Basel Committee’s risk weighted bank capital requirements is fodder for our wishful thinking hopes.

I refer to Tim Harford’s “From forgeries to Covid-denial" On how we fool ourselves: Whether believing implausible statistics or falling for frauds, humans are addicted to wishful thinking” FT, January 30, 2021.

Sir, I ask, the Basel Committee’s risk weighted bank capital requirements, could that just be a forgery made to satisfy our deep wishes of our banks always being safe?

Now why so little objections? Edward Dolnick explained it with: “Experts have little choice but to put enormous faith in their own opinions. Inevitably, that opens the way to error, sometimes to spectacular error.”

By the way. Where has Academia been on all the regulatory distortion of the allocation of bank credit?

Excessive “intellectual gravitas” can sometimes be just as dangerous, or even more, than an insufficient one.

Sir, James Politi writes: Greg Mankiw, a respected Republican economist, did not mince words when he posted his reaction to Donald Trump’s nomination of Stephen Moore for a seat on the Federal Reserve board saying: “Steve is an amiable guy, but he does not have the intellectual gravitas for this important job.” “Donald Trump’s Fed nominee faces broad backlash” March 25.

That reminded me (again) of Edward Dolnick’s “The forger’s spell” (2009), which makes a reference to Francis Fukuyama saying that Daniel Moynihan opined: “There are some mistakes it takes a Ph.D. to make”. 

The intellectual gravitas of all those at the Fed and of all their colleagues in the bank regulatory sphere, primarily in the Basel Committee, came up with: risk weighted capital requirements for banks based on the utter nonsense that what’s ex ante perceived as risky, is more dangerous to our bank systems than what’s perceived as safe. 

An outrageous example of it is how Basel II, in its standardized risk weights, to that so dangerous because it is rated AAA to AA, they assigned a meager 20% risk weight, while, to that which is so innocous, because it has been rated a below BB-, they smacked with a 150% one.

And now, 10 years after a crisis that broke out because of excessive exposures to AAA rated securities, or to assets to which an AAA rated entity like AIG had issued a default guarantee for, the intellectuals with gravitas, persist in their mistake.

Sir, I do not know Stephen More but, if he possesses common sense, some experiences on Main Street and the willingness to question, then his possible lack of intellectual gravitas should be welcome, as something of that sort is much needed to guarantee diversity able to help block some of the incestual thinking processes.

@PerKurowski

If only a cost benefit analysis had been performed on the risk weighted capital requirements for banks

Tim Harford while reviewing Cass Sunstein’s“The Cost-Benefit Revolution” mentions, “In 1981, Ronald Reagan signed Executive Order 12291, requiring administrative decisions to weigh the costs and benefits of action and maximise net benefits.”, “A valuable study of a quiet victory for technocrats”, September 17.

How sad the risk weighted capital requirements for banks were no subjected to such a cost benefit analysis.

On the cost side, one would have to include the possibility that, since it would impose a tariff, by means of higher capital requirements, on the lending to the risky, and therefore de facto create a subsidy for when lending to the safe, that this could seriously distort the allocation of bank credit to the real economy… financing too much the safer present and too little that indispensable riskier future.

And, when reviewing its supposed benefit, that of making the bank system safer, one would have had to consider the possibility that, since the risky would then have to pay higher relative risk premiums than usual, that this could make them even riskier; plus the possibility that since the safe would get more credit at lower rates, that meant the safe could get too much credit at too low risk adjusted premiums, and banks could build up that type of excessive exposures to the safe that has always been the stuff bank crises are made off.

Adding then to the costs these possible negative benefits would certainly have caused this silly and dangerous regulation to be rejected… and the 2007-08 crisis avoided.

Hartford mentions that “Hayek’s objection to central planning is that it cannot work because the planners will never have enough information” I agree, but I am also sure that central planning often fails, not for lack of information, but simply because of them not understanding they lack information; and all there planning carried out in a group-thinking mutual admiration club.

In the “The forger’s spell”, a book by Edward Dolnick about the falsification of Vermeer paintings, the author makes a reference to having heard Francis Fukuyama in a TV program saying that Daniel Moynihan opined “There are some mistakes it takes a Ph.D. to make”. And Dolnick also refers to George Orwell’s comment, in “Notes on Nationalism”, that “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” 

Sir, time and time again I find reasons to be reminded of that book.

http://subprimeregulations.blogspot.com/2011/08/no-ordinary-man-could-be-such-fool.html

@PerKurowski

No one but a PhD or an MBA could have come up with the foolish risk weighted capital requirements for banks

Sir, Philip Delves Broughton in his “The business school tradition feels like an outdated Grand Tour”, October 7, refers to a book I am just to begin to read, Mihir Desai´s The Wisdom of Finance.

In that book Desai, writes about “how many of his MBA students avoid risk in order to retain their ‘optionality’... a concept they had picked up from finance… [but] often remain in companies saying to themselves, ‘Why not stay another year and create more options for down the road?’; ending up frustrated. The tool that was supposed to lead to more risk-taking ends up preventing it.”

Sir, I am not sure an option-searcher has ever in him to be a real risk-taker. That normally belongs to those who just close their eyes and jump at any opportunities in front of them. But, that said, I sure know of a tool that produces just the opposite. It was supposed to lead to less risk-taking, but ends up causing much more of it.

I mean of course the risk weighted capital requirements for banks. By giving banks the incentives to create excessive exposures, holding the least capital, to what has always caused major bank crisis, namely what was ex ante perceived as safe but that ex post turned out to be very risky, instead of reducing the risks to the bank system, it increased it exponentially.

Broughton also refers to a book by Will Dean, It Takes a Tribe, in which the author holds that entrepreneurs learn by doing, while MBAs fail by over-thinking. Will Dean is by far not the first to argue such a thing.

My daughter Alexandra, an art fanatic, on hearing my explanation about the mistake of the Basel Committee, pointed me to “The forger’s spell”, a book by Edward Dolnick about the falsification of Vermeer paintings. Boy was she right! 

In that book Dolnick makes a reference to having heard Francis Fukuyama in a TV program saying that Daniel Moynihan opined: “There are some mistakes it takes a Ph.D. to make”. And Dolnick also speculates, in the footnotes, that perhaps Fukuyama had in mind George Orwell’s comment, in “Notes on Nationalism”, that “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” 

I am very happy with the MBA degree I received from IESA in Caracas 1974; but that does not stop me from being extremely disappointed with all MBA and Finance Schools all around the world, for not having been able to see, and much less stop, those regulations that are so dangerously distorting the allocation of bank credit.

Dolnick wrote: “Experts have little choice but to put enormous faith in their own opinions. Inevitably, that opens the way to error, sometimes to spectacular error.”

All of which leaves me with the problem that seemingly no ordinary financial reporters either, like those in FT, can really come to grips with believing, or even daring to believe, that experts could be such fools.

@PerKurowski

PS. My letter in 2019 to the Financial Stability Board 

Universities, allow imperfect and perhaps even inadequate minds, to have a voice in your classrooms. That's diversity!

My daughter, an art fanatic, on hearing my explanation about the monstrous mistake of credit-risk weighted capital requirements for banks, pointed me to “The forger’s spell”, a book by Edward Dolnick about the falsification of Vermeer paintings. Was she right!

In it Dolnick makes a reference to Francis Fukuyama having heard Daniel Moynihan opining: “There are some mistakes it takes a Ph.D. to make”. And Dolnick also speculates that perhaps Fukuyama had in mind George Orwell’s comment, in “Notes on Nationalism”, that of: “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” 

That is why when now Della Bradshaw reports about “a growing recognition that the world’s intractable problems need business solutions means MBA directors are searching for students with a more diverse background to fill their classrooms” I say: “Way to Go!” “More variety is the spice of classroom life” October 5.

Of course we must inject some confident ordinary minds in the classes in order for these to pose the questions that must be made. My impression is that experts never really try sufficiently to convince other experts of why they are right and others wrong, but they do their utmost when it comes to convincing the non-experts that they are the best experts.

Oh if I only had been in those classes where the minds of sophisticated future bank regulators were trying to estimate unexpected losses in the same direction as those expected losses derived from perceived risks.

My ordinary mind would not have been able to hear such foolishness and keep silence. Don’t you know that out there, in the real world, what is really risky is that what we can wrongly perceive as absolutely safe? I have never heard of a substantial number of persons dying because of bungee jumping. Have you?

As an Executive Director in the World Bank I once stated: "A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind.” So, universities, please allow for imperfect and even inadequate minds, to also have a voice in your classrooms.

That said, be careful though with what the calls for diversity really means. It could be modern Giuseppe di Lampedusa types wanting to diversify only in order to remain the same.

@PerKurowski ©

Europe, and the Western world, is spiraling down to its death, embraced by crazy "risk" adverse bank regulations.

How on earth can Europe regain internal balance with bank regulations which are based on the principle that the safer you ex ante look, like the more surpluses you have, like Germany, the less will the banks need to hold in capital lending to you, and so the more will banks expect to earn in risk-adjusted returns on equity when lending to you, and so the less will they lend to those perceived as riskier?

That is a death spiral that will make Europe and the whole Western world implode, as it only guarantees that banks will, naked with no capital, die because of lack of oxygen, in dangerously overpopulated “safe-havens” like Germany.

If you really want to have a future, then you need to give banks incentives to finance it, and not only like now, give these especial incentives to refinance the safer past.

Sir, Martin Wolf, again, in “Germany is a weight on the world” November 6, in spite of my so many letters to him on that issue, does not make a reference to this problem described above. 

Edward Dolnick, in “The Forger´s spell”, when looking to explain how those big experts that had considered some fake Vermeer paintings original, hang on to their beliefs until death, “despite incontrovertible proof to the contrary”, quotes the psychologist Leon Festinger saying: “A man with a conviction is a hard man to change. Tell him you disagree and he turns away. Show him facts or figures and he questions your sources. Appeal to logic and he fails to see your point”.

I believe that applies perfectly to Martin Wolf, but, then again, it could just the same really apply more to me. What do you think?

PS. In the article Wolf writes “just as others had a right to complain about past US regulatory failures”, but it is hard to figure out what he means with that.

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.

With regulators like Mark Carney there is no future in finance for the City, or for the rest of the economy for that matter

Sir, John Gapper writes that Mark Carney, the new “Bank of England governor, has arrived from Canada with a dose of can-do spirit”, “Carney is wise to nurture the City´s future in finance” October 31.

“Can-do spirit”? Ha! There is nothing as far from a can-do spirit than capital requirements for banks which are higher for what is perceived as safe, than for what is perceived as risky. These not only guarantee that banks will not finance the future but mostly refinance the past, but also guarantee the kind of distortions that will make it impossible for the banks which are not in the shadows, to survive.

How can we have reached a point where we can write about “a knowledge industry that has been vital to growth and trade since the 19th century” blithely ignoring there is no way that 19th century banks could have done what they did, with current regulations.

Let me try to explain the regulatory lunacy again, in terms of knowledge. If banks know (or believe they know) the risks, and adjust for these in interest rates, size of exposures and other terms, what business have regulators adjusting for exactly the same “know” in the bank capital?

The role of a banker is to stop his bank from failing”, while the role of a regulator is to see how to stop bankers from failing to stop their banks from failing, and, if banks fail, to see that the hurt will be contained as much as possible. In other words: Though a banker might very well look at credit ratings, a regulator must not look at these, but at how bankers look at credit ratings. Why is it so hard for Mark Carney and his colleagues (and John Gapper and his colleagues) to understand that?

PS. From Edward Dolnick’s “The Forger’s Spell” I extract that the psychologist Leon Festinger once marveled: “A man with conviction is a hard man to change. Tell him you disagree and he turns away. Show him facts or figures and he questions your sources. Appeal to logic and he fails to see your point”. Does this apply to me, or to the bank regulators and Financial Times journalists, or to all of us?

“No ordinary man could be such a fool”

My daughter Alexandra, an art fanatic, on hearing my explanation about the mistake of the Basel Committee pointed me to “The forger’s spell”, a book by Edward Dolnick about the falsification of Vermeer paintings. Boy was she right! 

In that book Dolnick makes a reference to having heard Francis Fukuyama in a TV program saying that Daniel Moynihan opined “There are some mistakes it takes a Ph.D. to make”. And he also speculates, in the footnotes, that perhaps Fukuyama had in mind George Orwell’s comment, in “Notes on Nationalism”, that “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” 

And that comprises about the most appropriate explanation I have yet seen so as to understand why our bank regulators were able to commit their huge mistake that got us into this financial and economic crisis that threatens the Western World. No “ordinary man” would have told his children to beware about what he knew his children were afraid of, and stimulated them to go more where they wanted to go as it seemed safe… which is precisely what the current capital requirements for banks do when they are quite sizable whenever the perceived risk of default is high and small or even inexistent whenever the perceived risk of default is low. 

And then, just like to force down our throats, Dolnick writes “Experts have little choice but to put enormous faith in their own opinions. Inevitably, that opens the way to error, sometimes to spectacular error.” All of which now leaves me with the problem that also “no ordinary” FT reporter can come to grips with believing that experts could be such fools.