12 years since, and yet the true cause of the 2008 crisis shall seemingly not be told

Sir, John Flint a former Before chief executive of HSBC writes: “Before 2008, regulators’ approach to conduct risk in banking was what they called “principles based” — deliberately light touch. It relied too much on banks’ abilities to govern themselves and it failed.” “Warning lights are flashing for Big Tech as they did for banks” November 30.

“principles based”? Yes, but tragically with risk weighted bank capital requirements based on a very wrong principle, namely that what’s perceived as risky is more dangerous to our bank system than what’s perceived as safe.

“It relied too much on banks’ abilities to govern themselves and it failed.”? No, it relied way too much on some very few human fallible credit rating agencies, a systemic risk.

“deliberately light touch”? If as Basel II allowed​, ​ banks could leverage a mindboggling 62.5 times their capital with assets rated AAA to AA, I would not call that a “light touch”, I would call it putting Minsky Moments on steroids.

“This time it is the technology sector rather than the financial that is leaving us all exposed.”

Sir, current bank capital requirements, 12 years since the 2008 crisis, are still mostly based on the expected credit risks banks clear for on their own; not on misperceived credit risks, 2008’ AAA rated MBS, or unexpected dangers, like COVID-19. Therefore, banks will again stand there with their pants down. A good job Sir?

@PerKurowski

Here a formal statement in 2003 as an Executive Director of the World Bank 

Here my brief explanation of the 2008 crisis

And here the 2019 letter I sent to the Financial Stability Board

The coronavirus will unleash a horrific Minsky moment in our bubbled-up debt overextended economies

Sir, I refer to Martin Wolf’s “The virus is an economic emergency too” March 18. 

Indeed, more than a week ago I tweeted: “The world is prepared somewhat for the expected, but not enough for the unexpected. That’s why, worldwide, coronavirus will cause larger number of deaths because of its economic consequences, than because of its health implications”.

And for years I have also tweeted, “The current fake-boom, put on steroids by huge central bank liquidity injections, low interest rates, and Basel Committee’s pro-cyclical risk weighted bank capital requirements, will end in a horrific Minsky moment bust, equally put on steroids.”

Sir, bank capital requirements used to be a percentage of all assets, something which to some extent covered both EXPECTED and UNEXPECTED risks. But currently Basel Committee’s risk weighted bank capital requirements, those that operate over the silly low 3% leverage ratio, are solely BASED ON EXPECTED credit risks. So even if Wolf can write “The pandemic was not unexpected”, for banks and its regulators it sure was completely, 100%, unexpected. And all the banks will now soon stand there completely naked.

And what help can banks be expected to give entrepreneurs and SMEs when they are required to hold much more capital when lending to these, than when holding “safe” sovereign debts and residential mortgages? Will banks be able to raise the needed 8% in capital or will regulators lower that requirement?

Wolf writes, again, “Long-term government debt is so cheap”. Sir, when will Wolf dare think about what those rates would be, for instance in Italy, if its banks needed to hold the same amount of capital against loans to their government than against loans to their Italian entrepreneurs?

“Governments can just send everybody a cheque”. Yes, a perfect moment to build up an unconditional universal basic income scheme; but it needs to be well funded, not with public debts expected to be repaid by our grandchildren. Possible sources are high carbon taxes, something which would align the incentives in the fights against climate change and inequality; another possibility is to tax those advertising revenues generated by exploiting our personal data.

PS. As to USA it should immediately eliminate of all health sector discrimination in price, access or quality, between the insured and the uninsured.

PS. As to education all professors and administrative personal should have their salaries reduced, something which should be compensated by participating somewhat in their students’ future income streams.

http://subprimeregulations.blogspot.com/2020/03/the-basel-committee-for-banking.html

@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