Please, could somebody urgently brief Fed Chair Janet Yellen on the fact that there are different kinds of bubbles?

Sir, Robin Harding reports that Janet Yellen holds that the Fed “is more interested in having a resilient financial system that can cope when asset bubbles burst than it is in popping them through rate rises” “No need to lift rates to curb risk, says Yellen” July 3.

I would totally agree with her… if only we found ourselves within a productive bubble and not as now within a useless bubble. Let me explain.

There are bubbles based on a lot of risk taking which albeit sometimes they have very large costs, at least takes us forward. And then there are bubbles, like this one based on risk aversion, that though just as costly, keeps us, in the best case scenario, stamping waters.

For instance the dotcom bubble cost us a lot, but left some useful advances, while the housing bubble with its AAA rated securities backed with mortgages to the US subprime sector was pure pain with no gain.

Unfortunately it seems that no one has briefed Janet Yellen about the implications of risk-weighted capital requirements for banks.

Regulators painted the banks into the dangerous corner of holding much of what is perceived as safe against little capital.

Sir, Alberto Gallo notes “The irony is that the Fed is becoming trapped by its own policies. QE and low rates have helped to solve the banking crisis, but also pushed investors to take on bigger risks” “Fed has grown complacent on credit market risk” July 1.

Yes but what has trapped them even more than so is that while providing liquidity and low rates because portfolio invariant risk weights, they forced banks into ever larger and dangerous exposures to what is, for the times being, officially perceived as “absolutely safe”.

Look for instance at the UK where even though BoE expresses concern of a housing bubble, it still permit banks to hold much less capital against mortgages than for instance against loans to SMEs.

The real problem we face today is that it is impossible for regulators to help banks out of the dangerous corners they have been painted, while they refuse to admit the possibility that it was they who did most of that painting.

The only bubble our young unemployed really need is the one really absent, having been prohibited by bank regulators.

Sir, Patrick Jenkins writes “There are other bubbles out there beyond UK house prices” May 27. He is of course right. But in the same way that a stress test on banks should not only include what is on their balance sheets but also what is not, an inventory of bubbles should also analyze the absent bubbles.

And in this respect let me assure you that the most conspicuously absent bubble, in the UK, in Europe and largely in America too, is the one our young unemployed most needs, and I refer to the “Medium and small businesses entrepreneurs and start-ups” bubble. That is the bubble that has been prohibited by the risk-weighted capital requirements for banks imposed by our dangerously risky risk adverse bank regulators.

More on "Bubbles"

What is a European bank to do, but to help inflate the sovereign debt bubble and pray?

Sir, I refer to Claire Jones and Ferdinando Giugliano reporting “Draghi signals imminent action to combat eurozone inflation” May 9.

So what is a European bank to do if there is more liquidity, the ECB pays nothing on deposits, and it has no capital to meet the capital requirements for lending to anyone else but to sovereigns? It has no choice but to help to inflate the sovereign bubble… and of course join whole Europe in prayers for that these central bankers know what they are doing.

As you know... since they do not understand that risk-weighted capital requirements for banks creates huge and dangerous distortions in the allocation of bank credit, at least I do not think they do know what they are doing.

Ms Tett. Not having a clue, “conventional blissful ignorance”, should not be confused with having an idea, “conventional wisdom”.

Sir, Gillian Tett writes “Ideas must adjust to new ‘facts’ of finance”, December 27. But as I see it therein she refers to what mostly had nothing to do with ideas, and all to do with simply not knowing. What Tett calls “conventional wisdom” is nothing but “conventional blissful ignorance”.

For instance “Before 2008 [leverage] seemed irrelevant”. Well go to all the initial reports on the 2007-08 crisis, and you will only be able to read about reasonable leverages… and that is because markets, and reporters, had no idea, most still do not have, of how much leverage could hide behind the risk-weighting of assets. Most of those compliant with “stricter Basel III capital rules” are still today, in not risk-weighted terms, leveraged over 30 to 1.

Tett also writes “Before 2008, it was almost outlandish to suggest policy makers might deliberately shape the direction of finance with policy interventions”. Really? What if not an extreme policy intervention is capital requirements based on perceived risks? That, which allows banks to earn much risk adjusted returns on their equity on assets deemed ex ante as “absolutely safe” than on assets deemed as “risky”, is for instance what drove the banks into the arms of those AAA rated securities which detonated the crisis.

And surprisingly Tett also states “Before 2008, policy makers liked to think they could mop up after excesses, if necessary, rather than intervene in advance. No longer.” What? Is not all Quantitative Easing going on based on the basic assumption that they will be able to mop it up before it all overflows into inflation?

Happy pondering Ms Tett!

Why should banks earn higher risk adjusted returns on equity financing property than when financing businesses?

Sir, John Plender writes “Historically, the biggest single cause of financial crises in the UK has been the bursting of property bubbles” “BoE lacks tools needed to prick property bubble” September 25.

If that is so, which I have no reason to suspect it is not then would he, or Lord Turner, explain to us, why were regulators allowing banks to lend to property against less capital than when doing much other lending? Did that not signify that banks would be earning higher risk adjusted returns on equity on property lending than on other lending? Did that not doom banks, next time a property bubble burst, that everything would be so much worse, since banks would be standing there with especially little capital?

BoE does not lack tools. It just needs to arm itself with a new generation of regulators capable of understanding that risk-taking is not something dirty, even when banks do it. And of understanding that there is nothing as risky as excessive risk-aversion.

But the AAA-ratings-bubble was the fault of very few!

John Authers is correct in that “Bubbles are the fault of the many – not the few” April 3, but that is of course with the exception of the AAA-ratings-bubble and which when it blew up caused the current crisis.

That bubble was the fault of only 3 credit rating agencies and of those very few regulators who empowered the credit rating agencies with so much credibility when they made their credit risk analysis of the clients of the banks, determine how much capital the banks should have… even to the extent of allowing the banks to hold a truly minuscule 1.6 percent in capital when lending to a private AAA client and, good grief, no capital at all when lending to a sovereign AAA.

You can’t explode a bubble and have it too

Sir are we in the future going to have to read Nouriel Roubini’s “The mother of all carry trades faces an inevitable bust” November 2, as another example of how we were warned about the risks? I hope not. First because it does not contain a single word about the what-to-do and also because it ignores that all traders, though aware that yesterday’s results has little to do with tomorrows, just in order to make a living, need to keep the dancing halls open and the public dancing.

In comparison, Wolfgang Münchau’s “We must not be too late with starting the Big Exit”, and which calls for starting to increase the interest rates in the US, is a more valiant effort to face the sad truth that you can’t explode a bubble and have it too.

The signs pointing towards “risk-free” land are still there; and to some they still mean exactly the same.

Sir Tony Jackson admonishes us “Don’t believe bubbles have been scientifically abolished” August 10. Of course not! How can we be that stupid? Especially since all those risk-free AAA signs that led so many over the cliff are still there and taken to mean exactly the same as before, at least by the regulators.

But when Jackson suggests that “the aim should not be to prevent [the next crisis] but to contain its effect next time around, may I humbly add... and what about giving a little more purpose to the boom?

Let us not forget the rental options

Sir though I might have picked a somewhat more gentle title I agree full heartedly with Martin Wolf’s “Let Britain’s housing bubble burst” April 18. Having said that perhaps it would also have been appropriate to include a remark about the bias that has been spread throughout the whole world and that favours the ownership of houses as compared to the alternatives provided by the rental markets.

In a global mobile work market where a house when owned often signifies a ball chain around the ankle it would seem that renting should be a very good option, if it is able to overcome the stupid hurdle of having almost been socially derided as a second class choice.

No, it is the courtesy of the regulatory agencies

Sir, John Plender in “A stretched credit cycle, a more savage downturn” May 22, gives a very clear explanation of the blissful-ignorance-bubble when he mentions the fact that many of the positions “are not marked to market” but instead “marked to model”. Where he is wrong though is when he says that “Credit is being mispriced courtesy of credit rating agencies that are insensitive to market risk.” For that we should thank our financial regulators who by ordering the market to listen to the credit rating agencies created a totally new form of non-market market risk.

And please, why does Plender have to say that “high finance has never been more sophisticated”? when in fact many of us suspect we might be living the period where never have high finance people understood so little of what they really were up to.

Please assure Mr. Merton that no one is holding him personally responsible

Gillian Tett does a splendid work interviewing Mr Robert Merton “The appliance of financial science” May 21 and let us hope that on the behalf of all of us she has really been able to convey that we really will not hold him personally responsible for whatever could happen with all of his and his friend’s inventions and creations such as derivatives, option pricings and what have you, just as no one does holds Einstein and his friends responsible for what more bad the nuclear bomb might bring. Of course it will all come down to how these great and useful inventions are used.

Having said that I would like to comment on that when Merton says “Just think of all the crises that haven’t happened, say with the downgrade of General Motors and Ford” it really does not mean the negative effects have disappeared, just that they have been so diluted that we do not notice it. Spreading ink in a lake instead of a bathtub will get less noticed but keep on doing it and then suddenly you will have a whole lake go ink-blue and that could suddenly turn to be even catastrophic.

Question. Are derivatives a way of pushing things forward to future generations so as to better being able to enjoy the blissful ignorance bubble?