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

If Trump wins that could be because some journalists, like Martin Wolf, withheld the truth of what has happened

Sir, Martin Wolf writes “The US is the greatest republic since Rome, the bastion of democracy, the guarantor of the liberal global order. It would be a global disaster if Mr Trump were to become president” “How great republics meet their end” March 2.

Absolutely, I agree 100 percent.

But, in Charles Goodhart’s “The Basel Committee on Banking Supervision: A History of the early years 1974-1997:” 2012, Cambridge Press Goodman (p.167) refers to Steven Solomon’s The Confidence Game (1995) 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 achive 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 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.”

And that started the mother of all distortions to the allocation of bank credit to the real economy, that which got us into the economic low growth mess we’re all in.

And so when Martin Wolf now, with respect to Trump, worries that “An American ‘Caesarism has now become flesh” I have to ask him: Where were you Wolf when American and British regulators believed themselves to be Caesars and acted like such?

Martin Wolf, by defending the bank regulation's Caesars, you might very well be part of the reason why Donald Thrump can now aspire to be a Caesar. Sleep on that!

@PerKurowski ©

Urgently fire those damn bank regulators who abandoned the young and ignored their needs for jobs and a future

Sir, I refer to the true tragical horrors described by Tobias Buck in “The fear and despair of Spain’s young jobseekers” March 2.

And I tell you again, though you will most probably ignore me again, that nothing as serious as that would have happened had not some few powerful and arrogant bank regulators, while trying to level the field for banks to compete, unleveled the real economies’ access to bank credit.

Read the chapters of “Capital adequacy and the Basel Accord of 1988” and “The BCBS and the social sciences” in Charles Goodhart’s “The Basel Committee on Banking Supervision: A History of the early years 1974-1997” 2012, Cambridge Press and you will understand. There is not one single reference to that how banks allocate credit to the real economy was of any concern whatsoever to regulators. And most probably it still is not.

Had they given that banks’ social purpose the slightest thought, they would have understood, unless too dumb, that their credit risk weighted capital requirements for banks impeded banks to adequately serve the economy.

Allowing banks to leverage equity differently based on “risk”, allows banks to earn higher risk adjusted return on equity on what is perceived or deemed to be“safe”, than on what is perceived as “risky”

So now “The safe” get too much credit on too lenient terms, while “The Risky” have no access to bank credit, that is unless they pay much higher risk adjusted premiums than they would ordinarily have to pay in an undistorted market.

Houses are safe so lend to that, but SMEs and entreprenuers the job creators are risky so cut them off!

Sovereigns are safe so lend to these, but the private sector is risky so, except for the AAArisktocracy, cut it off!

And so now our banks do not finance the “riskier” future they just refinance the “safer” past.

These regulators must be stopped! They are financial terrorists who threaten the future of our kids. And you FT must stop covering up for them.

“A ship in harbor is safe, but that is not what ships are for” John Augustus Shedd, 1850-1926

But not even ships are safe in a safe harbor if that harbor gets to be dangerously overpopulated.

@PerKurowski ©

Here a call in Spanish to the young to demand the risk taking they need

Here a letter in Spanish to the King asking for him to help the youth of Spain

Fairness to debt burden countries and taxpayers, starts by getting rid of risk weighted capital requirements for banks

Sir, Charles Goodhart writes: “But how can one… be fair to … countries with debt burdens enlarged by the global financial crisis; and fair also to the taxpayers in creditor countries…? There is, I believe, a way to do so… real gross domestic product bonds” “Restructure all or most of Greek debt into real GDP bonds” August 6.

That might be but, writing “debt burdens enlarged by the global financial crisis”, is unfair to both debtors and taxpayers. What first needs to be done, so that these tragedies are not repeated, is to acknowledge the role the distorting portfolio invariant capital requirements based on credit risk played in causing the crisis. And then to rid the world of these that doom the safe havens to become dangerously overpopulated, and the risky but more interesting bays from being sufficiently explored.

@PerKurowski

Let us welcome John Kay’s awakening. Better late than never! Let us now hope he wakes up completely

Sir, John Kay, refers to “Goodhart’s law”, from the 1970s, which states that “any measure adopted as a target loses the information content that appeared to make it relevant. People [bankers] change their behavior to meet the target”, “The law that explains the folly of bank regulation”, September 12. 

Well, if that law was known, one could have presumed someone would have alerted the bank regulators about that, when they in the Basel Committee were concocting their capital requirements for banks targeted based on perceived risks. Where was Charles Goodhart, and those who knew of his law, when we needed him? 

The fact though is that in this case it was even worse, forget about “changed behavior” because when regulators set their capital requirements, they even ignored the initial behavior of bankers when reacting to the perceived risk, and which of course ignored the fact that bankers already had a propensity to go for the “absolutely not risky”. And, in doing so, they doomed our banks to a crisis larger than ordinary bank crisis. 

But now at least John Kay writes about the Basel Committee’s “irrelevant” “conclaves”, held “to give politicians and the public a sense that something is being done while enabling banks and regulators to go on doing what they have always done”. But, honestly, that Kay can do so without the slightest word of “sorry”, after he in the midst of this monstrous crisis has himself, for years, blithely ignored Goodhart’s Law, is sort of sad. 

That said, let us welcome John Kay’s awakening, better late than never, and let us hope he now wakes up completely. 

PS. In http://teawithft.blogspot.com/search/label/John%20Kay you will find the letters I have written in response to John Kay’s articles.

Let us hope we are not ordered to do or not to do something because of long term central-bank projections.

Sir, Charles Goodhart in “Longer-term central bank forecasts are a step backwards” February 2, writes: “If official predictions contain additional information beyond that implied by market forecasts of the term structure of short-term interest rates then well and good. If not, then all central bankers are doing is exposing that they are as clueless about the future as the rest of us.” 

That is correct, but at least a long-term central bank forecasts is, for now, not being pushed down the throat of a market which has already considered that information, like happens when the bank regulators, with their capital requirements based on perceived risk, and as primarily perceived by their outsourced official risk perceivers, the credit rating agencies, push that information again down the throats of the banks. 

But, who knows, any moment, someone could order us to do or not to do something based on those long-term central bank forecasts.

“Unwittingly”… or simply stupidly and irresponsibly?

Sir, Charles Goodhart in “Basel marches down wrong path to tackle systemic risk” July 7, writes “Regulation may unwittingly have actually added to procyclicality and systemic fragility by encouraging similar behavior.” Seriously, where goes the border line between “unwittingly” and either stupidly or irresponsibly?

In January 2003 the Financial Times published a letter I wrote which ended with “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds.” And if that was clear to me, an ordinary strategic and financial advisor, that should have been perfectly clear to bank regulators. 

The regulators bet the health of the financial sector on capital requirements for banks based on the credit ratings being right, instead of taking the precautions to safeguard the financial system for when these ratings would, sooner or later, be wrong, and now we are all paying the price of it. 

Sir, if FT’s “Without fear and without favour” motto means anything to you why do you insist on being so lenient with the bank regulators? If it had been many bridges collapsing because of structural design flaws, I am sure you’d gone after the engineers responsible of that. Is it really so that a BP management can be held accountable but a Basel Committee not? It is truly amazing to see basically the same bank regulators keep on regulating with basically the same faulty paradigms... and an FT keeping mum!

Finally some real heavy-weight support!

Sir at long last an important number of academicians are speaking out asking to remove “the biases created by the current risk-weighting system” imposed on the world by the Basel Committee on Banking Supervision for the purpose of determining the capital requirements of banks, “Healthy banking system is the goal, not profitable banks” November 9.

The hundreds of letters related to this issue that I sent to the Financial Times over the last five years, and that were ignored, will serve as proof of the immense difficulties of fighting a regulatory paradigm that sounds so extremely logical as capital requirements based on (ex-ante) perceived risk does, but that is still so utterly faulty. In fact it has proven even more difficult than making Citi’s Charles Prince stop dancing.

I hope that the fundamental revisions to the financial regulations, when they come, as they sure will come, will also include the need of avoiding the trap of placing important regulatory issues in the hand of non-transparent mutual-admiration clubs like the Basel Committee which are not diversified sufficiently so as to avoid the risk of degenerative intellectual-incest.

By the way, just for additional clarity, I wish the title of their letter had said “Healthy and useful banking system is the goal”, but again I am more than glad enough, for the time being.

Free the banks from the chaperones and get the party going!

Sir Charles Goodhart´s and Avinash Persaud´s “A party popper’s guide to financial stability” June 5 reads like the desperation of a garage fixer to fix something with whatever epoxy he can lay his hand on.

I have myself often proposed a progressive tax on banks, based on the-bigger-you-are-the-more-it-will-hurt-if-you-fall-on-me principle but, what on earth do they mean by taxing the growth rate of bank assets, which is what raising capital requirements mean? That slow growing banks can just sit back and trade growth allotments, like if bank assets were carbon type contaminants?

No instead of worrying so much about the possible hangovers why do they not worry more about making the party better. The current risk adverseness implied in the minimum capital requirements based on risk and as measured by the credit rating agencies, have the markets playing boring and unproductive minuets, like consumer finance dressed up as “risk free” securitizations.

The world is clamouring for decent jobs, and if the banks are to help us create them, they need to be given more freedom and responsibility. In that sense, set the capital requirements for banks at a fixed percentage of assets and get the chaperones out of their hair, so that we can get more of that risky salsa that when if times comes for a hangover, makes it at least more bearable... since the party was great!