Does not “safe(ish) activities such as holding government bonds” contain the fattest most dangerous tail risks?

Sir, Gillian Tett writes “the Fed and the Office of the Comptroller of the Currency introduced proposals to “tailor leverage ratio requirements to the business activities and risk profiles of the largest domestic firms”. In plain English, this means banks can operate with a little less capital to absorb losses, provided they focus on safe(ish) activities such as holding government bonds.” “Trump’s mixed record on rolling back bank reform” April 13.

The Fed’s Governor Laid Brainard, in a recent speech “An Update on the Federal Reserve's Financial Stability Agenda”said: “The primary focus of financial stability policy is tail risk (outcomes that are unlikely but severely damaging) as opposed to the modal outlook (the most likely path of the economy).”

So let me ask: What is the tail risk of “safe(ish) activities” compared to that of riskier activities?

How fat or dangerous is the tail risk of what is rated below BB-? Very skinny indeed.

How fat or dangerous is the tail risk of what is rated AAA? Very, very fat indeed.

Government bonds? When in 1988 the regulators, with Basel I, decided to assign a 0% risk-weight to some sovereigns they painted themselves into a corner. If that risk weight is not increased, then sovereigns will become, sooner or later over-indebted, and their risk will grow until it hits 100%. If that risk weight is increased, ever so slightly, markets will be very scared. How to get out of that corner is the most difficult challenge central banks and bank regulators face. Let us not forget that in 1988 US debt that was $2.6 trillion. Now it is US$21 trillion, growing, and still 0% risk weighted.

PS. The only way to solve the 0% sovereign risk weight conundrum that I see, is to increase the leverage ratio applicable to all assets, until that level where the risk weighted capital requirement totally loses its significance.

@PerKurowski

Martin Wolf do not low rates on Treasuries depend quite lot on how these are favored by bank regulators?

Sir, its hard for me to follow Martin Wolf’s explanation of the “Reason for low rates is real, monetary and financial” “World Economy” October 9. For instance what does he mean with “The saving glut was a casual factor. But its impact came via monetary policy and the financial system, and so via financial booms and busts”

That said, since he mentions low Treasury yields that according to Andy Haldane, the Bank of England’s chief economist “are the lowest real interest rates for 5,000 years” I do have a question for him.

Mr Wolf, would it not be possible that those ultralow interest rates are supported by the fact that the least capital the capital scarce banks need to hold against assets, are those they need to hold against their sovereigns… their governments… the Treasuries?

Does Martin Wolf believe Treasury yields would be so low if bank had to hold as much capital against Treasuries than what they are required to hold against risky SMEs and entrepreneurs? I mean the current risk weight for Treasury is zero percent, while the risk weight for a private American unrated SME and entrepreneur is 100 percent.

Zero percent – 100 percent… truly amazing!

At one place Wolf mentions with respect to one explanation: “one has to argue that the crisis was just the result of foolish deregulation and wild profit seeking in an irresponsible sector”. No! I argue that it was just the result of foolish regulation that allowed profit seeking banks to earn much higher risk adjusted returns on equity on safe assets than on risky assets. But seemingly I do not express myself too clearly either, as there is no way I can be understood by Mr. Wolf.

@PerKurowski ©  J

Fooled by the nominal interest rates, Mr. Summers asks the government to fall for another type of teaser rates

Sir, Lawrence Summers is just another economist fooled by looking only at the nominal low interest rates for government debt of some “infallible” sovereigns, “Look beyond the interest rates to get out of the gloom”. Those interest rates do not reflect real free market rates, but the rates after the subsidies given to much government borrowing implicit in requiring the banks to have much less capital for that than for other type of lending. 

If the capital requirements for banks when lending to a small business or an entrepreneurs was the same as when lending to the government… then we could talk about market rates. As is, to the cost of government debt, we need to add all the opportunity cost of all bank lending that does not occur because of the subsidy… and those could be immense. 

Mr. Summers even suggests that governments should issue debt to buy government buildings it currently rents… and to me that sounds like tempting the government to fall for another type of teaser rates. 

PS. It is amazing that the Financial Times has not made an issue yet of the current interest rates not being what the market rates they are supposed to be.

Big time meddler Greenspan is no one to warn us about meddling with the market.

Sir, Alan Greenspan is one of those responsible for the regulations which require banks to hold quite a lot of capital when lending to small businesses and entrepreneurs but allow these to lend to the government against no capital at all. As such he is de-facto one of the biggest market meddlers of our time, and has no moral right to appear in the Financial Times preaching us with “Meddle with the market at your peril” January 26. 

As former chairman of the US Federal Reserve he must be aware that the whole world economy is flying blind, because of those capital requirements… like what would the rate on US treasury be if the banks had to treat citizens and government alike?

Why would cash-rich investors need bank intermediation?

Sir, Gillian Tett wonders why “Faced with a choice between betting on the safety of US government, or its banks, cash rich large companies and asset managers are choosing the former”, “Cash-rich investors are choosing crazy Treasury” August 12. 

What kind of silly question is this? Since the banks in these days of scarce bank capital would just turn around and also choose “crazy Treasury”, because that does not require any capital of them, why would cash-rich investors need intermediation?

When are you going to wake up that via bank regulations which favor public borrowing over any other kind of borrowing we are being embraced by communism? And, by the way, FT’s silence on all this is very suspicious to me.

A wanted safe haven is not the same as a wanted permanent home.

Sir Michael Mackenzie reports on “Concern at size of debt auctions” March 27, and of course they should be very concerned as so much of the current plans of helping the economy recover hinges on the possibilities of finding buyers for the US treasury bonds.

As I have often repeated the danger is that US confounds the eagerness of markets in finding a temporary safe-haven with a willingness of capitals finding a new permanent home in the US and that is as we all should know a totally different animal.

Also there is a clear and present danger in not being able to access the real market signals since the current rates out there have nothing to do with the rates required if the Fed was not doing so much buying. In some ways it is like a bank participating in buying some securities in order to make the harsh mark-to-market truth easier to digest. It only works over a short period of time.

Cheap money? Cheap credit? Humbug!

Sir, Chrystia Freeland in “The audacity for help” March 12, mentions “the era of cheap money” and “the end of cheap credit” May I suggest that the existence of an era of cheap money and cheap credit has just been a big bluff, promoted to make money on expensive credit, and that consumer credit is partially responsible for accentuating economic differences in the US and in most of the world.

When a consumer buys something at a rate that exceeds the rate of inflation and pays more than the risk free rate he is in fact impoverishing himself ,and would have been better off postponing any consumption and purchases he does not absolutely need.

Look just at the current reality. The US treasury pays about .01% on its short term debt and a US citizen has to pay at least 1,690 basis points more, at least 17% on his credit card. Who except a credit card salesman or credit card company shareholder, could even dream of calling that cheap money or cheap credit?

You want to see some of the wealth differentials reduced? Then teach the consumer about the worth of bargaining their purchases paying cash.

Will the world trust the American taxpayer?

Sir Mohamed El-Erian in respect to the Federal Reserve being “prepared” to buy Treasury bonds asks “Will the world be comfortable with two US public agencies offsetting operations that ultimately must be supported by someone else?”, “Era of policy activism opens door to global co-ordination” February 17.

That is either a slightly coward or a too kind way to phrase the issue since that “someone else”, when push comes to shove, is no one else but the American taxpayer.

The US dollar instead of “In God we Trust” should state “In the American taxpayer we trust and thereafter in God’s will”. What will the markets do when they realize the real picking order?