The Fed’s regressive bank regulations, makes it a biased source of information

Sir, Tom Braithwaite’s writes that “stock and bond prices for the banks would be more accurate if [the market] knew what the Fed thought about the strength of these banks and their management”, “Smoke needs to clear over Fed supervision of US banking system”, November 17.

Indeed, that sounds extremely rational but, unfortunately, if the views of the Fed are biased, the signals it sends out will of course make it worse for the economy as a whole.

I say this because it is clear that the Fed agrees with regressive regulations which much favors bank lending to the infallible, in detriment of lending to the risky, and so opining based on such mistaken criteria cannot lead to anything good.

Just look at the “Camels” ratings that Braithwaite refers to and that many want to be disclosed. These cover “capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk”; with no indicator for what is most important for the real economy, and thereby implicitly in the medium and long run is also vital for the banks, namely if the bank allocates credit efficiently to the real economy.

And so, even if in the land of the free and the home of the brave, the Fed would rate much higher a bank that exclusively lends to the sovereign and the AAAristocracy, than a bank that dares lending to “risky” citizens and their small businesses. And if that helps anyone, that might be those very elderly in want of short-term safety, and clearly not the young who need banks to take risks in order to have a future.

And what is really hard to understand is when Braithwaite refers to Jose Lopez, an economist at the Federal Reserve Bank of San Francisco, opining in 1999 that the disclosure of Fed’s Camels ratings “could benefit supervisors by improving the pricing of bank securities and increasing the efficiency of the market discipline brought to bear on banks”. Does the Fed need the market to reassure it by reaffirming the Fed’s own biases? Is it not doing enough damage as is?

The bank regulatory risk weights explain much of a growing lack of productivity.

Sir, I refer to Martin Wolf’s “Hope for the best on productivity, but prepare for the worst” November 14.

Here is a list of risk weights applied by bank regulators apply, even though banks already adjust for perceived credit risk by means of interest rates, size of exposure and other contractual terms.

Infallible sovereigns: 0 percent.

Members of the AAAristocracy: 20 percent

Financing of houses: around 30 percent

Medium and small businesses, entrepreneurs and start-ups: 100 percent.

Sir, do you think that risk weighting is compatible with a banking sector that can effectively help to finance increased productivity? I don’t. Martin Wolf seems to think there is no linkage.

Regulators are negating our descendants the freedom of risk taking by banks that brought us to where we all find ourselves. That is shameful... and useless. Lending to medium and small businesses, entrepreneurs and start-ups have never been the direct cause of any real large bank crisis.

Quite many of our modern day bankers have, unfortunately, never known a small or medium sized enterprise.

Sir, I refer to the analysis “Bank stress tests fail to tackle deflation spectre” October 28.

In it we read Jean-Pierre Mustier, head of corporate and investment bank at Unicredit saying: “I think the issue of small and medium-sized enterprises lending is one of demand and not so much of supply”.

And I have a feeling Mr. Mustier might be one of those modern bankers who have never ever known a small or medium sized enterprise.

And if Mr. Mustier does not understand the impact on the supply of credit to small and medium-sized enterprises, the fact that banks are required to hold so much more equity when lending to these than when lending to “absolutely safe” has, that might be because Mr. Mustier as a banker has only lent to “infallible sovereigns” or members of the AAAristocracy.

Why would ABS “junk loan bundles” be safer on ECB’s balance sheet than on the banks’?

Sir, Claire Jones and Sam Fleming report that “Draghi in push for ECB toaccept Greek and Cypriot ‘junk’ loan bundles” October 1.

And my question is… would these “junk loan bundles” be safer on ECB’s balance sheet than they are on the banks’? Because, if not, why not ask the Basel Committee to reduce the capital banks are required to hold against these “junk loan bundles” to what regulators allowed banks to hold against these assets when they placed it on the books, back at those good old days no one treated those assets pejoratively as “junk loan bundles”.

I guess the Basel Committee should be open to that plea by the ECB, since it was the Basel Committee which painted the whole banking system in the corner of too high exposures against was previously, ex ante, perceived as “absolutely safe” holding too little capital.

And even if these “junk loan bundles” might end up in something related to ECB… if you could solve it in other ways, meaning allowing banks to use the liquidity they have but that they cannot use because of lack of capital, what’s the rush of getting that “junk” there?

Janet Yellen, “normality” in the US, has it any longer anything to do with the “home of the brave”?

Sir, you hold that “Yellen charts a smooth course to normality” September 19.

Well, if normality is to have anything to do with “the home of the brave” that must mean of course getting rid of those senselessly distorting credit-risk weighted capital requirements for banks.

But, since we have not heard Yellen mentioning anything about that, I guess “normality” here means the new risk-adverse normality of the US… that which has Americans suing soccer teams for being hurt while playing or that which forces me out of the pool every hour so that they can take water quality tests… that which allows banks to earn much much higher risk adjusted returns on equity when lending to its AAAristocracy or its “infallible” government, than when lending to a so "risky” American entrepreneur.

What a pity, the world was indeed much benefitted by having the US being “the home of the brave”… let us at least hope they keep up “the land of the free” part... cross your fingers.

Let us hope the golf handicap system does not fall into the hands of something like the banks' Basel Committee.

Sir I refer to Anjum Hoda’s “The Bank of England´s fixation with price stability has cost us all” August 26.

Hoda puts squarely the blame for current problems, like weak wage growth and banking crisis, on “central bank’s decisions to price money incorrectly- a mistake that led to disjointed, mutually unsupportive outcomes in the capital and in the labour markets”.

I do not know sufficiently to hold an opinion on what role that played, but I do firmly believe that much more culpable were the risk-weighted capital requirements for banks, based on perceived risks already cleared for, which profoundly distorted the allocation of bank credit.

Since after soon a thousand letters to you trying to explain it I have not been able to do so, and though I do not know whether Anjum Hoda or you play golf, let me use its handicap system to illustrate what is going on.

The golf handicap system allows good and bad players to compete. Of course, now and again, the handicaps do not reflect the real golfing abilities of the players, just like credit ratings sometime misses the credit risk.

But what would happen if a Basel Committee for Golfing, because those with higher handicaps could be cheating themselves into some unjust winnings, decided to copycat their colleagues in the Basel Committee for Banking Supervision and instruct the following:

All those with handicap between 13 and 18 will have their handicap automatically reduced with 9 strokes, those between 7 and 12 with 6, and those between 1 and 6 with 3 strokes. 

Would that solve it? No, the unfortunate “unexpected consequence” of it would be that only scratch players were to be able to play golf competitively. Just like risky small businesses and entrepreneurs cannot currently compete in a fair way for access to bank credit, since that credit is now given primarily to the credit risk scratch players, namely the “infallible sovereigns”, the members of the AAAristocracy and house purchase financing.

PS. August 14 FT published a special report on Golf. In it Roger Blitz in “Sport stuck in a rut has to get a grip on its future” wrote “A single [governing] body would appear a logical outcome for an increasingly global game”. Let us golf lovers pray it does not fall in hands similar to the Basel Committee… since our breed would die out so much faster.

How long are individual countries to accept that risk-weighting capital requirements bullshit from the Basel Committee?

Sir, John Plender writes that “In the eurozone the banking system has become increasingly fragmented… [and that] The new parochialism is reflected in the way European governments have been encouraging banks to shrink their balance sheets while simultaneously demanding that they lend mote to domestic small business” “A threat to prosperity if the world cuts the ties that binds” August 19.

Not sure Plender has got the title right… because the global bank regulation, the “ties that bind”, that are coming out of the Basel Committee imply that the local banks are better off lending to any far away infallible sovereign, or any far away member of the AAA-ristocracy, than lending to their local medium and small businesses, entrepreneurs and start-ups… and, sincerely, that does not sound right... for prosperity!

Bank regulators, Basel Committee, Financial Stability Board, listen to Violet Crawley “Don’t be defeatist, it’s so middle class.”

Sir, Lawrence Summers writes “Sooner or later inequality will have to be addressed. Much better that it be done by letting free markets operate and then working to improve results. Policies that aim instead to thwart market forces rarely work, and usually fall victim to the law of unintended consequences”, “America risks becoming a Downton Abbey” February 17.

He is right. One reason for growing inequality is that notwithstanding banks already lend less, at higher interest rates and in tougher terms, to those perceived as risky, regulators decided to intervene by requiring banks to also hold much more capital when lending to “risky” medium and small businesses, entrepreneurs and start-ups, than when lending to an “infallible sovereign”, or to the AAAristocracy.

And regulators did that because they were too scared of risk as such and because they never got down to understand: first, that for the banking system, what is truly dangerous is what is perceived as absolutely safe and can therefore generate too big exposures; and second, for the real economy, what is most dangerous long terms is not taking the necessary risks.

And so, if I was to bring Downton Abbey into this issue, that would be by quoting Violet Crawley with her straight to the point “Don’t be defeatist, it’s so middle class.”

Getting rid of stupid risk-weighted bank capital requirements, that is a dog hair to write home about.

Sir, I refer to Martin Wolf´s “Hair of a dog risks a bigger hangover for Britain” February 14.

There Wolf writes: “It is widely believed that it is safer to rely on private borrowing as a source of demand. An expansion of private borrowing to buy evermore expensive houses is deemed good, but an expansion of government borrowing to build roads or railways, is not. Privately created credit-backed money is thought sound, while government-created money is not. None of this makes much sense.”

What is he talking about? Those whose beliefs are the most relevant in these matters, the bank regulators, they very strongly believe, as they express in the risk-weights which determine the capital requirements for banks, that lending to the government, the infallible sovereign, is enormously safer when compared to lending to anything private, including houses.

Of course, that said, bank regulators also strongly believe, in that much egged on by politicians, that lending to buy houses, is enormously safer when compared to lending to any “risky” medium and small business, entrepreneurs and start-up… those who could help to create the jobs that could pay for the costs of living in the houses.

Do I mind governments building roads and railways? Of course not, but I sure do mind government and housing (and the AAAristocracy) getting much more and cheaper financing than what would ordinarily be the case, only because shortsighted and monumentally naïve regulators think that lending to be safer than lending to the “risky” real economy.

Want to really get rid of the hangover Mr. Wolf? Well then get rid of the current bank regulators, and of their dumb and distorting risk-weighted capital requirements. That is indeed a dog hair to write home about.

PS. Sir, I leave it in your hand to copy or not copy Martin Wolf with this letter, since I do not wish to receive a letter from him telling me again I write too much, or that he already knows what there is to be known, on issues such as the risk-weighted capital requirements for banks.

FT, Martin Wolf, be brave, dare pickup the lessons of the crisis’s keys lying there under the lamppost.

Martin Wolf in “We still need to learn the real lessons of the crisis” December 20, refers to the search for the keys under the lamppost, only because that is “where the light falls”.

I would hold that with respect to what is currently happening, or not happening, with the economy and the banking sector, the keys have been there under the lamppost, for quite some time. The fact though is that very few seem to be willing to pick these up… and that could be because it would shine light on the sad fact that our magnificent global bank regulators, the Basel Committee and the Financial Stability Board, are just clueless.

Those keys are the risk-weighted capital requirements for banks based on perceived risks; those which allow banks to earn much more risk adjusted return on equity, when lending to the “infallible sovereign” and the AAAristocracy, than when lending to the “risky” like medium and small businesses, entrepreneurs and start-ups.

Those capital requirements being much lower for what was perceived as “absolutely safe” also guaranteed, when shit hit the fan, as always happens, and something ex ante very safe ex post turns out to be very risky, that banks would stand their naked with no capital.

In January 2003, while an Executive Director at the World Bank, FT published a letter in which I wrote: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors to be propagated at modern speeds”.

Of course if credit ratings are already being used to determine interest rates, size of exposures, duration and other terms, to re-clear for the same ratings in the capital, condemned banks to overdose on these.

And in November 2004 FT also published another one of my letters which stated “We wonder how many Basel propositions it will take before they start realizing the damage they are doing by favoring so much lending to the public sector”

And it is still happening, banks are searching for refuge in the arms of sovereigns all the while out the in the real economy those credit needs that could hold the jobs for our youth remain unsatisfied.

No, a world where banks are told not to finance the “risky” future but only refinance the “safer” pasts is in a death spiral. And on imprudent risk aversion I wrote on the FT’s Economists’ Forum blog in October 2009.

And so Martin Wolf, be brave, and pick the keys up! Let’s get rid of those dumb innovative bank regulations the Basel Accord brought us.

PS. Sir, I leave it to you to copy or not Martin Wolf with this. 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.

France, risk weighted capital requirements for banks, guarantees you a weak and obese economy. Any growth... just froth

Sir, Lindsay Whipp and Claire Jones report “France business activity weakens” December 17.

This is to be expected. Risk weighted capital requirements for banks which allow these to earn much higher risk-adjusted returns on equity when lending to “infallible sovereigns” and the AAAristocracy, than when lending to the “risky” medium and small businesses, entrepreneurs and start-ups can only guarantee turning our western economies into weaklings.

Distorting the banks into refinancing the safe past and not financing the more risky future is no way to create a strong and healthy economy. Any sigh of growth you might see in the interim, is pure froth… or let´s say pure fat no muscles… in other words the economy turning dangerously obese.

Even though I am aware that FT does not want to report on this, for reasons of its own, I will be remembering you about it every time I see the need for it.

Tim Harford, be very careful, regulators might wish to regulate baking more

Sir, Tim Harford ends his splendid “Why can´t banking be made more like baking” November 2, with, “I wonder if even Mr Carney will be able to make the market for pensions work like the market for croissants”.

Harford should be much more careful, because other regulators might be lurking in the shadows with desires to regulate baking. For instance they could come up with a tax on low fiber content in bread, in order to help the British people digest better, which would result in, sooner or later, in the British people only being offered fiber.

I say this because bank regulators, like Lord Turner, and like Mark Carney, the current chairman of the Financial Stability Board, considered that the only socially “useful” activity that a bank could engage in was to make certain it would not default. And, to that effect they concocted capital requirements for banks based on perceived risks.

And that regulation allows banks to earn much much higher risk adjusted returns on equity when lending to “The Infallible”, sovereigns, housing and the AAAristocracy, than when lending to “The Risky”, medium and small businesses, entrepreneurs and start-ups. And in this case we all see how, instead, all the fiber is being taken out of UK´s real economy.

Current economic growth is not based on risk-taking but on risk-aversion, and therefore creates more fat than muscles

Sir, I refer to your Special Report on the World Economy, October 11.

While bank regulations that make it harder for medium and small businesses, entrepreneurs and start-ups to access bank credit are not eliminated, and regulators stop insisting on that banks shall only lend to the “infallible” sovereign, the housing sector and the AAAristocracy, any economic growth will only be of the type that leads to obesity.

If Peter Clarke is right, Keynes would be outraged about capital requirements for banks based on perceived risk.

Sir I do not know enough of economic history, or of Lord Keynes, to know whether Peter Clarke is correct when he says that Keynes “would have recognised the long gradual deterioration in income equality, and its consequences. He would also have been concerned about the redistributive effects of today’s extreme monetary policy. He would have recognised that today’s financial system is ineffective at channelling savings towards long-term productive investment and is configured more towards rent extraction”, “Reach of Keynes’ thinking deserves to be appreciated” October 2.

But, if that is what Keynes would opine, then I can swear he would be as outraged as I am, about the stupid capital requirements for banks based on ex ante perceived risk, and which allow for much higher risk adjusted returns on bank equity when lending to “The Infallible”, like sovereigns, housing and AAAristocracy, than when lending to “The Risky”, like the medium and small businesses, the entrepreneurs and the startups.

In order to survive, the banks need to get their balance sheets real dirty, with real “risk”, not with excesses of “absolutely safes”

Sir, Wolfgang Münchau in “Do not kid yourself that the eurozone is recovering” September 30 writes that “The single largest constraint on the resumption of eurozone growth is the continued failure to clean up the banks”

That in itself is an indication that after more than five years, the “experts” do not yet understand what has been going on. It is not that banks have been building up excessive risks to what is perceived as “risky” like loans to medium and small businesses, entrepreneurs and start ups, but excessive exposures to what is perceived as “absolutely safe” like sovereigns, housing and the AAAristocracy.

If, as Münchau hopes, Mario Draghi, the president of the European Central Bank, is serious in producing a clean and honest quality [bank] asset quality review next month” that would also including the review of what is NOT on the banks balances. Fat chance! Mario Draghi was for years the chairman of the Financial Stability Board.

“The Risky” borrowers, if only they knew, would envy like crazy the banks and “The Infallible”, their Basel Committee lapdog

Sir, Patrick Jenkins, reports “Watchdog to retreat from strict capital rules”. September 30. In it Stefan Ingves, the Swedish central banker who is the head of the Basel Committee on Banking Supervision, is quoted opining that perhaps they should be softening the “tough capital rules on securitisation introduced four years ago”. Why do not the “risky” borrowers have a similar access to a regulatory lapdog?

The more the regulators soften the capital requirements for banks on whatever can be construed as belonging to “The Infallible”, the more will these directly discriminate against those already being discriminated against by banks and markets, on account of being perceived as “risky”, such as medium and small businesses, entrepreneurs and startups.

When the “risky” become “safe”, by means of being bundled up in securities, the profits of lowering the capital requirements for banks, goes almost entirely to the bundler and the banks. Why does not that profit go primarily to those being bundled? 

It just comes to show that the small and “risky” of the real economy, even though they have never ever caused a bank crisis, are just chicken shit in the eyes of regulators who just love to mingle with the AAAristocracy.

If banks and QE finance sovereigns, housing and AAAristocracy, who is to finance “the risky”? You and me? Widows and orphans?

Sir, I refer to John Authers’ “Side-effects that should call time on the QE medicine” September 23.

The market, as the compass that directs the allocation of financial resources, has been rendered useless by the introduction in its center of two big chunks of iron. The first is capital requirements based on ex ante perceived risk, the other is QE. If these sources of magnetic distortion somehow neutralized each other, for instance QE mirrored the deleveraging of the banks the economy might not head too much out of course. But, unfortunately, they just reinforce each other.

The capital requirements push banks to lend to sovereigns, housing and the AAAristocracy, and QE, buying sovereigns to ease the borrowing rates of government, and help housing, push in the same direction. The question which remains is then who is going to take care of financing the risky. Truth is that if we get out of this storm alive and are able to find safe harbor, we can count ourselves extremely lucky indeed. As is what is most probable is that we end up sitting in million dollar houses, without a job, to help us pay the utility bills.

If monetary stimulus irrigates swamps and not deserts, it will make all so much worse.

Sir, bank regulators, by allowing banks to hold absolute minimal capital against what was perceived as “absolutely safe”, 1.6 percent or less, effectively injected huge amounts of liquidity in the economy. And precisely because of how these capital requirements were skewed, in favor of “The Infallible” and against “The Risky”, they directed our banks to lend too much, at too low interest rates and in too lenient terms to sovereigns, housing and the AAAristocracy, and too little, at too high rates and in too strict terms to “the medium and small businesses, the entrepreneurs and start-ups.

And with that distortion inflicted on the real economy, they not only created the current crisis but also keep us there. Unfortunately, even though he has assured me that he understands it, Martin Wolf does still not get it. And perhaps that is because this argument might stand in the way of his macroeconomic imbalances explanations. “We still live in Lehman’s shadow” September 18.

And, if now Wolf’s favorite to Fed chairman, Janet Yellen, does not understand that either, and is appointed, and keeps on swamping the swamps and drying the deserts, so help us God.

PS. Sir, jut to remind you again that I am not copying Martin Wolf with this comment. He has asked me not to send him anything more on “distorting bank capital requirements” as he already knows it all… at least so he thinks.

Mr. Bob Diamond. Is not a level playing field for borrowers in the real economy accessing bank credit, even more important?

Sir, Bob Diamond, a banker, holds that “A level [regulatory] playing field… is essential to ensure banks have consistent and predictable financial targets” “‘Too big to fail’ is still a threat to the financial system”, September 16.

But, is not a level playing field for when the actors in the real economy access bank credit even more important? Because, there is no level playing field there as long as bank regulators allow for different capital requirements based on perceived risk.

Currently banks are earning much much higher risk-adjusted returns on equity when lending to “The Infallible”, like to some sovereigns, housing and the AAAristocracy, than when lending to “The Risky”, like to SMEs, entrepreneurs and start-ups.

And that as you of course would understand, but that bankers prefer to conveniently ignore, causes, consistently and predictably, our banks to lend too much, at too low interest rates and in too lenient terms to “The Infallible”, and too little, at too high rates and in too strict terms to “The Risky”. And that is a distortion inflicted on the real economy, and therefore also a threat to the financial system.

Questioning Gillian Tett on the seventh and largest uneasy truth about the not cleaned up crisis

Sir, if banks are allowed to hold much less equity against what is perceived as “absolutely safe” than against what is perceived as “risky”, the banks will earn much higher risk adjusted returns on their equity when lending to “The Infallible”, like to some sovereigns, housing and the AAAristocracy, than when lending to “The Risky”, like the medium and small businesses, the entrepreneurs and start-up. 

And that as you of course will understand, causes banks to lend too much, at too low interest rates and in too lenient terms to “The Infallible”, and too little, at too high rates and in too strict terms to “The Risky”.

And so here is a question to Ms Gillian Tett. Does she believe those risk weighted capital requirements will lead to stability in the bank sector, or to the correct allocation of bank credit in the real economy?

If she says “Yes”, well then there is little I can do. Perhaps I should not expect more from an anthropologist. But, if she says “No”, then I would have to ask her on why she insists on ignoring this most outrageous “uneasy truth”, like when she describes how the “Insane financial system lives on post-Lehman”, September 13.

I say all this because the fact remains that the outright dangerous and so insane “risk-weighing” of capital requirements, has been, and still is, the fundamental pillar of all the Basel Committee’s bank regulations… and that mostly because that comprises a too uneasy truth for regulators’ egos to handle.