Wolfgang Schäuble, bank regulators imposed on Europe (and the world) a very dangerous risk taking austerity

Sir, Guy Chazan quotes Wolfgang Schäuble with: “Economists all over the world are concerned about the increased risks arising from the accumulation of more and more liquidity and the growth of public and private debt. I myself am concerned about this, too”, “Schäuble says debt and liquidity levels endanger global economy” October 9.

If you put a risk-tax on sports, to cover for the societal costs of injuries, like a10 percent tax on cricket and one of 1 percent on croquet, would you not expect the result being many more playing croquet than cricket, with whatever implications that could have for the society in general.

That “accumulation of more and more liquidity and growth of public and private debt”, is made worse by the fact that this is being so distorted by the risk weighted capital requirements for banks; those which de facto are a subsidy to “The Safe” and a tax on “The Risky.

According to Chazan “Mr Schäuble also warned of risks to stability in the eurozone, particularly those posed by bank balance sheets burdened by the post-crisis legacy of nonperforming loans”. To me it is amazing to observe how regulators seem to concern themselves so much more with the ex ante perceived risks. than with the ex post realities.

And then Jim Brunsden Mehreen Khan and Guy Chazan write that though Wolfgang Schäuble “was an architect of the stringent bailout programmes carried out in Greece and elsewhere during the eurozone’s sovereign debt crisis, he insists the goal was never to impose austerity on Europe”, "Schäuble feels vindicatedby tough reforms in bailout nations"

Schäuble, being a German lawyer, could perhaps be personally excused, but all those economists and other technocrats surrounding him should have informed him that those risk-weighted capital requirements were imposing one of the most dangerous kinds of austerity, that of insufficient risk-taking.

“Insufficient risk-taking?” “Have you gone mad Kurowski?” “Have you not seen all the excessive risk-taking that took and is taking place?”

Not at all, it was, and is, excessive exposures to “The Safe”, like to sovereigns, AAArisktocracy and mortgages that caused the crisis. That’s more excessive risk aversion.

It is also insufficient bank credit to “The Risky” like to SMEs and entrepreneurs that allows so much QE and low interest rates stimuli to go to waste.

Sir, I strongly believe that Mr Wolfgang Schäuble would never pass my litmus test for the initial screening of a central banker or a regulator, but then again neither would you.

@PerKurowski

How can expectations be high when you discriminate against the future, on account of it being riskier than the past?

Sir, John Kay writes: “It is not because interest rates are too high that eurozone consumption is sluggish but rather because expectations are so low. Fiscal austerity and the aftermath of the global crisis have dimmed the employment prospects of a generation of young Europeans. Low interest rates have as intended pushed up the prices of long-dated bonds and houses” “The twisted logic of paying for the privilege of lending”, September 10.

Frankly, how can expectations not be low, when we have regulators that order banks to hold more capital against what’s perceived as risky, the future, a job to be created; than against what is perceived as safe, the past, a house that has already been built?

And Kay writes: “There are obvious requirements for investment in the eurozone — to provide power through cleaner energy plants, to improve roads and relieve overcrowding on trains, to build houses, to accommodate tens of thousands of recent refugees and above all to fund the new businesses that will promote innovation on the continent.”

Yes, but, if so, why do we not have capital requirements for banks based on those purposes?

Mr. Kay, I tell you, it is not “dysfunctional capital markets, rather than any excessively high interest rates, that are behind an investment shortfall across Europe”. It is totally dysfunctional bank regulations.

Mr. Kay also reminds us of the “aphorism that people will lend you money so long as you can prove you do not need it”. But Sir, that is what Mark Twain told us long ago: “The banker lend us the umbrella when the sun shines and wants it back when it looks like it could rain”; and which is precisely why the Basel Committees’ risk weighted capital requirements for banks don’t make sense.

Mr. John Kay, wake up!... and you too Sir.

@PerKurowski ©

FT, why do you keep mum on the greatest austerity of all; the bank regulation ordered credit-risk-taking austerity?

Sir, you write: “Given huge disparities in the bloc, this is no time for more austerity” “A tentative upturn in the Eurozone economy” May 4.

And yet you keep mum about the most serious austerity of all; the risk-taking austerity imposed on banks by regulators and who have these not financing more the riskier future but mostly refinancing the for the rime being safer past.

And truly idiotic it is. Basel II assigned a risk weight of 20% to AAA rated assets and 150% to that rated below BB-. That is like a nanny telling the children to beware of the ugly and foul smelling and embrace more the nice looking gentlemen who offer them candy.

When you have seen how much stimulus has been thrown at the economy without it responding with any seemingly sustainable strength don’t you get curious about why? Or is it that you believe that as long as ECB’s Mario Draghi manages to hit an inflation target everything is going to be fine and dandy?

PS. Here again is an aide memoire on other regulatory stupidities.

@PerKurowski ©

Most of our resilience capacity has been spent, for no particularly good or sustainable reason

Sir, I refer to Ludger Schuknecht’s “What bankers can teach stimulus-addicted economists” October 6.

Schuknecht writes: “In too many countries debt and public spending are high, and interest rates close to zero… Yet, after decades of attempts to fine-tune the economic cycle by running fiscal deficits and cutting interest rates at times of weak demand, many economies are fragile”

And I ask…why? Could it have something to do with credit risk weighted capital requirements for banks that stops banks from financing the tough we need to get going when the going gets tough… like “risky” SMEs and entrepreneurs?

Schuknecht writes: What governments save, because debt service costs are low, they often spend. Public debt in many countries is now well above 100 per cent of gross domestic product. This would have been unthinkable a decade ago.

And I ask… could it have something to do with this? In November 2004 in a letter published in FT I wrote: “I wonder how many Basel [bank regulation] propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector.”

Schuknecht writes: In too many countries debt and public spending are high, and interest rates close to zero. This leaves little room for effective policy when the next crisis hits — as it surely will.

And I fully agree: Indeed we have spent up most of our resilience capacity… for no particularly sufficiently good and sustainable purpose. 

@PerKurowski ©  J

The credit-risk weighted capital requirements for banks should never even have been on the table as an alternative.

Sir, Dominic Rossi writes “Negative real interest rates on bank deposits cannot be the road to prosperity, yet the promise of low nominal returns on traded securities looks risky… It is only by investing in innovation that we can escape this otherwise humdrum nominal world”, “Don’t look for escape routes when the third deflationary wave hits” September 3.

And I just ask: Are current credit-risk weighted capital requirements for banks helpful or not when it comes to allowing fair access to bank credit to finance innovations? Or is it only borrowers with high credit ratings who should be allowed to innovate?

The global deflationary wave that is hitting our economies is very much caused by the retrenchment of bank credit to whatever is perceived as risky, caused by the risk weighted capital requirements being applied to scarcer bank equity.

It is amazing to read how many claiming for less government austerity are simultaneously ignoring or even claiming for more bank credit austerity. 

If we want to get out of this we must realize that since risk taking is the oxygen of any development, we must get rid of that loony risk aversion of regulators that hides behind the risk-weights. God make us daring!

@PerKurowski

Capital requirements, non-performing loans, down-ratings and fines are causing severe bank credit austerity.

Sir, Henny Sender writes: “A world awash with dollars is rapidly being replaced by a dollar-scarce world” “Pain for those most in debt looks certain to become more severe” August 26.

Yes, and that dollar scarcity will, as is, primarily generate a contraction of bank credit. Consider what is happening:

Regulators are increasing capital requirements, which put banks lending capacity under pressure.

More non-performing loans and credit down-ratings of borrowers put additional strain on the banks.

And to top it up there are the fines. The recently reported fines of $260bn for the largest 25 banks, when calculated for a leverage of 15 to 1 results in about 4 trillions less bank-credit availability.

But when Sender writes: “It is still not sure how the pain will be distributed though”, I would tend do disagree.

If bank regulations keep the risk-weighted capital requirement component, there is no doubt of who are going to suffer the most; that will be those who generate the highest needs of capital, namely “the risky”, like SMEs, entrepreneurs and the downgraded.

Since those risky already are perceived to generate much expected losses, they will generate much less “unexpected losses”, and so we should lower the capital requirements for banks when holding these assets.

Sir, if austerity has to be imposed, I much prefer that to be government spending austerity than bank credit austerity. Banks have to put up at least some capital (equity) while government bureaucrats need not to risk a dime of their own.

@PerKurowski

$260bn in bank fines results in about 4 trillions less bank-credit availability.

Sir, Laura Noonan, with respect to the 25 largest banks, reports “Banks fine tally since crisis hits $260bn” August 24.

And I do some multiplication $260bn times let us say a 15 to 1 leverage, results in $3.9 trillions less in bank lending capacity. So many scream bloody murder about government austerity, while not caring one iota about bank-credit austerity… how come?

Can you imagine if this $260bn in fines had been paid in fresh issued non-voting bank equity to be held by governments for about a decade?

@PerKurowski

This is the icebreaker Alexis Tsipras should use with Angela Merkel

Sir, Wolfgang Münchau refers to the new discussions between Greece in Germany and that are to be held in a climate that could not be characterized as friendlier. “A stealthy route to Grexit”, July 7.

As I have argued many times, if I was Alexis Tsipras, as a potent icebreaker, I would tell Angela Merkel: 

“Please don’t just blame Greece. The Basel Committee, between June 2004 and November 2009, allowed banks to leverage their equity and the explicit and implicit support they received from taxpayers 62.5 times when lending to Greece.

That gave European banks irresistible incentives to give Greece loans that by nature are irresistible to most politicians and government bureaucrats.

Had it not been for that dear Angela… we would be sitting here discussing much more pleasant affairs.” 

@PerKurowski

At long last, the truth about the incestuous relation between banks and sovereigns, is coming out of the closet

Sir, at last someone in the highest spheres, Jens Weidmann, the president of the Deutsche Bundesbank, speaks out. In “Stop encouraging banks to load up on state debt” October 1, he dares to admit that the banks’ “Sovereign exposures are privileged by low or zero capital requirements”

What Weidmann now denounces is that viciously incestuous relation I have denounced for more than a decade and which can be described in terms of: “I government allow you banker to lend to me without capital, and I in my turn will guarantee your obligations to the market” 

And as Weidman daringly admits: “This undermines market discipline for governments and reduces their incentive to carry out the necessary reforms” and “banks, which can obtain unlimited cash against sovereign collateral from the central banks, are protected from discipline from investors who provide the funding.”

In this respect let me remind you of my letter to you, published on November 18, 2004, and which said:

“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 (sovereigns)? 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. Please, help us get some diversity of thinking to Basel urgently; at the moment it is just a mutual admiration club of firefighters”

As an Executive Director at the World Bank 2002-04, I also protested loudly against privileging the sovereign, but to no avail.

Over many years I have not seen anyone in the Financial Times even mentioning the issue of how privileging so much the sovereign, and others like the AAAristocracy, completely distorts the allocation of bank credit to the real economy. I must say that speaks quite badly about your journalists, unless of course you want to excuse them by having to push a political agenda.

So will some of them now, again, bash Jens Weidman’s rational arguments for being excessively austere?

Of course, Mr. Weidman seems to just recently be waking up to the problem, and is not yet totally clear about it. For instance when he states “No market participant would judge a French bond to be as risky as the Greek one: the riskiness of each is reflected in their prices” he is probably not aware that he is with that really explaining why the whole idea of setting capital requirements for banks, based on an ex ante perceived risks, as Basel regulations does, is so utterly dumb, and only dooms banks to overdose on perceived risk.

PS. Here is how the EU made Greece pay for EU's insane mistake of assigning Greece a 0% risk weight.

PS. Here is my letter to the Financial Stability Board (FSB) that was officially received. Will it be answered?

Without eliminating regulatory distortions, neither austerity nor profligacy can help Europe

Sir, Martin Wolf writes: “the hope that [the European countries in crisis] will grow their way out of their difficulties, via eurozone demand and internal balancing, is a fantasy, in the current macroeconomic context”, “The German model is not for export” May 8. 

Wolf’s line of argument, again, points to the “austerians”, as he likes to call them, being wrong. I agree with this. But that does not mean that their opposites, let’s call them the “profligates”, would be right either.

Europe, to stand a chance, and the European youth to find the next generation of jobs, needs to get rid of those distortions which direct bank credit, not based on its productivity, but based on perceived risk-avoidance. And before that is done, I would have to be an “austerian”… since wasting away scarce profligacy space on nothing is just plain stupid.

In fact those regulations are more than stupid they might in fact even signify a crime against humanity.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, since he has asked me not to send him anything more about the implications of these “capital requirements for banks based on perceived risk”… he already knows it all… at least so he thinks.

Distortion is not free, current low public interest rates are an illusion and could be the highest real rates ever

Sir, during the two years I had the fortune to have a voice as an Executive Director at the World Bank, 2002-2004, there were a lot of discussions on the issue of debt sustainability for poor developing countries. I hated those. They always sounded like a torturer calculating how much he could go on before his victim fainted. No doubt much of the ongoing, and I would have to say much less civilized debate between the austerians and the profligarians, reminds me of that.

And I also remember when some years ago some environmental austerians fouled up some research, which was immediately interpreted as a great go ahead by the environmental profligarians.

I do pity Kenneth Rogoff and Carmen Reinhart, for probably having been too interpreted by vested interests, hand having to end up in the eye of the current storm on debt. They do a good job of fixing their positions in “Austerity is not the only answer to a debt problem” May 2. Of course it is not a question of either or… and it is not even necessary for them to call on Keynes to testify in their defense.

That said, what they entirely miss, probably because it has never been an area of research or concern to them, is how current bank regulations, which so immensely favor sovereign borrowings, leads to the illusion of low rates.

Just one example: Banks in Europe lending to Germany do not need to hold any capital, something which implies an authorized infinite leverage of their equity. But, if they lend to a German small or medium business or entrepreneur, then they need to hold 8 percent in capital and can only leverage the risk-adjusted returns of that loan on their equity 12.5 times to 1. 

Anyone who does not understand that translates into a direct subsidy of Germany´s borrowing rate, paid by taxing the more “risky” and the real economy losing out of opportunities, has little idea about how banking and capitalism work. 

If some real game changing opportunities are thereby lost by Germany, it could in fact currently, and quiet unwittingly, be paying they highest interest rates ever on their public borrowings.

On the Battle between “Austerians” and “Profligarians”

Sir, Martin Wolf refers sort of contemptuously to “austerians”, to whom he holds “a financial crisis is a mark of moral turpitude, to be redeemed only by suffering. “Why the Baltic states are no model” May 1.

But Wolf himself could also with moral turpitude equally be accused of being a “profligarian” in holding that a financial crisis should only be redeemed by just letting the party go on… in the best style of an Après moi, le déluge baby-boomer’s perspective.

Before the worst type of austerity is eliminated, namely that which hinders banks to take the real risks the real economy demands, I find myself definitely to be an “austerian”, because otherwise fiscal and monetary profligacy would just be a waste of fiscal and monetary space.

Now, once the regulatory establishment has come to its senses, God willing, and eliminated the current capital requirements for banks based on risk-weighting for perceived risks which have already been weighted, by means interest rates, amounts of exposure and other terms, then I will gladly think of joining the camp of the profligarians. I said “think” because I would need to be sure regulators really understood how dumb they had been, so as to never again repeat similar nonsense.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, since he has told me not to send him anything more about the implications of these “capital requirements for banks based on perceived risk”… he already knows it all... at least so he thinks.

Europe what you really need is much less risk-taking austerity

Sir, Philip Stephens refers to the “high public debt suffocates growth” vs. “it is low growth that drives up debt” controversy. It all sounds so Lilliput vs. Blefuscu to me, “The New Deal for Europe: more reform, less austerity” April 26.

What currently suffocates the growth of the real economy are those crazy capital requirements for banks that create enormous incentives for banks to shun all what is officially perceived as “risky” like small and medium businesses and entrepreneurs, and to earn all their return on equity by lending to what is perceived as “absolutely infallible”. And, since in Europe the banks have normally been more in charge of financing the risky than those in the US, where more alternative sources of funds exists, Europe suffers the most.

Stephen refers to the existence of “ossified labour markets that lock out young people and discourage investments and innovations”, and he is right of course, but, when compared to bank regulations which lock out the “risky”-risk-takers in the real economy, their effects are sort of minor.

When banks have effectively been castrated, and are singing in falsetto, even low public debt does not help growth and, since currently the lowest capital requirements for the banks apply when these lend to the public sector, higher public debt level will result. It suffices to read Martin Wolf’s almost monothematic preaching for the public sector to take advantage of low interest rates, so as to borrow and take on large infrastructure projects, without understanding that those low rates are just a mirage, caused by regulatory subsidies paid for by the many extremely onerous missed opportunities in the real economy.

Europe, please inform your overly timid and dumb bank regulators that no major bank crisis ever has resulted from excessive bank exposure to the “risky”, they have all resulted from major exposures to what was dangerously perceived as “absolutely safe”.

Martin Wolf, monetary profligacy should not be an article of faith either

Sir, Martin Wolf, insists in that because those “for room for maneuver, such as the US and even the UK” because they did not create stimulate enough the economy the “recovery has been even weaker and so the long run cost of the recession far greater than was necessary”, “Austerity loses an article of faith” April 24.

And to back up his arguments Wolf uses foremost the fact that UK, after reaching a net public debt of 240 per cent of gross domestic debt level, something that most probably most public sector lenders were blissfully unaware of, managed to work down the debt load, thanks to the industrial revolution.

Mr. Martin Wolf, let me just ask you the following four questions:

Where is today’s industrial revolution? 

Do you really think that back then the UK had regulators who gave banks extraordinary incentives to avoid taking risks? No matter what Carmen Reinhart and Kenneth Rogoff hold, in this sense, this time is indeed different.

What soaring private and public debt which led to the crisis was not the direct result of minuscule capital requirements for the banks required for the “absolutely safe”?

Finally what are we supposed to recover to, to the skewed economy we had before? Just so that house prices go up and banks earn 30 percent on their equity?

In October 2009, Martin Wolf kindly published in his Economist Forum my “Free us from imprudent risk-aversion” and I still hold, more than ever that it contains the explanation for what brought us the current crisis and what stops us from getting out of it.

Before we correct the incredibly dumb regulatory bias against risk-taking, any stimulus will just eat up any scarce stimulus space we have, for absolutely no good reason at all. 

Would the US not still be treading water had their QE’s been twice as large?

Again, and as I read Mr. Wolf’s arguments, to me, day by day he is becoming, more and more, a worthy representative of those baby-boomers with an “après mois le deluge” philosophy. As a grandfather, I should try to stop him.

Guido Westerwelle, ask Stefan Yngves, Basel Committee, to explain “risk-adjusted regulatory bank returns” to you.

Sir, Guido Westerwelle makes a passionate plea for deepening the reforms in Europe, since “In some countries youth unemployment has risen to intolerable levels”, “Europe needs austerity and reforms – not spending” March 15. 

Mr Westerwelle, the foreign minister of Germany, is unfortunately not aware that there is another sort of “unilaterally austerity imposed from the outside”, an “austerity curse”, which has been destroying the economies in Europe and impeding job creation for quite some time. 

I refer to the capital requirements for banks imposed by the Basel Committee, I do not know with which authority, and that makes lending to those perceived as “absolutely safe” borrowers, immensely more profitable for the banks¸ than lending to the “risky” borrowers, like all the small businesses and entrepreneurs. And that has effectively castrated the banks and made it impossible for these to allocate economic resources efficiently. 

May I suggest Mr. Westerwelle, that he picks up the phone and calls Stefan Ingves, the Chairman of the Basel Committee to ask him: “Stefan what are these “risk-adjusted (regulatory) returns” that you mention in your March 12 speech?

Here I explain more of this 

PS. Sir, just to let you know, I am not copying Martin Wolf with this, since he has told me not to send him anything more about these “capital requirements”… he already knows it all... so he thinks.

Eliminate the loony regulatory risk-taking austerity imposed on banks, and you will help the real economy

Sir, Wolfgang Münchau writes that “If you are serious about structural reform it will cost you upfront money, and so therefore “Austerity is the obstacle to real economic reform” February 25.

Indeed there might be many much needed reforms that might require increased fiscal spending, but not all of them do.

The reform that I most advocate is eliminating the negative effects on the real economy that bank regulators’ runaway risk-taking austerity is causing. That would not cost the tax-payer money today, and that will actually save the tax-payer money tomorrow.

The lunacy of allowing banks to earn a much higher expected risk-adjusted return on equity for exposures to what is perceived as “safe”, than for exposures perceived as “risky”, only guarantees ineffective resource allocation by banks, and the dangerous and very expensive overcrowding of today’s “absolutely-safe” havens.

There is no fiscal or monetary policy that can make up for bad and distortive bank regulations

Sir, Gillian Tett draws four quadrants by on one axis showing the private sector in a credit boom, and the public sector stimulating, and on the other axis the private sector deleveraging and the public sector also deleveraging, going for austerity, trying to rein in any inflation threats. 

And this tool makes it easy to understand that it is only in the quadrant where both the private sector and the public sector are deleveraging that the risk of a liquidity trap and deflation exists, and so, when there both “monetary policy and fiscal expansion must be stimulative, since loose money alone will not work”. And this Ms Tett does in “It’s time to embrace a new mental map of central banks” January 11.

Absolutely! But using the same methodology, and in this case including on one axis what is ex-ante perceived as absolutely safe, and what is perceived as risky, and on the other axis what ex-post turns out to be safe, and what turns out to be risky, one should also be able to understand that it is only the quadrant containing what was ex-ante perceived as absolutely safe and that ex-post turned out to be risky, that poses any major threat to the banks. 

And therefore one could conclude in that capital requirements for banks like the current ones, higher for what is perceived as risky and lower for what is perceived as absolutely safe, make no sense whatsoever and only distorts.

And so again, for the umpteenth time, let me repeat that it really doesn’t matter if you select the absolute correct fiscal and monetary policy if at the same time, by using loony and distortive bank regulations, you are going to impede these to work.