When will the history of the Basel Committee’s concoctions haunt us?

Sir, I refer to Owen Walker’s “Haunted by his­tory” FT Magazine, August 10. It ends with “Unfor­tu­nately Monte dei Pas­chi will not help to develop and sus­tain Siena as it has done for more than five and a half centuries.” 

Unfortunately, that goes for all banks that were of importance to their localities.

In 1988 regulations known as Basel I was approved. It favored government debt and residential mortgages. That distorted but not too much. Loan officers used to follow the wishes of diverse Medici, must not have been too surprised. But then, in 2004, Basel II hit the banking world. With its risk weighted bank capital requirements so much dependent on credit ratings, the traditional loan officers, like Britain’s beloved George Banks, were thrown out. In came dangerously creative financial engineers. Their mission was now to maximize return on equity, not by good lending, but by minimizing bank capital, meaning bank equity, meaning bank shareholder’s skin in the game; in other words by maximizing leverage.

Not that all loan officers have been saints. Of course not. As in all parts of life, embezzlement and general uselessness was way too often present; but it was localized. Now it has been globalized. Monte dei Paschi’s financial engineers’ use of derivatives fabricated by Deutsche Bank or Nomura is just a minor example of it. A major one is how those securities backed by USA subprime mortgages, that when rated AAA allowed banks to leverage 62.5 times their capital, inundated European banks and caused the 2008 GFC.

How long will it take for the world to wake up to the fact that their expert bank regulators and supervisor, who lately, with all Basel III complexities multiplied in number and complexities, all missed their lectures on Bayesian conditional probabilities. As a consequence, they never understood that if they were going to use risk weighted bank capital requirements, something that for a starter was a bad hubris filled idea, then at least the weights should be conditioned to how bankers could be expected to act when perceiving risks.

Sir, David Rossi’s death, no matter how it occurred, is sad, but not remotely as much as the death of our banking system, that which made the western world prosper beyond belief.

One day our grandchildren will ask: How could our grandfathers so much favor banks refinancing their safer present, instead of financing our riskier future.

PS. Recently I asked ChatGPT which alternative, a leverage ratio or risk weighted capital/equity requirements, would most empower loan officers, and which one creative financial engineers. Here its answer

@PerKurowski

http://teawithft.blogspot.com/2012/07/its-whats-safe-thats-risky.html

https://teawithft.blogspot.com/2016/12/the-way-ft-insists-in-treating-bank.html

Spurn bank regulators' false promises.

Sir, Martin Wolf makes a good case for “We should not throw liberal trade away for the wrong reasons and in the wrong way”, “Spurn the false promise of protectionism” FT June 16.

Yet, when regulators, decades ago, decided to throw liberal access to bank credit, by imposing credit risk weighted bank capital requirements, something which completely distorted the access to bank credit, Wolf and 99.99 percent of those who should have spoken up, kept mum.

Though I’ve no idea whether they read it, in a 2019 letter I wrote to the Executive Directors and Staff of the International Monetary Fund, I argued that these risk weights are to access to credit, precisely what tariffs are to trade, adding “only more pernicious” 

Wolf writes that “the US economy has suffered from high and rising inequality and a poor labour force performance” and includes among other explanations the “rent-extracting behaviour throughout the economy”

But anyone who reads “Keeping at it” 2018 in which Paul Volcker’s 2018 valiantly confessed: “The assets assigned the lowest risk, for which bank capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages”, should be able to understand that rent-extraction also occurs by means of cheaper and more abundant access to credit.

And boy did regulators throw away unencumbered access to credit in “the wrong way”

Here follows four examples: 

To establish their risk weights, they used the perceived credit risks, what’s seen “under the street light” while, of course, they should have used the risks for banks conditioned on how credit risks were perceived. 

By allowing banks, when the outlook was rosy, to hold little capital, meaning paying high dividends, lots of share buy backs, and huge bonuses, they placed business cycles on steroids.

Very little of their capital requirements cover misperceived credit risks or unexpected events. Therefore, just as in 2008 with the collapse of AAA rated mortgage back securities, and now with a pandemic, banks were doomed to stand there with their pants down.

With risk weights of 0% the sovereign and 100% the citizens, which de facto imply bureaucrats know better what to do with credit they’re not personally responsible for than e.g., entrepreneurs, they smuggled communism/statism/fascism into our banking system.

“We will make your bank systems safe with our credit risk weighted bank capital requirements” Sir, what amount of wishful thinking must have existed for the world, its Academia included, to so naively have fallen for the hubristic promises of some technocrats.

@PerKurowski

Could the Basel Committee learn enough from puzzles and poker so as to correct their misinformation?

Sir, I refer to Tim Harford’s “What puzzles and poker can teach us about misinformation” FT Weekend December 5.

When deciding on what’s more dangerous to banks the regulators in the Basel Committee, with “expert intuition” and great emotion shouted out the “below BB-” and, for their risk weighted bank capital requirements, assigned these a 150% risk weight, and a very smallish 20% to what’s rated AAA.

But, with what type of assets can those excessive exposures that could really be dangerous to our bank systems built-up, with assets rated below BB- or with assets rated AAA?

Never ever with assets perceived as risky, always with assets perceived as safe.

Sadly, the regulators had missed their lectures on conditional probabilities.

And their “expert intuitions” are so strong that they were not able to understand the clear message sent by the 2008 AAA rated MBS. 

What does Tim Harford think regulators could learn from puzzles and poker to correct their misinformation?

PS. Trying to understand the how come of the so loony bank regulations, by reading Daniel Kahneman’s “Thinking, Fast and Slow” 2011.

@PerKurowski

The case against insane globalism also remains strong.

The purpose of the Basel Committee for Banking Supervision BCBS, established in 1974 is to encourage convergence toward common approaches and standards. That sure reads as it could qualify as that global cooperation Martin Wolf asks for in his “The case for sane globalism remains strong” July 16.

But what if it is not sane?

BCBS has basically imposed on the world the use of credit risk weighted capital requirements for banks.

Since perceived credit risks are already considered by bankers when deciding on the interest rate and the size of exposures they are willing to hold, basing the capital requirements on the same perceived credit risks, means doubling up on perceived credit risks. 

And Sir, as I have argued for years, any risk, even if perfectly perceived, causes the wrong actions, if excessively considered. 

I dislike the concept of any kind of weighted different capital requirements, because that distorts the allocation of credit with many unexpected consequences. But if we wanted to have perceived credit risk to decide bank capital, it would of course have to be based on the conditional probability of what bankers are expected to do when they perceive credit risks, and these might be wrongly perceived.

Would we in such a case assign a 20% risk weight to what is rated AAA and a whopping 150% to what is rated below BB- as in Basel II’ standards? Of course not!

And if we did not think that government bureaucrats know better what to do with bank credit they are not personally liable for, than entrepreneurs, would we then assign the “safe” sovereign a 0% risk weight and the “risky” not rated entrepreneur a risk weight of 100%, which would clearly send way too much credit to sovereigns and way too little to entrepreneurs? Of course not!

And if we thought having a job as important or even more so than owning a house, would we then allow banks to leverage so much more with residential mortgages than with loans to small and medium enterprises, meaning banks can obtain easier and higher risk adjusted returns on their equity by financing “safe” houses than by financing “risky” job creation? Of course not!

Sir, in 2003, when as an Executive Director of the World Bank I commented on its Strategic Framework I wrote: "A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind."

Does this mean that I do not agree with Martin Wolf when he argues in favor of multilateral co-operation? Of course not! But it sure argues for being much more careful when going global with plan and rules.

By the way in those same 2003 comments at the World Bank I also wrote: “Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market”. And it did not take the world long before drowning in 2007 and 2008 in the AAA rated securities backed with mortgages to the subprime sector in the U.S.

But have those who concocted those ill suited risk weighted bank capital requirements ever admitted a serious mea culpa? No, they have blamed banks and credit rating agencies.

And in EU the authorities assigned a 0% risk weight to all Eurozone sovereigns even though they all take up debt that is not denominated in their local printable currency. And no one said anything?

Sir, in the whole world, I see plenty of huge dangers and lost opportunities that can all be traced back directly to BCBS risk weighted bank capital requirements. 

So, besides having to be very careful when going global, we also have to be very vigilant on what the global rulers propose. Of course, for that our first line of defense are the journalists daringly questioning what they do not understand or like.

Has FT helped provide sufficient questioning about what the Basel Committee has and is up to? I let you Sir answer that question.

http://subprimeregulations.blogspot.com/2003/03/my-comments-on-world-banks-strategic.html

@PerKurowski

To explain the 2008 financial crisis a two pieces puzzle could suffice.

Sir, Tim Harford writes, “Raghuram Rajan, when he was chief economist of the IMF, came closest to predicting the 2008 financial crisis. He later observed that economists had written insightfully on all the key issues but had lacked someone capable of putting all the pieces together”, “How economics can raise its game” June 29.

According to 2004’s Basel II, a corporate rated AAA to AA, could offer banks to leverage their equity 62.5 times (100%/(8%*20%)) with its risk adjusted interest rate, while one rated BB+ to BB-, or not rated at all, could only offer banks to have their risk adjusted interest rate leveraged 12.5 times (100%/(8%*100%))

Sir, I am not arguing whether it is better to be a hard or a soft economist but, any economist looking at that proposition and not seeing it would cause serious misallocation of bank credit, should either go back to school, perhaps to take some classes on conditional probabilities, or go out on Main-street, and learn a bit of what real life is about.

62.5 times leverage? What banker could dare resists that temptation and stay out of competition thinking, what if that AAA to AA rating is true?

PS. That leverage applied for European banks and US investment banks supervised by SEC.

@PerKurowski

Loony risk-weighted capital requirements block entrepreneurs’ access to fair credit.

Sir, Eric Schmidt writes“Right now, the UK, the EU and the US share a growing problem: we are experiencing a market failure in the way we support entrepreneurs.” “Our narrow view of entrepreneurs squanders talent”, November 28. 

Absolutely! But some market failures are government produced. 

If a bank lends to someone wanting to buy a house, something perceived as safe, the regulators allow it to hold much less capital that if it lends to an entrepreneur, something perceived as risky. 

So if a bank lends to someone wanting to buy a house, something “safe”, it will be able to leverage its capital much more than it can do if it lends to an entrepreneur, something

So if a bank lends to someone wanting to buy a house, something “safe”, it will be able earn much higher expected risk adjusted returns on its equity than it can do if it lends to an entrepreneur, something “risky”. 

But was it always this way? Of course not! This happened when bank regulators introduced the risk weighted capital requirements for banks. That which is based on that truly loony concept that what bankers perceive as risky, is more dangerous to our bank system than that what bankers perceive as safe. 

Since then millions of credit requests have been either negated or if approved, have had to support a higher than needed interest rate. 

Schmidt also writes about the need to “drop the tunnel vision promoted by many academic and professional specialisations”.

Absolutely! I have often argued that had there been: 

a plumber or a nurse disturbing the regulators’ group-think with an innocent question like “what has caused big bank crises in the past?” 

or a professional that had taken a course in conditional probabilities, 

or someone (incorrectly) quoting Mark Twain with “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain”, 

or a golfer asking “why would you assign more handicap strokes to good players taking these away from lousy players like me?”, 

then the 2008 crisis would not have happened… and Lehman Brothers would still be alive and kicking.

God make us daring!

@PerKurowski

Which bonds, the high-yield or the low-yield, cause the most sufferings when things go wrong?

Sir, Robert Smith quotes Inge Edvardsen, head of fixed income sales at Pareto Securities with “High-yield bonds offer high returns with associated risks but it is of course unfortunate when our clients suffer losses”, “Dreams turns to Sweden for high-yield deal as UK retailing debt feels strain” November 23.

Similarly Edvardsen could have said “Low-yield bonds offer low returns with associated risks but it is of course unfortunate when our clients suffer losses” 

So let me ask you Sir, which of the bonds, the high-yield or the low-yield, do you associate with clients suffering the most when things go wrong?

I have no doubt; it is the low-yield-low-perceived-risk ones, because these usually attract the highest portfolio exposures at the lowest risk compensation premiums.

But, our bank regulators, they think differently; they think the high-yield-high-perceived bonds cause more sufferings, because those would be the bonds against which they would require banks to hold more capital.

It’s all so dangerously loony to me. Our current bank regulators have clearly confused ex ante risks with ex post dangers, and they have not the slightest idea about what conditional probabilities mean.

Sir, it sure surprises me that you seem to agree with the regulators.

@PerKurowski

Paul Volcker warns public administration training is no longer on universities’ radar. Neither seems conditional probabilities and Bayes’ rule to be

Sir, interviewed by Gillian Tett, Paul Volcker’s tells her, “I would like my legacy to be some attention to public service. When I grew up good government was a good slogan. But now the phrase ‘good government’ is a mockery [and] universities have effectively abandoned practical public administration training, focusing instead on ‘policy’",“Volcker sets a challenge for the next generation” October 26. 

And Ms. Tett laments, “Few students want to make the type of financial sacrifices that Mr Volcker did for many decades, in the name of public service”

That concern has great merits, especially because the alternative would be to see our public service posts filled with experts in negotiating what crony statism could have to offer.

The Paul Volcker as Fed chair in the 1970s crushing inflation was a hero of mine. Unfortunately I woke up to the fact he helped doom to failure our banking system.

Getting the clue from Charles Goodhart’s “The Basel Committee on Banking Supervision: A History of the Early Years 1974-1997”, in Steven Solomon's “The Confidence Game: How Unelected Central Bankers Are Governing the Changed Global Economy” of 1995 I 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…

Adequate capital – the bank’s buffer against bankrupting loss- was the keystone of a central banker’s mission to uphold financial system safety and soundness.

They literally wiped the blackboard clean, then explored designing a new risk-weighted capital adequacy for both countries… 

It included… a five-category framework of risk-weighted assets… It required banks to hold the full capital standard against the highest-risk loans, half the standard for the second riskiest category, a quarter for the middle category, and so on to zero capital for assets, such as government securities, without meaningful risk of credit default.”

That led to the Basel Accord, Basel I in 1988. And of course, setting the capital requirements for the banks based on the risks that bankers cleared the most for, credit risk, had to dangerously distort the allocation of bank credit to the real economy. As I say over and over again, any risk, even if perfectly perceived, will cause the wrong actions if excessively considered.

Suffices to say that 100% of the assets that caused the especially large 2007-08 crisis were assets that, because they were perceived as especially safe, generated especially low capital requirements for the banks.

When I consider the total silence by universities on the consequences for the stability of our banking system and for the dynamism of our economies produced by the risk weighted capital requirements for banks, I am also saddened.

Universities, like Harvard Business School, do have “Conditional Probabilities and Bayes’ rule” on the curriculum. Could it be that professors are kept too busy preparing these courses so to have time to look out at what’s happening in the world? Or could it be their students, like Paul Volcker, never understood them.

Sir, wake up! When hubris filled besserwisser regulators tell you: “We will make your bank system safer with our risk-weighted capital requirements”, as if they were great clairvoyants, and you believe them, you have fallen for some pure, unabridged and very dangerous populism. 

The risk weighted capital requirements for banks guarantee especially large exposures, to what’s perceived as especially safe, against especially little capital, which dooms bank systems to especially severe crises.

PS. If regulators want to use risk weighted bank capital requirements, these should be based not on the credit risk of assets per se, but on the risk for the bank system the assets pose, conditioned on how risks are perceived and acted on by bankers. Who has the power to tell them so?

@PerKurowski

Myths, and truths that shall not be told, is why so little has changed since the financial crash

Sir, Martin Wolf writes: “The financial crisis was a devastating failure of the free market… The persistent fealty to so much of the pre-crisis conventional wisdom is astonishing.” “Why so little has changed since the financial crash” September 4.

Myths and truths that shall not be told, so that regulators shall not be held accountable, is the cause of that, not the failure of markets that were not free by a long shot. Here follows some of the more important of these.

Lack of regulations: Wrong! Total missregulation. Regulators for their risk weighted capital requirements for banks used the perceived risk of banks assets, those that bankers were already clearing for, and not the risk that bankers would perceive and manage the risks wrongly. They seemingly never heard of conditional probabilities.

Excessive risk taking: Wrong! It was the regulators excessive risk aversion that gave banks incentive to build up excessive exposure to what was perceived safe.

Greece did it: Wrong! EU authorities did Greece in, when assigning a 0% risk weight to its debt.

But Wolf is correct when arguing, “Today’s rent-extracting economy, masquerading as a free market, is, after all, hugely rewarding to politically influential insiders”

Because yes, crony statism is all around us, beginning with the “We governments guarantee you banks, and then assign ourselves a 0% risk-weight so you need not to hold any capital when lending to us, and so then you can return the favor by lending to us. 

Sir, Wolf concludes: “If those who believe in the market economy and liberal democracy do not come up with superior policies, demagogues will sweep them away”. That is right! But let us not ignore that “We will make your bank systems safe with our risk weighted capital requirements” was and is pure unabridged besserwisser demagoguery.

PS. Of course journalists who refuse to ask regulators the right questions since they are scared that if they do they will never be invited to Davos and Jackson Hole gatherings are also part of the explanation.

PS. Here is an aide memoire on some of the mistakes in the risk weighted capital requirements for banks.

@PerKurowski

When will someone invited dare to pose the question that shall not be made at a Davos or Jackson Hole gathering?

Sir, Gillian Tett writes: “The International Monetary Fund calculates that between 1970 and 2011, the world has suffered 147 banking crises... But whatever their statistical size, the pre-crisis period is marked by hubris, greed, opacity — and a tunnel vision among financiers that makes it impossible for them to assess risks.”, “When the world held its breath” September 1.

Sir, and why should regulators, who impose risk weighted capital requirements for banks, and stress test these be less affected by that “tunnel vision”? 

If regulators knew about conditional probabilities, if they absolutely wanted and dared to distort the allocation of bank credit, they would have set their risk weights based, not on the perceived risks of assets, but on how bankers’ perceive and manage risks.

Tett quotes Alan Greenspan with “I originally assumed that people would act in a wholly rational way, that turned out to be wrong.” Shame on him, had he just done his homework, he would have known that what was perceived as risky never ever causes financial crises, that is always the role of what was thought as very safe.

Tett also quotes Paul Tucker, the former deputy governor of the Bank of England with, “There is a dynamic which pushes banking and the penumbra of banking to excess, over and over again”. That “dynamic” force was the regulators pushing bankers into excesses, for instance by allowing them to leverage 62.5 times if only an AAA to AA rating issued by human fallible credit rating agencies was present.

Tett recounts: “One day in the early summer of 2007, I received an email out of the blue from an erudite Japanese central banker called Hiroshi Nakaso”, who warned her “that a financial crisis was about to explode because of problems in the American mortgage and credit market.” 

Tett was astonished, though she did, by then, not disagree with the analysis. May 19th 2007 I wrote the following letter to FT, which was not published.

“Sir, after reading Gillian Tett’s “A headache is in store when the credit party fizzles out” May 19, it is clear we should all go down on our knees and pray for that she is right, in that it is only a headache that is in store for us. 

As for myself I have serious doubts that the consequence of this blissful-ignorance-bubble resulting from our hide-and-not-seek the risks with derivatives, is unfortunately going to be much more painful than that. When that day comes though, before putting the sole blame on the poor bankers earning their luxurious daily keep; I suggest we look much closer at the responsibility of our financial regulators.”

Sir, sadly, that suggestion has been way too much ignored until now. 

“Why do you require banks to hold more capital against what by being perceived as risky is made less dangerous to our bank systems, than against what by being perceived as safe, poses so many more dangers?” That is the questions that seemingly shall not be asked by anyone who markets his name in the debate and does not want to risk being left out from Davos or Jackson Hole gatherings.

PS. Here is somewhat more extensive aide memoire on the mistakes in the risk weighted capital requirements for banks.

@PerKurowski

EU needs to find a president of the European Central Bank quite different from Mario Draghi… whatever it takes

Sir, you opine, “The most worthwhile tribute that European governments can make Mario Draghi, the president of the European Central Bank, is to find a successor who most closely replicates his attributes and has the best chance of continuing his success. There are few harder acts to follow in global policymaking than his. He has helped rewrite the central banking handbook, shepherding the euro through an existential threat from the sovereign debt crisis and the danger of a deflationary recession. “Next ECB chief should be in the Draghi mould” August 30. 

I disagree and believe that FT, at some point down the road, will have to eat up these words of praise for Draghi; who alsopreviously served as the Chairman of the Financial Stability Board from 2009 to 2011 and Governor of the Bank of Italy from 2005 to 2011.

Draghi, as a regulator, with the risk weighted capital requirements for banks was partt of the team that introduced a risk-aversion, which ignored all the valuable services banks provided, when acting as the societies’ designated risk-takers.

Draghi, as a regulator, ignoring conditional probabilities, supported risk weighted capital requirements for banks based on the perceived risk of assets and not based on how banks could manage those assets dependent on their own perceptions of risk. That distorted the allocation of credit, causing among other banks to fall over a precipice when chasing those AAA to AA rated securities they were allowed to leverage a mind-blowing 62.5 times with.

Draghi, as a regulator, was, is, a statist of first degree, for agreeing with risk weights of 0% for the sovereign and 100% for the citizen.

Draghi, as a European central banker, who must have known that the challenges the euro posed had not been taken care of, irresponsibly agreed when Greece was assigned a 0% risk weight, which caused its current tragedy.

What Draghi did in ECB, was just to act as the principal member of that kicking team that kicked the crisis-can down the road, willfully ignoring the fact that European grandchildren will suffer when that can begins to roll back on them.

Sir, in summary, the next ECB chief should know about the importance of risk taking, about conditional probabilities, should not be a statist, and should be able to refuse punishing a EU nation, like Greece, for the mistakes of EU authorities. 

So, whatever it takes, he should be very different from Draghi. I would hold that EU’s own chances of survival depends much on that. 

@PerKurowski

Sweden sadly forgot risk-taking was the oxygen of its development.

Sir, Martin Sandbu, when discussing Scandinavian countries, the Nordic mixed model begins with: “Ten years ago, the global crisis laid bare the failures of financial capitalism.” “Nordic lessons for today’s socialists” August 29

That most still believe the crisis “laid bare the failures of financial capitalism”, is just the result of what seems to be one of the greatest cover up stories in mankind, promoted by those who want the regulatory mistake of the risk weighted capital requirements for banks to remain forever as something that shall not be named.

And it has absolutely to do with the subject discussed here because, one of the reason little Sweden, the Nordic country I best know, became such huge success, was the willingness of many Swedes to take extraordinary risks. In the Swedish Church psalm book we find a psalm that begs, “God make us daring”.

I find it outright shameful that a Swede, Stefan Ingves, could chair the Basel Committee and not enlighten his colleagues on risk-taking being the oxygen of development.

Of course, to top it up, that the risk weights are foolishly based on the risk of assets per se, and not on the risks of how bankers perceive and manage the assets, namely the conditional probabilities, makes it all so much worse. We will not have explosions fueled by risk-taking but much worse explosions fueled by excessive risk-aversion 

Today Swedish banks, as most of the world, are on route to build up extremely dangerous exposures to what is perceived as safe, like to sovereigns, residential mortgages or any other concocted security that manages to get hold of an AAA rating. 

Sir, today Swedes risk end up in their “safe” houses from which they have extracted all equity, and without the jobs needed to service their mortgages or to pay the utilities. Sad!

@PerKurowski

Bank regulators would do well reading up on Shakespeare (and on conditional probabilities)

Sir, Robin Wigglesworth writing about risk and leverage quotes Shakespeare in Romeo and Juliet, “These violent delights have violent ends”, and argues “It is a phrase investors in the riskier slices of the loans market should bear in mind.” “Investors should beware leveraged loan delights that risk violent ends” August 25.

Sir, we would all have benefitted if our bank regulators had known their Shakespeare better. Then they might have been more careful with falling so head over heels in love with what looks delightfully safe.

The Basel Committee, Basel II, 2004, for their standardized approach risk weights for bank capital requirements, assigned a risk weight of 20% to what was AAA to AA rated, and one of 150% to what is below BB- rated. 

That meant, with a basic requirement of 8%, that banks needed to hold 1.6% in capital against what was AAA to AA rated and 12% against what is rated below BB-.

That meant that banks were allowed to leverage 62.5 times if only a human fallible rating agencies awarded an asset an AAA to AA rating, and only 8.3 times if it had a below BB- rating.

That meant that banks fell for the violent delights of the AAA to AA rated, which of course caused the violent ends we saw in 2007/08.

Sadly, from what it looks like, our current regulators might not have it in them to understand what Shakespeare meant, just as they have no idea about the meaning of conditional probabilities… if they could they might be able to understand that what is ex ante perceived as risky is really not that dangerous.

@PerKurowski

Are our productivity, real salary, unemployment, and GDP figures up to date?

John Authers writes, “If ever there was a good place to take a deep breath and gain context on our unnecessarily complex world, it would be Jackson Hole, Wyoming” “Powell avoids foreign complications in the winds of Wyoming” August 25.

In a recent post in Bank of England’s blog “bankunderground” I read: “With the rise of smartphones in particular, the amount of stimuli competing for our attention throughout the day has exploded... we are more distracted than ever as a result of the battle for our attention. One study, for example, finds that we are distracted nearly 50% of the time.”

So, one interesting way for central bankers to get an understanding of our ever more complex world would be to ask them: If you deliver the same at work as a decade ago, but now you spend 50% of your working hours consuming distractions, on your cell or similar, how much has your productivity, your real salary, your voluntary unemployment increased? And what about GDP?

PS. Sir, as you well know, before initiating the Jackson Hole proceedings, I would love for all central bankers there to assist a seminar on the meaning “conditional probabilities.” Had they known about it before imposing their risk weighted capital requirements for banks it would have saved the world from a lot of problems.

@PerKurowski

During this year’s central bankers’ Jackson Hole meetings, will there finally be a seminar on conditional probabilities?

Sir, you write “The global economy and financial markets remain relatively benign, but the political environment in which central banks once operated has changed, perhaps for ever” “The tricky politics of being a central banker” August 24.

Indeed, but all is not that tricky for central bankers and their financial sector regulation colleagues. Just think of how they have all been able to progress, for soon thirty years, Basel I 1988, without any knowledge about conditional probabilities. 

Imagine, even after a 2007-08 crisis, caused 100% by assets that had extremely low capital requirements, only because these assets were perceived as extremely safe, and they have not yet been called out on that.

If I were to be invited, I would again ask them: Why do you believe that what’s perceived risky is more dangerous to our bank system than what’s perceived safe, have you never heard of conditional probabilities? But of course I am not invited.

Sir, again I will invest some hope that a “Without fear and without favor” FT journalist dares to asks that question. I must confess though that investment will be quite small, as I want to avoid having to be so disillusioned again.

PS. Conditional probabilities and risks for the bank system

@PerKurowski

Are identified non-performing loans truly riskier to bank systems than those many still out there waiting to be identified as such?

Sir, Arthur Beesley reports that “ECB’s Single Supervisory Mechanism, a watchdog created in 2014 to oversee eurozone banks, is pressing Irish lenders to achieve a 5 per cent NPL ratio in line with European norms”,“Irish banks step up efforts to shed bad debts” August 22.

Of course it is in general terms good when banks clean up their balance sheets but, I must ask: Why should identified non-performing loans be more risky to a country’s financial stability than those loans that could be about to be identified as such?

“A 5 per cent NPL ratio in line with European norms” That sounds precisely like what deskbound regulators might invent in order to show everyone they’re working hard. How much better would it not be for all if these regulators took some time off in order to take a course on the meaning of conditional probabilities; I mean so that could move away from that simpleton idea of risk weighting the capital requirement for banks based on the risks that are perceived.

“There’s a very healthy demand for loan assets on Irish property,” said Owen Callan, equity analyst at Investec in Dublin…[so] it’s not a bad opportunity to get rid of some of these loans in what is a very strong market.”

Great! But if that was not the case, should Irish banks anyhow have to obey regulators sitting in Fankfurt am Main inventing general rules that should apply to all European banks, independent of their particular realities… like they did when they assigned a 0% risk weight to Greece?

Sir, I would never have voted for Brexit but, each day that goes by and I see how EU authorities do not confront the real EU challenges; like how to handle the absence of a foreign exchange adjustment mechanism lost with the Euro; and instead promote themselves with all type of small issues that are better handled by local authorities, I get the feeling it might have not been such a crazy vote.

@PerKurowski

Even after the crisis there has been no change in who are represented when deciding on bank regulations.

Sir, Sarah O’Connor writes: “If we want groups to make fair decisions, our best shot is to make the groups representative of the people who are subject to those decisions.” Hear hear!, “Diversity coaching from the Olympic dressage event” August 22.

In the matter of bank regulations, where were all those who perceived as risky by the banks, like entrepreneurs, suffered the Mark Twain realities of bankers lending you the umbrella when the sun shines and wanting it back if it looks like it could rain?

Had they been present perhaps regulators would have understood the concept of conditional probabilities, and therefore had realized that assets perceived by bankers as risky become safer, not riskier; while assets perceived by bankers as safe become riskier, not safer.

Can you imagine how much tears, sufferings and lost opportunities that would have saved the world, primarily our young?

The saddest part of the story is that even after the crisis should have evidenced to all the regulators had no idea of what they were doing, there has been no changes at all in who are being represented when analysis and decisions are taken, so they still keep seeing and considering the risks in the same or quite similar way, the bankers are perceiving the risks. 

How good it would have in the Basel Committee some representation of the young who know that risk taking is the oxygen for the development they need, and that the older do not have the right to “safely” extract all equity from the current economies.

@PerKurowski