The history I’ll tell my grandchildren has little to do with Philip Stephens’ history.

Sir, Philip Stephens writes: “Twenty-five years ago… the world belonged to liberalism. Soviet communism had collapsed. Historians will record the 2008 global financial crash as… the moment western democracies suffered a potentially lethal blow. The failure of laissez-faire economics was visible before the collapse of Lehman Brothers.” “The west is the author of its own weakness” Financial Times, October 1, 2021.

The history I will be telling my grandchildren is quite different.

Thirty-three years ago, the world belonged to liberalism and Soviet communism was collapsing. Historians will record how in 1988, one year before the Berlin Wall fell, the western world’s bank regulators introduced risk weighted bank capital requirements that distorted the allocation of credit. That put an end to any laissez-faire economics. With risk weights of 0% the government and 100% citizens, as if bureaucrats know better what to do with credit than e.g., entrepreneurs, communism took over. 

The 2008 global financial crash resulted from banks being allowed to leverage their capital/equity/skin-in-the game a mind-boggling 62.5 times, with assets that human fallible credit rating agencies had assigned a AAA to AA rating.

Yes, the west is the author of its own weakness… it much renounced to the willingness to take risks that had made it great. 

Sadly though, there are way too many interested in not disclosing what really happened… and therefore our banks are still in hand of insane risk aversion. “Insane”? Yes, because those excessive exposures that could become dangerous to our bank systems, are always built-up with assets perceived as safe, never ever with assets perceived as risky.

PS. My 2019 letter to the Financial Stability Board

Loony risk-weighted capital requirements block entrepreneurs’ access to fair credit.

Sir, Eric Schmidt writes“Right now, the UK, the EU and the US share a growing problem: we are experiencing a market failure in the way we support entrepreneurs.” “Our narrow view of entrepreneurs squanders talent”, November 28. 

Absolutely! But some market failures are government produced. 

If a bank lends to someone wanting to buy a house, something perceived as safe, the regulators allow it to hold much less capital that if it lends to an entrepreneur, something perceived as risky. 

So if a bank lends to someone wanting to buy a house, something “safe”, it will be able to leverage its capital much more than it can do if it lends to an entrepreneur, something

So if a bank lends to someone wanting to buy a house, something “safe”, it will be able earn much higher expected risk adjusted returns on its equity than it can do if it lends to an entrepreneur, something “risky”. 

But was it always this way? Of course not! This happened when bank regulators introduced the risk weighted capital requirements for banks. That which is based on that truly loony concept that what bankers perceive as risky, is more dangerous to our bank system than that what bankers perceive as safe. 

Since then millions of credit requests have been either negated or if approved, have had to support a higher than needed interest rate. 

Schmidt also writes about the need to “drop the tunnel vision promoted by many academic and professional specialisations”.

Absolutely! I have often argued that had there been: 

a plumber or a nurse disturbing the regulators’ group-think with an innocent question like “what has caused big bank crises in the past?” 

or a professional that had taken a course in conditional probabilities, 

or someone (incorrectly) quoting Mark Twain with “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain”, 

or a golfer asking “why would you assign more handicap strokes to good players taking these away from lousy players like me?”, 

then the 2008 crisis would not have happened… and Lehman Brothers would still be alive and kicking.

God make us daring!

@PerKurowski

The world will come to deeply regret central bankers avoided a cleansing hard landing in 2008... and opted instead for kicking the crisis forward (and upwards)

Sir, Merryn Somerset Webb asks: “The consequences of those solutions found in 2008, one of which was to make rich people richer in the hope they would spend more, look like they could end up neutering capitalism — the greatest poverty destroying system ever. Was avoiding a few more years of recessionary misery after 2008 worth that?”, “A post-crisis cure that has stored up economic pain” September 15.

Somerset Webb then proceeds to contrast the fortunes of a middle-aged man with a large mortgage in central London in 2008 and an equity portfolio [who] has had a brilliant decade, with the hardships of cash savers and pensioners suffering the impacts of low interest rates, and the many tenants who know they can never save enough for a house deposit. She is, sadly, so absolutely right.

In 2006, when troubles started brewing, I wrote a letter that was published by FT and in which I briefly but clearly (I think) exposed the benefits of a hard landing. 

When the FED, and later ECB, decided that the best thing to do was to kick the crisis can forward, and proceeded with a huge stimuli package that included foremost quantitative easing and ultra low interest rates, I accepted it. What was I to do? 

But what I never thought would happen was that all that stimuli would be injected into the economy, without eliminating the distortions that had created the crisis in the first place. And I refer here of course, for the umpteenth time, to the risk weighted capital requirements for banks; those that favor banks lending to what is perceived or decreed safe, like AAA rated securities, residential mortgages and sovereigns; and to stay away from the risky, like entrepreneurs.

Because of that, the stimuli had no chance of yielding sustainable economic result and we are now fretting and waiting for that huge growing by the minute can to roll back, with vengeance, on us, on our children or on our grandchildren.

Somerset Webb opines that “the political conversation these days focuses not, as it surely should, on wealth creation but on long-term wealth redistribution: new property taxes; rises in capital gains taxes; more corporate taxes; workers on boards; the nationalisation of industries in the UK; higher minimum wages; maximum wage ratios; the limiting of the rights of people who are non-resident for tax purposes, and the like.”

I agree. After besserwisser statist regulators have messed it up so completely, the last thing we need is for redistribution profiteers to expand the value of their franchise.

As I see it some of our priorities are:

First, to work our banks out of that corner into which regulators have painted them in, something which, as it includes a statist 0% risk weight for sovereigns, is easier said than done.

Second, initiate, even with very low amounts an unconditional universal basic income scheme. That will allow us to begin creating those decent and worthy unemployments we will need, before society begins to break down.

Third, stop the populist from promising heavens, by asking them to explain clearly how wealth, mostly invested in assets, could be redistributed without unexpected negative effects.

Sir, you know I am from Venezuela. I have seen my homeland taken to pieces in less than two decades, and the many Chavez and Maduro there are in the world frightens me. I guarantee you they will stop at nothing once they begin.

PS. Thank God Lehman Brothers collapsed when it did. Can you imagine if the AAA rated subprime mortgages securities craze, that regulators allowed banks to leverage a mind-blowing 62.5 times with, would had gone on for one or two years more?

September 2008 when the crisis bomb exploded is not as important as the dates when the bomb was planted

Sir, Philip Stephens writes: “The process set in train by the September 2008 collapse of Lehman Brothers has produced two big losers — liberal democracy and open international borders. Historians will look back on the crisis of 2008 as the moment the world’s most powerful nations surrendered international leadership, and globalisation went into reverse”. “Populism is the true legacy of the crisis”, August 31.

I agree with most of what Stephens writes, especially on how “central bankers and regulators, politicians and economists, have shrugged off responsibility” for the crisis. What I do take exception of is for the date of the collapse since much more important than when a bomb detonates, is when the bomb is planted. In this respect three dates come to mind. 

1988 when regulators announced: “With our risk weighted capital requirements for banks we will make our bank system much safer” and a hopeful world, who wanted to believe such things possible, naively fell for the Basel Committee’s populism.

April 28, 2004, when the SEC partially delegated their authority over US investment banks, like Lehman Brothers, to the Basel Committee. 

June 2004, when with Basel II, the regulators put their initially mostly in favor of the sovereign distortions on steroids, like for instance allowing banks to leverage a mind-blowing 62.5 times with assets that managed to acquire from human fallible credit rating agencies an AAA to AA rating. And EU authorities decided that all EU nations, like Greece should, in an expression of solidarity be awarded a 0% risk weight.

Populism? What’s more populist than, “We will make your bank systems safer with our risk-weighted capital requirements for banks”? 

PS. Here is somewhat more extensive aide memoire on the mistakes in the risk weighted capital requirements for banks.

@PerKurowski

The US 2008 financial crisis was born April 28, 2004

Sir, Janan Ganesh writes: “A financial crisis that was experienced as a fragmented chain of events is being commemorated as just one: the fall of Lehman Brothers, 10 years ago next month",” “Political distemper preceded the financial crisis” August 30.

That is only because the truth shall not be named. In the case of the United States, that crisis started on April 28, 2004 when the SEC decided that the supervised investment bank holding company ("SIBHC"), like Lehman Brothers, “would be required periodically to provide the Commission with consolidated computations of allowable capital and risk allowances (or other capital assessment) consistent with the Basel Standards." 

When the Basel standards approved in June 2004 included allowing banks to leverage a mind-boggling 62.5 times with any asset that have been assigned by human fallible credit rating agencies an AAA to AA rating, or had been guaranteed by an AAA rated corporation like AIG, the crisis began its construction. That in the European Union the authorities also included allowing banks to lend to sovereigns like Greece against no capital at all would only worsen the explosion.

Populism? What’s more populist than, “We will make your bank systems safer with our risk-weighted capital requirements for banks”? 

PS. Here is somewhat more extensive aide memoire on the mistakes in the risk weighted capital requirements for banks.

@PerKurowski

Don’t help bank regulators get away from being held accountable for their mistakes by politicizing the issue.

Sir, Gillian Tett commenting on Ben Bernanke, Henry Paulson and Timothy Geithner comments on the 10-year anniversary of the Lehman Brothers collapse writes:“Critics on the right complain that markets have been hopelessly distorted by government meddling” “European banks still have post-crisis repairs to do” July 20.

Frankly, you do not have to be from “the right” to “complain that markets have been hopelessly distorted by government meddling”

In 1988 bank regulators, based the risk weighted capital requirements for banks they were introducing on the nonsense that what was perceived as risky was more dangerous to our bank system than what was perceived as safe. With that they dangerously distorted the allocation of credit to the economy… and caused the crisis.

Would the Lehman Brothers have suffered the same collapse had not the SEC authorized it in 2004 to follow Basel II rules, and it could therefore (just like the European banks) leverage 62.5 times with securities backed with subprime mortgages, if these counted with an AAA to AA rating issued by human fallible credit rating agencies. Of course no!

But here we are a decade later and this major flaw of current bank regulations is not even discussed. What especially excessive exposures to something perceived decreed or concocted as safe are banks in Europe, America and elsewhere building up only because of especially low capital requirements, and which will guarantee, sooner or later, especially large crises? That should be the concern.

But, come to think of it, it could be that Ben Bernanke, Henry Paulson, Timothy Geithner and Gillian Tett, still believe in the story the Basel Committee told them, perhaps because they want so much to believe that a fairy could make banks safe and still be able to serve the economy. 

@PerKurowski

Madame Guillotine could be better than assisted euthanasia

Sir, Martin Wolf is absolutely right when in “Do not learn the wrong lessons from Lehman’s fall” September 16 he writes that “No normal profit-seeking business can operate without a credible threat of bankruptcy”. But then he goes into some mumbling about living-wills and assisted euthanasia and though it sounds kind and gentle both these alternatives start when it might already be too late, and so we should not forget that what we could really require is for Madame Guillotine to enter swifter into action.