Capital requirements for banks that favor the financing of the safer present like houses and sovereigns, over the riskier future like entrepreneurs doom the world to secular stagnation.

Sir, Martin Wolf writes: “the financial mechanisms used to manage secular stagnation exacerbate it. We need more policy instruments. The obvious one is fiscal policy. If private demand is structurally weak, the government needs to fill the gap. Fortunately, low interest rates make deficits more sustainable.” “Monetary policy has run its course” March 13.

No! Secular stagnation is guaranteed by capital requirements for banks that favor the financing of the safer present like houses and sovereigns, over the riskier future like entrepreneurs. The subsidies implicit in having assigned a 0% risk weight to public debt translate into artificial low market rates. Weigh the sovereigns equal to citizens, at 100% and you will immediately see those rates shoot up.

Of course kicking the can further down with more fiscal spending based on more public debt will give our economies a breather, but for what purpose? Had central bankers and regulators accepted in that loony 62.5 times allowed bank leverages for anything rated as AAA, and insane 0% risk weight assigned to Greece that caused the crises; and gotten rid of their risk weighting based on ex ante perceptions and not on ex post possibilities, our economies would be in a much better shape. But no, their huge liquidity injections seem to have mostly been put in place in order to cover up for their mistakes. And statist journalists backed them up by solely blaming banks, credit rating agencies and markets. 

Déjà vu😡 https://teawithft.blogspot.com/search/label/secular%20stagnation

@PerKurowski

Indeed, reforming the credit rating market is an urgent necessity. Indeed, shame on the regulators

Sir, Arturo Cifuentes concludes, “Reforming the credit rating market is an urgent necessity. Shame on the regulators” “Few lessons have been heeded 10 years after Lehman collapse” August 23.

Yes shame on the regulators! But also for some other reasons than those Cifuentes mentions.

Just for a starter, the credit rating agencies would never ever have caused so much damage had their opinions not been leveraged immensely by the risk weighted capital requirements for banks. Imagine, Basel II, 2004, allowed banks to leverage 62.5 times if only a human fallible credit rating agency assigned an asset an AAA rating. 

It should have been crystal clear that with that the regulators were introducing a huge systemic risk in the banking sector. That I mentioned for instance in a letter published by FT in January 2003; and I loudly explained and protested it while an Executive Director in the World Bank during those Basel II preparation days.

In Europe, the EU authorities even overrode the credit rating agencies opinions and assigned Greece a 0% risk weight, which of course doomed it to its current tragic condition. 

Then, let us mention the mother of all regulatory mistakes; for their risk weighted bank capital requirements, initiated in 1988 with Basel I, the regulators used the perceived risk of assets instead of the risks of those assets conditioned on how their risks are perceived? How loony, how sad, what a distortion, what a recipe for disaster was not that? And still, 30 years later, they do not even acknowledge their mistake.

By the way, when Cifuentes denounces that Solvency II, with its myopic risk view, will discourage insurance companies, the natural holders of illiquid assets, to hold these investments, and it will therefore increase the systemic risk by making their portfolios less diversified, I could not agree more.

Sir, you know that for over more than a decade I have written to Financial Times 2.787 letters objecting to the “subprime banking regulations”, this one not included. Galileo could indeed be accused for being obsessed with his theories, but, could those doing their utmost to silence his objections, the inquisitors, not be accused of the same?

PS. Cifuentes mentions “Olivier Blanchard’s 2016 admission that incorporating the financial sector in macro models would be a good idea”, I might have had something to do with that.

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

@PerKurowski

The interest rates on public debt are distorted by QEs and bank regulations. Seemingly no one dares to research that

Sir, Baroness Ros Altmann, when commenting on Martin Wolf’s (“Capitalism and democracy are the odd couple” of September 20, writes:

“Global central banks have artificially distorted capital markets for several years, by creating vast amounts of new money to buy sovereign debt. The supposedly “risk-free” interest rate, on which much of the system depends, has been undermined (and she concludes)… it is important to consider the democratic dangers to capitalism which prolonged QE may pose. ” “Disguised fiscal measures play role in democratic recession” September 22.

She is absolutely correct, and I have over the years written for instance Martin Wolf numerous letters on it.

But there is also the regulatory distortions provoked by the risk weighted capital requirements for banks introduced in 1988 with Basel I, and which assigned a 0% risk weight to sovereigns.

That meant at that time, and well into current Basel III times, that banks needed to hold little or no capital when lending to sovereigns; meaning banks were authorized to leverage immensely when lending to sovereigns; meaning banks could earn fabulous risk adjusted returns on equity when lending to sovereigns; meaning banks would lend too much and at too low rates to sovereigns.

So, when to QEs we add this through-the-back-door regulatory subsidies to government borrowings from banks (and now with Solvency II extended to insurance companies) it is absolutely clear we have no idea what the real cost of public debt is; and so we are all flying blind… and government bureaucrats having much easier access to bank credit than SMEs or entrepreneurs.

Last November, during IMF’s Annual Research Conference, I got at long last one of the major experts, in this case Olivier Blanchard, to agree with me in that “lets make sure that we have removed all the distortions which we can, which affect r (rates), so we have the right r”.

Sir, as of this moment that was the last time I have heard about it.

Why is there no response? Perhaps the answer is found in Upton Sinclair’s “It is difficult to get a man to understand something when his salary depends upon his not understanding it.”

PS Here is the link to my own response to that particular article of Martin Wolf

@PerKurowski

Who sold IMF the fake idea that risk weighted capital requirements for banks do not distort the allocation of credit?

Sir, Shawn Donnan, referring to a IMF paper recently released by Christine Lagarde, “Gone with the Headwinds: Global Productivity”, writes that IMF economists warn: “The world’s economy is caught in a productivity trap thanks to an abrupt slowdown caused by the 2008 global financial crisis, which will yield more social turmoil if it is not addressed hold that” “IMF raises fear of slowing productivity” April 4.

Bank assets, based on how they are perceived ex ante, can be divided into safe and risky assets. The “safe”, by definition, currently include sovereigns and corporates with good credit ratings, and residential mortgages. The “risky” include what is unrated or what does not possess very good ratings… like loans to SMEs and entrepreneurs. It is also clear that she safe includes more of what is known; meaning what’s in the past or present, and the risky more of what is unknown, meaning what lies in the future.

Then suppose regulators had transparently told the banks: “We hate it so much when you take risks so that, from now on, if you finance something that is perceived as safe and stay away from what is perceived as risky, we will reward you by helping you to make you much higher risk adjusted returns on equity”.

In such a scenario, could it not be reasonably expected that IMF would be identifying regulatory risk aversion as something that could be slowing productivity? I mean, as John A Shedd said: “A ship in harbor is safe, but that is not what ships are for"

But, rewarding the banks for going for the safe, and staying away from the risky, is exactly what the current risk-weighted capital requirements for banks does.

And the IMF, even though here the report mentions: “Growing misallocation during the pre-global- financial-crisis financial boom [and] The global financial crisis might have worsened capital allocation further by impeding the growth of financially constrained firms relative to their less constrained counterparts.” says nothing about distorting bank regulations having something to do with this misallocation; an only produces second-degree explanations such as “banks may have “evergreened” loans to weak firms to delay loan-loss recognition and the need to raise capital”. How come?

April 3, in FT, Anjana Ahuja in reference to Robert Hare’s 1993 “Without Conscience: The Disturbing World of the Psychopaths Among Us,” wrote the following:

“Uncertainty is unsettling and certainty is alluring. Beware anyone who offers the latter with charisma, especially at this jittery juncture. Arm yourself against the charlatans…not only criminal psychopaths but the white-collar kind — who overstate their abilities, denigrate subordinates, have a tenuous grip on truth and seek greater power with shrinking oversight.”

Could it really be that one or more of these spellbinding salesmen of certainty illusions, technocratic besserwissers, managed to enthrall and blind the whole IMF? If so, Mme Lagarde owes herself and the IMF to find who they were… and to put a stop to it.

May I suggest she starts doing so by sending around to all those in the IMF that have had anything to do with bank regulations, some of those questions that, without any luck, I have tried to get answered, many times even in the IMF. Here’s the link: http://subprimeregulations.blogspot.com/2016/12/must-one-go-on-hunger-strike-to-have.html

But perhaps IMF already knows who those “charlatans” were, and just want to spare some members of their mutual admiration club some very deep embarrassments. If so then IMF is not fulfilling its responsibilities, as it should.

Too much is at stake! More than ever the world need to develop the capability of filtering out any fake experts, no matter how nice they are and no matter how important the networks they belong to.

PS. Twice I have had the opportunity to ask Mme Lagarde on this subject, and twice she kindly answered me, but nothing seems to have come out of it 

http://subprimeregulations.blogspot.com/2011/09/my-question-at-civil-society-townhall.html

http://subprimeregulations.blogspot.com/2013/10/my-question-for-umpteenth-time-to-world.html

PS. In December 2016, during the IMF’s Annual Research Conference, Olivier Blanchard also agreed with me there were needs to research how these capital requirements distort.

http://subprimeregulations.blogspot.com/2016/11/olivier-blanchard-agrees-there-is-need.html

@PerKurowski

ECB’s policy makers, without corrective glasses, have no chance of reading the economy’s real signals.

Sir, Claire Jones reports on “How ECB policymakers will be reading the signals ahead of stimulus decision” December 7.

Fat chance they will be able to read those signals correctly. ECBs policymakers are seemingly not even aware of their need to wear glasses that correct for the distortions produced by the risk weighted capital requirements for banks.

Let's see if IMF can come up with some helpful research

@PerKurowski

Influential columnists, like Martin Wolf, are much more responsible for current state of economies than Donald Trump

Sir, Martin Wolf sneers disgustedly, with besserwisser gusto, at what president elect Trump has been proposing in order to tackle current difficulties, and in many cases brand new economic circumstances. “Trump’s false promises to his supporters” November 15.

Many, not all, of Wolf’s warnings are indeed very correct, though I must say his own lately what-to-do instead main suggestion, is not much convincing either. 

For governments to take advantage of low interest rates, to invest in infrastructure, is based on the premise that the interest rates are not low because of artificialities, like regulatory subsidies and QEs; and that the government is capable to embark efficiently on a major infrastructure constructions. Both those premises seem quite doubtful.

For instance last week Olivier Blanchard, the previous Chief Economist at IMF, when referring to my argument that current capital requirements for banks are lowering the interest rates of public debt, answered that the possibility of that needed to be researched, and, if true, the first order of business must be to eliminate the distortions.

I would of course also ask Martin Wolf how much he himself would be willing to invest in long term public debt at current rates… or is that supposed to be done solely by pension funds, insurance companies or profit-squeezed banks desperate for any solution that would keep them out of jail if events turn really sour?

Sir, Mr. Wolf would do well remembering that as a very influential columnist he is, until now at least, much more responsible for whatever conditions the world economies find themselves in than president elect Donald Trump. Where was Wolf in 1988 when the Basel Accord decided that the risk-weight of the Sovereign was 0% and that of We the People 100%? Where was Wolf in 2004 when Basel II assigned amazing much importance to the criteria of some very few human fallible credit rating agencies? And those questions are just for starters?

PS. What would I do? I would grandfather all current capital requirements for banks’ current assets, and then eliminate all distortions that stand in the way of SMEs and entrepreneurs having equal to all access to bank credit, foremost those that favor the government but also including those that favor the financing of houses. And then I would sit down and do nothing for six months, except of course trying to reach approval for a Universal Basic Income scheme that could benefit working and not working citizens.

@PerKurowski

Who should we most blame for distorting risk weighted bank capital requirements; central banks or politicians?

Sir, John Authers writes “Blaming central bankers, as many of the people behind the UK and US populist revolts tend to do, misses the point. The loose monetary policies of the past eight years helped deepen inequality by raising the wealth of those already with assets, without breathing sufficient life into those economies. But central bankers were for the most part following these policies to buy time for politicians to take the needed longer-term measures.”, “A bonfire of the certainties” November 10.

And Authers’ pities the “Central banks [that] have looked increasingly uncomfortable with their new role, while each fresh dose of monetary easing has had less impact than the one before.”

But what Authers’ does not do is to mention the bank regulations promoted and sheltered by central banks and which distorted the allocation of bank credit to the real economy. The statism, the silly risk aversion, the discrimination against the risky and the all that for no good safety reason, and that is imbedded in that piece of regulations, will go down in history as a shameful mistake, and disgrace all those who by commission or omission are responsible for it.

I ask, are central banks really auhorized to independently distort bank credit allocation

At the very end of the recent 2016 Annual Research Conference, none other than Olivier Blanchard, the former Chief Economist of the IMF, admitted that indeed more research was needed to better understand the underlying factors for the trend to lower public debt interests that can be observed the last 30 years; and that this trend might very well be explained to an important extent by current bank regulations.

When that research ends up showing we have for decades been navigating with a subsidized public borrowing rate as a proxy for the risk free rate, a financial compass distorted by the Basel Committee’s magnetic field, there will be many questions. Among these, why did FT silence more than 2.000 letters I wrote to it on this issue.

PS. The origin for this regulatory risk weighting can be found in Steven Solomon’s The Confidence Game” 1995. “On September 2, 1986, at the Bank of England governor’s official residence… when the Fed chairman Paul Volcker sat down with Governor Robin Leigh-Pemberton and three senior BoE officials, the topic he raised was bank capital”

@PerKurowski

It is time for America to ask bank regulation’s risk weights of 0% Sovereign and 100% We the People, to take a hike!

Sir, Martin Wolf, in reference to the United States writes: “In the country of the blind, the one-eyed man rules… the next administration will take over a country with mediocre growth of productivity, high inequality, a growing retreat from work and a declining rate of creation of new businesses and jobs… loss of dynamism… business fixed investment has been persistently weak… rise of new regulatory barriers is disturbing.” “An economic in-tray full of problems” November 9.

Of course, as usual, obsessively, Wolf says not a word about the possibility that the risk weights of 0% sovereign, 20% AAA rated, 35% residential housing and 100% SMEs, set for the purpose of defining the capital requirements for banks, are distorting the allocation of bank credit to the real economy, with disastrous consequences.

At least last week, during IMF’s Annual Research Conference, at the very end of the conference, none other than Olivier Blanchard, the former Chief Economist of the IMF, admitted that: indeed more research was needed to better understand the underlying factors for the trend to lower public debt interests that can be observed the last 30 years; and that this trend might very well be explained to a certain extent by current bank regulations.

When the truth about the risk weighted capital requirements for banks unravel, I wonder how Mr. Wolf is going to explain his and FT’s silence on my thousands of letters.

By the way, after yesterdays American election results, is it not high time for the Home of the Free and the Land of the Brave to ask those risk weights of 0% Sovereign and 100% We the People, to take a hike?

PS. What caused the unexpected election results? I really don’t know, I am not American so I did not have to vote (phew what a relief) but the irritating smugness of technocrat and media besserwissers, sure must have played an important role.

PS. I forgot, fairly recent I twitted: “As I see it there's one vote for the next 4 years, and then there’s one for the next 40. The latter could be for Gary Johnson”

@PerKurowski

With so much regulatory distortion, why is FT so fixated about the low nominal real interest rates on public debts?

Sir, you write: “It is a puzzle why the Fed is so keen about raising US interest rates… Central banks should err on the side” “The prevailing case for caution by central banks” November 5.

Sir, may I say you keep on being fixated on the nominal real interest rates, unable to see the real real-nominal interest rates.

Would any serious economist discuss gas prices at the pump ignoring taxes? No!

Would any serious economist discuss milk prices ignoring various subsidies? No!

Then why have almost all serious economists, FT included, only been discussing low real interest rates on public debt ignoring the regulatory subsidies?

In 1988, the Basel Accord, Basel I, for the purpose of setting the capital requirements for banks, decided that the risk weight of the sovereign was 0% and that of We the People 100%.

That would hence mean that banks would be able to leverage much more their equity, and the value of any explicit or implicit government guarantees they received, with loans to the public sector than with loans to the private sector.

That would hence mean banks could obtain higher risk-adjusted returns on equity when lending to the public sector than when lending to the private sector.

That would hence mean that the interest rates of bank loans to the public sector included a regulatory subsidy.

That would hence mean that the subsidies for the access to bank credit by the public sector was to be paid by taxing the private sector with more restricted or more expensive access to bank credit.

And that should hence have meant that in order to know the real real-rate on public debt, to the nominal rates, we would have to add the cost of the regulatory taxes paid by the private sector.

That has not been done! All references to the interest rates of public debt have been limited to using the nominal rates. That has led experts like Lawrence Summers, Lord Adair Turner, FT's own Martin Wolf and many other, to argue that the public sector should take advantage of extraordinary low rates in order to finance public investments, like in infrastructure.

That is so wrong! If we include the economic cost of restricting the access to bank credit over the decade and around the world, for many millions of SMEs and entrepreneurs, the current real real-interests rates on public debt could in fact be the highest ever.

So, if the Fed, ECB or any other central bank, really wants to lower the interests in order to stimulate the real economy, then they should begin by asking bank regulators to take away those so costly subsidies of public debt.

Sir, You if anyone should know I have been raising this issue for a long time; in 2004 in a letter you published I wrote: “How many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector (sovereigns)? In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

But sadly my arguments have until now fallen on deaf ears. Perhaps I never managed to explain myself correctly in those thousands of letter I have written to FT over the years about the distortions that are caused by the risk-weighted capital requirements for banks.

But now, at long last, I might have been able to reach through, at least to the IMF. At the very end of the recent 2016 Annual Research Conference, none other than Olivier Blanchard, the former Chief Economist of the IMF, admitted that indeed more research was needed to better understand the underlying factors for the trend to lower public debt interests that can be observed the last 30 years; and that this trend might very well be explained to an important extent by current bank regulations.

I pray that translates, as fast as possible, into many of IMF’s PhDs and other researchers trying to figure it out. It is absolutely vital. Public debt usually serves as a proxy for those risk-free rates that so many of our market and financial decisions are based on.

We have all a responsibility towards our grandchildren to help our economies to navigate towards better waters and, if we are to succeed doing that, we need our compasses or GSPs to be functioning correctly.

@PerKurowski

Most economists do still not understand the current regulatory distortion of the allocation of bank credit to the real economy.

Sir, Tim Harford, when analyzing and questioning the economic arguments on Brexit writes of “the low reputation of economists, the result of a global financial crisis that only a few in the profession warned us against”, “Metropolitan myths that led to Brexit” July 23. And among “the four articles of centre-left faith” Harford brings up that of the “economists are reliably wrong”.

Yes, the economists did not warn, as they should have done, had they been interested, as they should have been. But so much worse is it that, after all the evidence of a crisis that breaks out because of excessive exposures to “safe” assets, those assets against which banks were allowed to hold very little capital, most economists do still not understand how the risk-weighted capital requirements for banks distorts the allocation of bank credit to the real economy. Or is it they just do not care? Or is it that they just do not dare to criticize?

I am just going through “Progress and Confusion: The State of Macroeconomic Policy” edited by Olivier Blanchard, Raghuram Rajan, Kenneth Rogoff and Lawrence Summers; recently published by IMF and MIT. The book has its origin in a conference organized by IMF in April 2015 titled “Rethinking Macro Policy”, the third one.

In it only Anat R. Admati refers to “distortion” and writes: “The presence of overhanging debt creates inefficiencies… In banking such distortions may result in biases in favor of speculative trading or credit card or subprime lending and against creditworthy business”.

Good for her, Admati is one of the few on the right track. Unfortunately, she has not yet fully grasped the fact that allowing banks to leverage their equity, and the support they receive from society differently, depending on ex ante perceived risks, produces a totally different set of expected risk-adjusted ROEs than those that would result without such regulatory distortion.

And the confusion between ex ante perceived risks and ex post realities persists. When Admati mentions “subprime lending” she refers to it as something risky, forgetting the risk-weights for those operations was (and is) 20 to 35%; and when she writes about “creditworthy business”, most of it was (and is) risk weighted at 100%

Frankly, all those economists who regulate banks without clearly defining the purpose of the banks, are putting a very black mark on our profession.

All risk management must begin by clearly identifying those risks we cannot afford not to take… and, in banking, we cannot afford the banks not to take the risks the real economy needs.

PS. Dare read about the so many mistakes!

@PerKurowski ©

All economies need a good volume of pleasant surprises to grow. Bank regulators are now blocking these.

Sir, Olivier Blanchard writes that the reason for the surprisingly weak growth response to extraordinary stimulus, “must be found in mediocre medium term prospects”, “Slow growth is a fact of life in the post-crisis world” April 14.

If you advance bad news and do not allow risks to be taken, you cannot but guarantee mediocre term prospects”. And that is what bank regulators did.

In a very simplified way below are the four possibilities with respect to ex ante perceived credit risk and ex post outcomes.

Something perceived safe turns out safe. No surprise.

Something perceived safe turns out risky. Bad news.

Something perceived risky turns out risky. No surprise.

Something perceived risky turns out safe. Great news.

It is always what is perceived as safe but that turns out risky, which poses the greatest dangers to financial stability.

And it is always what was thought as risky but turns out safe, which most gives the economies the impetus to move forward.

But what did the regulators do with their credit risk weighted capital requirements for banks?

They guaranteed that if something safe turned out risky, banks would have very little capital to cover up with.

And they made sure banks would not risk delivering the good surprises our economies need.

No Mr. Olivier! Slow growth has not to be a fact. God make us daring!

@PerKurowski ©

The Basel Accord 1988 guaranteed hysteresis, economic Alzheimer. Was it because of regulators’ memory loss or ideology?

Hysteresis can be described as a permanent weakening of the capacity to respond as a consequence of memory loss… a sort of an economic Alzheimer illness.

Sir, Claire Jones mentions that, “Hysteresis’s first brush with economic fame was in 1986, when it was used by Mr Blanchard and Lawrence Summers to explain Europe’s last brush with high joblessness”, “Hysteresis’ returns to Europe as central bank frets over recovery” May 25.

In1988, with the Basel Accord (Basel I), regulators adopted the use of credit-risk-weighted capital (equity) requirements for banks and set the following risk weights: Lending to the government = Zero percent risk weight; and lending to the citizens’ SMEs and entrepreneurs = 100 percent risk weight.

Sir, with regulators displaying such a total loss of memory about the importance of the private sector; or ideologically engaging in such obnoxious manipulation and distortion of the bank-credit markets in favor of the public sector… of course hysteresis had to follow.

The consequences of such hysteresis are indeed nefarious. For instance, in 2012, it already caused me to have to write an Op-Ed titled “We need worthy and decent unemployments”.

But, to have the slightest chance to regain our economies’ memory and vitality, we need to denounce what happened and to remove those who block such efforts… whether for reasons of mental sickness or sick ideology.

@PerKurowski

FT argues IMF should be listened to because of its consistency, but fails to apply the criteria to others.

Sir, in “The Solomonic advice of the IMF”, October 12, though you accept that IMF “like most other forecasters has been proved over-optimistic on the strength of the recovery” you still argue that its advice deserves a serious hearing, primarily because of its “consistency”. 

Now I have, as you know, very consistently, argued from before the crisis that regulators were dooming us to a crisis, even in FT, and then that there was no way of recovering any sturdy and sustainable economic growth with bank regulations that discriminate in favor of what is ex-ante perceived as not risky, “The Infallibles”, and against “The Risky”, the small businesses and entrepreneurs. 

And from what I see, read and hear, the reigning majority of IMF economists, have still no complete idea about how we got into this mess, and so, clearly, much less a complete idea on how to get us out of the mess. 

But still, I do not get any brownie points for consistency, because that is not really what it is all about, and so my arguments are silenced by FT, consistently

By the way "Solomonic": “Exhibiting or requiring the wisdom of Solomon in making difficult decisions”, come on, I respect IMF, though I sure hope they would be smarter, but is that not taking it all a bit too far?

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.