Current central bankers are just as lost as Greenspan and friends were lost before 2008, for exactly the same reason

Sir, Sebastian Mallaby when discussing the “alarming froth” in asset prices like shares, bonds and houses, due to “extraordinarily loose monetary policy”, but yet producing “low growth and low inflation” writes: “A … troubling echo concerns the role of regulation. If financiers seem to be taking too much risk, today’s doctrine holds that regulation should restrain them.” “Bubbly finance and low inflation cause alarm” October 8.

NO! NO! NO! Today’s regulations hold that banks should be taking on too much safety. Banks are not allowed to build up dangerous exposures to what is perceived as “risky”, like for example the below BB- rated, which has been assigned a risk weight of 150%; but banks are sure allowed to leverage immensely their capital, and the support they receive from society, with assets rated AAA to AA, risk weighted a mere 20%.

And, if the banks are big and “sophisticated” enough, then they are even allowed to use their own risk models even if, by definition, banks are always interested in minimizing their capital requirements so as to allow them to maximize their expected returns on equity.

There must be something in the air that stops expert central bankers from reaching out to their inner common sense and be able to understand how loony current bank regulations are.

The risk-weighting completely distort the allocation of bank credit to the real economy, making banks ignore their vital role in financing the “riskier” future, and having them to concentrate solely in refinancing the “safer” past. That dooms the world to gloom and doom or as they prefer to call it, to secular stagnation.

And all for nothing! Major bank crises never ever result from excessive exposures to what is ex ante perceived as risky; these always result from unexpected events or from excessive exposures to what was ex ante erroneously thought to be very safe.

@PerKurowski ©

The more qualified experts become, like the Fed’s, the more in awe will too many be of their inscrutable mumbo jumbo.

Sir, Sebastian Mallaby writes: “By toggling short-term rates, the Fed hopes to guide the more important long-term ones that matters to homebuyers and businesses, but the transmission mechanism is unstable” “Whether they raise or hold, central bankers are due a fall” September 12.

But the transmission mechanism has been also made more unstable than usual by means of very faulty bank regulations that have been imposed on banks.

Mallaby writes: “Gone are the days when the Fed was a holding pen for cronies and chancers… modern bankers have become more scientific and sophisticated [but] there is a danger in pushing this reverence too far”

Indeed, Edward Dolnick in his “The forger’s spell” wrote about Daniel Moynihan opining “There are some mistakes it takes a Ph.D. to make” and also quoted George Orwell, from “Notes on Nationalism”, with: “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.”

And the pillar of current bank regulations, the portfolio invariant credit-risk weighted capital requirements for banks, is a truly great example of the kind of mumbo-jumbo that can be produced by experts.

John Kenneth Galbraith wrote in his “Money: Whence it came, where it went” 1975: “If one is pretending to knowledge one does not have, one cannot ask for explanations to support possible objections.” And one of the great dangers of these times of ample access to information is that the number of those pretending knowledge is increasing exponentially.

@PerKurowski

Bank regulators are the most important pushers of shortsighted short-term capitalism

Sir, Sebastian Mallaby writes: “The US presidential frontrunner, the boss of McKinsey, and the chief economist of the Bank of England declare that capitalism is misfiring” and quotes Dominic Barton of McKinsey with: “the continuing pressure on public companies from financial markets to maximise short-term results”, usually at the expense of research and investment”, “Shortsighted complaints about short-term capitalism” August 7.

If companies cannot use investable resources, they should simply return those to the economy… and once there, the banks are the most important agents to recirculate those resources, to those who want to do something with these.

And that is where the real problem starts. Because now, with the current capital requirements for banks that are much higher when lending to what is perceived as risky than when lending to what is perceived as safe, regulators have de facto ordered banks to recirculate those resources to the old and existent economy, which is usually perceived as safer, and stay away from financing the future economy, which is usually perceived as riskier. And, if that is not short-termism, what is?

@PerKurowski

The mission statement for our banks as decreed by its regulators does not make any sense.

Sir, Sebastian Mallaby writes: “Banks are underwritten by taxpayers via deposit insurance as well as the too-big-to-fail safety net; they need to be reined in, and if they shrink, so be it”, “Stringent rules for hedge funds make the financial system fragile” November 17.

Indeed but, why are banks underwritten by taxpayers? What are banks supposed to deliver in return?

The current mission statement imposed by regulators on banks, by means of credit risk weighted capital requirements, seems to be that of lending more and cheaper than normal to all those perceived as “absolutely safe”, and to stay away from lending to the “risky”. Is that what we want? I don’t think so. If it were, there would be no reason for us to underwrite anything.

For example the: “We the people underwrite the banks so that these can lend more and cheaper to our "infallible" sovereigns… in the hope that doing so we don’t have to pay taxes”… sounds more like underwriting the sovereign than underwriting the banks.

No, I believe we taxpayers agreed on underwriting the banks so that these would be better equipped to take on the risks of lending to all those risky small business and entrepreneurs we all know should get credit, so that the economy grows and as a result we all are better off. That was the quid pro quo!

And Mallaby also writes: “Regulators need to remember that financial risk will not go away… there will be difficult judgments about how capital should be allocated. So there has to be a theory of where this risk can best be housed. If hedge funds are part of the answer, regulators make the world less safe by clamping down on them.”

Absolutely, if not the banks, then who is going to house the risk-taking we support and that most of the world, not understanding the regulations, still think is housed in the banks?

Bernanke might be a great inflation slayer but, in terms of job creation and bank regulations, he is in way over his head.

Sir, I refer to Sebastian Mallaby´s “Bernanke – the rebel with a cause” December 19, where he suggests Bernanke as a runner up to Mario Draghi as FT´s person of the year, also much based on the same machismo of offering to do “whatever it takes”.

That fighting unemployment might be a great cause, no one doubts, but let us not forget that the road to hell is paved with good intentions, just like the road to the current bank crisis was paved with good intentioned capital requirements for banks based on perceived risks.

To me any person who sets out to fight unemployment by injecting liquidity while there are regulations in place that will not allow that liquidity flow freely, but will channel it mostly to what is perceived as “The Infallible”, simply has no idea about what creates jobs in the long term, nor about how to regulate banks, since it is only among “The Infallible” ex-ante, that the ex-post real big disasters occur. 

In order to create a new generation of jobs you simply cannot discriminate against the access to bank credit of “The Risky”, the small and medium businesses and entrepreneurs. And in order to make our banks safer, you simply cannot ignore what “The Risky” contributes when helping to create a more sturdy economy.

And so Ben Bernanke might be a great inflation slaying central banker, but, in terms of job creation and bank regulations, unfortunately, he is in way over his head, just like Mario Draghi.

Spain, Europe, America, should not bank credit go to the most profitable projects, those that generate jobs and growth? It does not!

Sir, I read Sebastian Mallaby’s “Spain is in need of urgent repair”, November 21, and though I agree with much there said, it does not even mention the urgent need for bank credit to go to the most profitable projects, to those that generate jobs and economic growth. 

Currently and for the last decade that it does not! Overly frightened bank regulatory nannies, caring not a iota about the purpose of bank credit, decided to allow banks to hold much less capital when exposed to “The Infallible” than when to “The Risky”.  And that signifies of course that banks will be earning much higher expected risk-adjusted returns when lending to The Infallible than when lending to “The Risky”. 

As an example, if any European bank wants to lend to a small businesses or an entrepreneur it needs, according to Basel II, 8 percent in capital and can therefore leverage 12.5 to 1. But if that same European bank lent instead to a sovereign rated like Greece was recently, it could do so holding only 1.6 percent in capital, for a mind-blowing 62.5 to 1 leverage. 

If Spain, Europe, America want to have a real chance to get out of this monumental financial imbroglio they find themselves in, they need to get themselves a complete new set of bank regulators who also care about growth and jobs. 

I do not live in Europe but, if I did, I would sure be part of an Occupy the Basel Committee for Banking Supervision movement… and frankly if I lived in Spain I would be demanding some relief in the capital requirements for banks on exposures that have a special potential to create jobs for the young.

For now I will not buy Sebastian Mallaby’s risk averting potion, it might even enhance the risks.

Sir, I refer to Sebastian Mallaby’s “Economics must heed political risk” November 7. There he mentions the idea that “The familiar statistics on gross domestic product [could be] coupled with an index of financial risk-taking, so that the usual focus on growth would be tempered by a measure of the danger that growth might suddenly implode” and creating “a forecast of output divided by a measure of the risks to the forecasts; [something akin to] a Sharpe ratio for economic growth. 

Questions: Would that increase or decrease the risks? How would that help? Could that not also result into some risks becoming exaggeratedly considered? 

Quite recently, too radical academic finance regulators, believed they could control risks in banking, by setting up capital requirements based on ex-ante perceived risk of bank assets. And, what happened? Absolute disaster! 

Not only did they ignore that a bank has other purposes than just avoiding risks, but also, worse, the risk of default became excessively considered. It was taken into account when banks set their interest rates, amounts of exposure and other terms, and so to use precisely the same ex-risks to also set the capital requirements was sheer lunacy… though the responsible geniuses, seem not to have realized it yet. 

And how on earth does Mallaby suggest the IMF gives outlook projections that are not based on some simple assumptions, but based on a more diffuse concept of political risk? Would that be more accurate, or more believable? I doubt it. It is hard enough for the IMF as is. 

The US GAO Report in 2003, subtitled “Challenges Remain in IMF’s Ability to Anticipate, Prevent, and Resolve Financial Crises” stated: “Internal assessment of the Fund’s EWS (Early Warning System) models shows that they are weak predictors of actual crisis. The models’ most significant limitation is that they have high false-alarm rates. In about 80 percent of the cases where a crisis was predicted over the next 24 months, no crisis occurred. Furthermore, in about 9 percent of the cases where no crisis was predicted, there was a crisis.” From reading the report it is easy to understand that one of IMF’s problems is that what it opines, becomes a political and an economic risk too. 

Finally Mallaby seems to completely ignore the issue of retro alimentation of risk perceptions. When writing that if “eurozone authorities fail to contain sovereign and banking risk… Capital will flee from Europe’s periphery to the centre and from risky corporates to the remaining comparatively safe sovereigns”, he forgets that being the receptor of all that “”hot capital” flight, also carries enormous risks. 

Anyone should be free to manage risks the way he likes, and if someone wants to buy from an economic growth political risk ratio from Mallaby, he should feel absolutely free to do so. But, to sell us the institutionalization of a risk-neutralizing product, right now when our economies have been so neutralized by one of these, sounds to me too much like selling us magical potions on a country fair. So, no thanks!

Bank regulators should keep it simple, and not allow complexity to distract them from their real business.

Sir, as you know by now, I agree completely with the need for simplifying bank regulations, like recently suggested by Andrew Haldane, and now also strongly supported by Sebastian Mallaby, “Regulators should keep it simple”, September 5. 

But, my reasons for doing so, are not really because the issues are too complex, and the data is too hard to gather, but because the regulators have no role playing risk-managers to the world, and thereby risk adding distortions to the markets; their role is to prepare for when complex risk-management fails. 

Look at what happened! Bankers react of course to the perceived risks, by means of interest rates, amounts of exposure and terms of loans, and so, when too creative busybody regulators came along and used the same perceived risks to set their capital requirements; the whole banking sector overdosed on perceived risks… and so now we have a crisis because of obese dangerous bank exposures to what was perceived as absolutely safe, and anorexic bank exposures to what was officially perceived as “risky”, like small businesses and entrepreneurs. 

There is an economic war raging, so we need ministers and bank regulators with vision, not janitors and nannies!

To create jobs, we should start by firing the current bank regulators!

Sir, Sebastian Mallaby in “The US labour market does not work” August 22, reduces the discussion about the increasing unemployment to an issue about the government incentives for the workers to work, which is important, but leaves out completely the much more important angle of creating the new generation of jobs that will provide its own incentives to work. 

Let me just hint at one possibility. If the capital requirements for our banks were partially based on the potential of job creating ratings, instead of as now on the perceived risks of default of which have already been considered by the bankers, our small businesses and entrepreneurs might stand a chance to deliver us the new jobs we need and want. 

Frankly, one of the best ways of getting jobs is putting the current generation of bank regulators who do not understand one iota about the need for risk-taking, out of a job.

The Western world is being brought to its knees by mad bank regulators.

The Western world is the result of risk-taking in all shapes and forms… “God make us daring!”, ends one of the psalms sung in its churches. 

And so when regulators, with their capital requirements, decided to give the banks additional incentives to embrace what was perceived as “not-risky” and further avoid the “risky”, like small business and entrepreneurs, only so that banks would not fail, they stuck a dagger in the very soul of the Western world. 

And besides, they used a lousy dagger that could not stop banks from failing, because it is precisely when banks embrace too much something that is perceived as absolutely not risky, when they fail, en masse. 

And Mario Draghi is one of those Western-world-slayers regulators who do not yet even understand he is very much responsible for “L’economia castrata”. Therefore, Sebastian Mallaby’s heading “This will not be enough, Mr. Draghi”, August 8, would have been more precise stating “Nothing Mr. Draghi does, will be enough” 

Survival of Europe has to begin by rescuing the possibilities of its risk-takers to take risks, and that begins by firing the nannies in the Basel Committee and in the Financial Stability Board, and renaming the latter immediately the Financial Functionability Board.

Sometimes, when the sunrays are dangerous, finance might be better off in the shadows.

Sir, Sebastian Mallaby in “Finance must escape the shadows” August 1, writes “the explosion in securitization was partly a response to a global craving for safe assets”. The question he needs to respond to though, before drawing any sort of conclusion, is how much of that was natural market craving, and how much the result of artificially induced appetite stimulation, such as allowing banks to hold these securities, if highly rated, against very little capital. 

With regulators who allowed banks to leverage their equity more than 60 to 1 when holding AAA securities or lending to Greece, we might all have been better off if all our banks had remained in the shadows, instead of exposing themselves to that kind of dangerous type of sunrays. The shadows, if not just fraudulent, would never ever have permitted such leverages. In fact Sebastian Mallaby’s own “More Money Than God” offers, in the case of the hedge funds, a great defense for finance to sometimes remain in the shadows. 

Now when Mallaby writes “Wherever you come down on these questions what is really striking is their absence from the public square”, there I cannot but agree wholeheartedly and express the same concern. Indeed you just need to see how FT have ignored or minimized this problem… and that cannot just be because it was little censored me who alerted FT about this in hundreds of letters.

What I would look for, as a bank investor.

Sir, Sebastian Mallaby writes “Breaking up thebanks will win investor’s approval” July 18, and this is absolutely correct, provided we do not consider the costs and the dilutions that must result for those breakups to be successful… there might be a lot of alimony to be paid. 

But, as it could be of interest to some of your readers, let me expose what I would be looking for, as a bank investor. 

The first thing I would want from the bank is that it dedicates itself exclusively to lending to what is officially considered as “risky”, like small business and entrepreneurs, and for which the bank is required to have capital... which of course means that I as a shareholder will count. 

In other words, I would abhor my bank to lend to anything that is officially considered as “absolutely safe”, for 4 reasons: a.- it will probably mean they will be less careful, b.- they can do so with much less bank capital and so therefore as a shareholder I become less important, c.- it is only in what is considered as not risky that the banks can build up that type of exposures that can lead me to lose it all, and d.- if I want to invest in something perceived as “absolutely not risky”, I certainly do not need a bank for that… we can all read the credit ratings.

By the way, I suppose you know about "risk-adjusted rates of returns"

How to break up a too big to fail and too big to capitalize bank... in hours!

Sir, Sebastian Mallaby is absolutely right about that the too big to fail banks must be broken up, ”Woodrow Wilson knew how to beard behemoths” July 5.

The largest problem though is that they are also too large to capitalize, as a consequence of the current capital requirements being too small for assets perceived as not-risky, but that are turning riskier by the hour, and which have left the banks with a contingency of extraordinary needs of capital. 

As a consultant I table the following break-up plan. 

First, decide that all resulting banks will need to have 8 percent in equity against any asset from there on. (See the Ps) 

Then create four management teams and have them, in turn, round after round, select 10 billion of assets belonging to Senior Mammoth Bank, until you have four Junior Mammoth banks. 

Then force all those who hold credits against Senior Mammoth bank in excess of 250.000 dollars to convert whatever percent of these is required to cause each of the four Junior Mammoth banks to have 8 of all assets in equity. 

And then let the market work swapping assets and pricing the final value of the breakups. 

If, there is a need for it, repeat the process again, for each of the four juniors. 

Ps. Mallaby writes “If the regulators impose a simple leverage ratio, measuring a bank’s capital against its assets, then they fail to distinguish between risky assets and safe ones, perversely rewarding banks that make the diciest loans.” He is stubbornly wrong. 

The difference between risky and not risky assets is already covered for in the interest rates, the size of the exposures and other terms, and so what the current risk-weighting produces, is an amazing distortion that allows the banks to earn (leverage) more on their equity, on what is perceived as not risky. That just dooms all our banks to end up gasping for oxygen and capital on the last officially perceived safe beach… perhaps, the US Treasury or the Bundesbank.

If you want to invest in a bank then you need to know that your capital injection is the last one needed… otherwise you are better off waiting for better opportunities. The regulators postponing bank capital increases into the future, thinking they are helpful, are just making everything so much worse, for everyone. 

The confidence in the dollar and USA’s defense capabilities are as connected as they can be

Sir, when Sebastian Mallaby in “American power requires economic sacrifice”, July 7 discusses USA’s spending on defense he fails to mention one important related question namely… how much of the world’s clearly extreme confidence in the US dollar depends on the US conserving at least the appearance of omnipotence? My answer would be “much much more than what you think… this is really terrain where realpolitik reigns”. 

In this respect any defense savings that comes, for instance, from not fighting useless wars will be acceptable, but any saving that leads to a perception of a lessened military readiness of USA would become extremely expensive, as a result of the dollar being worth less, or the markets demanding higher interest rates to hold US public debt.

Just send the regulator geeks packing!

Sir, Sebastian Mallaby in “The Radicals are right to take on the banks” June 8, suggest that the capital requirements for the banks, in order to reserve against the “notoriously treacherous” calculations of the risk-weights, should hold “a further buffer against ‘model error”, aka geeks who screw it up”.

Just in case Mallaby is referring to other geeks, the geeks in this case were the regulator geeks in Basel, who started to play risk-managers for the world setting arbitrary risk-weights based on the perceived risk of default, and that had already been cleared for by the markets. They set for instance a risk-weight of only 20 percent for lending to anything that carried a AAA rating and 100% for lending to unrated small businesses, even though the latter, because they are rightly perceived as more risky, have never ever set of a bank crisis.

The previous utterly confused the whole market, specially the trusting non-geeks, and so the best thing would just to send those regulator geeks packing, and apply one single capital requirement with no risk-weighting.

What we least need is a non-transparent “Financial Stability Oversight Council”.

Sir Sebastian Mallaby´s “How to fsoc it to the hedge funds” July 16, clearly indicates that with the Financial Stability Oversight Council, a brand new source of systemic risk has been introduced, much the same when regulators empowered the credit rating agencies with a very important role in setting the capital requirements for banks.

In order to increase our chances to escape from new major disasters, we must avoid the markets having to entertain additional useless speculation about what some holed up “systemic risk experts” might be thinking. In this respect I would suggest that the FSOC is required to open a blog; and place a first post saying “We have the following list of systemically risky institutions” and then allow for the public to comment on whatever they say.

Of course, some good whistleblower protection programs for employees of possible systemically risky institutions might also be useful.