FT, on banking and finance who are you to believe, Francis Fukuyama or Paul Volcker?

Sir, Francis Fukuyama in “The war on liberalism” FT March 5, writes:

“Liberals understand the importance of free markets — but under the influence of economists such as Milton Friedman and the “Chicago School”, the market was worshipped and the state increasingly demonised as the enemy of economic growth and individual freedom. Advanced democracies under the spell of neoliberal ideas trimmed back welfare states and regulation, and advised developing countries to do the same under the “Washington Consensus”. Cuts to social spending and state sectors removed the buffers that protected individuals from market vagaries, leading to big increases in inequality over the past two generations.

While some of this retrenchment was justified, it was carried to extremes and led, for example, to deregulation of US financial markets in the 1980s and 1990s that destabilised them and brought on financial crises such as the subprime meltdown in 2008.”

Paul A. Volcker in his autobiography “Keeping at it” of 2018, penned together with Christine Harper, with respect to the risk weighted bank capital requirements he helped to promote and which were approved in 1988 under the name of Basel I wrote:

“The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages. Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011. The American “overall leverage” approach had a disadvantage as well in the eyes of shareholders and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return US government securities."

Sir, in reference to advising developing countries with the “Washington Consensus”, in November 2004 you kindly published a letter in which I wrote:

“Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector? 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.”

So, there are two completely different bank systems:

Before 1988, one in which banks needed to hold the same capital against all assets, credit was allocated based on risk adjusted interest rates and the market considering the bank’s portfolio, accurately or not, values its capital.

After 1988, one risk weighted capital requirement banks where credit is allocated based on risk adjusted returns on equity, something which clearly depends on how much regulators have allowed their capital to be leveraged with each asset... clearly favoring government credit, which de facto implies bureaucrats know better what to do with (taxpayers') credit than e.g., small businesses and entrepreneurs. Communism!

Sir, I am of course just small fry, not even a PhD, but, if you have to choose between describing what has happened in the financial markets since 1988 as a “deregulation”, as Fukuyama opines, or an absolute statist and politically influenced misregulation, as Volcker valiantly confesses, who do you believe?

Sir, is this topic taboo… or just a too hot potato for the “Without fear and without favour” Financial Times?

PS. In Steven Solomon’s “The Confidence Game” 1995 we read: “On September 2, 1986, the fine cutlery was laid once again at the Bank of England governor’s official residence at New Change… The occasion was an impromptu visit from Paul Volcker… When the Fed chairman sat down with Governor Robin Leigh-Pemberton and three senior BoE officials, the topic he raised was bank capital…”

@PerKurowski

Bank capital requirements or bank leverage allowances?

Martin Wolf referring to Windows of Opportunity by David Sainsbury writes that growth is “exploiting new opportunities that generate enduring advantages in high-productivity sectors and so high wages… developing something fundamentally new is often costly and risky” “Why once successful countries get left behind” February 22.

Indeed, but as Pope John Paul II, in his Apostolic Letter "Novo Millennio Ineunte" reminded us of the words of Jesus when one day, he invited the Apostles to "put out into the deep" for a catch: "Duc in altum" [and] "When they had done this, they caught a great number of fish".

Sir, “risk weighted bank capital requirements” reads like a very sophisticated tool that, when it comes to keeping our bank systems safe, is expected to assure great prudence. For instance, a 20% risk weight assigned to AAA rated asset and 100% to loans to unrated entrepreneurs and using Basel Committee’s basic 8% capital requirement, translates into 1.6% in capital for AAA rated assets and 8% for loans to unrated entrepreneurs. At first sight, that seems quite reasonable, because of course AAA rated could be five times riskier than what’s not rated.

But there is another side of that coin, that of a very costly risk-taking avoidance. It becomes much clearer if we label the former as “risk weighted bank leverage allowances”. 

Doing so we observe banks are allowed to leverage 62.5 times to one with assets rated AAA, but only 12.5 times with loans to unrated entrepreneurs. The question then is: if banks are allowed to leverage 50 times more their capital with AAA rated assets, why would any bank lend to unrated entrepreneurs, that is unless these pay much more in interest rates would in order to make up for that regulatory discrimination?

Sir, John A. Shedd wrote “A ship in harbor is safe, but that is not what ships are for” and I am sure FT agrees that applies to banks too. Unfortunately, current regulations have banks dangerously overpopulating “safe” harbors, e.g. residential mortgages, while leaving those deep waters that need to be explored in order for once successful countries not ending up left behind.

PS. Much as I already wrote 2009 in Martin Wolf's Economic Forum. 

With bank regulations biased against risk taking, the oxygen of development, emerging has been made so much more difficult for nations

Sir, I refer to Jonathan Wheatley’s report on emerging markets “Falling further behind” July 17. 

Banks used to apportion their credit between those perceived as risky, and those perceived as safe, based on their own portfolio considerations and risk adjusted interest rates. But that was before the Basel Committee’s risk weighted capital requirements.

Now banks apportion credit between those perceived as risky, and those perceived as safe, based on their own portfolio considerations, the risk adjusted interest rates, and the times bank equity can be leveraged with those risk adjusted interest rates, so as to be able to earn higher risk adjusted returns on equity.

That has leveraged whatever natural discrimination in access to bank credit there is in favor of the “safer present” against that of the riskier future. Since risk taking is the oxygen of any development, what might this have done to the emerging markets?

PS. Here is the document I presented in October 2007 at the High-level Dialogue on Financing for Developing at the United Nations, New York.

@PerKurowski

Is banking regulation unfinished business? You bet, risk weighted capital requirements are still used

Sir, I have not read Tamim Bayoumi’s “Unfinished Business” yet, so for the time being I have to go on what John Authers writes in “A fresh way to learn from the financial crash” October 2.

From what I see the book seems in much like another example of Monday morning quarterbacking. For instance when it states “In early 2007 anyone in Wall Street would have said that naive European banks were the most enthusiastic buyers for dubious debt securities” we must really ask what is meant by qualifying European banks as naïve? These were AAA rated securities, these were the type of securities that their own regulators had just in 2004 with Basel II authorized the to leverage 62.5 times to 1 their capital with.

What we had (and still have) is amazingly naïve bank regulators… who for instance still allow banks to use their own models, as if banks were not interested in generating the largest risk adjusted returns on equity, something that, because of regulators, is nowadays foremost done by minimizing capital requirements.

It also says: “the US widened the collateral that banks could use in repo transactions [this] rule encouraged them to create mortgage-based securities, and “game” rating agencies into giving them undeserved strong ratings”. But that is wrong, or at the most, just a minor cause of the disaster.

Anyone who has taken time as I did to understand what had happened (I passed exams for real estate and mortgage intermediation licenses in the US for that purpose) would be clear on the following. The profit potential in securitization is a direct function of the quality difference between what is put into the securities, and what comes out. To be able to feed the sausage with subprime mortgages yielding 11 percent, and then because of AAA ratings be able to resell these (to Europe) at 6%, was a profit opportunity to big and juicy to miss.

Finally Authers comments: “Meanwhile, models resting on assumptions disproved during the crisis are still in use. There is indeed unfinished business.” Indeed, the risk weighted capital requirements are still used.

Sir, the first of about 50 letters I have written to John Authers since July 2007, more than a decade ago, ended with: “This all is lunacy and we are being set up for even bigger disasters and it must end, before it ends us. We need urgently to punish the regulators, at least on the count of being very naive.”

But clearly someone in FT did not want to hear my arguments, or at least not these coming from me.

@Per Kurowski

Bank regulators need Business Education… perhaps Finance professors too… if not, they sure need History Education

Sir I refer to your special magazine “FT: Business Education”, September 11, 2017.

If you were a banker, of that type that until 1988 (Basel I) existed for about 600 years, you would, in order to obtain the highest risk adjusted return on equity, and while keeping a close eye on your whole portfolio, lend money to whoever offered you the highest risk adjusted interest rate… of course as long as all your other costs were covered.

If for instance you had to hold 10% capital, perhaps so that your depositors or regulators felt safe, then your expected return of equity would be the average of those net risk adjusted interest rates times 10 (100%/10%)… this before taxes of course.

If an SME or an entrepreneur offered the bank a perceived risk adjusted net margin of 1.25% while an AAA rated only offered 0.75%, the banker would in that case naturally prefer giving the riskier borrower the loan... though probably it would be a much smaller loan.

Sir, do you agree with that? No? Why?

Because when bank regulators introduced risk adjusted equity requirements, they completely changed banking. Since then the risk adjusted net margins borrowers offered, have to be multiplied, by the times these margins can be leveraged on equity.

For instance Basel II, 2004, with a basic 8% bank capital requirement, assigned a risk weight of 20% to any private sector exposure rated AAA, which meant banks needed to hold 1.6% (8%*20%) against these exposures, which meant they could leverage equity 62.5 times (100%/1.6%).

That same Basel II assigned to for instance an unrated SME or entrepreneur, a risk weight of 100%, meaning a capital requirement of 8%, meaning banks could leverage only 12.5 times their equity with this type of loans.

So now what happened? The AAA’s 0.75% net risk adjusted margin offer would become almost a 47% expected risk adjusted return on equity, while the riskier’s 1.25% would only represent about a 16% expected risk adjusted return on equity. Therefore the bank would now by much prefer the AAA rated… Bye-bye SMEs and entrepreneurs.

To earn the highest perceived risk adjusted ROE on the safest, must clearly be a wet dream come true for most bankers; well topped up by the fact that requiring so little capital from their shareholders when lending to the “safe”, left much more profits over for their bonuses.

Did not regulators know their risk weighted capital requirements would distort in this way the allocation of bank credit to the real economy? Seemingly not and that is why I suggest they should go and get some basic business education… after the professors who did not see this have also gone back to the most basic basics.

That because, if regulators did know about the distortion they would cause, then they have no idea of history… or worse, they are financial terrorists. That because no major bank crisis have never ever resulted from excessive exposures to what is ex ante perceived as risky; these have always, no exceptions, resulted from excessive exposures to what was ex ante perceived, and never ever from what was ex ante perceived as risky.

Sir, come to think of it you and most of your collaborators, perhaps all, should also go back to a business education 101.

@PerKurowski

Not just China needs to allocate capital to the more productive, dynamic and employment-generating parts of the economy

Sir, Eswar Prasad, a professor at Cornell University and senior fellow at the Brookings Institution, writes: “Fixing the financial system is not just about managing risks and avoiding disaster, but also about allocating capital to the more productive, dynamic and employment-generating parts of the economy.”, “How to fix China’s unstable financial system” July 19.

How do you do that, not only in China but everywhere, with bank regulators who do not care one iota about the efficient allocation of credit to the real economy, but only about banks avoiding what is perceived as risky?

Especially since 2004’s Basel II, banks have been allowed to multiply their capital with many times more the net risk-adjusted margins when investing in something “safe”, like the past and the present, like sovereigns, the AAArisktocracy and residential houses, than when investing in something “riskier”, like the future, like SMEs and entrepreneurs.

That has completely distorted credit allocation and for no particularly good reason, since there is never ever major bank crisis that result from excessive exposures to something ex ante perceived as risky when placed on banks’ balance sheets.

@PerKurowski

When facts do not make those who should be the most curious curious, like FT journalists, what are we to do?

Sir, Tim Harford discusses “agnotology”, a term coined by Robert Proctor, a historian at Stanford University, which refers to the study of how ignorance is deliberately produced. “The problem with FACTS”, March 10.

Harford writes: “Facts rarely stand up for themselves – they need someone to make us care about them, to make us curious… Mainstream journalists, too, are starting to embrace the idea that lies or errors should be prominently identified… [but] We journalists and policy wonks can’t force anyone to pay attention to the facts... Curiosity is the seed from which sensible democratic decisions can grow.”

Indeed but here follows two facts about which I have written to the Financial Times more than 2.500 letters over the last decade but that has not been able to raise its curiosity or perhaps belong to the group of the facts that shall not be checked.

First fact: Regulators, with their Basel II of 2004, for the purpose of setting capital requirements for banks, assigned a risk weight of 20% to what was rated AAA to AA and one of 150% to what carried a below BB-rating.

A below BB-rating ex ante indicates a very high risk, something which precisely make clients so rated to signify no risk at all for the banking system.

What is rated AAA to AA ex ante indicates a very low risk, something that precisely induces banks to generate those excessive exposures capable of causing a major crisis, if ex post it turns out to really be very risky.

Second fact: By allowing for different capital requirements, the regulators allow banks to leverage differently their capital with different assets. That produces expected risk adjusted returns on equity that are quite different from what would have been the case in the absence of such regulations; something which clearly must distort the allocation of bank credit to the real economy.

Harford mentions the presence of “motivated reasoning” distraction, and lies can help to cloud or even make impossible the understanding of truths. In the case of bank regulations and the 2007-08 crisis, two that stand out.

Motivated reasoning: we do not want banks to fail. Just the phrase “risk weighted capital requirements for banks”, if compared to “not risk weighted capital requirements for banks”, indicates something so much more prudent… and therefore likable. It is hard for most to understand that risk weighing can in essence mean nothing if the risk weights are wrong, as they sometimes are; and also that since the clearing for risks already occurs by means of sizes of exposures and risk premiums, the doubling down on the same perceptions, now in the capital, makes it impossible to adjust for risks… even if the risks are ex ante perfectly perceived.

Distraction: derivatives. Does it not sound so delightfully sophisticated when we speak of the dangers of derivatives? How can anyone dare questioning the expertise of someone capable of that?

A qualified lie: deregulation of banks. Banks were effectively somewhat deregulated with the repeal of the Glass-Steagall Act in 1998. But that “deregulation” was really insignificant when compared to the imposition of such intrusive and distortive regulation as the risk weighted capital requirements for banks. Never ever have banks been so miss-regulated as now.

Harford writes: “Agnotology has never been more important” “We live in a golden age of ignorance,” says Proctor today. “And Trump and Brexit are part of that.”. To this I would have to add, Bank Regulations!

So Mr Undercover Economist, and you too Sir, why not begin by some fact checking on your own fact avoidance.

PS: Harford quotes Molière “A learned fool is more foolish than an ignorant one.” George Orwell also wrote in “Notes on Nationalism”: “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” 

And according to Edward Dolnick, Francis Fukuyama has heard Daniel Moynihan opining: “There are some mistakes it takes a Ph.D. to make”

@PerKurowski

As banks “pressure employees to hawk products”, regulators pressure banks to odiously discriminate against the risky

Sir, John Gapper writes about “the intense pressure Wells Fargo placed on employees to hawk products” “Wells Fargo reaches the end of its journey” September 22.

But, by means of the risk weighted capital requirements for banks, regulators have placed much pressure on banks to lend to what was perceived, decreed or concocted as safe; because that’s were they could leverage the most their equity; because that’s where they could earn the highest expected risk adjusted returns of equity; and so banks end up with excessive exposures to residential home financing, AAA rated securities, loans to sovereigns like Greece and other such fancy safe stuff.

That created also a de facto immoral regulatory discrimination against the access to bank credit of those who ex ante are perceived as “risky”, like SMEs and entrepreneurs. I place quotation marks around risky because in fact, by being perceived as that, they are never as dangerous to the bank system than what is perceived as “safe”.

Incentives are temptations, aren’t they? 

@PerKurowski

When will the Basel Committee define the purpose of our banks, and regulate accordingly?

Sir, Jim Brunsden writes of a “letter from the banking associations [that] calls on the Basel Committee on Banking Supervision to scrap plans for a floor limiting how far a bank can decrease its capital requirements by using internal risk models. “Lenders step up their fight against global capital reform.” September 2.

My immediate reaction could be to ask the bankers: When will you return to earning your returns on equity by doing banking and not by minimizing equity?

The current confusions about bank regulations all begin with that mindboggling fact that the regulator has not defined the purpose of banks. “A ship in harbor is safe, but that is not what ships are for.” John A Shedd, 1850-1926

When will the regulator understand that banks must finance the “riskier” future and not just refinance the “safer” past?

When will the regulator understand that what’s rated AAA is more dangerous to banks than what’s rated below BB-?

When will the regulator understand Voltaire’s “May God defend me from my friends. I can defend myself from my enemies”

When will the regulator understand that risk weighted capital requirements distorts the allocation of credit?

When will the regulator understand the full monstrosity of its risk weighted capital requirements for banks?

PS. Sir, from your steadfast silence on these issues I can only deduct your “Without fear and without favour” is pure BS. You are clearly beholden to banks and their regulators, caring very little for the real economy on Main Street.

@PerKurowski ©

Regulators tell banks “Occupy what’s safe”; and so expel widows, orphans and pension funds, to handle what’s risky

Sir, Brooke Masters reports on how the Security Exchange Commission is making sure that private equity industry duly manages conflicts of interest and treats its clients fairly. “SEC enforcers must keep bearing down on private equity” August 27.

But Masters also writes: “Historically, PE clients have been highly sophisticated. So they are either well placed to decipher complex investment contracts or rich enough not to quibble about extra fees. But that is changing. Public pension funds are shifting more and more of their money into private equity as they chase higher yields. Pension fund managers are far less experienced with the sector.”

Why did this happen? When regulators, with their risk weighted capital requirements told banks they could leverage more, and therefore obtain higher risk-adjusted returns on equity with assets perceived as safe than with assets perceived as risky, they made banks occupy that area in which, without leverage, widows, orphans and pension funds used to dwell.

So see what they done. By trying to make banks safer they clearly made life for widows, orphans and pension funds much riskier. That is what happens when regulators regulate with no concern about the impact their regulations will have.

And the saddest part of it all is that it is all for nothing. Major bank crisis are never the result of excessive exposures to what is perceived as risky, but always the result of unexpected events or excessive leveraged exposures to what was ex ante perceived as safe, but that ex post turned out not to be.

PS. For the sake of our children and future pensioners, I pray we can reverse this, and that there are still some bankers out there who know how to be bankers, and not only how to be equity minimizers. 

@PerKurowski ©

Italy has no chance of solving its bank and economy problems, if it does not understand the regulatory distortions

Sir, Sarah Gordon writes: “Thousands of small and medium-sized companies have gone under, taking with them the bank loans on which they depended, as well as demand for lending”, “The spreading pain of Italy’s bank saga”, August 11.

First let us make on thing very clear, those thousand and SMEs that have gone under more than they were expected to go under, did so as a result of the 2007-08 crisis. They had not one iota to do with causing the crisis.

And so let me explain it again, for the umpteenth time: Before current bank regulations, pre 1988, pre Basel Committee, no one made a distinction between a Lira or an Euro in capital invested in something perceived as safe, or in something perceived as risky.

But then the Basel Committee came along and decided that, if banks invested in something perceived, decreed or concocted as safe, then a unit of their capital (equity) could be leveraged more than 60 to 1, while, if invested in for instance some loans to SMEs and entrepreneurs, that same unit could only be leveraged 12.5 to 1.

And so of course that introduced a very serious distortion of the allocation of bank credit to the real economy, which persists until today, all because our besserwisser bank regulators, insist on that they are besserwissers.

If Italy does not allow its SMEs or entrepreneurs to have fair access to bank credit then it is doomed to stagnation… that is unless La Banca Sommersa comes to its rescue.

@PerKurowski ©

We need banks that profit by taking reasoned risks; and that have capital to cover for a good chunk of the unexpected.

Sir, I refer to Dan McCrum’s and Thomas Hale’s “Stagnation saps enthusiasm for Europe’s banks” August 6.

It includes contradictory statements like “the financial architecture appears solid” and “most people accept there is enough capital in the system now. Not just investors, but regulators as well” with that of “a rounding error of just 1 per cent on European asset values would wipe out More than a third of European bank equity, the all-important number determining ability to absorb losses.”

The ex ante perceived risk-weighted capital requirements for banks has introduced total confusion into banking. Not only with respect of these having reasonable equity, but also with respect to their business. Over the last decades, banks have looked to maximize their returns on equity much more by reducing the capital required, than by analyzing gross risk/reward ratios as such. And that must come to an end.

First EBA’s recent stress tested European banks indicated that they were leveraged almost 24 to 1, and that makes them clearly undercapitalized, not so much in terms of the expected, but in terms of the unexpected, which is what bank equity should be there for.

And secondly, we urgently need banks to assume their more traditional role of earning their profits by taking reasoned risks in the real economy… that economy in which a unit of capital is a unit of capital, independently of it being invested in something safe or something risky.

To avoid risks, especially when currency does not carry negative interest rates, a mattress seems to suffice. And for the society (taxpayers) to support banks that make their profits by avoiding taking risks, and not by helping it to build future, is stupid.

Some tweet sized conclusions:

The last decades banks have earned huge returns on equity mostly by minimizing equity, that has to stop.

European banks are severely undercapitalized, not that much in terms of the expected, but in terms of the unexpected.

Banking should be about helping society to take risks, not avoiding these. For that mattresses suffice.

Bankers capable of reasoned audacity are magnificent. Equity reducing bankers, are, at best, absolutely tedious.

Just looking at their dumb risk-weighted capital requirements, bank regulators should be disgraced by society.

@PerKurowski ©

IIF confesses the distortions in the allocation of bank credit caused by Basel’s risk weighted capital requirements

Sir, Laura Noonan writes “The Institute of International Finance has denounced regulators’ proposals to give banks less freedom to use their own models to decide how much capital they need to support their loan books.”, “Risk warning over change to lenders’ safety measures”, June 7. It contains the following fascinating information.

“A low quality borrower with a risky BB- credit rating. Right now…generates a return on capital of just 7.7 per cent today. At the other end of the credit spectrum, a bank’s return on equity for an A+ rated borrower could fall from 13.9 percent today”.

So here IIF confesses that because of the risk weighted capital requirements, an A+ rated borrower (50% risk weight) currently generates about twice the return on equity for the bank than a BB- rated one (100% risk weight). Sir, do you think banks in such a case would lend to those BB- rated? Of course not! But are there not many BB- rated who should have access to bank credit, even if in small amounts? Of course there are. Can’t they get credit? Of course they can, but only if they pay much higher interest rates, so as to overcome the regulatory discrimination against them. 

Sir, that bankers, those who are supposed to be able to evaluate credit risks, should now earn a higher risk-adjusted return on equity on what is perceived as safe than on what is perceived as risky, sounds to me like the regulators have made bankers’ wet dreams come true.

And IFF then states that “a bank using the new rules could earn a return on capital of 11.4 percent on a low quality borrower with a risky BB- credit rating [but], a bank’s return on equity for an A+ rated borrower could fall to 4.6 percent under the new regime.”

Does that mean the A+ rated borrowers would not have access to bank credit any more? Of course not! It is only that they would have to pay slightly higher interest rates since they would not count with as much regulatory subsidies.

Sir, I have soon written a thousand of letters to you all in FT on how the risk weighted capital requirements dangerously distort the allocation of bank credit to the real economy. You have ignored all of these. Now here you are getting a clear and loud confirmation of that distortion from the horse’s mouth, will you still ignore it?

How should it be? Those rated A+ and those rated BB-, and all other, should compete on equal footing for bank credit, by means of offering different risk premiums, and the bank should assign the credit in an appropriate amount to whom has offered to provide it with the highest risk adjusted return on equity. And that can only happen if the capital required for lending to an A+ or to a BB- is exactly the same.

PS. An “appropriate amount” is that which guarantees a good diversification of the banks’ portfolios. The current risk weighted capital requirements are, to top it up, portfolio invariant.

@PerKurowski ©

FT, more bank credit to “safer” grown-up trees, and less to “riskier” green-shoots, must result in lower productivity

Sir, you write “There can be few problems that are so important and yet command so little consensus about their source and solution as the general slide in productivity growth across the world’s economies”, “The puzzle that baffles the world’s economies”, May 30.

And yet you refuse to echo my concerns that the risk-weighted capital requirements for banks, which allow banks to earn higher risk adjusted returns on equity on what is ex ante perceived, decreed or concocted as safe, than on what is perceived risky, creates serious distortions in the allocation of bank credit.

I have I written at least on 100 letters to you on that issue? How many have you ignored? All!

@PerKurowski ©

Martin Wolf and I have three fundamental differences in opinions. Sir, dare decide, without favour, should I shut up?

Week after week I read Martin Wolf articles, and week after week, though I have clearly been blacklisted, I write letters to you commenting on these. Most of these letters refer to three issues on which I am obsessive, I confess, but on which Martin Wolf is equally obsessed, ignoring these, though he has not confessed. 

I insist in doing so because I truly believe these are issues of utter importance to the well being of my children and grandchildren, and indeed for the whole western society with its Judeo-Christian traditions to which I belong.

First: I know that, allowing banks to leverage equity differently with different assets depending on perceived credit risk, does seriously distort the allocation of bank credit to the real economy. As it permits banks to obtain higher expected risk adjusted returns on what is perceived safe than on what is perceived risky, it introduces a dangerous credit risk aversion that will do no one any good. Risk taking is the oxygen of any development.

Martin Wolf does not think so. In fact he has told me that even if, hypothetically, there were distortions, it is the responsibility of bankers to ignore these, to forget about maximizing shareholder’s returns and to do what is right for the society. Sir, sincerely, I truly doubt any banks and bankers doing so would survive for long in a competitive environment.

Second, Martin Wolf believes, like current bank regulators do, that those perceived as risky are far more dangerous to the banking system than those perceived as safe; and hence Basel II’s 150% risk weight for those rated below BB- and meager 20% risk weight for those rated AAA to AA, do seem logical to them. 

I on the contrary, having walked a lot on Main Street, know that what is perceived as safe, poses intrinsically a much larger threat to the banking system, than what is perceived as risky. To me the regulators are behaving like nannies telling the children to beware of those ugly and foul smelling who approaches them, but to embrace the nice looking gentleman who offers them candy.

Third: Basel I of 1988, by assigning a zero risk weight to sovereigns and a 100 percent risk weight to the citizens upon which the sovereign strength depends, introduced by means of bank regulations, through the back door, a for me unforgivable and hateful statism. Martin Wolf has not voiced any serious objection to the concept of an infallible monarch.

Sir, so what is your opinion, should I stop sending you letters commenting on Martin Wolf’s articles? Until now he has not given me one valid reason for me to believe I am wrong and he is right.

For instance this week Martin Wolf hits down (again) on Germany’s policies versus the Eurozone. “Germany is the eurozone’s biggest problem” May 11.

Had the regulatory distortions I complain about been removed, I might very well have agreed a lot with him. But while that has not happened, I feel sure that any German ECB or other Eurozone stimuli will be wasted, and might very well set Europe up to something worse. Frankly, when push comes to shove, it is always better to build solutions around at least someone being strong, and not based on a by all shared utter weakness. 

PS. Here the most recent aide memoire on what is wrong with Basel Committee’sregulations.

@PerKurowski ©

The timidity of bankers is selective, and the result of the very dumb selective timidity of the regulators

Sir, Giles Wilkes writes: “Finance has become … more timid since 2009” “Short View” May 5.

Why since 2009? And “timid” is also only applicable to staying away from what is perceived as risky, because the wanting to leverage as much as possible with what is perceived, decreed or concocted as safe, is still very well alive and kicking.

The banks were instructed to be selectively timid, ever since the risk weighted capital requirements for banks were introduced. With those regulators allowed banks to earn higher risk adjusted returns on equity when financing what was deemed safe” than when financing the “risky”. And so therefore banks were given new incentives to timidly stay away even more than usual of what they already stayed away much from.

Basel II of June 2004 set the risk weight for an AAA rated asset at 20%, and for a below BB- asset at 150%. That in essence was like a nanny telling the kids to stay away from ugly and foul smelling individuals, and embrace much more those nice looking gentlemen who offer them candy.

Yes Sir, that is the kind of bank regulators we have. Holy moly!

And Sir, seemingly, you don’t mind them. Holy moly!

PS. Here again is an aide memoire on other regulatory stupidities.

@PerKurowski ©

Is there something like a “not with the banks in my backyard” syndrome that blinds?

Sir, Tim Harford discusses “How to manage industrial decline” April 23.

In my mind the golden rule is that the sooner you find its substitutes, the less you have to go through the convulsions of managing it.

But how on earth do we explore new opportunities when bank regulators have decided to deny explorers like SMEs and entrepreneurs fair access to bank credit, just on account that these are risky?

It is truly hard for me to understand how who has written “Adapt… why success always starts with failure” is not up in arms against the risk weighted capital requirements for banks.

Could it be some “not with my banks in my backyard” syndrome? NWMBIMBY?

As for the “give them money… a topic for next week” I sure hope to see something about a Universal Basic Income scheme… I mean we have more than enough redistribution profiteers.

@PerKurowski ©

The crash was not caused by casino capitalism but by bank regulators who manipulated the odds at the casino

Sir, Simon Schama writes of “a crash engineered by the worst excesses of casino capitalism”, “New revolutionaries generate much heat but little action” April 23.

That “casino” reference is so utterly wrong!

In roulette, absolutely all bets have the exact same expected value, and if not so, there would be no casinos in which to play roulette.

In the same way all bank credits used to have the same expected risk adjusted return. That is, before regulators came up with the risk-weighted capital requirements for banks. By allowing banks to leverage their equity more with what was perceived, decreed or concocted as safe, than with what was perceived as risky, suddenly banks made higher expected risk adjusted profits with The Safe than with The Risky.

It was that manipulation of the odds, which promoted the “safe” like AAA rated securities, sovereigns like Greece and mortgages, that caused the crisis 2007-08.

And it is that manipulation of the odds, which hinders the access to bank credit of the risky like SMEs and entrepreneurs that blocks the road for an effective recovery.

All other manipulations like that of Libor put together have not caused even a fraction of the damages the full of hubris and besserwisser manipulating regulators have caused.

@PerKurowski ©

The World Bank should object IMF’s support of bank regulations that hinders development and promotes inequality

 Sir, you opine that “Crisis lending should be the job of the International Monetary Fund” “Mission creep must stop at the World Bank”, April 20. 

I am not familiar with the cases of Nigeria and Papua New Guinea, but the way you argue it, you most certainly seem to have a point. That said I am not sure that China’s bilateral lending and the new Asian Infrastructure Investment Bank should be taken as direct substitutes for the World Bank in providing development finance. 

But we can also argue that IMF, by supporting the very bad bank regulations coming out of the Basel Committee, has also overstepped its boundary. Let me explain. 

In order to make banks safer, regulators now require banks to hold more capital when lending to The Risky than when lending to The Safe. 

That means that banks will be able to leverage more their equity when lending to The Risky than when lending to The Safe. 

That means that banks will be able to earn higher expected risk adjusted returns on equity when lending to The Risky than when lending to The Safe. 

That distorts the allocation of bank credit to the real economy, favoring with too much credit at too generous conditions The Safe, and causing The Risky to have too little and too expensive access to bank credit. 

That perceived, decreed or concocted as “safe” is sovereigns, residential housing and the AAArisktocracy. That perceived as “risky” are unrated citizens, SMEs and entrepreneurs. 

And since risk-taking and the efficient allocation of credit are essential elements for development, IMF is helping to make the World Bank’s mission of combating poverty, that much harder. 

And one day the IMF will also discover those regulations are bad for its own mission of promoting financial stability. The 2007-08 crisis was entirely caused by The Safe. 

And by denying “The Risky” a fair access to the opportunities that bank credit can provide, those regulations also promote inequality. 

Sir you also write that the World Bank “should switch much more of its energy towards plugging the real holes in development, the provision of ‘global public goods’”. 

Yes, and speaking out loudly against these truly lousy bank regulations is long overdue. 

In March 2003, as an Executive Director of the World Bank I formally stated: “The sole chance the world has of avoiding the risk that Bank Regulators in Basel, accounting standard boards, and credit-rating agencies will introduce serious and fatal systemic risks into the world, is by having an entity like the World Bank stand up to them—instead of rather fatalistically accepting their dictates and duly harmonizing with the International Monetary Fund.” 

And in April 2003, also as an ED, I argued: “In the Basel Committee’s drive to impose more supervision and reduce vulnerabilities, there is a clear need for an external observer of stature to assure that there is an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth. The World Bank seems to be the only suitable existing organization to assume such a role." 

I am still waiting! 

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

God make us daring!

The risk weighted capital requirements for banks, put the “Minsky moments” on steroids.

Sir, you write “A period of stability leads to rising investment, financed by borrowing, which drives up asset prices until cash flows generated by those assets can no longer support the debt taken on to buy them. Eventually there is what has been dubbed the “Minsky moment”: a dash for the exits as asset prices plunge. After the bubble bursts, the debt burden remains and can depress activity for a long time. “The challenge posed by oil’s ‘Minsky moment’” March 29.

But the regulators, with Basel II, told banks “If you think that something is safe then you can hold less capital against it”. And, in their Standardized Approach to Credit Risk, the regulators allocated the basic capital requirement of 8 percent according to the following risk weights: zero percent for loans to AAA-rated sovereigns; 20 percent on loans to the AAArisktocracy, 35 percent risk weight on the finance of residential mortgages; and 100 percent risk weight on exposures to unrated citizens.

And that translated into banks could leverage equity unlimited times when lending to AAA rated sovereigns; 62.5 times to 1 when lending to the AAArisktocracy, 35.7 times when financing residential housing 35.7, and only 12.5 times to 1 when lending to the unrated citizens.

And of course that allowed banks to earn different risk adjusted returns on equity not based on what the market offered, but much more based on what the regulators dictated.

And since “Minsky moments” never occur in areas ex ante perceived as risky but always in what is perceived as safe, that is of course equivalent to putting the “Minsky moments” on steroids.

You also end with: “As Minsky argued, booms and busts are endemic to capitalism. Sensible policy strives not to abolish the cycle but to mitigate its effects.”

But the risk weighted capital requirements signifies banks will have especially little capital precisely when the busts occur. And that has nothing to do with “mitigating” its effects, just the opposite.

Sir, I must have written to you and your colleagues well over 2.000 letters trying to explain the dangerous distortions caused by the risk-weighted capital requirements for banks, but apparently it has not yet been understood.

Sir, between us in petit committee, although I understand that it probably has to do with you wanting to sound sophisticated, I do not think you have earned the right of referring to Minsky into your editorials.

PS. This is not a critique directed solely to you Sir. For example, out there, the less many seem to understand what is really going on with our banks, the more they express concerns about “derivatives”, only because that word sounds so delightfully sophisticated.