Britannia, to have a chance to become its former self, needs to free its financial systems from its mis-regulators.

Sir, Martin Wolf asks: “Britannia is not ‘unchained’. It is instead sailing in perilous waters. Can the new captain and first mate even see the rocks that lie ahead?” “The economic consequences of Truss” FT September 21.

Wolf writes: “Thatcher and those who followed her allowed the search for safety in corporate pensions to shift portfolios away from the supply of risk capital to business to ownership of government bonds. This in effect turned the plans into state-backed pay-as-you-go schemes.”. 

Sir, more than three decades late Martin Wolf seems to notice that huge rock of Basel I that, for its risk weighted bank capital requirements, decreed weights of 0% government, 30% residential mortgages and 100% citizens. Better late than never… but really?

These bank capital requirements are based on that what’s perceived as risky, e.g., loans to small businesses and entrepreneurs are more dangerous to bank systems than what’s perceived as safe, e.g., government debt and residential mortgages.

That de facto translates into it being much more important for banks to hold government debt and residential mortgages than loans to small businesses and entrepreneurs. Something which, with Solvency II, applies to its insurance companies too. Really, is that how Britannia got to be strong?

Sir, the Western world’s banks were taken from the hands of savvy loan officers who knew their first duty was to know their clients and understand what their loans were going to be used for and placed into the hands bank own capital minimizing/leverage maximizing dangerously creative financial engineers.

“UK has a deregulated economy… in which the successful are well rewarded, but those who do less well are penalised. Such Thatcherite aims then are now a reality” No! Bank regulators reward those ex-antes perceived or decreed as safe over those perceived as risky. That has zero to do with their ex-post success. Has the UK's public debt been well employed?

Let’s hope someone like Liz Truss dares to set aside whatever mandates she might have, no matter how worthy these might be, in order to tackle a real financial regulatory reform.

Sir, what would Edmund Burke with his intergenerational social contract have opined about prioritizing the refinancing of the “safer” present over the financing of the riskier future?   

 

If we want public debt to protect citizens today and tomorrow, it behooves us to make sure it cannot be too easily contracted.

Sir, I refer to John Plender’s “The virtues of public debt to protect citizens” FT February 7, 2022.

Sir, as a grandfather I do fear debt burdens we might impose on future generations, but I’m absolutely not an austerity moralist. I know public debt is of great use if used right but also that the capacity to borrow it a reasonable interest rates (or the seigniorage when printing money), is a very valuable strategic sovereign asset, especially when dangers like war or a pandemic appear, and which should therefore not be irresponsibly squandered away.

In 2004, when I just finished my two-year term as an Executive Director of the World Bank, you published a letter in which I wrote “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage, they are doing by favoring so much bank lending to the public sector?”

1988 Basel I’s risk weighted bank capital requirements decreed weights of 0% the government and 100% citizens. It translates into banks being allowed to hold much less capital - being able to leverage much more, with loans to the government than with other assets.

Of course, governments, when their debts are denominated in the currency they issue, are, at least in the short-term and medium term, and in real terms before inflation might kick in, less risky credits. But de facto that also implies bureaucrats/ politicians/apparatchiks know better how to use taxpayer’s credit for which repayment they are not personally responsible for than e.g., small businesses and entrepreneurs. And Sir, that I do not believe, and I hope neither you nor John Plender do that.

Such pro-government biased bank regulations, especially when going hand in hand with generous central bank QE liquidity injections, subsidizes the “risk-free” rate, hiding the real costs of public debt. In crude-truth terms, the difference between the interest rates sovereigns would have to pay on their debts in absence of all above mentioned favors, and the current ultra-low or even negative interests they pay is, de facto, a well camouflaged tax, retained before the holders of those debts could earn it.

But of course, they are beneficiaries of all this distortion, and therefore many are enthusiastically hanging on to MMT’s type Love Potion Number Nine promises.

@PerKurowski

The privileged subsidizing of sovereign debt that apparently shall not be named

Sir, let us suppose that as credit risks, banks perceived Martin Wolf and me as equally risky or equally safe. We would then, for the same amount of borrowings, be charged the same risk adjusted interest rate.

But then suppose that for whatever strange reason, regulators allowed banks to leverage much more with loans to me than with loans to Martin Wolf, and so banks would therefore obtain higher returns on equity when lending to me than when lending to Martin Wolf.

And also suppose that for some even stranger reason, Bank of England would buy my loans from the banks, but not those loans given to Martin Wolf.

Clearly the result would be that I would be able to borrow much more and at much cheaper rates from banks than what Martin Wolf could.

Would Martin Wolf in such a case opine that the higher interest rates he had to pay was the result of the market?

I ask this because Martin Wolf frequently makes reference to the very low rates that many sovereigns have to pay, and holds they should take advantage of it by borrowing as much as they can, in order to invest for instance in infrastructure.

And Martin Wolf seemingly refuses to consider those “very low rates” a consequence of regulatory favors of sovereign debts and QE purchases of it.

That distorts the allocation of credit in such a way that, de facto, regulators and central banks believe bureaucrats / politicians know better what to do with credit they’re not personally responsible for than for instance entrepreneurs. 

In the best case I would call that crony statism, in the worst outright communism. 

One day future historians will recount, and Paris’ Musée de L’Homme exhibit: “1988 Basel I: When Regulators introduced Financial Communism”

The selection of independent central bankers should not be politicized, but neither should the criticism of the candidates be

Sir, you argue that Stephen Moore nor Herman Cain seem to be “remotely qualified to sit in the monetary cockpit of the world’s reserve currency”, “Trump must be stopped from packing the US Fed”, April 6.

Sir, you might very well be right, I know very little about those candidates but I do know that those who have been sitting there for the last decades were perhaps not sufficiently qualified either. 

The 2008 crisis was caused by the distortions in credit allocation produced by the risk weighted capital requirements for banks. To then having central bankers to inject huge amounts of stimulus by means of QEs and ultra low interest rates, without removing those distortions, does show they don’t have a sufficient understanding of what they are up to. Sir, what they have achieved is only to kick the crisis can forward and upwards. Let us pray it will not roll back too hard on us, our children or our grandchildren.

Sir, to be sincere, I do believe that FT’ team, with its silence, has lost any right it could have to throw first stones in the matter of who are suited or not to man the Fed, or any other central bank for that matter.

You argue: “The merest hint that Mr Powell is doing Mr Trump’s bidding is enough to corrode the Fed’s independence.” Sir, for the umpteenth time, when the Fed and other central banks, in 1988, Basel I, approved of risk weighted capital requirements for banks that assigned a risk weight of 0% to the sovereign and 100% to the citizens, they went statists and gave up their independence.

In truth they did exactly what a Hugo Chavez or a Nicolas Maduro would want a Venezuelan central banker to do, namely to be act under the presumption that any bank credit to the government is managed better than a credit to the private sector.

Look back three decades; have you seen any president anywhere who objects to such a Sovereign Debt Privilege?

Greece, a Eurozone nation that takes on debt in a currency that is de facto not its domestic printable one, was even more crazily assigned a 0% risk weight, and ECB knew about it, and kept silence on it. I do not remember you thinking ECB’s bankers as inept.

@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

FT journalists. Is this really the legacy you want to leave to your children?

Not daring to ask bank regulators to explain why they've decided that what’s ex ante perceived as risky, is more dangerous ex post to our bank systems than what’s ex ante is perceived as safe

Why should Donald Trump or Gillian Tett worry about US’s public debt when the experts, the bank regulators, assign it a 0% risk?

Sir, Gillian Tett, making it a Democrat vs. Republican issue, expresses anxiety about the US debt and suggests “a new version of the bilateral Simpson-Bowles Commission” “Investors start to fret about ballooning US public debt” November 9.

Sir, you know the regulators, for the purpose of bank capital requirements, assigned a risk weight of 0% to the sovereign debt of the USA and one of 100% to unrated American citizens (except when buying houses). That translates into that the interest rate politicians see is a subsidized interest rate, not its real cost. That dooms the US public debt to become, sooner or later, unsustainable… and especially so if markets begin to feel the US is losing its absolute military supremacy.

The bilateral Simpson-Bowles Commissionin 2010 presented many important recommendations that should be pursued, but it did not even mention the need to eliminate the regulatory subsidy to public debt.

Sir, unfortunately, getting rid of that distortion is no easy task, as regulators have really painted themselves into a corner. Can you imagine if regulators where to announce that the risk weight of US debt has been increased from 0% to 0.01%?

PS. In 1988, when with Basel I, statist regulators assigned that 0% risk weight the US debt was $2.6 trillion, now it is more than $22 trillion... but what has that to do with anything?

 

@PerKurowski

If Paul Volcker leaves an explanation for why a person like he never saw the dangers of the risk weighted capital requirements for banks, it would be a truly important legacy.

Martin Wolf, the Chief Economics Commentator of the FT, rightly praises Paul Volcker for his gigantic work, as chairman of the Federal Reserve between August 1979 and July 1987 of slewing the run away inflation of those years. How could one like me who in 2006 wrote about the long-term benefits of a hard landing, disagree with that? “The last testament of Paul Volcker”, October 30.

But then Wolf opines: “Yet, unlike many who should have known better, he understood that the central bank is responsible for financial stability, too. The book is full of Volcker’s painful experiences with the financial sector and his deep doubts about it… 

It would be too much to insist that the financial crisis would not have happened if Volcker had been Fed chairman in the 2000s. But he would have done his best to prevent it.”

And there Wolf and I part ways, sadly, because Volcker was also a true hero of mine. As I found out, in March 2016, Volcker is one of the main original driving forces behind the insane risk weighted capital requirements for banks; so he sure helped to cause the crisis.

What could have come into the mind of a man like Wolf describes, “endowed to the highest degree with what the Romans called virtus (virtue): moral courage, integrity, sagacity, prudence and devotion to the service of country”, to consider that this way of interfering in the allocation of bank credit to the real economy, could bring stability without risking any other serious consequences? An effort to answer that would also be something very valuable to see included in a Paul Volcker’s testament,

PS: Charles Goodhart’s “The Basel Committee on Banking Supervision: A History of the early years 1974-1997” 2011, Cambridge Press Goodman (p.167) refers to Steven Solomon’s “The Confidence Game: How Unelected Central Bankers Are Governing the Changed Global Economy” (1995). In it we read:

On September 2, 1986, the fine cutlery was laid once again at the Bank of England governor’s official residence at New Change… The occasion was an impromptu visit from Paul Volcker… When the Fed chairman sat down with Governor Robin Leigh-Pemberton and three senior BoE officials, the topic he raised was bank capital…

At dinner the governor’s hopes had been modest: to find areas of sufficient convergence of goals and regulatory concepts to achieve separate but parallel upgrading moves… 

Yet the momentum it galvanized… produced an unanticipated breakthrough of a fully articulated, common bank capital adequacy regime for the United States and United Kingdom. This in turn catalyzed one of the 1980’s most remarkable achievements – the first worldwide protocol on the definitions, framework, and minimum standards for the capital adequacy of international active banks…

They literally wiped the blackboard clean, then explored designing a new risk-weighted capital adequacy for both countries… 

It included… a five-category framework of risk-weighted assets… It required banks to hold the full capital standard against the highest-risk loans, half the standard for the second riskiest category, a quarter for the middle category, and so on to zero capital for assets, such as government securities, without meaningful risk of credit default.”

@PerKurowski

To minimize the next unavoidable financial crisis, get rid of the dangerous risk weighted capital requirements for banks.

Sir, Martin Wolf backs IMF’s Global Financial Stability Report of October 2018 by requiring that “above all we must keep [bank] capital requirements up”, “How to avoid the next financial crisis”, October 9.

No one, except of course those bankers whose bonuses depend a lot on not having to compensate much capital, would argue against banks having to hold more capital. But, after a bank crisis that resulted exclusively from excessive bank exposures to assets especially perceived as safe, and that therefore regulators allowed banks to hold against especially little capital, it should be clear that even more important than more capital, it is to get rid of the risk weighted capital requirements for banks, those which so distort the allocation of bank credit.

Wolf writes: “The pre-crisis world was one of globalisation, belief in markets and confident democracies” Really? If so that’s because way too few knew what was happening.

“Confident democracies” In 1988, with the Basel Accord, one year before the Berlin Wall fell, bank regulators, without due consultations, smuggled in risk weights of 0% for the sovereign and 100% for the citizens. Sir, no matter how you see it, that is statism imposed by unelected autocrats that has nothing to do with democracy.

“Belief in markets” When regulators, with Basel II of 2004, assigned a risk weight of 150% to what was rated below BB- and only 20% to what was rated AAA to AA, they very clearly, stated, bankers don’t see shit, so we must help them out.

Sir, some might take comfort that current figures, even not as good as if the crisis had not happened, are still acceptable. They will soon wake up to the fact that these relative decent post crisis results, come from kicking the crisis can forward, and from the debt-financed anticipation of demand. That can, will soon start rolling back on our children and grandchildren. Great kicking authorities!

PS. Again! Had regulators understood that risk-weighted capital requirements for banks only guarantee especially large exposures, against especially little capital, to what’s perceived or decreed as especially safe, an especially big crisis like that of 2008 would not have happened

@PerKurowski

I trust banks and markets much more when regulators keep their hands off.

Sir, I refer to John Authers’ “In nothing we trust” Spectrum, October 6.

Let me give you brief one page version of my story:

1998, in an Op-Ed (in Venezuela I wrote) “In many cases even trying to regulate banks runs the risk of giving the impression that by means of strict regulations, the risks have disappeared…History is full of examples of where the State, by meddling to avoid damages, caused infinite larger damages”

1999 in another Op-Ed “What scares me the most, is what 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 collapse”

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

April 2003, as an Executive Director of the World Bank, in a formal statement, I repeated that warning: "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"

June 2004, the Basel Committee on Banking Supervision issued Basel II. By means of their standardized risk weights, they allowed banks to leverage a mind-blowing 62.5 times their capital if only an asset carried an AAA to AA rating issued by a human fallible credit rating agencies.

October 2004, in one of my last formal written statements as an ED at the Board of the World Bank I held: “We believe that much of the world’s financial markets are currently being dangerously overstretched, through an exaggerated reliance on intrinsically weak financial models, based on very short series of statistical evidence and very doubtful volatility assumptions”

After reading an incomprehensible explanation provided in June 2005 by the Basel Committee I have, in hundreds of conferences tried to get the regulators to answer the very straightforward question of: “Why do you want banks to hold much more capital against what, by being perceived as risky, becomes less risky to our bank systems, than against what perceived as safe poses so many more dangers?” I have yet to receive answer.

So we have regulators who still, after a crisis caused exclusively by assets perceived as safe and that therefore banks could be held against less capital, allow especially large bank exposures, to what’s perceived as especially safe, against especially little capital. 

Sir, that dooms our bank system to especially severe crises. Why on earth should I or you trust them?

Sir, in hundreds, if not thousands of letters to you over the last decade, I have also tried to enlist FT in helping me ask that question (one that seemingly shall not be made) and to insist on receiving a comprehensible answer. I’ve had no luck with that either, so, respectfully, why should I trust your motto “Without fear and without favour”?

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

PS. And this letter does not refer to the horrendous introduction of full fledged statism that happened when with Basel I in 1988 the regulators assigned a risk weight of 0% to the sovereign and one of 100% to the unrated citizen.

@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

How many Greece will it take before the bank-sovereign doom loop is really discussed and then dismantled?

Sir, Isabel Schnabel, a member of the German Council of Economic Experts writes about a “contentious issue: the regulation of banks’ sovereign exposures. Currently, this benefits from regulatory privileges, being exempt from capital requirements and large exposure limits. The result is high volumes of sovereign debt on banks’ balance sheets, with a strong bias towards domestic bonds… it is up to the European Commission to shift this important issue to the top of the agenda”, “How to break the bank-sovereign doom loop”, August 29.

About time! It is now thirty years since regulators, with the Basel Accord, Basel I, introduced risk weighted capital requirements for banks; and thereto assigned risk weights of 0% to sovereigns and 100% to citizens, and so gave birth to the bank-sovereign doom loop.

It was European Authorities who assigned a 0% risk weight to Greece and thereby doomed it to its current tragedy.

If there is something the EC firsts need to come clear with, is how that happened.

When I first heard rumors about that regulatory statism, around 1997, I just did not believe it… I mean did not the Berlin wall fall in 1989? 

In a letter published by FT in November 2004, soon 14 years ago, I wrote: “We wonder how many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.” And of course that applies to developed nations too.

Why has this issue never really been discussed? How come the world has allowed itself to be painted into a corner with sovereign risk-weights it dares not change scared of that would on its own set off a crisis? Why did Greece have to pay for a EU mistake? Is that a way to treat a union member? And thousands of questions more.

Sir, how do we stop this "I guarantee you and you lend to me (against no capital)” incestuous relationship between sovereigns and banks?

@PerKurowski

Indeed, reforming the credit rating market is an urgent necessity. Indeed, shame on the regulators

Sir, Arturo Cifuentes concludes, “Reforming the credit rating market is an urgent necessity. Shame on the regulators” “Few lessons have been heeded 10 years after Lehman collapse” August 23.

Yes shame on the regulators! But also for some other reasons than those Cifuentes mentions.

Just for a starter, the credit rating agencies would never ever have caused so much damage had their opinions not been leveraged immensely by the risk weighted capital requirements for banks. Imagine, Basel II, 2004, allowed banks to leverage 62.5 times if only a human fallible credit rating agency assigned an asset an AAA rating. 

It should have been crystal clear that with that the regulators were introducing a huge systemic risk in the banking sector. That I mentioned for instance in a letter published by FT in January 2003; and I loudly explained and protested it while an Executive Director in the World Bank during those Basel II preparation days.

In Europe, the EU authorities even overrode the credit rating agencies opinions and assigned Greece a 0% risk weight, which of course doomed it to its current tragic condition. 

Then, let us mention the mother of all regulatory mistakes; for their risk weighted bank capital requirements, initiated in 1988 with Basel I, the regulators used the perceived risk of assets instead of the risks of those assets conditioned on how their risks are perceived? How loony, how sad, what a distortion, what a recipe for disaster was not that? And still, 30 years later, they do not even acknowledge their mistake.

By the way, when Cifuentes denounces that Solvency II, with its myopic risk view, will discourage insurance companies, the natural holders of illiquid assets, to hold these investments, and it will therefore increase the systemic risk by making their portfolios less diversified, I could not agree more.

Sir, you know that for over more than a decade I have written to Financial Times 2.787 letters objecting to the “subprime banking regulations”, this one not included. Galileo could indeed be accused for being obsessed with his theories, but, could those doing their utmost to silence his objections, the inquisitors, not be accused of the same?

PS. Cifuentes mentions “Olivier Blanchard’s 2016 admission that incorporating the financial sector in macro models would be a good idea”, I might have had something to do with that.

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

@PerKurowski

To tell us “What really went wrong in the 2008 financial crisis” might require more distance to the events

Martin Wolf reviewing Adam Tooze’ “Crashed: How a Decade of Financial Crisis Changed the World” refers to the author’s question of “How do huge risks build up that are little understood and barely controllable?” “What really went wrong in the 2008 financial crisis?” July 18.

May I suggests as one cause, the nonsensical ideas that can be developed through incestuous groupthink in mutual admiration clubs of great importance, such as bank regulators gathering around with their colleagues of the central banks in the Basel Committee for Banking Supervision.

Wolf writes: “The crisis marked the end of the dominant consensus in favour of economic and financial liberalisation” 

Not so! The end in “favour of economic and financial liberalisation” happened much earlier when the regulating besserwissers decided they knew enough about making our bank systems safer, so as to allow themselves to distort the allocation of bank credit.

In 1988, the regulators, with the Basel Accord, Basel I, surprisingly, with none or very few questioning them, decided that what’s perceived as risky was more dangerous to our bank system than what’s perceived as safe, and proceeded to apply such nonsense with their risk weighted capital requirements for banks. More risk, more capital – less risk, less capital. 

That meant that banks could then leverage more their regulatory capital (equity) with “the safe” than with “the risky”; which translated into banks earning higher expected risk-adjusted returns on equity with “the safe” than with “the risky”. That would of course from thereon distort the allocation of bank credit more than usual in favor of the safe and in disfavor of “the risky”.

That of course ignored the fact that what is perceived as risky has historically proven much less dangerous to the bank system than that which is perceived as safe. 

Basel I, which already included much fiction, like assigning a 0% risk weight to sovereigns and 100% to citizens, was bad enough but then, in 2004, with Basel II, the regulators really outdid themselves allowing for instance banks to leverage 62.5 times their capital with assets that had an AAA to AA rating, issued by human fallible rating agencies was present.

We have already paid dearly for that stupidity, as can be evidenced by the fact that absolutely all assets that detonated the 2007/08 crisis had in common generating especially low capital requirements for banks, because these were perceived (houses), decreed (Greece) or concocted (AAA rated securities) as safe.

I have ordered it but of course I have not read Adam Tozze’s book yet. When I do I will find out if it makes any reference to this. If not, I might just have to wait for other historians who are more distant from the events.

@PerKurowski

Citigroup’s Chuck Prince said: “As long as the music is playing, you’ve got to get up and dance”, but bank regulators insist on playing the same 30 years old song.

Sir, Andrew Hill worries about how many of today’s banker class remember it, let alone worry, about the complacency expressed in Chuck Prince’s “As long as the music is playing, you’ve got to get up and dance. “James Gorman, chief executive of Morgan Stanley “Amnesia dooms bankers to repeat their mistakes” June 24.

Hill hopes Gorman “is experienced enough to have detected the echoes of 2007 in the current soundtrack of rising share prices and lowering regulatory burdens… and that he teaches “more of his younger, fresher-faced staff to recognize the tune and know when to bow politely and leave the dance floor.

As for me I would much rather prefer the regulators stopped playing that very same old song of the “risk weighted capital requirements for banks”, composed in 1988 by the Basel Accord, and otherwise known as “You earn higher returns on the safe than on the risky”. That song drove bankers into an intense maniac polka, in pursuit of the very high expected risk adjusted returns offered on what was perceived (houses), decreed (Greece 0% risk), or concocted (AAA rated securities) as safe.

PS. Hill refers to John Kenneth Galbraith’s The Great Crash 1929 account of the willful errors and self-interested speculation of the great investment banks. But Galbraith also wrote “Banks opened and closed doors and bankruptcies were frequent, but as a consequence of agile and flexible credit policies, even the banks that failed left a wake of development in their passing.” Money: Whence it came, where it went” (1975)

@PerKurowski

Central bankers have surely favored government borrowings… and the costs will be horrendous.

Sir, Desmond King reviews and discusses Paul Tucker’s “Unelected Power”, which asks:“To whom are central bankers responsible? How is oversight of their discretionary authority monitored in a democracy? Can central banks remain legitimate as they choose financial winners and losers?”

The starting point for Tucker’s questions seems to be when, in September 2008, “Citizens and bankers sat transfixed as Lehman Brothers collapsed, rattling equity and credit markets”.

Wrong! Not that I had any idea of it back then but the genesis of the problems herein referred to seem to me be in 1988 when bank regulators came up with the incredibly hubristic concept of risk weighted capital requirements for banks, as if anyone could measure ex ante the risks that would explode ex post.

From a cv. on the web I see that Paul Tucker worked in 1987 in “the Banking Supervision Division; as part of the 4 person team negotiating the Basle International Capital Convergence Agreement; and assistant to chair of Basle Supervisors Committee”

So when King writes that “Tucker argues that the “most compelling reason” for [central bank independence] is to “enable governments to save paying an inflation risk premium on their debt”, I must ask: “Really Mr. Tucker, does that require risk weighing the sovereigns with 0% while assigning the citizens 100%?” 

That regulatory subsidy causes, sooner or later, governments to take will be getting up too much debt, that which can only be repaid by the printing machine… meaning inflation… meaning tragedies. 

I have not seen anyone holding Sir Paul Tucker accountable.

PS. I dare Paul Tucker, the current chair of the Systemic Risk Council, to give a coherent explanation for why banks should hold more capital against what’s made innocous by being perceived risky, than against what’s perceived safe and therefore carries more dangerous tail risks? The distortion that produces in the allocation of bank credit constitutes, as I see it, a huge systemic risk.

@PerKurowski

Predictability, in bank regulations, is more a dangerous threat than help

Sir, I refer to Robin Wigglesworth’s excellent discussion on the difficulties and hard choices central banks face when communicating their feelings and policies “Central banks might benefit from a healthy dose of ‘constructive ambiguity’”. May 14.

But let me focus (for the umpteenth time) on the concluding note “Predictability may be a hindrance rather than a help”

The Fed’s Governor Laid Brainard, in a recent speech “An Update on the Federal Reserve's Financial Stability Agenda” said: “The primary focus of financial stability policy is tail risk (outcomes that are unlikely but severely damaging) as opposed to the modal outlook (the most likely path of the economy).”

That is how it should be, but it is not! That the riskiness of bank assets, for instance with the help of credit rating agencies, could be somewhat predicted, tempted regulators into creating risk weighted capital requirements for banks; but that same “predictability” also blinded them completely to the fact that the safer something is perceived, the more dangerous does its fat-tail-risk become. For instance they assigned a risk weight of only 20% to the AAA rated and one of 150% to that which was rated below BB-. Is not the fat-tail-risk of what has been rated below BB- almost inexistent?

Governor Leal Brainard also writes: “Treasury yields reflect historically low term premiums--. This poses the risk that term premiums could rise sharply--for instance, if investor perceptions of inflation risks increased.” 

Indeed, but to that we must also add the possibility of the investor perceptions of Treasury infallibility changes for the worse.

When in 1988 the regulators, with Basel I, decided to assign a 0% risk-weight to some sovereigns they painted these into a corner. If that risk weight is not increased, then sovereigns will become, sooner or later over-indebted, and risk will grow until it hits 100%. If that risk weight is increased, ever so slightly, markets will be very scared. How to get out of that corner is the most difficult challenge central banks and bank regulators face. Let us not forget that in 1988 US debt that was $2.6 trillion. Now it is US$21 trillion, growing, and still 0% risk weighted.

PS. The only way to solve the 0% sovereign risk weight conundrum that I see, is to increase the leverage ratio applicable to all assets, until that level where the risk weighted capital requirement totally loses its significance.

PS. Brainard also stated “Regulatory capital ratios for the largest banking firms at the core of the system have about doubled since 2007 and are currently at their highest levels in the post-crisis era.” Regulatory capital ratios, when risk weighted, might mean zilch.

@PerKurowski

Does not “safe(ish) activities such as holding government bonds” contain the fattest most dangerous tail risks?

Sir, Gillian Tett writes “the Fed and the Office of the Comptroller of the Currency introduced proposals to “tailor leverage ratio requirements to the business activities and risk profiles of the largest domestic firms”. In plain English, this means banks can operate with a little less capital to absorb losses, provided they focus on safe(ish) activities such as holding government bonds.” “Trump’s mixed record on rolling back bank reform” April 13.

The Fed’s Governor Laid Brainard, in a recent speech “An Update on the Federal Reserve's Financial Stability Agenda”said: “The primary focus of financial stability policy is tail risk (outcomes that are unlikely but severely damaging) as opposed to the modal outlook (the most likely path of the economy).”

So let me ask: What is the tail risk of “safe(ish) activities” compared to that of riskier activities?

How fat or dangerous is the tail risk of what is rated below BB-? Very skinny indeed.

How fat or dangerous is the tail risk of what is rated AAA? Very, very fat indeed.

Government bonds? When in 1988 the regulators, with Basel I, decided to assign a 0% risk-weight to some sovereigns they painted themselves into a corner. If that risk weight is not increased, then sovereigns will become, sooner or later over-indebted, and their risk will grow until it hits 100%. If that risk weight is increased, ever so slightly, markets will be very scared. How to get out of that corner is the most difficult challenge central banks and bank regulators face. Let us not forget that in 1988 US debt that was $2.6 trillion. Now it is US$21 trillion, growing, and still 0% risk weighted.

PS. The only way to solve the 0% sovereign risk weight conundrum that I see, is to increase the leverage ratio applicable to all assets, until that level where the risk weighted capital requirement totally loses its significance.

@PerKurowski

Jan Zielonka, yes, the ‘enlightened’ and not accountable to anyone besserwisser ‘experts’, are taking our world order down.

Martin Wolf writes that Jan Zielonka, in “Counter-Revolution”, holds that “liberal democracy and neo-liberal economics, migration and a multicultural society, historical ‘truths’ and political correctness, moderate political parties and mainstream media, cultural tolerance and religious neutrality…is under attack” and that he “is particularly critical of the EU, a “prototype of a non-majoritarian institution led by ‘enlightened’ experts”. “Project backlash”, February 3.

“Enlightened experts”? Absolutely! In 1988, without any real meaningful consultations, without thinking about the purpose of the banks, and without thinking thru its possible consequences, G10’s central bankers and regulators introduced risk weighted capital requirements for banks.

The Basel Committee then favored the sovereign with the outrageously statist risk weight of 0%; and, in 2004, the AAArisktocracy with 20% and the financing of residential houses with 35%; while disfavoring loans to unrated citizens, SMEs and entrepreneurs with a 100% risk weight.

Did those regulators ever explain why they should want to favor with lower capital requirements for banks that which is already favored by being perceived as safe, and thereby discriminate against that which is already disfavored by being perceived as risky? No. They are such besserwissers they don’t even hear the question.

These regulations seriously distorted the allocation of bank credit to the real economy by stimulating the banks to finance much more the “safer” present consumption than the future “riskier” production… something that truly constitutes a shameful intergenerational treason.

Besides a slowing economy, the only thing the risk weighting guarantees is that when banks systems really find themselves in trouble, which is when something perceived as very safe turns out to be very risky, banks will stand there with especially little capital. Brilliant eh?

Martin Wolf ends with “We can see the crisis of liberal democracy most clearly in the fact that so ardent, yet disappointed, a proponent offers not much more.”

Mr. Wolf what about your duty of “without fear and without favor” using your throne of influence to force the Basel Committee regulators to answer the questions that I have posed in thousand of letter to FT, and mostly to you?

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

Per Kurowski

If you want your sovereigns to have easier access to credit than your entrepreneurs, then you are not thinking on your grandchildren.

Sir, with respect to sovereign bond-backed securities you opine “bank regulation should be reformed to treat SBBS as favourably as national bonds in capital requirements — indeed, more favourably, since SBBS would make it less destabilising to have banks hold equity against concentrations of their own government’s bonds” “A rare chance to create a pan-eurozone safe asset” January 31.

What? Instead of a 0% risk weighting, these bonds collateralized with loans to sovereigns, should now have even a minus something risk weight percentage? So that banks can earn even higher expected returns on equity when lending to sovereigns? So that banks will lend even less to entrepreneurs. Sir, as a grandfather, let me tell you, that is a shameful proposition.

Defending the SBBS you argue: “the monetary union enjoys a well-deserved streak of growth”. Holy moly, what “well-deserved streak of growth” is that? Do you refer to that growth that has been financed by quantitative easing and by the low interest rates that makes it impossible for pension funds to live up to its offers? Come on! It is a totally undeserved growth… and one that will be very hard to repay.

You opine one should “create a truly pan-eurozone benchmark safe asset… the SBBS”

Sir, when you save, by investing in a bond, you should want the debtor invest your money well, so as to be able to repay you well. A eurozone SBBS seems here to be a bond designed so that no sovereign would have to repay it, and therefore no sovereign would be required to invest it well. Would you like your pension fund to invest in such SBBS with ultra low interest rates? 

And you also opine that “if issued in sufficient quantities, SBBS could help end the danger at the heart of the eurozone crisis: the “doom loop” between sovereign and bank debt. Banks holding senior SBBS would be safe from sovereign risk”

Sir, again, for the umpteenth time, that “doom loop” was created, in 1988, when regulators in their risk weighted capital requirements for bank assigned the sovereign a risk weight of 0% and the unrated citizens, those who form the backbone of any sovereign, a risk weight of 100%. And then I believe you said nothing about that!

@PerKurowski