FT, on banking and finance who are you to believe, Francis Fukuyama or Paul Volcker?

Sir, Francis Fukuyama in “The war on liberalism” FT March 5, writes:

“Liberals understand the importance of free markets — but under the influence of economists such as Milton Friedman and the “Chicago School”, the market was worshipped and the state increasingly demonised as the enemy of economic growth and individual freedom. Advanced democracies under the spell of neoliberal ideas trimmed back welfare states and regulation, and advised developing countries to do the same under the “Washington Consensus”. Cuts to social spending and state sectors removed the buffers that protected individuals from market vagaries, leading to big increases in inequality over the past two generations.

While some of this retrenchment was justified, it was carried to extremes and led, for example, to deregulation of US financial markets in the 1980s and 1990s that destabilised them and brought on financial crises such as the subprime meltdown in 2008.”

Paul A. Volcker in his autobiography “Keeping at it” of 2018, penned together with Christine Harper, with respect to the risk weighted bank capital requirements he helped to promote and which were approved in 1988 under the name of Basel I wrote:

“The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages. Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011. The American “overall leverage” approach had a disadvantage as well in the eyes of shareholders and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return US government securities."

Sir, in reference to advising developing countries with the “Washington Consensus”, in November 2004 you kindly published a letter in which I wrote:

“Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. 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? In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

So, there are two completely different bank systems:

Before 1988, one in which banks needed to hold the same capital against all assets, credit was allocated based on risk adjusted interest rates and the market considering the bank’s portfolio, accurately or not, values its capital.

After 1988, one risk weighted capital requirement banks where credit is allocated based on risk adjusted returns on equity, something which clearly depends on how much regulators have allowed their capital to be leveraged with each asset... clearly favoring government credit, which de facto implies bureaucrats know better what to do with (taxpayers') credit than e.g., small businesses and entrepreneurs. Communism!

Sir, I am of course just small fry, not even a PhD, but, if you have to choose between describing what has happened in the financial markets since 1988 as a “deregulation”, as Fukuyama opines, or an absolute statist and politically influenced misregulation, as Volcker valiantly confesses, who do you believe?

Sir, is this topic taboo… or just a too hot potato for the “Without fear and without favour” Financial Times?

PS. In Steven Solomon’s “The Confidence Game” 1995 we read: “On September 2, 1986, the fine cutlery was laid once again at the Bank of England governor’s official residence at New Change… The occasion was an impromptu visit from Paul Volcker… When the Fed chairman sat down with Governor Robin Leigh-Pemberton and three senior BoE officials, the topic he raised was bank capital…”

@PerKurowski

The political establishment fell prey to an idiotic regulatory technocracy they did not dare to question

Sir, Philip Stephens writes: “Rising populism has been fed by a political establishment in thrall to unfettered capitalism”, “Why the liberal order is worth saving” February 10.

Nonsense! The political establishment fell prey to an idiotic regulatory technocracy they did not dare to question.

Some of the Basel Committee for Banking Supervision’s risk weights used to determine the capital requirements for banks are: The Sovereign 0%; We the People 100%; AAA to AA rated 20%, below BB- 150%.

That has absolutely nothing to do with unfettered capitalism all to do with unchecked and dumb statist intervention.

The liberal order went out the kitchen door of the Basel Accord, in 1988, before in 1989 the Berlin wall felt and the “Washington Consensus” saw light.

Here are some questions that have yet to be posed by someone able to force bank regulators to answer:

@PerKurowski

If IMF seems to favor the private sector, rest assure it is favoring even more its shareholders, the governments.

Sir you write “International Monetary Fund last week…published an article questioning its own neoliberal tendencies…concluding that “instead of delivering growth, some neoliberal policies have increased inequality, in turn jeopardizing durable expansion”. And you describe it, marvelously imaged, with that “In seeking to be trendy, the IMF instead looks as out of date as a middle-aged man wearing a baseball cap backwards”, “A misplaced mea culpa for neoliberalism” May 31.

My opinion though is that if a mea culpa should be forthcoming from the IMF that should have more to do with how they allowed the label neoliberalism to cover up for statism. For instance most public services privatized in Latin America were awarded based on who offered to pay the governments the most, not on who offered to charge the lowest tariffs; and so all money received became de facto tax advances to governments, to be later covered by customers having to pay higher tariffs. Neoliberalism? Hah!

John Williamson coined the term “The Washington Consensus” that was rightly or wrongly adopted as a stand in for neoliberalism, in 1989.

The year before, the Basel Accord, determined that for the purpose of setting the capital requirements for banks, the risk weight of sovereigns, at least those of the OECD, was zero percent, while the risk weight of citizens, the private sector, was 100 percent.

What neoliberalism can thrive along side such virulent statism as that displayed by the Basel Committee?

Let us not fool ourselves; IMF represents the governments, not the private sector, not the citizens. If it does something that seems to favor the private sector, the citizens, rest assure it is by doing so favoring governments even more.

@PerKurowski ©

The pro-big-governments Basel Accord trumped the pro-private sector Washington Consensus

In July 1988 the Basel Committee on Banking Supervision put in place the Basel Accord, “The International Convergence of Capital Measurement and Capital Standards” Basel I.

Those standard imposed the following risk-weights, which would determine the equity banks needed to hold against different assets:

0% - For cash, central bank and government debt and any OECD government debt

0%, 10%, 20% or 50% - For public sector debt

20% - For development bank debt, OECD bank debt, OECD securities firm debt, non-OECD bank debt (under one year maturity) and non-OECD public sector debt, cash in collection

50% - For residential mortgages

100% - For all private sector debt, non-OECD bank debt (maturity over a year), real estate, plant and equipment, capital instruments issued at other banks

Those risk weights, applied to a basic equity requirement of 8 percent, translated into that banks were then allowed to leverage much more their equity when lending to governments, banks, developing banks and residential mortgages than when lending to the private sector.

And that meant that banks would find it much harder to obtain comparable risk-adjusted returns on equity when lending to the 100 percent weighted private sector than when lending to all other favored with lower risk-weights.

And that meant that the banks of the Western World were de-facto distorted into lending primarily to the public sector, to other banks, and to residential mortgages.

That of course meant that regulators tripped and fouled the efficient allocation of bank credit mechanism.

With Basel II of June 2004, all was made worse because different risk weights were also assigned then to the private sector based on credit ratings.

What did this mean?

That banks would allocate resources preferentially to the public sector.

That banks would allocate more resources for financing the house we live than for financing the creation of the jobs we need in order to pay the utilities and mortgages of our houses.

That banks would concentrate almost entirely on financing what is safe, refinancing the past, and stay away almost entirely from financing the riskier future.

And of course, it all started to go down hill from then.

And here we are more than 25 years later and read Philip Stephens’ "Why the business of risk is booming” without one single reference to what the regulatory forced risk aversion introduced in our banks have done or is doing to our economies.

To think that the Basel Accord with all its pro-big-government implications was introduced about the same time the pro-private sector Washington Consensus was discussed and vilified is truly mindboggling.

@PerKurowski

End of story…now what?

Sir how sad that the Washington Consensus is just a mythical phrase coined by John Williamson and not a document or a statue because, if it was, we could at least burn or topple it just to get over it, once and for all, and save us so much unnecessary obsessed rambling about how malicious it was, even though most of us agree that whether the recipes in that consensus worked or not had mostly to do with what ingredients were used, who cooked and how the cooking was done.

In “The Fund faces up to the competition” David Rothkopf, October 22, sort of gleefully talks about the IMF having soften their conditions for helping out, without reflecting on the possible fact that they now are just prescribing painkillers instead of remedies, because they, like all, have run out of answers.

The alternatives that Rothkopf seems to favour as he says that “Mr. Chávez distributed four times as much aid in South America” are plain ludicrous since the source of that help is the higher price that has to be paid for oil; and for countries like Honduras and Nicaragua no aid comes even close to being as significant as the remittances sent by their workers, from the US.

The Washington Consensus as interpreted and implemented did not work, at least so we think, end of story; and so now what?

The Basel Consensus on bank regulations has demonstratively really not worked, but there we have unfortunately not yet reached the phase of “end of story, now what?”