If central banks offered “unimpeachably safe liquid assets” to all, how much negative interests would these pay?

Sir, George Hatjoullis writes: “Only the central bank can provide unimpeachably safe liquid assets…[so] allow individuals and corporate entities to hold deposit accounts with the central bank… The banking system would be free to pursue its risky credit provision role and individual entities would have their safe liquid haven”, “Allow deposit accounts within central banks” September 25.

That is based on two false premises. The first one is that central banks really are riskless. Though they can always print money, there’s no guarantee they won’t print too much money, and therefore repay with money worth less.

The other is that you could provide some with “unimpeachably safe liquid assets… a safe liquid haven” at no costs. The opportunity cost of that, is not sharing into the benefits of risk taking.

When it comes down to risk management I always start by asking: “What risk is it that you can least afford not to take?” That is because the worst certainty comes hand in hand with the avoidance of all risks.

Sir, to allow some to have access to unimpeachably safe liquid assets, while others take the risks, just guarantees putting inequality on steroids. The society should not do that! An adequate bank system allows everyone to share, at least ever so slightly; in the risk-taking the society needs to move forward.

@PerKurowski

Accepting credit-risk weighted equity requirements for banks, is accepting the economy going into early retirement.

Sir I refer to Yoichi Takita’s “Split emerge between central bank and policy makers”, your special report on Japan, March 30.

Takita writes “ The government is working hard to ensure investment and employment growth will lead to an economic upswing.”… and for that Mr. Abe will try “eliminating disincentives such as high corporate tax rates, big electricity bills and excessive economic rules”.

I do not know enough about Japan to evaluate how much that could help, but, if it was for instance Europe, which depends so much on bank credit, then that would not suffice. That is because any country that tells its banks to go and leverage much their equity, and the implicit support they receive from taxpayers, on what is “absolutely safe”, and to stay away from “the risky”, is a country that has placed itself, unwittingly or voluntarily, in an early retirement mode not compatible with any sturdy and sustainable economic growth.

@PerKurowski

If only the Basel Committee for Banking Supervision had contracted an Abraham Wald.

Sir, Tim Harford’s recalls how the American statistician Abraham Wald when asked how to reinforce returning shot planes, advised to first figure out where those planes not returning had been shot, “ Learn from the losers”, November 29.

And Harford writes “It’s natural to look at life’s winners [but] if we don’t at life’s losers too, we may end up putting our time, money attention or even our armour plating in entirely the wrong place”.

Absolutely and had the Basel Committee for Banking Supervision contracted someone like Abraham Wald, they would have understood that banks did not really need to hold more equity for what was perceived as “risky” but, if anything, they needed to hold more of it for what was perceived as “absolutely safe”, because there were where the shots that brought them down usually hit.

PS. Reading this article I was also reminded of Benjamin Franklin’s beautifully counterintuitive but so correct saying of: “if you want something done, ask a busy person”.

Should not Basel II bank regulations have been piloted before applied globally?

Sir, I refer to Tim Harford’s “Why pilot schemes help ideas take flight” October 19.

Let us not forget though that the most important role of pilot schemes is to help us from allowing crazy ideas that might take us down from flying.

For instance, can you imagine what sufferings the world would have saved itself from had the Basel Committee for Banking Supervision done a pilot on Basel II? Then it would have seen only a couple of banks, and not the whole banking system, exposing themselves dangerously much to what is perceived as “absolutely safe”, and dangerously little to what is perceived as “risky”? Then they would have understood, earlier, how stupid this whole idea was.

The Financial Times “a better newspaper for the modern age” ignored the financial story of the century.

Sir, I refer to your new look as described in a special FT supplement on September 15.

Mark Twain said, so we are told, that bankers are those who lend you the umbrella when the sun is out, but want it back, immediately, when it looks like it is going to rain.

But for the Basel Committee bank regulators that was not enough, and so they told the bankers, if you lend while the sun is out, meaning to someone perceived credit risk wise as “absolutely safe”, then we will reward you by allowing you to hold much less capital (equity) than if you lend to someone when it rains, meaning some perceived as risky.

And so, if bankers were risk adverse before, they were now castrated… and of course they started to sing in falsetto accumulating extremely large exposures to what was officially perceive as “absolutely safe”, like AAA rated securities backed with mortgages to the subprime mortgage sector in the US, real estate in Spain and “infallible sovereigns” like Greece.

But, as if those regulations were not risk adverse enough, most financial commentators insisted on an excess of testosterone in the financial system, and so no corrections were made, and all those “risky” medium and small businesses, entrepreneurs and start ups, and who are the tough risky risk-takers we need to get going when the going gets tough, were left without having fair access to bank credit.

And about this story, the de-testosterone-mania that has affected and almost conquered the banks in the western world, the Financial Times has kept mum. And not that they were not informed about it. Truly amazing!

PS. Does this all mean that I would be against banks being well capitalized and therefore more risky? Of course not, requiring players to put plenty of their own skin on the line (or something private specifically related :-), increases the need for testosterone, as well as the need to know how to simultaneously control for it.

Let us aim for bankers capable of that reasoned audacity that can help our economies to move forward and avoid that risk aversion which only guarantees we will stall and fall.

Where would our economies be without chancers, hustlers and other wheeler dealers?

Sir, John Gapper rightly nudges the question of where our economies would be without chancers, hustlers and other wheeler dealers, “Ecclestone is a chancer who has earned a final chance” August 7.

And though we would surely not like to see one of our daughters marrying one of these we regard as social misfits, there is no doubt that without them our economies would go stale.

Think of it. How much capital is currently not in action, giving jobs to many, only because someone convinced its owners of being able to make huge returns with no risks? Are we instead to have all our savings only safely increasing the value of the Picasso’s hanging on our walls? 

But, even so, I abhor the risk-weighted capital requirements for banks based on perceived credit risks. 

With these we are giving special access to bank credit to those who specialize in dressing up as “absolutely safe”… like the infallible sovereign entrepreneurs. 

But why would we want to withhold fair access to bank credit for the “risky” medium and small businesses, entrepreneurs and start-ups, with other type of knowledge and drive? That sounds like an unnecessary limitation which can’t really be good for anyone… in the long run.

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.

Risk weighted capital requirements for banks guarantee excessive exposures against little capital

Sir, I refer to Martin Wolf’s lunch conversation with Andrew Smithers, “I don’t have any faith in forecasts” March 1.

In it Wolf quotes Smither saying “There’s a chapter in the new book on what I think economics should be about, which is not forecasts. It’s about not taking the wrong risks. You don’t know what’s going to happen but you can avoid excessive risk-taking and this, unfortunately, has not been the policy of the Federal Reserve”… and I would have to add, and neither of the Basel Committee.

Bank regulators, with their risk-weighted capital requirements, which are not even based on forecasts but on current ex ante perceptions of risks, guarantee excessive risk taking, against very little capital, to what is perceived as absolutely safe.

I am not copying Martin Wolf with this as he has expressed not wanting to hear more from me about risk-based capital requirements… he knows it all, at least so he says, but, since the above is precisely what Wolf seems unable to understand… perhaps you should copy him.