In terms of estrogen and testosterone, are there differences between bank exposures to what is perceived risky, and risky excessive exposures to what is perceived as safe?

“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” Mark Twain

Sir, Cordelia Fine writes: “Risk management in financial institutions is too important to be guided by scientific ideas well beyond their sell-by date. Blaming financial misadventures on a testosterone-fuelled male drive distracts us from what’s more likely to make a difference: regulation and culture. The best in-house antidote for bankers selling junk products and regulators bending to conflicts of interest isn’t women; it’s a dismissal slip”, “The Testosterone Rex delusion” March 3.

Absolutely! But with reference to the risks taken on by the banks that caused the 2007/08 crisis, that dismissal slip should foremost be given to regulators for having the ex ante perceived risks of banks assets substitute for the ex post dangers to our banking system.

And with reference to the absurd low response of the economy to the extremely high stimulates provided, the regulators should also be given that dismissal slip, for ignoring the purpose of banks, something that includes the efficient allocation of credit to the real economy.

Fine references Swedish journalist Katrine Marçal with whether “an investment bank named Lehman Sisters could handle its over-exposure to an overheated American housing market.” That is an ex post description that has little to do with the ex ante perception of the risks, and clearly less to do with bankers wanting to lend when it rained.

If some testosterone is needed to understand that risk-taking is the oxygen of development, and so the need for banks to also lend to those perceived as risky, like to entrepreneurs, then the regulators showed a fatal lack of it.

Their risk weighted capital requirements, more ex ante perceived risk more capital – less risk less capital is as dangerously nonsensical as can be. These only guarantee that when the true risks for our banking system happens, namely the dangerous overpopulation of safe havens, banks will stand there with especially little capital.

By allowing banks to leverage much more with assets perceived, decreed or concocted as safe, like AAA rated securities, like residential mortgages, like sovereigns (Greece) they allowed banks to earn the highest expected risk adjusted returns on equity on what was perceived as safe. Mark Twain could have said that made bankers wet dreams come true; and that was, while playing, the music to which Citigroup’s Chuck Prince held bankers had to dance.

And so, since what the members of the Basel Committee and the Financial Stability Board and most of their colleagues have really proven, is to be suffering from an excessive risk aversion, what would then Cordelia Fine opine, in terms of testosterone and estrogens?

God make us daring!

Here is an aide memoire on the major mistakes with the risk weighted capital requirements

@PerKurowski

Without the endorsement by regulators, banks would never have leveraged their equity 60 times to 1 with any asset.

Sir, Gary Silverman writes: “exempting the derivatives known as credit default swaps from more rigorous federal regulation…[was] one of the biggest mistake leading to the financial crisis”, “Why it is wrong to forget Lehman’s fall” September 20.

That is not so. Again, for the umpteenth time, I will explain prime cause of the financial crisis, namely the capital requirements for banks, and this by using the examples of Lehman Brothers, AIG and Greece.

The regulators in June 2004, with Basel II, decided that against AAA rated private sector assets, and against any sovereign rated as Greece was until November 2009, banks needed to hold only 1.6 percent in capital, meaning banks could leverage their equity with those assets over 60 times to 1. In comparison, when holding “risky” assets like loans to entrepreneurs and SMEs, banks were only allowed to leverage 12 times to 1. 

On April 28, 2004 the SEC decided that what was good for the Basel Committee was good enough for them, and so allowed Lehman to leverage over 60 times to 1 with AAA rated securities guaranteed with mortgages to the subprime sector… Since Europe were allowing their banks to do the same… the demand for these AAA securities became so huge that it overpowered all the quality controls in their manufacturing and packaging process… and Bang!

If AAA rated AIG guaranteed an asset, banks could also dramatically reduce the capital they needed to hold against that assets, and this overwhelmed AIG’s capacity to resist selling “very profitable” loan default guarantees… and Bang!

And Greece was of coursed offered loans in such amounts, and in such generous terms, so that its governments could not resist the temptations… and Bang!

As can be seen the above has nothing to do with deregulation, or with exempting anything from rigorous federal regulation, and all to do with imposing extremely bad and distorting regulations. On their own, and without the direct endorsement of regulators, banks would never ever have dreamt of leveraging their equity 60 times or more, with any asset… no matter how safe it looked.

If we are not going to spell out the real reasons why Lehman Brothers fell, then we better all forget Lehman’s fall.

PS. Here are 7 questions US Congressmen and Governors should ask bank regulators.

@PerKurowski

Jason Furman, things are not starting to go right. With the current distortion of bank credit, that’s impossible

Sir, Gillian Tett quotes Jason Furman, chairman of the US Council of Economic Advisors in that a “Greek exit would be taking a risk with the global economy just when things are starting to go right” “America fears a European sequel to Lehman”, April 24. 

Where does he get that “starting to go right” from? While regulators allow banks to earn higher risk adjusted returns on equity on what is perceived safe than on what is perceived as risky, things simply cannot go right. 

But of course there could be a sequel to Lehman. That, while banks are made to finance too much what is perceived as safe, is guaranteed. Excessive exposures to what is ex ante perceived as safe but that ex post turns out to be risky, is precisely the stuff major bank crises are made off. 

But, following this line of argument, Greece will not cause it. Greece has been perceived as risky, for a sufficient long time, so as to pose a major threat.

PS. I assume of course that the equity banks are required to hold when lending to Greece has been increased… and is no longer zero J

@PerKurowski

Regulators who darkened the banks in the sun, should not be allowed to shine light on those in the shadows

Sir, I refer to your “Regulators shine a light on the banking shadows” October 15. Therein your argue: “FSB’s rules on short-term securities lending are a sensible start” since “The shadow banking system was at the heart of the financial crisis” and then you refer to “the meltdowns of Lehman Brothers and AIG”

Quite a distorted view I would say… both Lehman Brothers and AIG troubles had little to do with the shadows and most to do with the regulations that applied to the banks in the sun.

On April 28, 2004, two months before Basel II was formally approved, SEC decided that " for Broker-Dealers that are Part of Consolidated Supervised Facilities and Supervised Investment Bank Holding Companies… computations of allowable capital and risk allowances (or other capital assessment) consistent with the Basel Standards" should apply.

And that meant that, for instance Lehman Brothers, would be able to leverage its equity 62.5 times to 1 when investing in AAA rated securities, such as those that detonated the disaster.

And the same Basel Standards implied that, if a company like AIG, proud bearer of an AAA rating, puts its name to a debt instrument, banks would be able to leverage these investments 62.5 times to 1… and so of course everyone wanted to hire AIG’s AAA rating… at a reasonable price.

And, if someone does not understand the temptations a 62.5 to 1 leverage implies for a financial company, he knows nothing about finance and less about regulations. As a reference, hedge funds, those animals of speculation, these can rarely leverage their equity more than 10 to 1.

Sir, I am not at all sure that current regulators, those who so much helped to darken the prospects of our banks, should even be allowed to try to shine a light on the banks in the shadows… they done enough damage as is.

May I here remind you of some minimum terms we need to lay down before we allow regulators to regulate any banks?

The Basel Committee and the Financial Stability Board have also some questions of ethics they should grapple with.

Sir, if a boy listens to the weatherman, and dresses up accordingly, but then comes his mommy and, having listened to the same weatherman, and ignoring what clothing the boy already has on, orders him to put on or take off additional layers of clothes, you can bet that boy will end up having too much or too little on, even if the weatherman turns out to be absolutely right about his forecast. And of course, and especially if the weatherman was wrong, as happens sometime, real tragedy could ensue with the boy dying from either excessive cold or heat.

That is precisely what happens when regulators, ignoring how banks have adjusted to the perceived risk of the asset through interest rates, size of exposure, duration and other terms, order banks to also adjust for the same perceived risk in the capital they are required to hold. 

Even if the risks have been perfectly perceived, the bank will as a consequence lend too much in too generous terms to those perceived as “absolutely safe” and too little in too harsh terms, to those perceived as “risky”. The introduction of this regulatory distortion puts both the banks and the real economy at serious risk.

And artificially favoring the borrowings of some bank clients over others, just to satisfy I do not what, is a highly unethical to do. And so Sir, in reference to Andrew Hill´s “Bankers grapple with question of ethics” December 9, I wonder if Dan Ostergaard, the managing partner of Integrity By Design and who is mentioned as advising on ethical training, might have a program for the Basel Committee for Banking Supervision and the Financial Stability Board. If not it seems urgently needed.

By the way it might also have to do with ethics when financial journalists refuse to make any reference to this regulatory distortion, for reasons of their own. Think of it, “Five years on, Lehman still haunts us” and the fact that it was the extremely low capital requirements allowed by the SEC to the investment banks under their supervision, when holding AAA rated securities, that most tempted Lehman into perdition, is not even discussed.

Too careful is also “carelessly”

Sir, Gideon Rachman writes “It is a standard, self-pitying complaint in Brussels that the crisis in the eurozone was triggered by the collapse of a US investment bank, Lehman Brothers”, “America cannot live so carelessly forever”, October 8.

Yes that is the superficial fact, but the real truth is that what caused both Lehman Brothers, the eurozone and the US to have a financial crisis, were bank regulations coming from the Basel Committee. For instance, on April 28, 2004, the Securities and Exchange Commission, which supervised Lehman Brothers, effectively delegated its role to the Basel Committee.

And by the way, the crisis was not caused by being too careless, on the contrary by being too careful. It was capital requirements for banks which were so much lower for what was perceived as “absolutely safe” than for what was perceived as “risky”, which caused that extraordinary dangerous large level of bank exposures, backed with minimal capital, to AAA rated securities, to banks of Iceland, to real estate in Spain, and to sovereigns like Greece.

Mr. Bob Diamond. Is not a level playing field for borrowers in the real economy accessing bank credit, even more important?

Sir, Bob Diamond, a banker, holds that “A level [regulatory] playing field… is essential to ensure banks have consistent and predictable financial targets” “‘Too big to fail’ is still a threat to the financial system”, September 16.

But, is not a level playing field for when the actors in the real economy access bank credit even more important? Because, there is no level playing field there as long as bank regulators allow for different capital requirements based on perceived risk.

Currently banks are earning much much higher risk-adjusted returns on equity when lending to “The Infallible”, like to some sovereigns, housing and the AAAristocracy, than when lending to “The Risky”, like to SMEs, entrepreneurs and start-ups.

And that as you of course would understand, but that bankers prefer to conveniently ignore, causes, consistently and predictably, our banks to lend too much, at too low interest rates and in too lenient terms to “The Infallible”, and too little, at too high rates and in too strict terms to “The Risky”. And that is a distortion inflicted on the real economy, and therefore also a threat to the financial system.

Even governments represent counter-party risks

Sir in “The legacy of Lehman Brothers” you write “Policymakers must own up to the fact that there are some institutions they can never credibly claim they will let fail. They must identify who they are implicitly backstopping so that they can charge a fee for that insurance” September 14.

This is indeed truly dangerous talk when what we need is for our regulators to be much more trigger happy, allowing bad institutions to fail; and when we know that the fees for such eternal life insurance would never be set objectively nor would it be set apart in a reserve, and so that, sooner or later, the final failure of any of these supreme institution, could bring the State down with it.

The economy does not need more government insurances than the ones currently awarded to individual depositors up to limited amounts, and to give more is counterproductive to the well-being of all of us, since an insurance is only worth as much as the insurance company is worth; and we do face a counter-party risk even when dealing with governments.

Not safer, better!

Sir once again in “The legacy of Lehman Brothers” you talk about the need of “a strategy for making finance safer” September 14 and you are wrong. What we need is a strategy for making finance serve our needs better. An absolutely failsafe bank can be an absolutely useless bank.

FT don’t be such a wimp. How can we get better regulations of the financial sector without, like the whole Basel regulations, speaking a word about the mission of the banks?

Do not undercut in any way the disciplinarian role of the market

Sir as an Executive Director at the World Bank 2002-2004 and as member of its Audit Committee I remember as one of my biggest frustrations continuously warning about counterparty risks and always ending up being answered along the lines of... “What counterparty risks? Don’t you know that a triple-A is a triple-A is a triple-A?”

This is why I take strong exception when Matthew Richardson and Nouriel Roubini in “Insolvent banks should feel market discipline”, May 7, though correctly advocating more of Schumpeterian creative destruction, are surprisingly lenient in the case of counterparty risk. They even write “But unlike with Lehman, the government can stand behind any counterparty transaction”. No!

What is counterparty risk? The risk that for example the insurance company you have insured yourself with cannot pay up when it should. This risk is clearly not a risk that an ordinary citizen should have to bear but for the financial system’s overall health it is an absolute must that all the qualified institutional participants bear with the full consequences of it.

In fact, in case they have not read it, current third pillar of the otherwise so discredited bank regulations from Basel – named the market discipline, “aims to encourage market discipline by developing a set of disclosure requirements which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposures, risk assessment processes, and hence the capital adequacy of the institution.” And that of course means the evaluation and the taking of counterparty risks.

And by the way, just as the markets would benefit from more creative destruction, let me also remind you that so would our financial regulators