FT, I have two questions and one observation to make about the securitisation and privatisation of student debt in UK.

Sir, Thomas Hale writes that after “the biggest privatisation of student loans…the first of a series of anticipated transactions that stand to create a market for graduate debt in the UK, the parliament’s spending watchdog concluded the government received too little in return for what it gave up”. “Spending watchdog criticises student loans privatisation” November 22.

The Department for Education, DfE, answered it was “confident that we achieved value for money for taxpayers… as Student loans are designed so that borrowers only repay when they can afford to [which] only means many students will never fully pay back their loans”

I have two questions and one observation to make

First question: Before a student has his debt packaged into a security to be sold off to investors, should he not have the right to make a preemptive offer for it? Not that it makes a real difference but, emotionally it might not be the same for some to owe their government than to owe Goldman Sachs  their student debt.

Second question: If taxpayer should receive value for money for all these student loans, should not those who are supposed to help students to repay their debts, the professors, the universities also have some skin in the game? I mean at this moment it would seem they get all the benefits from the students taking on debt, at no cost or risk for them.

I recently tweeted: Have you ever seen a university stating a normal investment disclosure like: “Warning, if you pay us for your studies by taking on debt, you might not earn enough to repay it.” 

Hale writes: “Securitisation, a process where assets are packaged together and sold on as bonds to investors, ranging from pension funds to alternative asset managers”

It is with respect to that I would like to make an observation, namely that of reminding that securitization is basically like making sausages, the worse the ingredients, the higher the profits. So pension funds, please beware!

@PerKurowski

The silenced conversation on the risk weighted capital requirements for banks.

Sir, Thomas Hale writes, “From the eighties onwards, a focus on capital constraints on bank balance sheets encouraged banks to sell mortgages and other loans through securitisation. The regulatory framework meant that profitability had become at least in part a function of state-directed regulatory rules around capital — a fact that persists today. For this reason, lending against a house might be preferable to lending to a business, even if the former represents, for whatever reason, a greater risk.”, “The broken conversation about financial regulation”, Alphaville, September 19.

Hale’s “even if the former represents, for whatever reason, a greater risk” does not explain the whole problem because, being perceived as safe, and therefore subject to some regulatory subsidies, is precisely what can most make this house-lending dangerous to our bank systems.

The safety of the banking sector is also a secondary issue because, for the long term good of the economy, lending to “risky” entrepreneurs seems to be preferably than the “safe” financing of house purchases.

Hale writes: “Discussion of post-crisis regulations really only take place in extremely rarefied and specialist settings… there are a few people talking about regulating the banks, but the conversation is mostly inaccessible.”

Inaccessible? Read some of the over 2.800 letters that I have written to FT over the years, which includes even some to Thomas Hale, related precisely to the problem with the risk weighted capital requirements for banks; those that distort the allocation of bank credit; those that are based on the flawed theory that what’s perceived as risky is more dangerous to bank systems that what’s perceived as safe.

These letters, even when I could show some credentials as having formally spoken out against these regulations while being an Executive Director at the World Bank, in times of Basel II preparations, were for all practical purposes ignored. Someone in FT told me that I was obsessed with that problem. Of course I am, and as a grandfather I should be. But much more obsessed has the Financial Times been in ignoring it. 

Sir, a lot of internal soul searching on the why of FT’s silence on the risk weighted capital requirements for banks, should be a much-needed exercise for a paper that as its motto has “Without fear and without favour”.

I was also told to write a book. Why should I, the only book I have written “Voice and Noise”, and that contains some clear pointers to this problem, I believe that not including those I purchased to give away, sold only 51 exemplars.

But perhaps there might be a future book based on all the letters to the Financial Time that are included in this my TeaWithFT blog.

@PerKurowski

Its worse! To central banks’ holdings of public debt we must add that of normal banks holding it against zero capital

Sir, Kate Allen and Keith Fray with respect to the QEs write that “The Fed’s balance sheet has expanded significantly several times in the past, including during the second world war when it soaked up debt sales in a bid to improve market conditions. But the current era is the first time in history that such a large group of central banks has undertaken such a substantial volume of co-ordinated buying over the space of nearly a decade.” “Decade of QE leaves big central banks owning fifth of public debt” August 16.

That’s not the only “first time in history” event. Thomas Hale and Kate Allen, in “Europe weighs potential ‘doom loop’ solution” write “A critical factor in deciding demand for sovereign bonds is risk weightings, which determine how much capital a bank needs against its investments in different kinds of asset. Sovereign bonds in Europe have benefited from a zero risk weighting, making them highly attractive to banks, many of which borrowed cheaply from the European Central Bank to buy sovereign debt after the crisis.”

That should make clear for anyone not interested in hiding it that, to whatever public debts the central banks hold, we must add those that all banks hold only because they are allowed to do so against zero capital. Q. What is a 0.1% return worth if you can leverage it 1000 times? A. 100%

Sir, as I have told you umpteenth times before, in 1988, one year before the Berlin wall fell, that which was taken to be a big blow to statism, bank regulators, through the back door, introduced a zero risk weighting of sovereign debt. The statists have been playing us for fools ever since.

And now, when reality is catching up, they want to package and hide all this public debt in some securities they have the gall to name these European Safe Bonds “ESBies”, issued in order to “make the continent’s financial system safer”. Or, as Gianluca Salford, a strategist at JPMorgan disguises it, to “transport sovereign risk to a place where it’s more manageable”.

Sir, try to sell all central banks’ and banks zero weighted held public debt into a free market and see what rate you get. Taking current artificial public debts for real, or for being revenue neutral rates, or for being risk free rates, or for justifying public investment in infrastructure, is either stupidity or a shameful manipulation of truth. 

Sir, the day our citizens discover what is being done by these statist they will flee all sovereign debts and governments will be left, like Maduro in Venezuela, with central banks that can only print money to keep the can rolling and rolling until…

PS. Mr Salford argues: “Securitisation is not an innately bad thing — it can be used well as a stabilising source” No! If securities are sold at their correct securitized risks they do not provide remotely as much profits as those sold incorrectly offering securitized safety. In other words, suffering from innately bad incentives damns these.

@PerKurowski

Current bank regulations also guarantee Canadian covered bonds will have more demand than Italian.

Sir, Thomas Hale while explaining the appetite for Canadian covered bonds quotes Michael Spies, a strategist at Citi with: “I’m buying a collateralised bank bond rated triple A, from a bank which is rated double A, in a country which is rated triple A,” he adds. “Now let’s put this together and compare it to an Italian covered bond.” “Canada’s housing rally owes a debt to Europe” July 12

That is not the whole story. Those Canadian covered bonds can, as a consequence of the risk weighted capital requirements, be held by banks against less capital than those “risky” Italian ones; and so therefore the banks can multiply their equity with more Canadian net risk margins than with Italian; and so banks will earn higher expected risk adjusted returns on equity with the Canadian than with the Italian; and so the Canadian covered bonds, when compared to the Italian, will have more demand than these would have had in the absence of the risk-weighting, and the Italian less.

That the distortion in the allocation of bank credit to the real economy the risk-weighted capital requirements for banks cause is not more discussed, is one of the great mysteries of our times.

PS. I was kindly informed of that "The risk weighting for a highly rated Italian covered bond is actually significantly lower (10%) than for a Canadian covered bond of the same rating (20%). This is because the European legislation (CRR) affords preferential treatment to issuers in the European Economic Area." I did not know that, but it sure makes me question whether Canada is aware of that it is subjected to this kind of European regulatory protectionism. 

@PerKurowski

When “Eurozone sovereigns rush to lock in rates”… whom are they locking out?

Sir, I refer to Thomas Hale’s “Eurozone sovereigns rush to lock in rates” March 20.

It reads like the sovereigns were totally disconnected from their subjects. Like if they are able to lock in low rates, this would not be paid by, for instance, those pension funds that will earn less?

And if sovereigns have some inside information that rates will shoot up, and still sells a long-term bond to a citizen (a bank or an insurance company) is that not stealing? Would a citizen not be fined and sent to jail if he did something like that?

Bank regulators decided for instance that banks and insurance companies need to hold less capital when lending to sovereigns than when lending to citizens. That of course leads to sovereigns being able to borrow at lower rates than what would have been the case in the absence of such regulatory favor. And who pays for that regulatory subsidy? The “risky” SMEs and entrepreneurs pay for it; by means of less and more expensive access to bank credit. 

Sir there is such an amazing disconnect between the sovereigns and its subjects. It is as if the sovereigns have totally forgotten that their future is absolutely dependent on the future of its subjects. Or is it that current technocrats are just too statists or too dumb to understand what they are doing.

It does not help of course when influential papers like the Financial Times refuses to ask the questions that should be asked… like these:

@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 ©

FT, when banks have less capital against assets, how can you be sure their capital positions have strengthened?

Sir, Thomas Hale and Richard Blackden write: “The weakness this month comes in spite of stress test results on Friday from the European Banking Authority, which showed banks’ capital positions have strengthened over recent years”. “European bank shares fall in brutal start to August” August 2.

Yes, if we are to use the regulators’ risk weights, one could say “the capital positions have strengthened over the recent years. But why should we? The risk weights of 20% given by regulators to AAA rated securities and sovereigns like Greece were not that correct. 

The real truth is that, unfortunately, the real gross undistorted capital position of banks, the assets to equity leverage, has, according to EBA, deteriorated from 19.2 to 23.8 to 1.

​

@PerKurowski ©

How could it be in the interest of any bank regulators to have CoCos with unclear and haphazard conversion terms?

Sir, I refer to Thomas Hale’s, Martin Arnold’s and Laura Noonan’s discussion on the regulatory uncertainty that exists, “Coco trade seeks to emerge from dark period” February 24.

I am amazed. If I was a bank regulator and I had signaled that one way for banks to cover for the capital regulators required were the CoCo’s, I would want these to be as clear and transparent as possible. That not only to make sure banks could raise these funds in the most competitive terms, but also to be sure I covered my own share of responsibility in the disclosure process.

Something must have gone seriously wrong if there is still such huge regulatory uncertainty. I mean I could not for a second believe that any regulator would want to withhold such information on purpose.

In April 2014 I sent you a letter that asked “Can bank regulators keep silence on the conversion to equity probabilities of cocos?" 

In it I wrote: “Do regulators have any moral or formal duty to reveal to any interested buyers of cocos if they suspect the possibilities of these having to be converted into bank equity being very high? I say this because if so, and if they keep silent on it, that would make them sort of accomplices of bankers. Would it not?... Of course banks need capital, lots of it, but tricking investors into it, does not seem like the right way for getting it.”

In May 2014 I wrote you a letter asking “Is it ok for a regulator, like EBA, to withhold information from 'experienced investors'?"

In it I asked “What would be the legal responsibility of bank regulators, towards any coco-bond investors, if they withheld important information with respect to the possibilities of those bonds being converted into bank equity?”... and also:“Britain´s regulator, the Financial Conduct Authority, has said it plans to consult on new rules to ensure cocos are only marketed to experienced investors…Would that imply that a regulator can withhold important information from “experienced investors”? If so, just in case, for the record, I have no knowledge about investments whatsoever.

And then in August 2014 I wrote you a letter that alerted: “The investors had priced market risks of CoCos, not the risks of bankers´ or regulators´ whims.”

But then again regulators might also have decided it was better to go and fly a kite J

@PerKurowski ©

Banks, tell me who your “absolutely infallible” are, and I will tell you who your “really risky” are.

Sir, Thomas Hale, Christopher Thompson and Josh Noble report on that “most major Chinese banks have existing Tier-1 capital adequacy ratios of at least 9.5 percent according to CLSA, meeting Basel III requirements”, “China financials lead EM debt sales” July 16.

What does that really mean? Which are the low-risk weight bank assets in China? For instance in the case of European banks these were AAA rated securities, mortgages in Spain and loans to infallible sovereigns like Greece.

For instance if we divide the risk weighted capital Tier-1 ratio of a bank by its un-weighted leverage ratio, then we have a better idea of how much could be hiding in the officially sanctioned safety… the fictitious safety ratio... the Basel Risk Ratio