Capital requirements, non-performing loans, down-ratings and fines are causing severe bank credit austerity.

Sir, Henny Sender writes: “A world awash with dollars is rapidly being replaced by a dollar-scarce world” “Pain for those most in debt looks certain to become more severe” August 26.

Yes, and that dollar scarcity will, as is, primarily generate a contraction of bank credit. Consider what is happening:

Regulators are increasing capital requirements, which put banks lending capacity under pressure.

More non-performing loans and credit down-ratings of borrowers put additional strain on the banks.

And to top it up there are the fines. The recently reported fines of $260bn for the largest 25 banks, when calculated for a leverage of 15 to 1 results in about 4 trillions less bank-credit availability.

But when Sender writes: “It is still not sure how the pain will be distributed though”, I would tend do disagree.

If bank regulations keep the risk-weighted capital requirement component, there is no doubt of who are going to suffer the most; that will be those who generate the highest needs of capital, namely “the risky”, like SMEs, entrepreneurs and the downgraded.

Since those risky already are perceived to generate much expected losses, they will generate much less “unexpected losses”, and so we should lower the capital requirements for banks when holding these assets.

Sir, if austerity has to be imposed, I much prefer that to be government spending austerity than bank credit austerity. Banks have to put up at least some capital (equity) while government bureaucrats need not to risk a dime of their own.

@PerKurowski

Here are two heartfelt recommendations to India.

Sir, I refer to Henny Sender’s very comprehensive “India’s shadow banks step in to lend where others fear to tread” May 26.

I just want to add the following:

First, India, as a developing country, can certainly not afford bank regulations that favors the allocation of bank credit to the safer past than to the riskier future… and so it urgently needs to get rid of the distortions that the Basel Committee’s credit risk weighted capital (equity) requirements for banks produce.

And second, with respect to its private sector banks, these could also benefit from a major re-capitalization plan, like the one Chile did in the early 80s. The central bank should issue bonds using the proceeds to acquire the banks’ non-performing loans (which will permit the reversal of all provisions) and the banks would commit to repurchase those loans from the Central bank, plus interests, before they can proceed with any dividend payments.

That could turn it around much faster for India.

Of course Europe would also benefit from implementing a similar plan.

@PerKurowski

Technocrats, pouring QEs over clogged financial transmission mechanisms, set us up for the mother of all hangovers.

Sir, Henny Sender puts her finger on what should be of utmost concern for most delegates to discuss during IMF and World Bank meetings next week, namely that “Weak growth suggests QE might not have been worth the costs” April 11.

And Sender is so right remarking on how “odd… is the absence of a vigorous debate about the costs of these experiments, whether in the US, in Japan or now in Europe.”

With their QEs, unelected technocrats are pushing our economies higher and higher up a mountain of risks, for absolutely no purpose. As I’ve written to you Sir, at least a hundred times, if the liquidity provided by these schemes, are not allocated efficiently to the real economy, then absolutely nothing good can come out of it.

But the same unelected technocrats, simultaneously, by means of credit-risk-weighted equity requirements, have clogged the financial transmission mechanism, hindering bank credit to reach where it is most needed, the SMEs and the entrepreneurs. In other words, we are being set up for the mother of all hangovers. Damn those technocrat clowns!

According to the report by Swiss Re that Sender quotes, “US savers alone have lost $470bn in interest rate income, net of lower debt costs”. That is only one of the first symptoms.

@PerKurowski

With the Basel Committee’s injudicious regulations, it is very difficult for a bank to give credit judiciously.

Sir, Henny Sender holds that “Banks must lend more judiciously to prosper in emerging markets” April 8. Who could disagree with that? That applies of course to all markets and not only emerging markets.

But in order to do that, banks need to focus 100 percent on the borrower and not, as now, spend too much time looking at how it can structure the loan so as to be required to hold the least of equity against it.

When we read about Stan-Chart’s “commodity-related exposures” and that “much of the lending uses property as collateral” one gets the feeling that perhaps the “minimize the equity” objective might have triumphed the “know your client” criteria.

And this is but one of the should-be-expected, unexpected consequences of the Basel Committee’s injudiciously distorting credit-risk-weighted capital requirements..

@PerKurowski

But our besserwisser bank regulators express no doubts about what banks should do.

Sir, Henny Sender asks: “Which is better - to invest in the debt of lower-rated issuers because they offer more attractive absolute yields; or, to invest in the debt of higher-quality companies but do so with leverage in order to generate acceptable returns?”, “When investing is all about second-guessing the Federal Reserve” February 15.

I don’t know the answer… but bank regulators, with their portfolio invariant credit risk weighted equity requirements, imply they know that very well. They have definitely instructed the banks to go for high-quality-very-high-leverage... like for AAA-rated-securities and sovereigns. 

By the way Sir, with respect to second guessing the Fed: If I now bought a10-year US government bond which pays 1.97%, and the Fed’s declares its inflation target to be 2%, would that imply I am buying a preannounced haircut?

Getting rid of regulatory distortions also hurts, and also creates risks, but is something that must be done.

Sir, I refer to Henny Sender´s “Reasons to disbelieve the Federal Reserve’s cheery message” February 3.

It states that “Basel-prescribed leverage ratios have changed the economics of funding, raising the cost of finance for dealers” which is affecting the liquidity they provided the market; “one Fed survey suggests that in the past 18 months the [repo] market has contracted by 25 per cent”.

And Sender argues that though that makes the system safer… it also means that the fall can be much greater when [market] sentiment turns negative.

But the question that also needs to be made is… what good is it to assist the repo market by means of allowing banks to hold less equity, compared to for instance assisting in the same way, the access to bank credit of small businesses and entrepreneurs?

Of course taking away distortions always create risks, but keeping the distortions, like the credit risk weighted bank equity requirements are still kept, will in the log run end up being the most costly alternative.

Take away all the financing of shares repurchase and surely the financing of private enterprise has also dropped dramatically… and that financing, being much lower on the food chain than financing the repo market, is therefore much more important to the real economy.

PS. Something does not read right. It is higher leverages, not lower ones, which are more often associated with greater falls when market sentiment changes.

We must indeed fret the possibility of some fundamental lack of character at the Federal Reserve

Sir, Henny Sender makes a well argued call in “The Federal Reserve must not linger too long on QE exit” July 5; concluding with opining that “The Fed wants to have its cake and eat it too”, and asking “Might it be that the Fed has everything in reverse?" It is truly scary stuff! 

On August 23, 2006, you published a letter I sent titled “Long-term benefits of a hard landing”. Therein I wrote:

“Sir, While you correctly argue (“Hard edge of a soft landing for housing”, August 19,) that “even if gradual, a global housing slowdown would be painful” you do not really dare to put forward the hard truth that the gradualism of it all could create the most accumulated pain.

Why not try to go for a big immediate adjustment and get it over with? Yes, a collapse would ensue and we have to help the sufferer, but the morning after perhaps we could all breathe more easily and perhaps all those who, in the current housing boom could not afford to jump on the bandwagon, would then be able to do so, and take us on a new ride, towards a new housing boom in a couple of decades.

This is what the circle of life is all about and all the recent dabbling in topics such as debt sustainability just ignores the value of pruning or even, when urgently needed, of a timely amputation.”

And now Sir, soon eight years later, we can only observe how the Federal Reserve, even when facing clear evidence all what their liquidity injections and low rates have achieved is increasing or maintaining value of existent assets, and little or nothing has it done for the creation of any new real economy… are unwilling to cut the losses short, and keep placing more and more bets on the table… with our money!

Sincerely, no matter how we look at the Greenspan-Bernanke and incipient Yellen era at the Fed, we have reasons to fret the existence of some fundamental lack of character.

PS. Of course, when it comes to banks, the regulators have already evidenced plenty lack of character with their phobia against “the risky”. And so now they also have our banks placing ever larger bets on what is “safe”, blithely ignoring that in roulette, as in so many other aspects of life, you can equally lose by playing it too safe.

Kid! If you eat your spinach you must eat your broccoli too.

Sir I refer to Henny Sender’s “Distress appears across Asian funding markets” January 15. In it Sender describes that banks are not in great shape and are too risk adverse to lend to lower rated companies… [aggravated] by regulatory changes which require more capital for anything other than investing in sovereign debt”.

Indeed, but the main constraint to lending to “the risky” is not risk-aversion but the risk adverse capital requirements. It is like telling children who don’t like spinach that if they eat it, they have to eat broccoli too.

And let us be frank… who but communists could believe that a bank system becomes safer by lending to the “infallible sovereign” and not lending to the “risky citizen”?

Of course it is all crazy… and it all derives from the fact that regulators, instead of setting the capital requirements for banks based on “unexpected losses”, as they should, based these on the “expected losses”, those which were already being cleared for by banks by means of interest rates, size of exposure and other terms. 

Recently on a blog when asking why regulators were not asked about this mistake, someone replied“there comes a point where the hypocrisy of the situation becomes so intense that it can no longer be addressed”.

Does that apply to you FT?

Force bank regulators to answer the question they do not dare to discuss.

Sir, Henny Sender asks: “As the disconnect between the rising prices of financial assets and the real economy continues, is it possible that even the most aggressive easing has its limits?”, “End point for runaway stocks rally comes in sight”, November 30.

The answer is… Yes! Moreover its limits have already been shown. I am sure that if the Fed only researched how much of all QEs and fiscal stimulus has translated into more bank credit to those on the margins of the real economy, and who are most in need of credit, like small businesses, entrepreneurs and start ups, they would be shocked at how little they would find.

But they won´t do that because if so they would have to ask themselves “why?” and that would lead to having to admit how seriously flawed or outright dumb the capital requirements for banks based on perceived risks are.

You see the question that the regulators dare not to discuss is:

If the perceived risks are cleared for in interest rates, size of exposure and other terms, does not re-clearing for the same perceived risk cause a serious distortion in how bank credit is allocated in the real economy?

It just compensates bankers´ love of chocolate cake (the safe) with ice cream, and their loathing of broccoli (the risky) with spinach.

I may be right, and I may be wrong. But do you not find it in at least curious that what I argue is not even discussed?

Sir, Henny Sender writes “Five years after the meltdown, it is clear the Fed´s quantitative easing is not about a real economic recovery, it is only about generating the liquidity that gives rise to incomes for the rest of us are not rising at all”, “Fed easing fuels growth in wealth over real economy”, November 19.

As you know very well I hold that is because the financial transmission channel is totally damaged. Capital requirements for banks based on ex ante perceived risks, more risk more capital, less risk less capital, make it completely impossible for banks to allocate credit efficiently in the real economy.

I may be right and I may be wrong, but do you not find it curious somehow that the possible distortion these capital requirements might produce is not even discussed?

And that is not because I am a complete loony. As you know very few, much less in high places, like as an Executive Director of the World Bank, warned in such clear terms about the problems.

Boy you sure seem like a very complacent bunch of journalists to me.

Yes “The Risky” borrowers are forced into the shadows, by criminally stupid bank regulators.

Sir, Anne-Sylvaine Chasanny’s and Henny Sender’s title, “Forced into the shadows”, June 7 describes precisely the results from having capital requirements for banks based on perceived risk which so odiously discriminates against the access to bank credit all those who are not perceived as “absolutely safe”. Though, where it says, “With Europe’s banks reluctant to lend”, a better phrasing would be “With Europe’s banks ordered not to lend to those perceived as risky”, because that is in effect what happens when with bank equity being extremely scarce, regulators tell banks they need more of it when lending to “The Risky” than when lending to “The Infallible”

I have explained this in perhaps over a thousand letters to FT, over many years, but FT has never understood or wanted to acknowledge how these bank regulations distort the resource allocation in the real economy. Yes, “The Risky” are being forced into the shadows, by criminally stupid bank regulators, and there is no other way to describe these.

How many ounces of gold richer am I?

Sir when reading Gregory Meyer and Henny Sender report that “Paulson starts gold fund amid record prices” November 19, and all of the rest noises or sounds on gold, I cannot but help questioning how long it is going to take before we ask our private investment bankers inform us not only of the returns produced in dollar or euro terms, but also of the returns measured in ounces of gold.

There is a not so secret “low-risk” leverage-enrichment facility in Basel.

Sir excuse me if I insist on it but after some hundreds of letters to you, I am still looking for the words that could help FT understand what was really the origin of the current financial crisis and why we will not be able to get out of it without getting rid of a paradigm that has chained our financial regulators, that of having the capital requirements of our banks depend on risk-weights.

Henny Sender in “Washington is the cheerleader but sentiment remains fragile” September 26, quotes a private equity executive saying “CDO´s destroyed prudent lending in America. It was like a nuclear bomb to good lenders”. What does prudent lending mean? Shying away from risks? No! Prudent lending means investing according to your risk tolerance and getting the right reward for it. In this respect prudent lending should have its own financial returns and not returns derived from arbitrarily set lower capital requirements.

What is the worth of one dollar invested in an operation perceived as having a higher risk? One dollar! What is the worth of one dollar invested in an operation perceived as having a lower risk? Also one dollar! Then how on earth can anyone sustain that a dollar lent to a BBB+ to BB- rated corporation is worth one dollar, while a dollar lent to an AAA to AA- rated one only represent 20 cents? Well this is exactly what the regulators did with their capital requirements for banks based on default risks and as assessed by human fallible credit rating agencies.

When a bank invests $1.000bn dollars in anything related to an AAA then that is subject to an arbitrary risk-weight of 20% and so the “risk-weighted assets” are reported as only $200bn, leading to low reported bank leverages, and which after a short while fooled even the designers.

And this is what has been produced in the not so secret “low-risk” leverage-enrichment facility in Basel and that has been proven to be so explosive and that I have been describing in http://theaaa-bomb.blogspot.com/

Sir it is so unimaginably risky to fool around with risk. Please consider that even if all the credit ratings had been absolutely precise, the world could still go so very wrong, as nobody in his sane mind will hold that the world’s future lies so much in areas perceived as having low financial default risks, that the investment in these areas have to be given especial incentives.

Friends, we need to urgently rid ourselves of regulators that can only dream about a world without bank defaults and put in their place regulators that dream of a better world, and who know that in order to reach such a world you have to learn to embrace risk… in a prudent way.

The world has had more than enough with this imprudent prudence!

Cheers

Per

Should used bank salesmen be trusted?

Sir Henny Sender “This year’s model for cash raising – the GMAC way” May 23, begs the question whether we should trust the used bank salesmen; a question that is difficult to answer when it is so hard to assess what’s under the hood of a bank, especially now when their assets are disclosed in “risk-weighted” terms.

GMAC is reported to have $173.bn of risk weighted assets, but taking away the impact of the weights, the real nominal asset exposure could easily be ten times that amount. For $173bn of risk-weighted assets an additional need of $11.5bn sounds “so reasonable”, but then it could just all be a mirage produced by that dangerous cocktail of faulty credit ratings and arbitrarily imposed risk-weights and that have hit and obscured the financial sector ever since Basel II got going.

The fact though is that while in Germany the sales of new cars are subsidized by a payment to scrap old used cars, in the US it is the financiers of used cars that are receiving government support and that sort of reflects quite different workout strategies.

The value of the CDS depend a lot on who contracts them

Sir Henny Sender in “CDS derivatives are blamed for role in bankruptcy filings” April 17 reports on how this type of instrument changes the behavior of creditors. One way I have found useful explaining the pro and con of the CDS is with a simile to life insurance.

Supposed Henny Sender took out a life insurance for a million quid to take care of her loved ones in case anything would happen to her. That should be a quite good responsible and tranquilizing thing to do. Now imagine instead that many of Henny Sender’s extended family and friends and even some total strangers took out million quid life insurance policies on her. Not so tranquiliz, baning eh?

AIG was only an addict and the Basel Committee its pusher

Sir, Henny Sender in “AIG saga shows how dangerous credit default swaps can be”, March 8, writes interestingly about the “regulatory capital forbearance” trades but without mentioning a word about the financial regulators who created such markets.

If she would take her time to read the current minimum capital requirements for banks she would find that if a bank lends to a sovereign country rated AAA it can have as much leverage it wants, there are no limits. If a bank lends to a corporation rated AAA or AA- it is authorized by the Basel regulations to have a 62 to 1 leverage. If it lends to a corporation that is not rated or one that has only received a BB- the banks are authorized to leverage their capital 12 or 8 times respectively.

Understanding this extraordinary range of authorized bank equity leverage, from limitless to 8 times, all of it depending on the criteria the credit rating agencies... where would AIG have been without the concept of an AAA? ... she could have but reached one conclusion, namely that AIG was an addict and that the Basel Committee was its pusher.