ECB, the virus of pernicious “seeping pessimism” infected our banks, courtesy of the Basel Committee (and FSB)

Sir, Claire Jones writes: “Mr Peter Praet, ECB’s chief economist, sees evidence of seeping pessimism in a reluctance to invest. While businesses contend that they are operating close to full capacity, the ECB contends that resources are being vastly underused. His worry is that without a pick-up in confidence and productivity-enhancing structural reforms by governments, the region will remain plagued by anaemic growth and high unemployment. A vicious cycle will develop, with economic weakness reinforcing the negativity”, “ECB to confront ‘seeping pessimism’” December 2

Mr Praet should dare to research the pernicious pessimism with which credit risk weighted capital requirements have infected the banks.

Banks are allowed to leverage more their equity with assets perceived as safe, than with assets perceived as risky; and are therefore able to earn higher risk adjusted returns on equity when financing what is ex ante perceived as safe, than when financing what is perceived as risky. That causes banks to avoid financing the always more risky future than the, at least for a while, safer past. And if that is not the sort of pessimism that causes a vicious cycle to develop what is?

Why do I suggest that Mr. Praet needs a dose of courage look at that? His boss, Mario Draghi, as the former chair of the Financial Stability Board, shares much blame for having allowed such regulatory stupidity.

@PerKurowski ©

ECB’s Peter Praet, seemingly solidary with deep-rooted pessimists, has no moral right to speak out against pessimism.

Claire Jones reports that Peter Praet, the member of the ECB’s top-ranking executive board responsible for economics said: “what worries me the most is that you have a sort of longer-term growth pessimism filtering through to expectations, and authorities in general have to be very attentive to this”, “ECB warns of ‘pessimism’ threat” November 18.

Frankly, are not capital requirements for banks based on perceived credit risks, and which are designed to make banks avoid taking risks on the “risky” and limiting themselves to financing the “absolutely safe”, an expression of profound pessimism? Of course it is. Optimism is equivalent to let’s go for it, even if its risky. And that is what Europe needs.

But, the problem Praet might have is that it must be difficult to discuss the distortions in credit allocation that that bank regulation causes, if your boss, Mario Draghi, as the previous chairman of the Financial Stability Board, is one of the most responsible for it.

My answer to Praet would be: You have to decide whether the future of your children and grandchildren is more important than yours. It is as easy (and as hard) as that!