Do risk weighted capital requirements for banks promote or kill the animal spirits Lawrence Summers think important?

Sir, Lawrence Summers writes: “Animal spirits are as fickle as they are important”, “A bitter comedown from Trump’s sugar high” January 17.

Question: Does Professor Summers believe that the pillar of our bank regulations since 1988, the risk weighted capital requirements for banks, promotes or kills those animal spirits he thinks important?

As for me I have no doubts it kills it! Giving banks extra incentives to go in pursuit of the safe and abandon the risky just means that what’s decreed, concocted or perceived as safe, will get too much bank credit, at too low interests, while that which is perceived as risky, like SMEs and entrepreneurs, will get too little or in too expensive terms.

If there is any animal spirit left in the banks after that, then surely it is not those of lions but those of hyenas.

P.S. Professor Summers, you who know so much, would you on behalf of bank regulators dare advance some answers to the following questions?

@PerKurowski

Risk weighted capital requirements for banks caused the animal spirits of hyenas to substitute for those of lions.

Sir. We had a crisis, which resulted directly from the distorted incentives for the allocation of credit to the real economy that the risk weighted capital requirements for banks caused. If anyone doubts that, just consider that Basel II, of 2004, allowed banks to leverage equity a mindboggling 62.5 to 1 with private sector assets, as long as these assets had an AAA to AA rating. If they did not posses a credit rating then a 12.5 to 1 leverage was the max.

True, FDIC and the Fed did not allow USA’s commercial banks to follow these Basel II rules initially, but the SEC did allow the investment banks to do so, as were European banks allowed to do. That set off the most voracious appetite ever for AAA rated assets, and the markets, understandably, set out to satisfy that demand, in any which way it could, even if by means of fraudulent behavior. Because that is what markets do!

To top it up, with Basel I of 1988, the regulators had risk-weighted Sovereigns with zero percent, and consequentially banks were allowed to build up huge exposures against little capital for sovereigns such like Greece.

And then we had Central Banks, Fed, by means of QEs, injecting the mother of all liquidity in the markets, and again, by foremost buying up sovereign debt, mostly benefitting governments, and indirectly those who already owned assets like stocks.

Sir, the can of the crisis was simply kicked down the road; and the regulations that make banks earn higher risk adjusted returns on equity when financing the “safer” past and present than when financing the “riskier” future kept in place. Our grandchildren will hold us accountable for this.

Martin Wolf nonetheless gives a very positive review of Obama’s eight years of economic policy, “How Obama rebuilt the economy” January 11. How come?

The truth is that Wolf does not get it yet! Here he writes of “a broader post-crisis loss of animal spirits” without being able to understand that those risk weighted capital requirements for banks that I referred to, pre and post crisis, what they have done is to substitute the spirits of hyenas for the spirits of lions.

@PerKurowski

C-suite experience can be just as irrelevant to real Main Street animal spirit as government bureaucracy experience.

Sir, Gillian Tett discusses the respective government and C-suite experience statistics of different government teams, and comments that those “83 years of C-suite experience” of Trump’s team and some of the policies announced, like tax cuts, “could ignite animal spirits”, “Team Trump unleashes animal spirits” January 6.

Sorry, the “animal spirit” of an extraordinarily well paid C-suite manager, the owner of a multi million dollar golden parachute, and who is invited to a great restaurant by a banker willing to discuss a billion dollar loan, might be for the purpose of repurchasing the shares of the C-suiter’s big corporation, can have as little of any real Main Street animal spirit, than any government bureaucracy lifer.

"Risky" SMEs and small time entrepreneurs, those who have their bank credit applications most often rejected, now most specially because of the risk weighted capital requirements for banks, those are the ones who really need to be present on Trump’s team, if he is ever going to have a chance to deliver on his popular populist promises.

In fact, C-suite managers could be too dangerous, since these are quite likely those who would be engaging the most in crony statism… in other words ”The Real Swamp”

PS. Came to thing about it. C-suite manager's animal spirits are more like animals in the zoo's spirits.

@PerKurowski

Animal spirits yes, but of lions, hyenas or pussycats? Do we have irrational exuberance, or rational fright?

Sir, John Authers commenting on how the Dow Jones Industrial Average can top the 20,000 mark for the first time writes: “Animal spirits are back. The enthusiasm is palpable, and is on a scale unseen since the height of the tech boom”, “Echoes of exuberance as the Dow stirs animal spirits” December 17.

Authers, with “markets… were in a very different state” would seem to agree with that we are not talking of the spirits of the same animals. The tech boom had lions with great illusion and too much optimism and bravery pursuing a brand new future. The current boom, resulting from low interests, QEs and excessive public debts everywhere, seems more one of pussycats taking refuge in whatever is offered. Of course, as always, hyenas are present in order to feast on the many cadavers any heightened volatility causes.

What brought all this on? Sir, as you know I think, but you do clearly not want the rest of the world to think, that this is the natural result of regulators taming, or castrating, the animal spirits of banks. That they did with their capital requirements based on ex-ante perceived risks, precisely those risks that were often already being cleared for too much by the ex-ante-risk-adverse bankers Mark Twain referred to.

Authers now writes: “Trump’s deregulatory agenda could delight markets.”

That’s a new view I very much welcome. Over the last decades, public opinion has almost exclusively been fed the notion that all of its troubles were only the result of financial deregulation.

The problem though is that Trump, even though he himself has been a bank borrower, does not really understand that without removing the odious regulatory discriminations against the “risky”, like SMEs and entrepreneurs like Trump, his stimulus plans, that which includes tax cuts, has not a fair chance to work.

@PerKurowski

Why does not FT, “without fear”, debate the distortions the credit risk weighted capital requirements for banks cause?

Sir, Martin Wolf writes that if that if “hysteresis” — the impact of past experience on subsequent performances” is the cause for the economy failing to recover its “Possible causes [could] include: the effect of prolonged joblessness on employability; slowdowns in investment; declines in the capacity of the financial sector to support innovation; and a pervasive loss of animal spirits” “In the long shadow of the Great Recession” November 11.

For more than a decade I have tried to explain for Mr. Wolf that, if you allow banks to hold less capital against assets that ex ante are perceived as safe than against assets perceived as risky, you allow banks to make higher expected risk adjusted returns on equity on safe assets than on risky, and that of course will decline the willingness of the financial sector to support innovation and erodes the animal spirit. When banks make the good returns on equity, on for instance financing houses, why on earth should they go an finance what requires them to hold more capital and is therefore harder to achieve good ROEs for?

But Martin Wolf, and FT, has never wanted to accept that as a serious source of distortion in the allocation of bank credit. I have never understood why. I dare him, or FT, or any bank regulator for that matter, to a public debate of that issue… come on, show us some of the “without fear”

Thomas Hoenig the Vice Chairman of FDIC has recently said: “Using simple leverage measures instead of risk-based capital measures eliminates relying on the best guesses of financial regulators to guide decisions.” I pray he is able to convince his colleagues of that. The world has had more than enough of that reverse mortgage regulators imposed and that makes banks finance more the safer past than the riskier future.

When I think of those millions of young people who will never get a chance of jobs that help them fulfill dreams, thanks to these hubristic and outright incapable regulators, I get so sad and mad.

PS. Here is a letter that Washington Post published today.

@PerKurowski ©

Martin Wolf, indeed, all Mario Draghi pulled out of his hat, was another little timid rabbit.

Sir, I refer to Martin Wolf´s “Draghi has pulled another rabbit out of his hat” June 6.

Instead of the “targeted long-term refinancing operations”, the TLTROs, to “help the credit-starved segments of the eurozone economy” I would have loved a real declaration of change such as:

“From now on we the ECB will not admit bank regulators treating medium and small businesses, entrepreneurs and start-ups, as intrinsically more risky for Europe, than the “infallible sovereigns”, the housing sector and the AAAristocracy”

That would have been a real animal spirit to pull out of the hat. As is, all we got from Draghi and ECB was indeed another little timid rabbit.

PS. Sir, again, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.

Mr. Osborne will receive little help from banks with the real economy, thanks to current bank regulators

Sir, Janan Ganesh, in “Britain’s journey from austerity has hardly begun”, October 15, writes that “Cajoling Britain’s animal spirits while shoring up its discipline will test [Osborne’s] dexterity as a national figure”.

Indeed, and he will not find the banks being able to help him out much either, thanks to the regulators. This, because if there is anything that can kill animal spirits so much, are capital requirements for banks which are higher the higher the perception of risk. And, if it is something that can test bank discipline so much, is allowing these to have minimal capital, and be able to earn huge risk-adjusted returns on equity, only on account of something being perceived, ex ante, as “absolutely safe”. What an utterly silly reason… especially when knowing that all major bank crisis have resulted from excessive exposures to what, ex ante, was being perceived as “absolutely safe”

The animal spirits, at least those of the banks, are not free to roam as they should.

Sir, Jesse Norman, a conservative MP in UK, writes that the recovery from a balance sheet recession, with a difficult process of deleveraging which reduces both demand and the effectiveness of monetary policy, requires not merely savvy economics, but a feel for animal spirits from policy makers”, “Britain has the political capital to boost investment” September 20. 

How I would like to sit down with Mr. Norman and explain to him how the capital requirements for banks, based on perceived risk, not only caused the explosion that brought us the balance sheet recession but, because this foolish regulatory discrimination, against what is perceived as risky, like the small businesses and the entrepreneurs is still well and alive, it also fundamentally hinders any recovery. 

Hopefully he finds time to read about it in my blog that contains my hundreds of letters, over many years, that I have written to FT on this issue, but that FT has preferred to ignore.

Tame the tamers!

Sir, John Plender’s “How to tame the animal spirit” September 30 leaves me utterly confused. What animal spirit does Plender refer to? 

That spirit which caused trillions to invest in AAA rated securities that offered a couple of basis points more or those who leveraged their investments in AAA rated securities because the regulator allowed them to do so by requiring ridicule small capital requirements on these?

As I see it those we really need to tame are the tamers, and in fact, looking at the global challenges the world needs to confront, perhaps we could benefit immensely from a little bit more of that old fashioned real animal spirit.

Let’s be clear about the true origin of the financial “snake-oil”.

Sir Robert Shiller in “A failure to control the animal spirits” March 9,  completely ignores that the “snake oil” the financial world bought was produced almost exclusively by the financial regulators, those who held that banks could leverage their equity 62 to 1 when they gave credit to corporations determined to be AAA or AA- by their official default risk surveyors the credit rating agencies.

Shiller writes that “It was part of a story that all investments in securitized mortgages were safe because those smart people were buying them”. He is wrong! It was part of the story that those securitized mortgages were safe because they “are AAA and, if the credit rating agencies are good enough for Basel, they’re good enough for you”