Central banks seem not able to tell their magic porridge pot to stop

Sir, Robert Armstrong, Oliver Ralph, and Eric Platt make a reference to the fairy tale of the magic porridge pot writing “Every working day, $100m rolls into Berkshire — cash from its subsidiaries, dividends from its shares, interest from its treasuries. Something must be done with it all. The porridge is starting to overrun the house.” “‘I have more fun than any 88-year-old in the world’” Life&Arts, April 27.

And the magic porridge pot fairy tale ends this way on Wikipedia: “At last when only one single house remained, the child came home and just said, "Stop, little pot," and it stopped and gave up cooking, and whosoever wished to return to the town had to eat their way back”

Sir, the excessive stimuli injected by means of QEs, fiscal deficits, ultra low interest rates and incestuous debt credit relations, like the 0% risk weighting of the sovereign that provides credit subsidies to who provides banks with deposit guarantees, or loans to houses increasing the price of houses allowing still more loans to houses, against very little capital… all of that is the porridge of our time.

And it’s clear central bankers everywhere, have no idea of how to tell their pot to stop.

Will we be able to eat our way back? Not without sweating it out a lot at the gym. You see too much porridge, meaning too much carbs, and too little proteins, meaning too little risk taking, produces an obese not muscular economy. 

@PerKurowski

In an age of “pervasive uncertainty”, how can bank regulators trusts ex ante perceived risks so much?

Sir I refer to Oliver Ralph’s “Age of uncertainty takes its toll” March 13, in order to make just one question… that in the title.

Sir, I dare you to explain to me, or to anyone, why the capital requirements for banks should be based on the risks perceived, and not on those risk that might not be perceived?

@PerKurowski

Why do regulators insist in realizing bankers and insurers wet dreams? It costs the real economy too much!

Solvency II does to the insurance industry what Basel regulations did to banks. It introduces what is known as the “risk-based approach” to capital and regulation.

In essence it means more ex ante perceived risk more capital, less ex ante perceived risk less capital.

That translate into the lesser the ex ante risk is perceived, the more you will be able to leverage your capital.

And the more you are allowed to leverage capital, the higher are the expected risk adjusted returns on equity.

And so, just like it realized the banker's wet dreams (more elegant "nocturnal emissions") Solvency II should now realize those of the insurers… namely that of being allowed to earn the highest risk adjusted returns on equity on what is perceived as the safest.

Evidence of the existing enthusiasm we find when Oliver Ralph quotes Omar Ripon, partner at accountants Moore Stephens with “Risk-based capital is a great thing. The best firms are looking at using it to improve their returns. If you only look at it from the compliance angle, you won’t get the benefits.” “Insurance divides over shared rules” March 14.

Unfortunately allowing bankers and insurers to realize their wet dreams has a very high cost for all the rest of us.

First it obviously distort a lot in the financial markets in terms of how credit, investments and capital is allocated.

When the European Commission explains why Solvency II is needed they hold that Solvency I “does not entail an optimal allocation of capital, i.e. an allocation which is efficient in terms of risk and return for shareholders”

But that is certainly what the risk based capital approach cannot do.

That is because all risks that are considered by the capital requirements are risks that have already been perceived and cleared for in other ways, by means of risk premiums, amounts of exposure and other.

And any risk, even if perfectly perceived, if it is excessively considered, causes the wrong action.

And then of course “hiding risks” or production of Potemkin ratings, which allows for higher leverages, becomes a competitive tool.

“Any risk you hide I can hide better, I can hide better the risks than you can… No, you can't - Yes, I can - No, you can't Yes, I can! Yes, I can!”

And if the distortions in capital allocation to banks and insurance are bad, the distortion it produces among those who access bank credit or insurance investment funds from the insurance companies is much worse. It will mean the “safe” will get too much, much more than what they already get (making them risky) and that the “risky” will get too little, much less than what they already get… and as a consequence our real economy will suffer a lot.

I know too little of the insura © nce industry to estimate their capital requirements but, in the case of banks, these should be required to hold 10 percent in capital against all assets to cover for the unexpected, which, even though it can be expected, includes such events as regulators having no idea of what they are doing.

PS. I challenge you to read the European Commission’s explanations of Solvency II and count the self confessed distortions it will produce.

@PerKurowski

What? “ROE is not a meaningful measure of performance”? If you are a shareholder it sure is.

Sir, Oliver Ralph writes: “Most big banks use their own assessments of risk when calculating RWAs, and there is no clarity about how they do so. “Flawed return on equity metric will not be shaken off easily” November 17.

There might not be clarity about the “how they do so” but there is no doubt about the why they do so. It is to lower the equity requirements, so that they can earn as high as possible expected risk-adjusted returns on assets. Just like kids would promote the nutritional value of ice cream and chocolate cake and negate steadfastly that of broccoli and spinach.

Of course the return on equity ROE is one of the most important measures they are and good luck to anyone trying to raise capital saying it isn’t so. Oliver Ralph is perfectly clear when stating “Ignore it at your peril”.

Bank ROE has of course mutated as an information tool. Nowadays it is very difficult to establish how much of it is produced from real banking… how much from over-leveraging banking, and how much from pitifully bad risk weightings.

Suffice to see the zero percent risk weights for sovereigns. Those sovereigns who in our face announce inflation targets so that can repay us with currency worth less… those which already mention the need of increasing taxes in order to repay their debts.

@PerKurowski ©

EDTF beware; disclosure requirements for banks can also be used as camouflaging material.

Sir, Oliver Ralph writes: “Maybe one day banks may be trustworthy enough not to have publish annual reports that are hundreds of pages long”, “Excessive disclosure by banks eludes comprehension” June 1.

Indeed but it is clear that publishing annual reports that are hundreds of pages long does not make banks more trustworthy either. One-way to concealed bad behavior, is to bury it under hundreds of pages of mumbo jumbo.

Ralph refers also to the Enhanced Disclosure Task Force’s (EDTF) “recommendation 7, which asks the banks to describe risks in their business models.” Would that cause banks to prepare their own homemade list of weights they assign to the risks in their business? That could shed some light on what risks the banks are not considering in their business model… but frankly, mostly it seems like generating profitable employment opportunities for bad and good fiction authors.

And I set all these efforts against the background of the regulators and the banks having colluded in producing that masterpiece of financial disinformation, which is the leverage that in the numerator does not use assets but risk-weighted assets instead.

Few days ago, a leading American newspaper, citing another leading American newspaper in its editorial expressed “banks are significant safer than they were prior to the 2008 financial panic, with an average of $13 in capital for every $100 in assets for member banks of the Federal Deposit Insurance Corp”. That is false! It should have stated for every $100 in risk-weighted assets; and it should have reported the real undistorted leverage too.

Since the risk weighing not only distorts information but also the allocation of bank credit to the real economy, something that is even more dangerous, the EDTF should start by clearing this out with the Basel Committee, before allowing banks more mumbo-jumbo material under which to hide.