so we are in fact flying blind with dysfunctional instruments.

Why, for a change, not listen to those who proved beyond reasonable doubt they knew?

Sir, in November 1999 I wrote in Economía Hoy, Caracas the following:

“The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse of the OWB (the Only Bank in the World)... Currently market forces favors the larger the entity is, be it banks, law firms, auditing firms, brokers, etc. Perhaps one of the things that the authorities could do, in order to diversity risks, is to create a tax on size.”

And you of all must be aware of the literally hundreds of letters that I, though accused of boring and monothematic, have sent you about the extremely faulty financial regulation that were produced by the Basel Committee… and this before the current Big Bang.

That is why I read with much satisfaction that Martin Wolf titles his article “The challenges of halting the financial doomsday machine” April 21, better late than never. Since he is planning to address what to do about it the next week, I do hope he will consider some of what I have written to FT and to him… if only because I sure gave evidence of that I knew and know what was and is wrong… and this even though I am not a member of his group of great influential economists with their PhDs.

Greece would be nothing compared to the big AAA-bomb already dropped!

Sir, of course Goldman Sachs´ Erik Nielsen is correct saying that “ECB must re-examine its dependence on rating agencies”, March 25, since “no country would hand the controls of a nuclear device to a third party”.

But this has really very little to do with Greece as that would be just a minor tactical puff! The real big AAA-bomb already exploded in the subprime heart of the Empire, causing a couple of trillions of dollars in damages and radiating many harmful after-effects that we are just beginning to tally and comprehend.

The AAA-bomb

There is a not so secret “low-risk” leverage-enrichment facility in Basel.

Sir excuse me if I insist on it but after some hundreds of letters to you, I am still looking for the words that could help FT understand what was really the origin of the current financial crisis and why we will not be able to get out of it without getting rid of a paradigm that has chained our financial regulators, that of having the capital requirements of our banks depend on risk-weights.

Henny Sender in “Washington is the cheerleader but sentiment remains fragile” September 26, quotes a private equity executive saying “CDO´s destroyed prudent lending in America. It was like a nuclear bomb to good lenders”. What does prudent lending mean? Shying away from risks? No! Prudent lending means investing according to your risk tolerance and getting the right reward for it. In this respect prudent lending should have its own financial returns and not returns derived from arbitrarily set lower capital requirements.

What is the worth of one dollar invested in an operation perceived as having a higher risk? One dollar! What is the worth of one dollar invested in an operation perceived as having a lower risk? Also one dollar! Then how on earth can anyone sustain that a dollar lent to a BBB+ to BB- rated corporation is worth one dollar, while a dollar lent to an AAA to AA- rated one only represent 20 cents? Well this is exactly what the regulators did with their capital requirements for banks based on default risks and as assessed by human fallible credit rating agencies.

When a bank invests $1.000bn dollars in anything related to an AAA then that is subject to an arbitrary risk-weight of 20% and so the “risk-weighted assets” are reported as only $200bn, leading to low reported bank leverages, and which after a short while fooled even the designers.

And this is what has been produced in the not so secret “low-risk” leverage-enrichment facility in Basel and that has been proven to be so explosive and that I have been describing in http://theaaa-bomb.blogspot.com/

Sir it is so unimaginably risky to fool around with risk. Please consider that even if all the credit ratings had been absolutely precise, the world could still go so very wrong, as nobody in his sane mind will hold that the world’s future lies so much in areas perceived as having low financial default risks, that the investment in these areas have to be given especial incentives.

Friends, we need to urgently rid ourselves of regulators that can only dream about a world without bank defaults and put in their place regulators that dream of a better world, and who know that in order to reach such a world you have to learn to embrace risk… in a prudent way.

The world has had more than enough with this imprudent prudence!

Cheers

Per

The marginal authorized leverage was then 125 to 1!

Sir John Gapper in “How banks learnt to play the system” May 7 is slowly identifying the AAA-bomb that set of this crisis. He writes about how regulatory bank equity, by not being real hard cash equity, and how assets, by being minimized through regulatory risk-weighting, made “some investment banks enter this down-turn with capital ratios of 30 times or more.”

But Gapper is not there yet since he seems to forget that in economics as well as in finance, the most important price is not the average but the marginal. If I am allowed to assume what Gapper seems to do that only the 4% equity of tier 1 capital was for real, and consider the fact that loans or investments to corporations and securities that were rated triple-A were risk-weighted at only 20 %, then he should be able to calculate that the marginal authorized leverage for the banks on some operation were 125 to 1... or more, if as Gapper holds, that even the tier 1 capital was partly made up of illusions.

P.S. I just wonder. If I had been a PhD, from a well known university, would I have not been referenced as someone who has warned and argued over this problem over and over again for years? After 258 letter to the Financial Times labelled “subprime banking regulations”? Not including this one.