The more voluminous data is, and the faster it is transmitted, the faster we can be sent over a cliff.

Sir, Robin Wigglesworth writes: “The amount of digital data around the world is unimaginably vast. As more of our social and economic activity migrates online, the quantity and quality is going to increase exponentially. The potential is mind-boggling”,“Big Data’s power to illuminate leaves public sector in the shadows” April 20.

In April 2003, when as an Executive Director of the World Bank I formally commented on its strategic plan I 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 sure happened. The AAA rated securities backed with mortgage to the subprime sector in the US, send us straight into the 2007/08 crisis. 

In other words it is not just a question of data availability, in real time, but also on how we respond to it. It might behoove us all, to take a long time to digest it, before we react to it.

For example, and I quote from a BBC report: “On the 26 of September 1983, in the early hours of the morning, the Soviet Union's early-warning systems detected an incoming missile strike from the United States. Computer readouts suggested several missiles had been launched. The protocol for the Soviet military would have been to retaliate with a nuclear attack of its own. But duty officer Stanislav Petrov - whose job it was to register apparent enemy missile launches - decided not to report them to his superiors, and instead dismissed them as a false alarm. This was a breach of his instructions, a dereliction of duty. The safe thing to do would have been to pass the responsibility on, to refer up. But his decision may have saved the world.”

Sir, so what delay factor do we need to introduce before we respond to any real time data? I have no idea. You tell me.

@PerKurowski

To prevent the next unpreventable financial crisis, let us at least try better and more accountable bank regulators.

Sir, Axel Weber a co-author of the Group of Thirty report writes: “Following the global financial crisis, we have significantly improved the resilience of the financial system, strengthened the capital and liquidity positions of banks and increased our ability to deal with failing lenders.” “Preventive measures will not stop the next financial crisis” September 18.

I have been arguing, for more than a decade, that what primarily caused the crisis, were the distortions in the allocation of credit produced by the risk weighted capital requirements. AS that distortion has not been eliminated, and given that generally higher capital requirements might on the margins even intensify those distortions, not enough has been done to improve the resilience of the financial system; nor that of the real economy on which so much the real long term financial stability really depends on.

So, to prevent the next crisis we must prevent having regulators who believe that what’s perceived as risky is more dangerous to our bank system than what’s perceived as safe. 

There’s no reference at all to that distortion in the Group of Thirty report that Mr Weber helped to author, though that should perhaps not surprise us. Looking at the members of that mutual admiration club, one could suspect that all have a vested interest in keeping that distortion as one that shall not be named. 

In an Op-ed of 1998 I wrote: “In many cases even trying to regulate banks runs the risk of giving the impression that by means of strict regulations, the risks have disappeared. Sometimes it is good faith... sometimes it is only pure faith… History is full of examples of where the State, by meddling to avoid damages, caused infinite larger damages”

But in that Op-ed I also wrote, “I do not propose, not for a moment, that the State abandons completely the regulatory functions, much the opposite, what I propose is that it assumes it correctly”

Sir, the State assuming correctly its regulatory functions must, sine qua non, include holding the regulators accountable for their mistakes, not promoting them, and much less allowing them to keep on regulating, covering up their own mistakes.

By the way, when is FT going to stop having such a prominent role in that cover-up?

@PerKurowski

If only a cost benefit analysis had been performed on the risk weighted capital requirements for banks

Tim Harford while reviewing Cass Sunstein’s“The Cost-Benefit Revolution” mentions, “In 1981, Ronald Reagan signed Executive Order 12291, requiring administrative decisions to weigh the costs and benefits of action and maximise net benefits.”, “A valuable study of a quiet victory for technocrats”, September 17.

How sad the risk weighted capital requirements for banks were no subjected to such a cost benefit analysis.

On the cost side, one would have to include the possibility that, since it would impose a tariff, by means of higher capital requirements, on the lending to the risky, and therefore de facto create a subsidy for when lending to the safe, that this could seriously distort the allocation of bank credit to the real economy… financing too much the safer present and too little that indispensable riskier future.

And, when reviewing its supposed benefit, that of making the bank system safer, one would have had to consider the possibility that, since the risky would then have to pay higher relative risk premiums than usual, that this could make them even riskier; plus the possibility that since the safe would get more credit at lower rates, that meant the safe could get too much credit at too low risk adjusted premiums, and banks could build up that type of excessive exposures to the safe that has always been the stuff bank crises are made off.

Adding then to the costs these possible negative benefits would certainly have caused this silly and dangerous regulation to be rejected… and the 2007-08 crisis avoided.

Hartford mentions that “Hayek’s objection to central planning is that it cannot work because the planners will never have enough information” I agree, but I am also sure that central planning often fails, not for lack of information, but simply because of them not understanding they lack information; and all there planning carried out in a group-thinking mutual admiration club.

In the “The forger’s spell”, a book by Edward Dolnick about the falsification of Vermeer paintings, the author makes a reference to having heard Francis Fukuyama in a TV program saying that Daniel Moynihan opined “There are some mistakes it takes a Ph.D. to make”. And Dolnick also refers to George Orwell’s comment, in “Notes on Nationalism”, that “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” 

Sir, time and time again I find reasons to be reminded of that book.

http://subprimeregulations.blogspot.com/2011/08/no-ordinary-man-could-be-such-fool.html

@PerKurowski

No coroner has asked for a postmortem examination of the global financial crisis to be performed by a truly independent pathologist.

Sir, Nouriel Roubini writes:“As we mark the 10th anniversary of the global financial crisis, there have been plenty of postmortems examining its causes, its consequences and whether the necessary lessons have been learnt” “Policy shifts, trade frictions and frothy prices cloud outlook for 2020” September 12.

Yes, many postmortems but none performed by a truly independent pathologist. 

Had that occurred he would have established that absolutely all assets that caused the crisis were those banks were allowed by their regulator to leverage immensely, because these were perceived, decreed or concocted as safe.

And from that he would have reported, not a lack of regulation but missregulation; and not excessive risk taking but excessive exposures to AAA rated securities, residential mortgages and 0% risk weighted sovereigns, like Greece.

And after such a report it is clear there would have been a total shake up of that group-thinking mutual admiration club known as the Basel Committee for Banking Supervision.

But since that report would have contained so many of truths that shall not be named, it never saw light, and consequentially the lessons have not been learned. 

Therefore the distortions in the allocation of credit have remained; something which has caused all the mindboggling large stimuli, like Tarp, QEs, fiscal deficits, growing personal debts that anticipate demand, and ultralow interests, to only result in kicking the crisis can forward and higher.

Sir, I have never been a bank regulator but from very early on I disliked much of what little I was seeing; and as an Executive Director of the World Bank I formally warned in 2003 against “entities such as the Basel Committee, accounting standard boards and credit rating agencies introducing serious and fatal systemic risks”

When later I discovered aspects like the runaway statism that was reflected into risk weights of 0% the sovereign and 100% the citizen; and the Basel II naiveté of allowing banks to leverage 62.5 times assets only because these had been rated AAA to AA by human fallible credit rating agencies, I could just not believe we had fallen so low.

Now, 10 years after the crisis, sadly, I am still waiting for any important authority to ask the regulators: 

“Why do you want banks to hold more capital against what by being perceived as risky has been made more innocous than against what by being perceived as safe poses so much more dangers to our bank system. Have you not heard about conditional probabilities?”

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

@PerKurowski

To really understand the 2007-08 crisis, it is the ex ante perceived risks that should be used, and not the ex post understood risks

Sir, Martin Sandbu, when reviewing Ashoka Mody’s “EuroTragedy: A drama in nine acts" writes: “Mody nails the biggest policy error of them all: the insistence that euro member states could not default on their own debt, or allow their banks to default on senior bondholders.” “A crisis made worse by poor policy choices” August 6.

That refers indeed to a great ex-post crisis policy error, but not to the biggest error of all, that which caused the crisis, namely the ex ante policy of the regulators, for the purpose of their risk weighted capital requirements for banks, assigning all EU sovereigns, Greece included, a 0% risk weight.

Mody (on page 168) includes the following: “If, for example, €100 of bank assets generate a return of €1, then a bank with €10 of equity earns a 10 percent return for its equity investors, but a bank with only €5 of equity earns a 20 percent return.” Though not entirely exact (because it might be slightly more difficult to generate that €1 with less capital) it shows clearly Mody understand the effect on returns on equity of different leverages.

But what Mody, and I would say at least 99.9% of the Euro crisis commentators do not get, or do not want to see, or do not dare to name, is that allowing banks different leverages for different assets, based on different perceived, decreed (or sometimes concocted) risks, distorts the allocation of bank credit to the real economy. In the case of the Euro, the two shining examples are: the huge exposures to securities backed with mortgages to the US subprime sector that, because they got an AAA to AA rating, could be leveraged 62.5 times; and the exposures to sovereigns, like Greece.

Sir, let us be clear, there is no doubt whatsoever that, had for instance German and French banks have to hold as much capital/equity against Greece that they had to hold against loans to German and French entrepreneurs, then they would never ever have lent Greece remotely as much.

The other mistake that Mody in his otherwise excellent book makes, and which is one that at least 99% of the crisis commentators also make, is that they fall into the Monday-morning-quarterback trap of considering ex post realized risks, as being the ex ante perceivable risks. Mody refers in the book to that George Orwell might have written about narrating history “not as it happened, but as it ought to have happened” In this case the risk referred to, are not the risks that were seen but the risks, we now know, that should have been seen.

Sir, Ashoka Mody’ EuroTragedy has so much going for it that it merits to be rewritten. Just reflect on what it means for the Greek citizens having to pay the largest share of sacrifices, for a mistake committed by European technocrats.

PS. Mody goes into the details of the demise of “the smallest of Wall Street’s five top tier investment banks” Bear Stearns. It “was an accident waiting to happen… it had borrowed $35 for every dollar of capital it held”. Had Mody added the fact that Bear Stearns had been duly authorized by the SEC to leverage this much and even more, the recounting of the events would have been different.

@PerKurowski