It is always dangerous when intuition overtakes understanding - The Kurowski Matrix

Sir, I refer to Lucy Kellaway’s “No need to ‘lean in’ when laziness can be just as effective”, February 23.

It mentions a clever vs. dim and lazy vs. energetic matrix designed by Helmuth von Moltke, head to the Prussian army, for the purpose of assessing the quality of officers. It produces the “clever and lazy” as the “top field commanders as they get results”.

And Kellaway compares that with how “management theorist have ruined it” by picking “the clever and lazy” CEO’s as those “in need of coaching”.

I have also used a matrix; call it the Kurowski matrix if you want in order to explain what with our banks, is really dangerous for us. My matrix is composed of what is ex ante perceived as risky vs. safe and what ex post turns out risky vs. safe.

My matrix indicates, without a shadow of a doubt, that what is really dangerous is what banks (and regulators) perceive as absolutely safe, but that ex-post turn could turn out to be very risky… quite often, precisely because perceived as “safe”, it got way too much bank credit.

And what have our current bank regulating theorists in the Basel Committee done? They decided that what is perceived ex ante as “absolutely safe” merits the lowest equity requirements. That is of course a mistake of monstrously tragic implications for our economies and our banks.

How to solve it? Not easy. With “more perceived credit risk more bank equity… less perceived credit risk less bank equity” sounding so logical, intuition manages to overtake understanding.

FT, respectfully, in reference to bank regulations, you are better off pleading ignorance.

Sir, you refer to a bank levy that motivated banks “to slim down risky balance sheets”, as something positive, “A misguided raid on the banking sector” December 5.

But what slimming down of the balance sheets do you refer to?

The shedding of the “risky assets” backed by quite reasonable bank equity, or the “absolutely safe assets” backed by little or no bank equity?

The small and well-diversified bank exposures to those perceived as “risky”, or the huge bank exposures to those perceived as “absolutely safe”?

Sir, might it be you have really no idea about what you are talking about?

As I see it, because of the distortions introduced by  their regulators, banks have been slimming down precisely what we least need them to slim down... like loans to small businesses and entrepreneurs.

And Sir, please do not get upset with me. If I held you knew what you were talking about, and so that you agreed with the shedding of “the risky” from the balance sheets of banks, that would be so much worse.

PS. Of course you are right about that plunking the banks on capital is sort of wrong as “The UK could do with having more capital”. You know that in many letters to you I have argued that, for instance, all fines levied on banks, should be paid in voting shares... as to ask for cash seems pure masochism.

If we want debt to earn the credit it merits, we need to get rid of current bank regulators.

Sir, I refer to Nigel Dodd’s, a professor at LSE, “Cast aside the moral judgment and give debt the credit it deserves”, November 1.

Unfortunately it seems that professor Dodd has not heard about the arguments against odious and stupid bank regulatory discrimination based on perceived credit risks. Had he done so, I believe his article would have taken a different form.

I say this, especially when reading his conclusion: “Credit is morally neutral. As an institution, it is neither good nor bad; and it is a grievous error to confuse creditworthiness with moral probity. Credit should be available to those who need it most. The price should be reasonable, and it should entail neither stigma nor penury.”

Indeed, professor Dodd, but one of the most important reasons for why this is not so, is the bank regulations that have been in place for about three decades; most especially since Basel II was approved in June 2004.

Those regulations order the banks to hold much more equity when lending to those perceived as “safe” than when lending to those perceived as “risky”; which of course allows banks to earn much higher risk-adjusted returns on equity when lending to the safe, than when lending to the risky.

And that means that regulators, on their own, without our approval, decided that bank credit should primarily be available to what from a credit risk point of view was perceived as “safe”, like financing house purchases, or lending to “the infallible sovereigns” or to the members of the AAAristocracy.

And which also means that anyone perceived as “risky”, would have to pay even more risk premiums, or have even less access to bank credit.

And that means denying fair access to bank credit to those we, who depend the most on the real economy, most need and want should have fair access to it, like the medium and small businesses, the entrepreneurs and the start-ups.

If we want debt to get the credit it deserves, we need to get rid of these regulators.

Why do so many ignore what stops liquidity in Europe from reaching where it is most needed?

Sir, I refer to Wolfgang Münchau “If Europe insists on sticking to rules recovery will be a distant dream” October 6.

In it he suggest that for monetary policy to work better for Europe a “portfolio balance channel: when the ECB buys five-year sovereign bonds, the sellers will try to replace those bonds with securities of similar characteristics – say five-year corporate debt. If that happens, the price of the bonds would rise, the interest rates on them would fall, and companies will find it easier to raise money.”

And I have to ask, for companies able to raise funds through bonds in Europe, are the interest rates not low enough? What about all those medium and small businesses entrepreneurs and start-ups who, because of the limited amounts they need, have no access to the bond-markets? Why should they have no fair access to bank credit only because regulators with their credit risk-weighted capital requirements for banks want to favor “the infallible”?

Why would Münchau ignore the distortions produced by bank regulations and which stops liquidity in Europe from reaching where it is most needed? Are the small risky borrows not important enough for him to care?

Janet Yellen, “normality” in the US, has it any longer anything to do with the “home of the brave”?

Sir, you hold that “Yellen charts a smooth course to normality” September 19.

Well, if normality is to have anything to do with “the home of the brave” that must mean of course getting rid of those senselessly distorting credit-risk weighted capital requirements for banks.

But, since we have not heard Yellen mentioning anything about that, I guess “normality” here means the new risk-adverse normality of the US… that which has Americans suing soccer teams for being hurt while playing or that which forces me out of the pool every hour so that they can take water quality tests… that which allows banks to earn much much higher risk adjusted returns on equity when lending to its AAAristocracy or its “infallible” government, than when lending to a so "risky” American entrepreneur.

What a pity, the world was indeed much benefitted by having the US being “the home of the brave”… let us at least hope they keep up “the land of the free” part... cross your fingers.

Would Janet Yellen be able to hear my question, if I was able to make it?

Sir, Robin Harding quotes Janet Yellen: “There are still too many people who want jobs but cannot find them, too many working part time but would prefer full-time work, and too many who are not searching for a job but would be if the labour market were stronger” “Yellen sticks to script as impatience rises”, September 18.

If I had a voice in the Federal Open MarkeT Committee, which I have not, I would have loved to have asked Janet Yellen: 

“And how many of those so affected, can we estimate to be the result of us requiring our banks to hold much much more capital, meaning equity, when they lend to medium and small businesses entrepreneurs and start ups, than what we require them to have when they lend to the Federal government or to the AAAristocracy?”

I wonder whether Janet Yellen would have even heard my question.

Prudence is ok. But prudence on top of prudence is very dangerous too!

Sir, William Rhodes holds that “Without prudence as a value we are all at risk” August 8. Absolutely, that is only as long as we are prudent when being prudent. Let me give you the mother of examples about what I mean.

Bankers already looked at credit risks when deciding interest rates, amounts of exposure and other terms of their financial assets. And they did so in a quite risk adverse way; if we remember Mark Twain’s saying “A banker lends you the umbrella when the sun shines and wants it back when it looks like it is going to rain”.

But then came the regulators and, in the name of their prudence, set also the capital requirements for banks based on the same perceived credit risks… something which suddenly allowed banks to earn much higher risk-adjusted returns on equity when lending to “The Infallible” than when lending to “The Risky”… and which of course resulted in distorting the allocation of bank credit in the real economy.

And so if we begin loading prudence on top of prudence, especially on top of the same prudence, that is when we enter into that Roosevelt territory of having nothing to fear as much as fear itself.

These nanny regulators from Basel, who basically force bankers to eat broccoli when they eat spinach and reward them with ice cream when eating chocolate cake, have now turned our economies into obese monsters, with none of the muscles provided by credits to the risky medium and small businesses entrepreneurs and start ups.

There are two entirely different kinds of risks. Investing in “risky”, and excessive investment in “safe”

Sir, Tracy Alloway reports that, as a result of “low volatility” which sets off ‘feedback loop”, “Banks warn of ‘excessive’ risk taking” August 7.

Excessive risk taking comes in two forms. Investing in something ex ante perceived as risky, and the most dangerous one, investing excessively in something, ex ante, perceived as “absolutely safe”.

It is important to make that distinction because while other investors might be running more of the first kind of risk, banks, especially because of risk-weighted capital requirements, are much more exposed to the second kind of risk.

For the society the second kind of risk is of course much more dangerous, since excessive investments in what is perceived as “absolutely safe” will take us nowhere.

No Mr. John Plender, it is the lousy risk weights corset imposed on banks by the Basel Committee which is strangling the sunlit banks.

Sir, John Plender quotes Sir Charlie Bean of the BoE arguing “if lenders do find ways of moving activities outside the regulatory perimeter, there may be times when monetary policy is the only game in town to guard against incipient financial stability risks”, “Don the corset but beware the risks in dark corners” July 1.

Hold it there Mr. Plender, “risks in dark corners”? If there are any real dangerous risks those are the ones that remain within the regulatory perimeter of the sunlit banks.

With their silly risk weighted capital requirements regulators imposed on the banks a badly designed corset which only allowed these to show off their absolutely safe, but oh so boring parts.

Where is all that excitement which bank lending to the risky medium and small businesses, to entrepreneurs and start-ups can provide the economy? It is nowhere to be seen.

On the contrary all banks can now show-off is that obesity that comes from financing “infallible sovereigns”, the housing sector and the AAAristocracy… so much fat that we are even scared they could suffer an infarct any moment soon.

What a difference it would be had banks been allowed to diversify their exposures with millions of small risky loans!

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.

For Europe to reduce the horrors of its house of debt, it needs to allow its risky-risk-takers to get going.

Sir, Wolfgang Münchau writes about a “balance sheet recession: the notion that indebted households and corporations do not care about cheap interest rates but just want to offload debt. When that happens monetary policy becomes ineffective” and then, salt on the wound, he quotes Moritz Kramer of Standards & Poor’s saying “The Europeans have barely begun to deleverage”, “Europe faces the horrors of its own house of debt” June 16.

Has Münchau ever heard that “when the going gets tough the tough get going”? If so I would ask him who he thinks might be the real tough in Europe. And I would advance that would be all those with a spirit of initiative who are willing to risk either their good name or whatever little capital they have, in order to take on a business venture.

And, if you agree, then reflect on that these are precisely those who are now locked out from having a fair access to bank credit by the sissy bank regulators and their risk-weighted capital requirements.

And so, if Europe is going to have a chance to reduce “the horrors of its own house of debt”, it must start by inducing banks to allow the risky-risk-takers of Europe, wherever you can find them, to get going. 

Given the real and urgent needs of Europe, the risk-weight on loans to “risky” medium and small businesses, entrepreneurs and start-ups, should be lower than that of their “infallible sovereigns.”

If talking about the decline of morality of bankers, let us not forget that of their regulators... and of journalists.

Sir, John Plender referring to banks and bankers holds that “The crisis shows moral capital is in secular decline” June 10. And I am not going to argue about that, especially when I fully agree with his point of the need for retreating “from the obsession with punishing corporations rather than senior executives.

But when Plender writes about “the absence of an international regulator provided banks for ample opportunity for regulatory arbitrage”; and about how “banks shaped their business to minimise regulatory capital requirements”; and about the role of “lower capital requirements on mortgage backed securities relative to those on conventional mortgages” then he really ticks me off.

Mr. Plender if we are going to talk about morality in banking, those who have most breached it are the bank regulators who, with their capital requirements favored bank lending to “the infallible”, those who already were favored by bankers with higher loans at lower interest rates, and which translated into an outright discriminating against bank lending to “the risky”, those who already were being discriminated against by bankers with higher interest rates and smaller loans. That, in and on itself, was and is a truly immoral (and stupid thing to do)… as immoral it is for journalists and editors that should know better, to keep quiet about that.

Mr. Plender, it was the bank regulators of the Basel Committee, and no one else, who with their Basel II authorized banks to buy securities against only 1.6 percent in capital, if these were AAA to AA rated… and you should know that… or you should not be writing about these issues.

More than “risk” it is “absolute safety” which was and is mispriced in the risk-weighted capital requirements for banks.

Sir, I refer to Bilal Khan´s letter “The lesson of the crisis was the mispricing of risk”, May 30, commenting on Martin Wolf´s “Disarm our doomsday system” May 28.

In it the economist and former central banker from Pakistan Khan suggests “a rethink on risk based capital requirements in general and the risk-free status of sovereign debt in particular”. 

Indeed I think he absolutely right as you should have learned from the over 1.300 letters during soon a decade that I have written to you on the subject. For some reasons, I hope not just because of petty mindedness, you decided to ignore more than 99% of these letters… thinking perhaps the theme was not important enough for FT.

As a reminder, before I got censored, in October 2004 you published a letter in which I asked “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 (sovereigns)?

But let me here argue with slightly cheek in tongue, that what was mispriced was not “risk”. The 8 percent basic capital requirement of Basel II, when lending to “the risky” medium and small businesses, entrepreneurs and start-ups was clearly more than sufficient. What was and is really mispriced is “absolute safety”, "the infallible" like the AAA-rated securities, the housing sector in Spain, the sovereign loans like to Greece and other similar.

Who is Mark Carney to talk about inequality and about undermining the basic social contract of fairness?

In fastFT we read: Inequality is “demonstratively” growing and risks undermining the basic social contract of fairness, warns Mark Carney the governor of the Bank of England. 

Who is he to warn about this? As a chairman of the Financial Stability Board, Mark Carney has for years approved risk-weighted capital requirements for banks, which discriminate against bank lending to “the risky”, those already discriminated against, precisely because they are perceived as “risky”, and favors bank lending to the “absolutely safe”, those already favored, precisely because they are perceived as “absolutely safe”.

In order to rein in inequality, bank regulations must change too.

Sir, I refer to Professor Robert H Wade’s letter “In order to rein in inequality, market need to change”, February 21. Therein Wade writes: “any serious attempt to rein in income and wealth inequality in the US, Britain and elsewhere has to change the institutional structure of markets so that they are less efficient at sluicing pre-tax income up towards the top”.

That is correct but let us not ignore that at the core of that “sluicing”, lies the number one source of damnable inequality politics, namely that which impedes equal opportunities for all. And in this respect, nothing is sluicing cheap and plentiful bank credit away from the “risky” medium and small businesses, entrepreneurs and start-ups, towards the “infallible sovereign and the AAAristocracy, than the current risk-weighted capital requirements for banks.

And that these capital requirements do by allowing banks to hold much less capital against assets deemed “safe”, than against assets deemed “risky”, which of course means that banks will earn much higher risk-adjusted returns on equity when lending to what is perceived as “safe”, than when lending to what is perceived as “risky”.

And all that odious regulatory discrimination for nothing, since never ever has a crisis of the bank system resulted from excessive exposures to what was ex ante perceived as “risky” these always have resulted from excessive exposures to what ex ante was perceived “absolutely safe” but that, ex post, turned out to be risky.

Sadly though, that regulatory discrimination seems to be of no concern whatsoever for most current “inequality fighters”… (like Professor Joseph Stiglitz)

Getting rid of stupid risk-weighted bank capital requirements, that is a dog hair to write home about.

Sir, I refer to Martin Wolf´s “Hair of a dog risks a bigger hangover for Britain” February 14.

There Wolf writes: “It is widely believed that it is safer to rely on private borrowing as a source of demand. An expansion of private borrowing to buy evermore expensive houses is deemed good, but an expansion of government borrowing to build roads or railways, is not. Privately created credit-backed money is thought sound, while government-created money is not. None of this makes much sense.”

What is he talking about? Those whose beliefs are the most relevant in these matters, the bank regulators, they very strongly believe, as they express in the risk-weights which determine the capital requirements for banks, that lending to the government, the infallible sovereign, is enormously safer when compared to lending to anything private, including houses.

Of course, that said, bank regulators also strongly believe, in that much egged on by politicians, that lending to buy houses, is enormously safer when compared to lending to any “risky” medium and small business, entrepreneurs and start-up… those who could help to create the jobs that could pay for the costs of living in the houses.

Do I mind governments building roads and railways? Of course not, but I sure do mind government and housing (and the AAAristocracy) getting much more and cheaper financing than what would ordinarily be the case, only because shortsighted and monumentally naïve regulators think that lending to be safer than lending to the “risky” real economy.

Want to really get rid of the hangover Mr. Wolf? Well then get rid of the current bank regulators, and of their dumb and distorting risk-weighted capital requirements. That is indeed a dog hair to write home about.

PS. Sir, I leave it in your hand to copy or not copy Martin Wolf with this letter, since I do not wish to receive a letter from him telling me again I write too much, or that he already knows what there is to be known, on issues such as the risk-weighted capital requirements for banks.

My New Year’s wish for FT. Wake up to what the risk-weighted capital requirements for banks really signify.

Sir, if banks could measure and price risks perfectly, then there would be no need for bank capital, as all expected losses and capital cost would be covered. But, since the measuring and pricing of risk is by nature imperfect, there will always be “unexpected losses”, and so regulators need to impose capital requirements for banks.

Unfortunately, the regulators decided that the “unexpected losses” would occur mainly in assets perceived as “risky”, probably because they confuse “unexpected” with ex-ante perceived risk, or because they only concerned themselves with individual banks; while I contend instead that the kind of “unexpected” which could threaten the stability of our whole banking system, is most likely to be found in the “absolutely safe” category.

And, requiring banks to reserve more for “unexpected losses” on “risky” than on “infallible” assets, allows banks to earn much higher risk-adjusted return on equity on the latter.

And, by allowing so, the regulators introduced a distortion that makes it impossible for banks to allocate credit efficiently in the real economy.

Tom Braithwaite ends his December 31 New Year’s “Reasons [for the banks] to be cheerful, despite the threat in the shadows” with “Even as regulators tighten the screws on the banks they seem unsure as to how much they want to police their shadow risks”.

If I could have a New Year’s wish about something that FT could do in 2014, then that would be to notice more how these regulations which discriminate based on ex ante perceived risks, really “tighten the screws” on the access to bank credit for all those ex ante perceived as riskier.

And, consequentially, to notice how that increases inequality, and hinders the banks from taking those risks that could help our young to have a future… those risks that generations before us took through the banks, so that we would all have a future. 

And all for nothing, because at the end of the day, what those regulations guarantees, is that our banks are going to end up gasping for oxygen, in some dangerously overpopulated “safe-havens”.

PS. Reducing the risk of bank failures increases, exponentially, the risk of banking system failure.

God make us daring!

Mario Draghi has no moral right to speak about discrimination among Europeans

Stefan Wagstyl reports that Mario Draghi, reacted against “nationalistic undertones” and stated “We are not German, neither French nor Spaniards, nor Italian: We are Europeans”, “Draghi hits at rate policy critics”, November 22.

Sir, Mario Draghi has no moral right to speak about discrimination among Europeans. As the chairman for many years of the Financial Stability Board, he approved of that banks need to hold much much less capital when lending to an “infallible” European than when lending to a “risky” one.

That caused of course banks to avoid lending to those were they could leverage their equity much much less, and thereby not obtain the high expected risk-adjusted returns on their equity the “infallible” offered them.

Talk about exclusion! Talk about increasing inequality gaps! Go home Mario Draghi! Europe was not built upon risk-aversion!

What Europe and America need is to return to straightforward conventional bank regulations

Sir, I refer to Wolfgang Münchau’s “Why Europe needs to try unconventional policy” November 18.

In it Münchau writes, with respect to a further cut by ECB of the interest rate that “We are in a situation of diminishing marginal returns”. And later he observes that “Since small and medium-sized companies in the eurozone are heavily reliant on bank finance, they are beyond the direct reach of a [QE]”.

Why is it so hard for some to connect the dots? Are they afraid of the picture they might find?

Those who can provide the highest marginal returns are the small and medium-sized companies, entrepreneurs and start ups, and who are in fact heavily reliant on bank finance, more so in Europe than in USA. And so the reason the returns are dropping, in Europe and in USA, is that those previously mentioned and who are in fact heavily reliant on bank finance, more so in Europe than in USA, have seen their access to bank credit seriously cut off by the risk-weighted capital requirements for banks.

Risk weighing capital requirements, which translates into banks being able to earn much much higher risk adjusted returns on their equity when lending to what is perceived as “absolutely safe” than when lending to what is perceived as risky is a loony unconventional concept that has only been around for about three decades but that really went crazy with the approval in 2004 of Basel II.

What Europe and America most need is instead return to what is really conventional, namely allowing the banks to discriminate on their own based on perceived risks, without the regulator reusing the same perceived risks for the purpose of determining the capital requirements.

Tim Harford, be very careful, regulators might wish to regulate baking more

Sir, Tim Harford ends his splendid “Why can´t banking be made more like baking” November 2, with, “I wonder if even Mr Carney will be able to make the market for pensions work like the market for croissants”.

Harford should be much more careful, because other regulators might be lurking in the shadows with desires to regulate baking. For instance they could come up with a tax on low fiber content in bread, in order to help the British people digest better, which would result in, sooner or later, in the British people only being offered fiber.

I say this because bank regulators, like Lord Turner, and like Mark Carney, the current chairman of the Financial Stability Board, considered that the only socially “useful” activity that a bank could engage in was to make certain it would not default. And, to that effect they concocted capital requirements for banks based on perceived risks.

And that regulation allows banks to earn much much higher risk adjusted returns on equity when lending to “The Infallible”, sovereigns, housing and the AAAristocracy, than when lending to “The Risky”, medium and small businesses, entrepreneurs and start-ups. And in this case we all see how, instead, all the fiber is being taken out of UK´s real economy.