On the current banking reform plans, I feel more like crying.

Sir, First question: What is worse, a general systemic bank crisis that destroys the economy, whether inside or outside a ring-fence, or that taxpayers need to pay for some of the losses of that crisis? Clearly the occurrence of the systemic crisis is the worst since the latter is just a consequence, and the taxpayer would still have to pay in so many other ways. 

Second question: What caused and is causing the current crisis, bad lending and investments by the banks, or too little bank equity. Obviously the first, since if all bank lending and investment yielded a positive return for the bank, in theory there would not even be a need for bank equity. 

Third question: What really caused the current crisis, excessive lending to what was officially perceived as not risky, or excessive lending to what was officially perceived as risky? Clearly the first, because the bank exposures to what ex ante is perceived as risky, are of course, as usual, very small. 

Fourth question: What does Martin Wolf believe caused the excessive exposures to what was ex ante officially deemed as not risky, and that he believes has now been solved so much that he gives “Two cheers for Britain´s banking reform plan” June 15? I don´t know, but if asked he would probably give me a rundown of all macroeconomic structural imbalances. See also next post "Mr. Wolf think he´s understood the problem with risk-weighted bank capital. He has not!"

But I do know that what caused the banks to indulge excessively in “safe” exposures was the fact that when doing so banks were allowed to have much less capital, meaning much more leverage, meaning much more return on bank equity, than when lending to or investing in the already scary risky. 

And since we have yet to hear the regulatory authorities even acknowledging the problem with that silly bank capital discrimination based on perceived risks which have already been discriminated for before, when setting interest rates and deciding on the amounts, I find no reason to cheer, much the contrary I feel like crying. (Especially since I have explained this to Mr. Wolf in about a hundred letters, and he was also a member of the Independent Commission on Banking)

Mr. Martin Wolf think he´s understood the problem with risk-weighted bank capital. He has not!

Sir, Martin Wolf in “Two cheers for Britain´s banking reform plans” June 15, states that rejecting a general rise in bank equity “makes almost everything depend on risk-weighted capital: a fallible, even intellectually fraudulent, concept, as the Independent Commission on Banking´s final report”. And so one could think Mr. Wolf has now finally understood the problem with risk-weighted bank capital. Unfortunately, not yet! 

The ICB report states: “Risk-weighting has merit in principle but inevitable imperfections in practice. For example, the low risk weights attributed to some sovereign bonds have clearly been inconsistent with the market’s view of the likelihood of their default. So there is a strong case for capping total (un-weighted) leverage too, as a backstop.” And this basically means that ICB thinks the problem with the risk-weights is that these could be wrong. But that´s not it, it is much more intellectually fraudulent than that! 

The use of the risk-weights based on perceived risk is wrong even if the weights are perfect, even if they are consistent with the market views, because these perceived risks have already been cleared for by the banks (by means of the interest rate, amount exposed and other terms) and so forcing that risk perception to also affect the capital of a bank, dooms the banks to overdose on perceived risks. 

If you really want to have correct risk-weights for bank capital then these would have to be calculated based on how bankers react to perceived risks. And then, at least according to Mark Twain´s “a banker lends you the umbrella when sun shines and wants it back when it rains”, you might find instead a need for higher capital requirements for banks when the perceived risk of default of the borrower is low than for when the perceived risk is high.