If the inflation-measured basket used house prices instead of rental costs, the story would be different.

Sir, Rana Foroohar points to “The latest Consumer Price Index figures show that almost all core inflation… was in rent or the owner’s equivalent of rent (up 0.3 per cent) [while] Core goods inflation, meanwhile, was down 0.2 per cent” and argues “that the housing market is once again completely out of sync with the rest of the economy.” “America’s new housing bubble” March 18.

Yes and no! No! “Rent” in much is a laggard response to the price of houses, and so it would be more precise for the arguments made by Foroohar to compare core goods inflation to what is happening to those prices.

Yes! “Hyman Minsky would have had a field day [more precisely many field years] with his Financial Instability Hypothesis that [argues] two kinds of prices — prices for goods and services, and asset prices.”

And yes, Daniel Alpert is correct: “What we have now is a form of inflation that’s never been seen before — it’s all concentrated in housing.”

To explain that with as “something the US Federal Reserve has actually exacerbated (albeit unintentionally) via low interest rates and quantitative easing that boosted housing prices in the very cities where the best paying jobs are located”, is correct but quite incomplete.

If banks needed to hold as much capital against residential mortgages as against for instance loans to entrepreneurs, something that was the case before the Basel Committee got creative, that would be happening much less.

As is, the resulting abundant easy financing when purchasing a house has helped morph houses from being homes into being investment assets. 

PS. In a letter I wrote and that FT published in 2006 (before it stopped doing so) titled “The information Mr Market receives could also be neurotic” I argued:

“Inflation as they, our monetary authorities, know it, is just obtained by looking at a basket of limited consumer goods chosen by bureaucrats and that although they might be highly relevant to the many have-nots, are highly irrelevant to measure the real loss of value of money. 

For instance, who on earth has decided for that the increase in the price of houses is not inflation? And so what should perhaps be argued is that really our monetary authorities have not been so successful fighting inflation as they claim they have been.”

@PerKurowski

The risk weighted capital requirements for banks, is the most potent steroid ever for having to suffer some truly bad “Minsky moments”.

Sir, John Plender correctly writes: “If Hyman Minsky were alive today, he would regard the current economic cycle as a testing ground for his instability hypothesis. That which holds the financial system has an innate tendency to swing from robustness to fragility because periods of financial stability breed complacency and encourage excessive risk-taking.” “Complacent investors face a Minsky moment as pendulum swings” November 14.

But what Plender does not mention, perhaps because it belongs to that which shall not be mentioned, is the greatest procyclical pro-Minsky-moment steroid ever, namely the risk weighted capital requirements for banks.

When times are good and credit rating outlooks are sunny, that regulation allows banks to leverage immensely with what’s perceived as safe but, when a hard rain seems its going to fall, and credit ratings fall, all recessionary implications are made so much worse by banks then, suddenly, having to hold much more capital… and since such capital might be hard to find during bad times, they take refuge in whatever is still perceived, or decreed as in the case of sovereigns, to be of less risk… just increasing the stakes

In 2004 I sent the first letter to FT on the pro-cyclical/counter-cyclical theme, FT never picked up on it.

Plender writes: “It is historically atypical in that central banks have been encouraging deflationary threat”. Really? At least with respect to banks they have encouraged these to build up ever-larger exposures to what’s perceived as safe, like residential mortgages, or to what’s decreed as safe, like loans to friendly sovereigns. 

https://teawithft.blogspot.com/search/label/pro-cyclical

@PerKurowski

The Basel Committee’s risk weighted capital requirements for banks, put the 2007/2008 “Minsky Moment” on steroids.

Sir, John Authers writes: “The greatest dangers to us are not from things we perceive to be high-risk, because we generally treat them carefully. Trouble arises from that which we perceive to be low-risk.”, “Unnatural calm sparks visions of a ‘Minsky Moment’” December 31.

Sir, you know I have written more than a thousand letters to FT over the last decade pointing out exactly that. For instance in July 2012 Martin Wolf wrote: “Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk."

Unfortunately FT has refused to accept the complete implications of this truth.

Authers, as if it suffices as an explanation now writes: “The crisis that came to a head in 2008 revolved around securities that the rating agencies had given the maximum rating of triple A — it would not have happened if they had been considered speculative”.

No! The full truth is that not only did markets and bankers consider and acted as if those AAA rated securities were safe. Regulators did too. With Basel II of 2004 they assigned what was AAA to AA rated, a risk weight of only 20 percent. Thereby they allowed banks to leverage 62.5 times to 1 their equity with these securities. Had banks been allowed to only leverage 12.5 times to 1, as they were limited to with loans to “risky” SMEs and entrepreneurs, that crisis might not even have been identified as a “Minsky Moment”.

Sir below is a link to the full explanation to what really happened with the AAA rated securities backed with mortgages to the USA subprime sector. Do you have it in you to share it with your readers?

http://subprimeregulations.blogspot.com/2016/12/here-is-succinct-but-complete.html

@PerKurowski

The risk weighted capital requirements for banks, put the “Minsky moments” on steroids.

Sir, you write “A period of stability leads to rising investment, financed by borrowing, which drives up asset prices until cash flows generated by those assets can no longer support the debt taken on to buy them. Eventually there is what has been dubbed the “Minsky moment”: a dash for the exits as asset prices plunge. After the bubble bursts, the debt burden remains and can depress activity for a long time. “The challenge posed by oil’s ‘Minsky moment’” March 29.

But the regulators, with Basel II, told banks “If you think that something is safe then you can hold less capital against it”. And, in their Standardized Approach to Credit Risk, the regulators allocated the basic capital requirement of 8 percent according to the following risk weights: zero percent for loans to AAA-rated sovereigns; 20 percent on loans to the AAArisktocracy, 35 percent risk weight on the finance of residential mortgages; and 100 percent risk weight on exposures to unrated citizens.

And that translated into banks could leverage equity unlimited times when lending to AAA rated sovereigns; 62.5 times to 1 when lending to the AAArisktocracy, 35.7 times when financing residential housing 35.7, and only 12.5 times to 1 when lending to the unrated citizens.

And of course that allowed banks to earn different risk adjusted returns on equity not based on what the market offered, but much more based on what the regulators dictated.

And since “Minsky moments” never occur in areas ex ante perceived as risky but always in what is perceived as safe, that is of course equivalent to putting the “Minsky moments” on steroids.

You also end with: “As Minsky argued, booms and busts are endemic to capitalism. Sensible policy strives not to abolish the cycle but to mitigate its effects.”

But the risk weighted capital requirements signifies banks will have especially little capital precisely when the busts occur. And that has nothing to do with “mitigating” its effects, just the opposite.

Sir, I must have written to you and your colleagues well over 2.000 letters trying to explain the dangerous distortions caused by the risk-weighted capital requirements for banks, but apparently it has not yet been understood.

Sir, between us in petit committee, although I understand that it probably has to do with you wanting to sound sophisticated, I do not think you have earned the right of referring to Minsky into your editorials.

PS. This is not a critique directed solely to you Sir. For example, out there, the less many seem to understand what is really going on with our banks, the more they express concerns about “derivatives”, only because that word sounds so delightfully sophisticated.

Wolfgang Münchau, what has risk weighted capital requirements have to do with the primary functions of banks?

Sir, Wolfgang Münchau writes: “Monetary policies, like the ECB’s quantitative easing program, filter into the real economy through various channels.” “The European Central Bank has lost the plot on inflation” March 14.

That is correct but again, so stubbornly, Münchau refuses to mention the not so unimportant fact that credit risk weighted capital requirements for banks, especially when regulatory compliant bank capital is scarce, seriously distorts the allocation of bank credit to the real economy.

Münchau also refers to ECB’s “targeted longer-term refinancing operations” in somewhat skeptical terms, arguing that there is no evidence of ample demand for loans. But there again I would ask if the lack of demand for bank loans is not a reflection of SMEs and entreprenuers having seen their loan applications so much rejected? And again those rejections are much the result of that kind of “risky” lending generating the highest capital requirements for banks.

Helicopter droppings? Yes but why not eliminate the regulatory distortions that serve no purpose first?

I was recently made aware of a paper written by Hyman P Minsky in October 1994, titled “Financial Instability and the Decline (?) of Banking: Public policy considerations”

In it Minsky describes the two primary functions of banking as supplying the means of payments; and channeling resources into the capital development of the economy.

And so Münchau, unless you disagree with Minsky, let me ask, for the umpteenth time, what has the pillar of current bank regulations, the risk weighted capital requirements, to do with banks fulfilling efficiently those two primary functions?

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

@PerKurowski ©

The pastor risk is the risk that investors just share into blissful ignorance.

Sir, Wolfgang Münchau is correct when saying “A risk shared may be more risky, not less”, April 23. As arguments he presents, first the deceased US economist Hyman Minsky’s general pessimism (or may we dare say realism) that instability is an inherent part of the system, and then Raghuram Rajan’s, former director of research at IMF, who argues along the line that the investor’s increased willingness to invest in “tail risk” and their “herd” mentality could lead to a catastrophic meltdown.

I myself have been writing and warning on these specific issues for a long time, though mostly on the risk present in assigning too much market decision power to very few credit rating agencies and which introduces not a herd but a “systemic pastor” risk.

For instance in the ongoing subprime mortgages debacle, the distance between the borrower and the final lender increased too much, just because everyone counted on others to be able to provide sufficient oversight. When we now start seeing how credit rating agencies rated without even sending a team to walk the streets in order to sample how those subprime mortgages originated, we should be able to conclude that the investors besides sharing risks, were also sharing blissful ignorance.