Imposing on banks risk aversion more suitable to older than younger, regulators violated Edmund Burke’s holy intergenerational social contract

Vanessa Houlder when writing about Richard Thaler’s ‘nudge’ theory and how our hatred of losses affects risk taking mentions: “Investing in a portfolio tilted towards equities makes sense for the young, although — given that share prices can drop dramatically — the proportion should be reduced as people near retirement, according to Thaler.” “Be lazy, the first rule of investing” December 23.

Sir, that refers precisely to something on which I have written to you hundred of letters over the years.

Regulators, with their risk-weighted capital requirements, by allowing banks to hold less capital against what is perceived as “safe”, like mortgages, than against what is perceived as “risky”, like loans to entrepreneurs, they allow banks to earn higher risk adjusted returns on what’s perceived safe than on what’s perceived risky.

With it regulators top up the natural risk aversion of bankers with their own one, and by there doom banks to primarily work in the interest of the older and against those of the young. That, phrased in Edmund Burke’s terms, is a shameful breach of the holy intergenerational social contract that should guide our lives. How our society has managed to turn a blind eye on this makes me, a grandfather, very disappointed and sad.

But all that risk aversion is also so totally useless. Major bank crisis never ever result from excessive exposures to what has ex ante been perceived as risky; but always because of unexpected events or excessive exposures to what was perceived, decreed or concocted as safe but then turned out to be risky, like AAA rated securities backed by mortgages awarded to the subprime sector and loans to sovereigns like Greece.

PS. It would be great if Vanessa Houlder could ask Richard Thaler why he thinks regulators want banks to hold more capital against what perceived as risky is made innocous than against what is perceived as safe is therefore intrinsically more dangerous? My own explanation is that they mistook the ex ante perceived risk of bank assets for being the ex post risks for banks.

@PerKurowski

Beware, nudging, like that done by bank regulators, can have very dangerous unexpected consequences

Sir, Tim Harford writes: “Professor Richard Thaler’s catch-all advice: whether you’re a business or a government, if you want people to do something, make it easy.”, “Thaler’s Nobel is a well-deserved nudge for behavioural economics” October 10.

Yes “making it easy” is great advice, but it is only truly helpful if what is made easier is really good for you… otherwise it could be outright dangerous… like nudging someone over a cliff.

Regulators, caring little or nothing for the credit allocation function of banks, foremost wanted these to avoid risks. To that effect they allowed banks to hold less capital against what’s perceived or decreed safe than against what’s perceived risky.

With that regulators allowed banks to easily obtain higher risk-adjusted returns on equity lending to The Safe than when lending to The Risky.

With that regulators dangerously nudged our banks into too much exposure to The Safe and too little to The Risky.

The result was a bank crisis because of excessive exposure to The Safe: sovereigns, AAArisktocracy and mortgages; and economic doldrums because of insufficient credit to The Risky: SMEs and entrepreneurs.

Sir, and so here we are, without most not even knowing about the odious regulatory nudging that was as is being done.

What rules do we have to impose on nudging to make sure it is done right?

https://teawithft.blogspot.com/2008/11/at-least-listen-to-joker-before-giving.html

https://teawithft.blogspot.com/2008/08/how-do-you-nudge-financial-times.html

https://subprimeregulations.blogspot.com/2015/12/professor-richard-thaler-do-not-give.html

@PerKurowski

At least listen to the Joker before giving more powers to the schemers

Sir, Richard Thaler and Cass Sunstein in “Human frailty caused this crisis”, November 12, hold that “regulators need to help people manage complexity and temptations” but ignore the frailty of the regulators and the dangers of all their regulatory temptations.

I can hear now the free market answering a confounded citizen by describing the bank regulators with the same words the Joker used in the movie The Dark Knight, 2008. “You know, they're schemers. Schemers trying to control their worlds. I'm not a schemer. I try to show the schemers how pathetic their attempts to control things really are. So, when I say that … was nothing personal, you know that I'm telling the truth. It's the schemers that put you where you are. I just did what I do best. I took your little plan and I turned it on itself. Look what I did to this city with a few…” collateralized debt obligations.

When I think of a small group of bureaucratic finance nerds in Basel thinking themselves capable of exorcizing risks out of banking, for ever, by cooking up a formula of minimum capital requirements for banks based on some vaguely defined risks of default; and thereafter creating a risk information oligopoly by empowering the credit rating agencies and which was all doomed, sooner or later, to guide the world over a precipice of systemic risks; like what happened with the lousily awarded mortgages to the subprime sector, I cannot but feel deep concern when I hear about giving even more advanced powers to the schemers.

PS. Here is the current summary of why I know the risk weighted capital requirements for banks, is utter dangerous nonsense.

How do you nudge the Financial Times?

After having tried it and failed miserably I would love to ask Richard Thaler or Cass Sunstein about how to go about to nudge the Financial Times… firmly or gently? Any special tips?