Who is to investigate how bank regulators manipulated markets in favor of US Treasury and similar sovereign debts?

In 1988, with the Basel Accord, bank regulators of the G20 countries decided that while the private sector should have a 100 percent risk weighing, their sovereigns, those represented by their bosses, the governments, were so safe so as to validate a zero percent risk weight.

That meant of course that, from that moment on, sovereigns have preferential access to bank credit… something that is of course paid by all those who do not count such preferential treatment.

Since de facto that also means regulators acted as if government bureaucrats could use bank credit more efficiently than the private sector, something that unless we are runaway statists or communists we know is absolutely false, the resulting distortion is also paid by future generations of unemployed.

And so, when compared to that manipulation, all the “potential manipulation of the US Treasury markets” referred to by Gina Chon and Martin Arnold” in “Probe into US Treasury markets” of September 10, is, excuse me, something like what is vulgarly known as chicken shit.

@PerKurowski

Though we cannot fine bank regulators, we should at least shame them, for the mother of all bank-credit markets riggings.

Sir, I refer to FT’s front-page report by Gina Chon, Caroline Binham and Laura Noonan “Six big banks fined $5.6bn over rigging of forex markets”, May 20.

Andrew McCabe, FBI’s assistant director is quoted saying “The activities undermined transparent market-based exchange rates that serve as a critical benchmark to the economy.”

Undoubtedly, the rigging of foreign exchange rates, and of the Libor rate, needs to be condemned in the strongest way… But, for that to really happen, it must be through mechanisms that does as a minimum not cause Lex describe these in terms of being “astonishingly opaque”… and commenting in “Bank fines: the wrong reaction” that “how the agencies decide what fines to impose is a mystery to everyone, the banks included”.

But, that said, in terms of the real consequences to the real economy, all that fraudulent market rigging is peanuts when compared to the mother of all market riggings, that which bank regulators, probably unwittingly, did to how bank credits were allocated.

I mean let’s look at Basel I, II and III. For the purpose of deciding how much equity a bank has to hold against a credit they establish: Sovereigns = 0% risk weight; Citizens = 100% risk weight. Really, is that not as big as market riggings come?

How much more bank credit at low rates did not governments, the regulators’ bosses, receive because of that? How much less bank credit did not all the SMEs, entrepreneurs and start-ups around the world, receive because of that.

Of course we cannot fine regulators (unless we can prove bad intentions… like ideological manipulation)… but should we not shame them at least?

@PerKurowski

Fed needs to make up its mind fast, because now it is really creating confusion about the banks.

Sir, I refer to Gina Chon’s and Tom Braithwaite’s “US and European lenders raise fears over ‘living will’ cash reserve demands” November 4.

In it is reported that banks that face a liquidity crunch can currently tap the discount window as part of the Federal Reserve’s lender of last resort programs, but, that in the process of preparing their ‘living-wills’, they have been told not to assume continued access to it.

What? The Fed now allows banks a 5% leverage ratio, which implies a mind-boggling 20 to 1 authorized leverage of equity… and yet now they want to retire their lender of last resort support? It better makes up its mind fast… because now all we others are becoming really confused. If we are not able to count on big strong Fed to help out, then there is no way we small weaklings can allow banks to leverage that much.

Joe Hockey, as an impact assessment, just ask bank regulators some easy questions.

Sir, Jamie Smith, Sam Fleming and Gina Chon report that “The B20, a business lobby group has called on… the Basel Committee to investigate further the side effects of financial regulations”, “G20 split over call to assess impact of financial rules” September 18.

About time! I just hope this B20 also includes a god representation of those borrower who because they are perceived as risky are, by means of credit-risk-weighted capital requirements for banks, being denied fair access to bank credit.

I just came back from Toronto where I saw the play “Our Country's Good” advertised with “Thieves, murderers, prostitute, actors…this is what made Australia”. I sure hope Joe Hockey, Australia’s finance minister, now reflects on what would have become of Australia’s economy if its banks had needed to hold much much more capital (equity) when lending to its own “risky” outcasts, than what they needed to hold when lending to the “absolutely safe”, like to Greece. 

Frankly, before requiring any impact assessments I would be great if Joe Hockey, just asked bank regulators to answer some kindergarten level questions, and did not let go until he had an answer that a kindergartener would understand. Like the following:

Q. Why on earth should a lot of money lent at low interest rates to Mr. Safe be safer, or less risky for the bank, than little money lent at high rates to Mr. Risky?

Q. Is the truth not that the risk of banks have nothing to do with the credit risks of Mr. Safe or Mr. Risky, and all to do with how banks lend to Mr. Safe or Mr. Risky which, as they say in French, is pas la meme chose?

Q. Why on earth would bank regulators expect the bank to keep on lending to Mr. Risky if it cannot leverage its equity as much as it is allowed to do when lending to Mr. Safe?

Q. And if banks only lend to the Mr. Safe of this world and avoid all the Mr. Risky, what might become of the real economy… a safer or a riskier place?

The sad truth is that all current bank regulations have been written without first settling the issue of what is the purpose of banks.

Overly risk adverse regulators ignored that risk-taking is the most fundamental element needed for keeping an economy going forward, without stalling, and falling. “A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

PS. Here a more complete definition of terms

PS. Sometimes when stress testing banks what is on their balance sheets is less important than what is not.

Are not living wills for banks’ just a nonsensical show to show off that something is being done?

Sir, Gina Chon and Tom Braithwaite report that Fed and FDIC demand better unwinding plans and are split over possible penalties “US rejects bank’s living wills” August 6.

And FT defines on its site those living wills as “Detailed plans that would enable banks to stipulate in advance how they would raise funds in a crisis and how their operations could be dismantled after a collapse”.

Frankly is not the whole concept of living wills for banks’ designed by the bankers themselves after a collapse just a show to show that the regulators are doing something?

I mean if I was a regulator, and wanted to go down that route, I would at least have a third party to look into what could be done in the case a bank passed away, and now and again confront the managers of the bank with those plans, in order to hear their opinions.

For instance there is a world of difference between a living will where the dead are going to be the own executors of the will, and one in which the dead will be dead and others will take care of the embalming.

And talking about that is it not the Fed or the FDIC that should state what contingent plan they really want… one where the bank is placed on artificial survival mode, and for how long, or one where it is sold in one piece, by pieces or even cremated?

To me it would seem that the Fed and FDIC need to give much clearer instructions about what they want those bankers currently working under the premise the bank will live on forever to do… as I can very much understand them being utterly confused.

A bank’s expected failure going from once in 1000, to once in 200 years, does not sound like an impressive improvement :-)

Sir, Gina Chon refers to Steve Strongin, head of Goldman’s investment research division stating: “In the past the mean time for the failure of a well-capitalized bank was 41 years… Now, with increased capital standards and stress tests scrutinizing how banks would withstand a crisis, it is estimated to be about 200 years”, “Dodd-Frank rules blamed for curbing growth” July 23.

To help you understand what an unbelievable scenario for bullshit that represents, let me mention that in the Explanatory Note on the Basel II IRB Risk Weight Functions of July 2005, the confidence level is described as “fixed at 99.9%, i.e. an institution is expected to suffer losses that exceed its level of tier 1 and tier 2 capital on average once in a thousand years. This confidence level might seem rather high. However, Tier 2 does not have the loss absorbing capacity of Tier 1. The high confidence level was also chosen to protect against estimation errors that might inevitably occur from banks’ internal Probability of Default (PD), Loss Given Default (LGD) and Exposure at Default (EAD) estimation, as well as other model uncertainties.”

Chon mentions “A senior Obama administration official said banks had overreacted and argued that a person with a high credit score should be able to obtain a mortgage on decent terms, which was not happening at many banks”. That official should ask regulators to explain that the system in place is first the banks reacting to perceived credit risks with interest rates, size of exposures and other terms… and then having the regulators, for good measure, to also react to the same perceived credit risks by means of setting the capital the bank needs to hold against assets… and, of course, reacting twice to the same risk, must cause an overreaction.

In this respect the Dodd-Frank Act cannot be much blamed for curbing growth that is unless you feel, like I do, that in the home of the brave, that Act should have prohibited the odious system of risk weighing the capital requirements of banks, something which negates the fair access to bank credit to for instance all SMEs.

Mark Carney, FSB, to begin, stop giving the Too-Big-To-Fail banks growth hormones.

Sir I refer to Sam Fleming, Ben McLannahan and Gina Chon reporting “BoE chief leads push to break ‘too big to fail’ impasse at G20”, July 21.

There they report on the efforts of Mark Carney as the current chairman of the Financial Stability Board to try to clinch a deal on bailing in creditors of globally significant, cross border banks that get into trouble”.

Mark Carney, to begin with should start by stopping giving the growth hormones that minimalist capital requirements for what is officially perceived as absolutely safe, represents for the Too-Big-to-Fail banks.

And then I would also suggest they think a little bit more about the implications of the Contingent Convertibles. The CoCos, hard to manage even in the presence of solely a leverage ratio rule, are mindboggling difficult when the capital requirements for banks are risk-weighted.

Perhaps Mr. Carney should read what George Banks had to say about CoCos when asked by his Board of Directors at theDawes Tomes Mousley Grubbs Fidelity Fiduciary Bank

Just like we do not like overly sissy nannies to educate our kids, we do not want overly sissy regulators to regulate our banks.

Sir, Sam Fleming and Gina Chon begin by quoting David Wright, secretary general of Iosco saying “It is extraordinary that here we are, nearly seven years in [from the financial crisis] and we still have an inadequate understanding of some of the key aspects of financial markets” “Push begins to put lenders’ house in order”, June 19.

But then reporting on the meltdown of the subprime loans, and even though they mention that some regulators “have imposed though capital requirements on investors who buy asset-backed securities, they basically support putting the blame on some “shadow finance”, and do not even mention the role extreme low capital requirements, for the banks in the sunshine, played in creating the demand for bundled subprime loans which caused the crisis.

Those low capital requirements resulted because sissy regulators, personally scared of some risks, thought those were the risks which were dangerous to our banks. And, in doing so, they are killing our economies, by keeping our banks refinancing the safer past and not financing the riskier future that our young unemployed so much need to be financed, in order not to become a lost generation.

No Sir! We, who have thrived on risk taking, cannot afford our banks now being in hands of so sissy regulators.

And those journalists too sissy to dare holding the regulators truly accountable, we do not need them either.

With respect to increasing bank capital we need banks and regulators to be partners, not enemies.

Sir I refer to Gina Chon and Camilla Hall’s “Fed looks beyond bank’s financial targets” March 27.

As a result of regulators falling for the risk-weights’ trick, banks are now, ate least when compared to pre-Basel Committee history, dramatically undercapitalized. It behooves everyone in the economy to see that capital increased substantially so that bank credit is not unduly blocked.

I have no idea of what the Fed saw in Citibank when performing its stress testing and that caused it to reject its capital plan for dividends and share buybacks, but I do know that if the word “punishment” describes it appropriately, the Fed is on the wrong track.

If the real economy is going to get out of this mess… and it is a mess… the Fed and the banks must be partners in finding lots of new bank capital in a credible way. And bank capital will not be raised sufficiently by mistreating the shareholders of banks… nor by fooling some investors into buying Coco bonds, suspecting the probabilities for these to be converted, are knowingly underrepresented.

In fact the Fed and other regulatory authorities must tread on the issue of Coco bonds with extreme care, less they also be liable for withholding information and misrepresentation. And for this I refer to “Flurry of Coco bonds sends yields tumbling” by Christopher Thompson.

If I buy a Coco today and become converted into a bank shareholder three years from now I guess I cannot complain... but what if that happens three weeks from now?

Indeed... why not a tax on too-big-to-fail-banks?

Sir, I refer to James Politi’s and Gina Chon’s “Big banks pledge to fight tax on assets” February 26.

In May 2003, more than a decade ago, as an Executive Director of the World Bank (2002-2004), below is what I told some hundred bank regulators gathered at the World Bank for a Risk Management Workshop.

“There is a thesis that holds that the old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, was much wiser than today’s no burning at all, that only allows for the buildup of more incendiary materials, thereby guaranteeing disaster and scorched earth, when fire finally breaks out, as it does, sooner or later.

Therefore a regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.

Knowing that “the larger they are, the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size. But, then again, I am not a regulator, I am just a developer.”

And while you're at it, Mr. Dave Camp, US Congress, House Ways and Means Commitee, look into this too

Risk weighted capital requirements for banks should be based on unexpected losses. They are not!

Sir, a bank should be free to calculate his own capital requirements in any which way he likes, and these will be almost entirely be based on expected losses. But a regulator should set the capital requirements based on the “unexpected losses” as these are those that should really be of his concern, but they do not.

Explicitly, for reasons of simplicity, the Basel Committee sets the capital requirements for banks that are there to cover for unexpected losses based on the same risk perceptions used to estimate the expected losses. And, to top it up, these capital requirements are also, explicitly, portfolio invariant… which means that the benefits of diversification is not accounted for, nor are the dangers of any asset concentration.

What a miserable state of affair of our bank regulatory system, if the implications of simple facts like that, cannot even be discussed.

In “Banks win concessions from Basel on leverage” January 13, Sam Fleming and Gina Chon report that if relying on a non-risk weighted capital requirement, such as the leverage ratio, that would tempt banks “to take on riskier loans to earn higher returns”. But again there is no discussion about the wisdom of allowing banks, by means of risk-weights to be able to earn higher risk-adjusted returns on safer loans, and which leaves hanging in the air the question of… who is then going to finance “the risky” medium and small businesses entrepreneurs and start ups?

That one can allow a Mario Draghi to mention “The leverage ratio is an important backstop to the risk-based capital regime”, without anyone asking him, the European Central Bank President, about the distortions in the allocation of bank credit to the real economy risk-weighting produces, is clear evidence that something is rotten in the Union of Europe.

Why and how are medium and small businesses, entrepreneurs and start ups, and normal citizens, ruled to be a systemic danger to the financial system?

Sir, Gina Chon reports that some senators are questioning how the Financial Stability Oversight Council might rule some non-bank financial institutions to represent a systemic risk to the financial system; and which among other could lead these to face higher capital requirements, “Senators warn over non-banks regulation”, November 29.

And again I must ask, for the umpteenth time, why and how are the medium and small businesses, entrepreneurs and start ups, and normal citizens, ruled to be a systemic danger to the financial system?

And I ask this because all higher capital requirements demanded from any financial institutions, when subjected to risk-weighing, naturally impacts the most those against which businesses the most capital is required, and which is of course those who have a high risk-weight.

Others, like the sovereign and the AAAristocracy, are often even favorably impacted by these higher capital rulings since, as the song goes, when capital gets to be scarce the low risk weighted get going.

Chon comments that “the senator’s criticisms could delay the council’s assessment of asset managers, giving them more time to lobby for the regulation to be watered down”. How sad no senator, in the home of the brave, seems interested in watering down the completely unwarranted and odious discrimination against those though correctly perceived as risky, have precisely because of that, never ever caused a major financial crisis.

Why should banks’ willing spirits but weak flesh be able to resist extreme regulatory temptations?

Sir, I refer to Kara Scannell, Tom Braithwaite and Gina Chon’s report on how government is now, seemingly for political reasons, trying to make up for lost time, by laying it hard on those guilty of producing and packaging lousy mortgages into AAA rated securities, “The paper tiger roars”, October 26.

I am a firm believer that those guilty of it should have been fully prosecuted, from day one, but, what most angers me, is how no blame has been placed on those regulators who, by tempting willing spirits but weak flesh too much, caused the whole problem.

Basel II bank regulations, those which the US also signed up on in June 2004, stated that banks, against loans to unrated businesses, were required to hold 8 percent in capital (equity), but, that against AAA rated securities, 1.6 percent sufficed. And that meant that banks were allowed to leverage their equity 50 times more when holding AAA rated securities, than when holding loans to unrated businesses.

How could regulators have expected the banks to resist such extraordinary temptations? Prosecute, as dumb, and have them parade down avenues wearing dunce caps, those regulators who so tempted our banks.