President Trump seems to be on route to become one of the greatest “paga-peos” (scapegoats) in history.

Sir, Gillian Tett writes that for her “money, there is another, darker, way to interpret this week’s [extreme volatility in US equity markets]. Two years into Mr Trump’s presidency, global investors are questioning the administration’s financial credibility…Steel yourself to cope with further turbulence triggered by Mr Trump”,“Expect more turbulence from Trump’s Fed fight”, December 28.

Indeed, president Trump is to be blamed for some of it, but the truth is that had the markets been more normal, not so much bubbled-up, he would only cause some ripples never Tsunamis.

That Trump has given indications to fire Jay Powell, the Fed chair, is bad in as far as it interferes with the necessary independence and credibility of a central bank. But, that said, let me also hold that, if a central banker or a regulator believes that what bankers perceive as risky is more dangerous to bank systems than what they perceive safe, and therefore use credit distorting risk weighted bank capital requirements, as they’ve done for a long time, that is a clear justified cause for their removal.

Venezuelan historians sometimes recount that in old days the refined ladies of the society always used to keep a young slave close by. Whenever they let out noisy and smelly gases, they would hit the slave hard and loudly on his head spelling out “Boy/Girl!” whichever applied. These useful blame-takers, scapegoats, were known as “paga-peos”, literally “fart-payers”.

Sir, President Trump clearly produces some gases himself, but he could also go down in history as one of the greatest paga-peos ever.

When booming equity markets, house prices and unsustainable debt levels everywhere, built up with easy bank credit, huge liquidity injections and ultra-low interest rates come crashing down, as they must, sooner or later, those who are much more to blame for it, could all jointly point at President Trump and shout “He did it!” and Ms. Tett might smilingly nod in agreement.

PS. Though in Spanish here you will find more interesting details about the “paga-peos” tradition and about how it can be used with even worse intentions.

@PerKurowski

Hercules Poirot, as a bank regulator, would be much more watchful of the “safe” than of the obvious risky.

Sir, Gillian Tett reminds us that “Any fan of Agatha Christie mystery books knows that distraction is a powerful plot device: if there was a commotion in the kitchen, detective Hercule Poirot would look for a body in the library, or other clues being hidden in plain sight, amid the noise.” “Federal Reserve attack is just a distraction”, November 30.

Indeed, but she could rest assure that Poirot, if cast as a bank regulator, would laugh at his current colleagues who show so much concern with what seems obviously risky, like when they in Basel II assign a risk weight of 150% to what’s rated below BB-, and so little about what seems very safe, like giving only a 20% risk weight to what’s rated AAA and is, therefore, if wrong, truly dangerous for the bank system.

Ms. Tett argues here that President Donald Trump “uses weapons of distraction more effectively than almost any leader before him”

She could be right but also, when GDP and inflation data are fraught with may uncertainties or outright errors, to hear the Fed discussing the “neutral rate”, could also be an intent to distract from the fact that they find themselves in that “dark room” deputy Fed chair Rich Clarida is quoted to have mentioned, and so that they therefore have not the faintest idea about what’s going on, and much less about what to do. 

Sir, when not knowing the answer to a question, proceeding to with a firm voice give an answer nobody is guaranteed to fully understand, also qualifies as a high quality distraction.

PS. That 20% risk weight of the AAA to AA rated, translated to a capital requirement of only 1.6% (8%*20%) which meant the banks were allowed to leverage mindblowing 62.5 times with such assets (100/1.6) which translated in to the cause numero uno for the 2008 crisis. 

@PerKurowski

Should central bankers answer my questions, or are they better off ignoring these?

Gillian Tett writes: “A century ago…central bankers barely talked to the public. Montagu Norman, the Bank of England governor from 1920 to 1944, is thought to have said: “Never explain. Never excuse.” That was partly because bank chiefs did not expect ordinary mortals to understand finance. But they also believed aloof detachment increased their authority.” “Should central bankers engage with the public?” July 28.

Sir, consider that I have with all means, even begging journalists to ask the questions, not been able to get an answer on something that should be very much within the general area of interest and responsibilities of a central banker, namely bank regulations.

My questions are simple and straightforward.

Why do you think that the regulators think that what is perceived as risky is more dangerous to our bank systems than what is perceived as safe? Could it be because regulators look at the risk of the assets of a bank, like bankers do, and do not look at the risk those assets could pose to the bank system, as regulators should do?

Why do you think that allowing banks to leverage differently their capital (equity) with assets based on different capital requirements, could not very dangerously distort the allocation of bank credit to the economy?

When are those European central bankers/regulators who assigned a 0% risk weight to Greece, going to be named and shamed, for dooming that nation to the so tragic consequences of excessive public debt?

Sir, “If Montagu Norman saw [my questions] what would he make of it all?”

Perhaps: “Never explain. Never excuse”, most especially when you have no explanation and you have no excuse?

@PerKurowski

Rana Foroohar. Please ask yourself a question and, if you cannot answer it, do ponder why.

Sir, I refer to Rana Foroohar’s “Three questions for the Fed’s Powell” February 26.

Ms. Foroohar (and you too Sir) should ask herself: why do regulators want banks to hold more capital against what, by being perceived as risky, has been made quite innocous, than against what, because it is perceived as safe, is so much more dangerous?

And if could not come up with a truly convincing answer, then that should give her a clue on that something very strange is going on in the field of bank regulations.

And if she had gotten to that point, then it should not be too hard for her to begin to understand how those different capital requirements, which allows for some assets to be leveraged much more than others, might distort the allocation of credit to the real economy… and thereby affect its “real non-financialised growth”

And at that point she would surely add, that same question she could not answer, to those three she proposes to ask Powell.

Foroohar also references companies “buying up the higher-yielding bonds of riskier companies at a favourable spread and holding those assets offshore [and that now after] President Donald Trump’s new tax rules… They will simply be able to move their money wherever they want, whenever they want, in cash.”

“Cash”? In order to become cash, all those assets the companies have bought and held offshore must be sold. Would that not have any consequences?

@PerKurowski

Banks now invest based on the risk-adjusted yields of assets adjusted for allowed leverages; that distorts the allocation of credit to the real economy.

Sir, Lawrence Summers, when writing about the challenges Jay Powell will face as Fed chairman mentions “Even with very low interest rates, the normal level of private saving consistently and substantially exceeds the normal level of private investment in the US” “Powell’s challenge at the Fed” February 5.

Not too long ago, markets, banks included, invested based on the risk adjusted yields they perceived the assets were offering. Some more sophisticated investors also looked to maximize the risk adjusted yield of their whole portfolio.

But, then in 1988 with Basel I, and especially in 2004 with Basel II, the regulators introduced risk based capital requirements for banks. As a consequence, banks now invest based on the risk-adjusted yields adjusted for the leverage allowed that they perceive the assets offer. As banks are allowed to leverage more with safe assets, which helps to increase their expected return on equity, they now invest more than usual, and at lower rates than usual, in “safe” assets like loans to sovereigns, AAA rated and mortgages. And of course, banks also invest less than usual, and at even higher rates than usual, in loans to the “risky” like entrepreneurs and SMEs.

That has helped to push the “risk free” down, and also explains much of the lowering of the neutral rate. Since the regulators now de facto block the channel of banks to the “risky” part of the economy, there is a lot of private investment that simply is not taking place any longer.

It is sad and worrisome that neither the leaving Fed chairman, Janet Yellen, nor the arriving one, Jay Powell (nor Professor Summers for that matter) can apparently give a clear direct and coherent answer to the very straight forward questions of: “Why do regulators want banks to hold more capital against what’s been made innocous by being perceived as risky, than against what’s dangerous because it’s perceived as safe? Does that not set us up for slow growth and too-big-to-manage crises?

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

@PerKurowski

Mr. Powell. Tear down that wall of risk weighted capital requirements that destroy bank systems and economies

Sir, Sam Fleming writes that Jeremy Stein, a Harvard academic describes Jay Powell, the newly appointed chairman of the Fed, as curious, incredibly collegial, and willing to learn. “A safe pair of hands takes over the Fed” November 4.

Sir, for the umpteenth time: All major bank crisis have resulted from unforeseen events, like major devaluations or wars, criminal behavior or excessive exposures to something that was perceived as safe when incorporated in the balance sheets of banks. Never ever from excessive banks exposures to something ex ante perceived as risky.

Therefore I pray Jay Powell is curious enough to ask the following question:

Colleagues, the standardized Basel II risk weights sets 20% for what is AAA rated and could be very dangerous; and 150% to what is below BB-, that which seems so innocous because bankers would not touch it even with a ten feet pole. Could you please explain the thinking process that supports such risk weights?

If he does, I hope Mr Powell will not be hindered by too much collegiality, so that he is able to realize that the absence of a convincing answer to that question should make him seriously suspicious of some of his colleagues. 

And if he then wants to learn something I would offer him as an appetizer offer him the following:

Mr. Powell, the future problems of the Fed (and other central banks) will be insurmountable if we persist in using risk weighted capital requirements for banks.

Credit is not flowing to where free markets offer the highest risk adjusted net margins but, since 1988, Basel I, and most specially since 2004, Basel II, it is flowing to what offers the highest risk adjusted returns on capital, something which totally distorts when banks are allowed to leverage assets differently, depending on how their risk have been perceived, decreed or concocted as safe.

And the distortions are alive and kicking in Basel III too.

That impedes the economy to realize its full potential and also does not in any way guarantee financial stability, much the contrary.

Our savvy bank loan officers have now been replaced by saddening bank equity minimizing, bonuses maximizing officers.

And for a more complete explanation I would refer Mr. Powell here

@PerKurowski