When will someone invited dare to pose the question that shall not be made at a Davos or Jackson Hole gathering?

Sir, Gillian Tett writes: “The International Monetary Fund calculates that between 1970 and 2011, the world has suffered 147 banking crises... But whatever their statistical size, the pre-crisis period is marked by hubris, greed, opacity — and a tunnel vision among financiers that makes it impossible for them to assess risks.”, “When the world held its breath” September 1.

Sir, and why should regulators, who impose risk weighted capital requirements for banks, and stress test these be less affected by that “tunnel vision”? 

If regulators knew about conditional probabilities, if they absolutely wanted and dared to distort the allocation of bank credit, they would have set their risk weights based, not on the perceived risks of assets, but on how bankers’ perceive and manage risks.

Tett quotes Alan Greenspan with “I originally assumed that people would act in a wholly rational way, that turned out to be wrong.” Shame on him, had he just done his homework, he would have known that what was perceived as risky never ever causes financial crises, that is always the role of what was thought as very safe.

Tett also quotes Paul Tucker, the former deputy governor of the Bank of England with, “There is a dynamic which pushes banking and the penumbra of banking to excess, over and over again”. That “dynamic” force was the regulators pushing bankers into excesses, for instance by allowing them to leverage 62.5 times if only an AAA to AA rating issued by human fallible credit rating agencies was present.

Tett recounts: “One day in the early summer of 2007, I received an email out of the blue from an erudite Japanese central banker called Hiroshi Nakaso”, who warned her “that a financial crisis was about to explode because of problems in the American mortgage and credit market.” 

Tett was astonished, though she did, by then, not disagree with the analysis. May 19th 2007 I wrote the following letter to FT, which was not published.

“Sir, after reading Gillian Tett’s “A headache is in store when the credit party fizzles out” May 19, it is clear we should all go down on our knees and pray for that she is right, in that it is only a headache that is in store for us. 

As for myself I have serious doubts that the consequence of this blissful-ignorance-bubble resulting from our hide-and-not-seek the risks with derivatives, is unfortunately going to be much more painful than that. When that day comes though, before putting the sole blame on the poor bankers earning their luxurious daily keep; I suggest we look much closer at the responsibility of our financial regulators.”

Sir, sadly, that suggestion has been way too much ignored until now. 

“Why do you require banks to hold more capital against what by being perceived as risky is made less dangerous to our bank systems, than against what by being perceived as safe, poses so many more dangers?” That is the questions that seemingly shall not be asked by anyone who markets his name in the debate and does not want to risk being left out from Davos or Jackson Hole gatherings.

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

@PerKurowski

Central bankers have surely favored government borrowings… and the costs will be horrendous.

Sir, Desmond King reviews and discusses Paul Tucker’s “Unelected Power”, which asks:“To whom are central bankers responsible? How is oversight of their discretionary authority monitored in a democracy? Can central banks remain legitimate as they choose financial winners and losers?”

The starting point for Tucker’s questions seems to be when, in September 2008, “Citizens and bankers sat transfixed as Lehman Brothers collapsed, rattling equity and credit markets”.

Wrong! Not that I had any idea of it back then but the genesis of the problems herein referred to seem to me be in 1988 when bank regulators came up with the incredibly hubristic concept of risk weighted capital requirements for banks, as if anyone could measure ex ante the risks that would explode ex post.

From a cv. on the web I see that Paul Tucker worked in 1987 in “the Banking Supervision Division; as part of the 4 person team negotiating the Basle International Capital Convergence Agreement; and assistant to chair of Basle Supervisors Committee”

So when King writes that “Tucker argues that the “most compelling reason” for [central bank independence] is to “enable governments to save paying an inflation risk premium on their debt”, I must ask: “Really Mr. Tucker, does that require risk weighing the sovereigns with 0% while assigning the citizens 100%?” 

That regulatory subsidy causes, sooner or later, governments to take will be getting up too much debt, that which can only be repaid by the printing machine… meaning inflation… meaning tragedies. 

I have not seen anyone holding Sir Paul Tucker accountable.

PS. I dare Paul Tucker, the current chair of the Systemic Risk Council, to give a coherent explanation for why banks should hold more capital against what’s made innocous by being perceived risky, than against what’s perceived safe and therefore carries more dangerous tail risks? The distortion that produces in the allocation of bank credit constitutes, as I see it, a huge systemic risk.

@PerKurowski

The more you stabilize, the more you risk making the system brittle, so the more you really destabilize.

Sir, I refer to Paul Tucker’s “The world needs different ways of taming capital flows” October 10.

I have always, in the case of small bath-tubes placed next to the global oceans, been in favor of capital controls. And I have most specially liked what Chile used to do, namely forcing funds to park themselves for a time doing nothing, in order to show their serious intentions, before these were allowed to court beautiful Chilean daughters.

But, I have also been aware that every time you stop funds from going somewhere, those funds could remain somewhere even more dangerous.

Here Paul Tucker, a former deputy governor of the Bank of England, holds that “the objective [of capital controls] should be limited: guarding against threats to stability”

But, when regulators, with their credit risk weighted capital requirements for banks decided to create great incentives for banks not sailing risky waters, and instead stay in safe havens… they completely ignored that safe-havens can become dangerously overpopulated… in a very short time.

In other words, the more you stabilize, the more you make the system brittle, so the more you really destabilize.

“A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

For sturdy long term stability we need lots of short term instability, and bank regulations which do not distort.

Sir I refer to Paul Tucker´s “Financial regulation needs principles as well as rules” June 19,

Sir, I do not care much for stability in the financial system, if that stability impedes clearing out lousy banks or bankers, or if that stability is obtained by tools that hinder growth. In fact little can assure to bring on the sturdy long term stability we need, than the existence of a lot of short term instabilities.

And that is why I do get nervous when I read Paul Tucker asking regulators to go for “systemic stability” and to assign them “an explicit goal in preserving stability”… “Financial regulation needs principles as well as rules” June 19. Forget it! The unemployed European youth that could become a lost generation need moving forward more than they need stability.

But when Tucker writes “we need a clearer framework for the regulations of markets, articulated as a coherent whole and based on clear economic and policy principles addressed to real-world vulnerabilities” there I whole heartedly agree.

Problem is though that would indicate the importance of not distorting the allocation of credit to the real economy, which is precisely what the risk-weighted capital requirements do; and that out there, in the real financial world, what is most dangerous is not what is perceived as risky but what is perceived as absolutely safe, something which would point to that the risk-weighted capital requirements for banks are weighing risks 180 degrees in the wrong direction.

PS. Today in an Op-Ed in Venezuela I published “The capital control the IMF supports” you may want to have a look at it.

Before sending watchdogs into the shadows, should we not get better ones for banks in the light?

Sir I refer to Sam Fleming and Patrick Jenkins reporting Paul Tucker saying “it would be ‘absolutely disastrous’ if the economic fragility of banks was recreated outside the mainstream banking sector”, “Watchdogs urged to look in the shadows”, October 18.

I do not agree. What we should really be scared of are for our truly bad watchdogs now also going for the shadows, after having messed up so much the banks in the light. Just as an example, in the shadows, no one would even dream of leveraging 30 to 50 times, like supervised banks were allowed to do, and did.

Sir, let me ask you one question, please!

If you were a regulator, what would you think poses the greatest dangers for us with the banks, the possibility of their excessive exposure to something rated AAA to AA and which then, ex post, turns out to be risky, or their “excessive” exposure to something rated below BB- ad which would, ex post, turns out to be even more risky than that?

I dare venture you would answer the first, since you would know there would be very few or no "excessive exposures" at all to anything rated BB-. And, if so, the banks would have collected a lot of risk premiums too... which is also capital (equity).

But the risk-weights of our current watchdogs are 20% for the first and 150% for the latter, meaning banks need, according to Basel II, only to hold 1.6% in capital against the first but 12% against the latter, which means banks are allowed to leverage 62.5 to 1 with AAA to AAs but only 8 to 1 with something rated below BB-. Explain that!

You see, the Basel Committee's risk weights measure the risks for the banks of their assets and borrowers, but not the bank risks for us. You see, our and bank regulators’ problems with banks, have absolutely nothing to do with banks and bankers getting it right, and absolutely all to do with banks and bankers getting it wrong!

Before sending watchdogs into the shadows, should we not get better ones for banks in the light?

Regulators bully banks, banks bully “The Risky”, and “The Infallible”, they just have a blast.

Sir, Brooke Masters, Claire Jones and Patrick Jenkins report “Big banks’ capital needs under microscope” November 30. 

"Regulators suspect banks have understated possible losses and need a 'material' amount of extra capital"

Of course I favor more capital in the banks, at least for their exposures to ‘The Infallible”, which are seriously under-capitalized as a result of overly generous capital requirements. 

But what regulators must remember is that while different capital requirements for different assets exists, their pressures on banks to increase their capital, will be mostly felt by those who generate the largest capital requirements, namely “The Risky”, like small business and entrepreneurs. 

Regulators bully banks, banks bully “The Risky”, the small businesses and entrepreneurs, and “The Infallible”, sovereigns and triple-A ,they just have a blast getting even more bank funds at even lower interest rates.

PS. Could these type of capital adjustments not trigger the conversion into zero clause of Barclays' recent $3bn contingent capital notes deal?   

I do not know if Paul Tucker is or not the right man for the Old Lady, but he sure does not seem the right man for Britain.

Sir, you hold that Paul Tucker is “The right man for the Old Lady”, November 16. And though I do not know much about the Old Lady I must disagree, because the last thing I feel that Britain needs at this moment, is someone who quite recently opined that “Stability comes before the good things in life”. 

It was stability searching nannies, with their silly and uncontrolled risk adverseness that made the banks to excessively increase their exposures to what was considered absolutely not risky, “The Infallible” and to doing so, not only causing many safe havens to become dangerously overpopulated but also stopping “The Risky”, like small businesses and entrepreneurs, from having access to bank credit on equal terms. 

You suggest that “the new governor should make room for intellectual free spirits, such as Andrew Haldane”. Though in some ways I have not felt Mr. Haldane yet to be free enough, I wonder why someone like him could not directly replace Sir Mervyn King.

A wicked question for the candidates for governor of Bank of England

Sir, as you write, finding a governor of all the talents required to run the Bank of England, is indeed an extraordinarily important and formidable task, September 14. 

But that is under normal circumstances. Currently though, given the difficulties with the banks, even more important and urgent than that, is to find a better regulatory paradigm. And for this purpose, I would begin by asking each candidate for governor, the following simple question: 

When do banks most need capital, when the risky turn out risky, or when the “not-risky” turn out risky?

And then follow it up with a “So?”

What the financial sector needs to be stable is a lot of shake rattle and roll.

Sir, Paul Tucker, a deputy governor of the Bank of England holds that “Stability comes before the good things in life”, April 5. Wouldn´t he, typical bank nanny, many other would hold that stability, like in the grave, comes last in life. 

Jest aside, when he writes that the Financial Policy Committee should not use bank capital weights to try to steer the supply of credit to achieve other objectives than stability, as “this is not an exercise in economic or social engineering”, I would just ask if forcing risk-taking out of our banks is not just an exercise in economic engineering? 

The more you allow the economy and the financial sector to shake rattle and roll, the more stable and productive it will be. It is when regulating busybodies interfere, like with setting the capital requirements for banks based on risk, even though theses perceived risks have already been cleared for with interest rates and others… that they doom the banks to overdose on perceived risks and to end up with dangerous obese exposures to what is or was considered as absolutely not risky, like triple-A rated securities and infallible sovereigns, and with anorexic exposures to what is officially considered as risky, like small businesses and entrepreneurs.

Wimps! Should our banks be as safe and useless as a mattress stashed away in Fort Knox?

In “Protecting finance from its demons”, April 26, you hold, we face the choice of “protecting the economy from finance” or “protecting finance from the economy”. May I ask, and what about finance helping the economy? Is that not what finance is supposed to be all about?

You quote Paul Tucker, the Bank’s deputy governor for financial stability saying that this “prevails where the financial system is sufficiently resilient that worries about bad states of the world do not affect the confidence of the system to deliver its core services to the rest of the economy”. Yeah, yeah, great sound bite, but… which are “its core services to the rest of the economy”? Mr. Tucker and his colleagues should first be clear about that, before regulating, so that our banks do not become some useless mattresses stashed away in a Fort Knox.

In the whole regulation literature produced by the global bank regulators we know as the Basel Committee, there is not one single word about the purpose of the banks, and anyone regulating something without defining its purpose, has no idea about what he is doing.

PS. The original link to this FT editorial does not appear any longer.