The 0% risk weight assigned by Eurozone authorities to Greece’s sovereign debt helped put that nation’s weaknesses on steroids.

Sir, Tony Barber quotes Roderick Beaton’s Greece: Biography of a Nation, with a Greek former government minister saying in 2017 that the homegrown causes included “poor governance, clientelism, weak institutions [and] lack of competitiveness”. For his part, Beaton observes: “Systemic problems . . . combined in a toxic way with structural weaknesses in the European project, particularly the systems devised to oversee the single currency without a single fiscal authority for the eurozone.” “Greece’s eternal conflict”, March 23.

I have not read the book but, if a former government minister can describe Greece as he does it should be absolutely clear that such sovereign does not merit a 0% risk weight, much less so when it is taking in debt denominated in a currency that de facto is not it domestic (printable) one. 

But yet the Eurozone authorities did so, which of course only could help to feed “poor governance, clientelism, weak institutions [and] lack of competitiveness”

The sad part is that those authorities have refused to recognize their mistake, and so Greece has been forced to take the full blame for its crisis. EU, what a Banana Union! 

@PerKurowski

How naïve were we when regulators told us “We will risk weigh the capital requirements for banks to make these safer for you”?

Sir, Simon Kuper in reference to Brexit writes “It’s hard now to fathom how naive we were in 2016. I thought…you couldn’t just stick a false slogan on your campaign bus, could you? “Trust, lies and videotape” October 20.

Sure you could! Like when or bank regulators told the world that what’s perceived as risky is more dangerous to our bank systems than what’s perceived as safe, and the world, including Simon Kuper, and the Financial Times, believed that to be true.

Kuper holds the popular gold standard of truth being, “I saw it with my own eyes.” Well not in this case! 100% of the assets that caused the 2007-08 crisis were assets that because these were perceived as safe, allowed banks to hold especially little capital, and that has yet to even be formally noticed.

Kuper quotes Umberto Ecco: “The genuine problem . . . does not consist of proving something false but in proving that the authentic object is authentic.”

Yes, like the problem I have had surpassing that seemingly unsormountable barrier of “what is risky is risky”, in order to warn regulators that what is “safe”, is even more dangerous… at least to our bank systems.

@PerKurowski

To tell us “What really went wrong in the 2008 financial crisis” might require more distance to the events

Martin Wolf reviewing Adam Tooze’ “Crashed: How a Decade of Financial Crisis Changed the World” refers to the author’s question of “How do huge risks build up that are little understood and barely controllable?” “What really went wrong in the 2008 financial crisis?” July 18.

May I suggests as one cause, the nonsensical ideas that can be developed through incestuous groupthink in mutual admiration clubs of great importance, such as bank regulators gathering around with their colleagues of the central banks in the Basel Committee for Banking Supervision.

Wolf writes: “The crisis marked the end of the dominant consensus in favour of economic and financial liberalisation” 

Not so! The end in “favour of economic and financial liberalisation” happened much earlier when the regulating besserwissers decided they knew enough about making our bank systems safer, so as to allow themselves to distort the allocation of bank credit.

In 1988, the regulators, with the Basel Accord, Basel I, surprisingly, with none or very few questioning them, decided that what’s perceived as risky was more dangerous to our bank system than what’s perceived as safe, and proceeded to apply such nonsense with their risk weighted capital requirements for banks. More risk, more capital – less risk, less capital. 

That meant that banks could then leverage more their regulatory capital (equity) with “the safe” than with “the risky”; which translated into banks earning higher expected risk-adjusted returns on equity with “the safe” than with “the risky”. That would of course from thereon distort the allocation of bank credit more than usual in favor of the safe and in disfavor of “the risky”.

That of course ignored the fact that what is perceived as risky has historically proven much less dangerous to the bank system than that which is perceived as safe. 

Basel I, which already included much fiction, like assigning a 0% risk weight to sovereigns and 100% to citizens, was bad enough but then, in 2004, with Basel II, the regulators really outdid themselves allowing for instance banks to leverage 62.5 times their capital with assets that had an AAA to AA rating, issued by human fallible rating agencies was present.

We have already paid dearly for that stupidity, as can be evidenced by the fact that absolutely all assets that detonated the 2007/08 crisis had in common generating especially low capital requirements for banks, because these were perceived (houses), decreed (Greece) or concocted (AAA rated securities) as safe.

I have ordered it but of course I have not read Adam Tozze’s book yet. When I do I will find out if it makes any reference to this. If not, I might just have to wait for other historians who are more distant from the events.

@PerKurowski

Where would America be today had not bank regulators distorted credit and central bankers kicked the crisis can forward?

Martin Wolf, expressing concerns we all deeply share asks, “Who lost “our” America?” and he answers: “The American elite, especially the Republican elite… They sowed the wind; the world is reaping the whirlwind. “How we lost America to greed and envy” July 16.

I respectfully (nowadays not too much so) absolutely disagree. That because supposedly independent technocrats generated the two following events:

First, in 1988 regulators with their so sweet sounding risk weighted capital requirements, promised the world a safer bank system, but then proceeded to design these around the loony notion that what was perceived as risky was more dangerous than what was perceived as safe. That distorted the allocation of bank credits in favor of the "safer" present and against the "riskier" future. That must have stopped much of any ordinary social and economic mobility.

Then in 2007/08, instead of allowing the crisis to do its natural clean up, central bankers, starting with the Fed but soon to be eagerly followed by ECB and other central banks, just kicked the can forward, favoring sovereigns and existing assets. Just as an example, with their repurchase of the failed securities backed with mortgages to the subprime sector, they saved the asses of many investors and banks (many European) while very little of that sacrifice flowed back to those who, in the process, had been saddled with hard to serve mortgages.

Martin Wolf, and you too Sir, would benefit immensely in trying to imagine how the world would be looking now, without that unelected and inept technocratic interference! What had specifically Republicans, or Democrats, to do with that interference?

As I see it if that had not have happened Trump would not even have been thinking of running as a candidate.

PS. An aide memoire on some of the mistakes with the risk weighted capital requirements.

@PerKurowski

Europe (and the rest of the world) needs to get rid of the distortions produced by QEs and risk weighted capital requirements for banks.

Sir, Karen Ward, discussing ECB’s asset purchase programme writes: “It’s very hard to get the population to worry about government borrowing when interest rates seem impervious to how much the government wants to borrow”… “to truly put the European economy on a long-term sustainable footing it may be time for the ECB to step back and let the market do its job”… “Bond vigilantes are an essential part of the micro economy and vital for a thriving macro economy” “Investors should resist urge to run for the hills if ECB calls time on asset purchases” June 12.

Absolutely! Right on the dot! But besides suspending the distorting asset purchase program, there is also much need for to eliminate the risk weighted capital requirements for banks, that which so much and so uselessly distorts the allocation of bank credit to the economy.

PS. “Mario Draghi, ECB’s president, is under pressure to provide guidance” Forget it! Draghi is one of those regulators who decided to assign a 0% risk weights to sovereigns like Greece, and thereby helped to cause the crisis. Therefore Draghi should be prohibited to provide any further guidance.

https://teawithft.blogspot.com/2018/06/to-salvage-european-union-its.html

@PerKurowski

Loss aversion has bank regulators looking too much at the cost of the crisis, while ignoring the benefits of the whole boom-bust cycle.

Sir, Tim Harford writes: The concept of “loss aversion” developed by Daniel Kahneman and Amos Tversky…showed that we tend to find a modest loss roughly twice as painful as an equivalent gain… Those who were forced to evaluate and decide at a slow pace were… not intimidated by short-term fluctuations… less likely to witness losses.”, “The languid pleasures of slow investing” February 10.

That is precisely what happens when bank regulators go into action during a crisis; they just look at the losses, and completely ignore what good might have been achieved during the whole boom-bust credit cycle.

And that is why our regulators in the Basel Committee, panicking, imposed risk weighted capital requirements for banks, which pushes debt that relies more on existing servicing capacity, like financing “safe” houses, than debt that hopes to generate new revenue streams, like loans to “risky” entrepreneurs.

And we all know there’s little future in that!

Harford ends with: writes: “Perhaps we slow investors should adopt a mascot. I suggest the sloth” Indeed, and let us send a stuffed one to Basel.

An aide-mémoire on the major mistakes with the risk based capital requirements

@PerKurowski

What extraordinary things since the crisis have central banks achieved? Having kicked the can down the road?

Sir, Alan Beattie writes: “By being prepared to embrace the radical in the face of ill-informed criticism… — central banks have achieved extraordinary things since the global financial crisis. It would be most peculiar if now, when the pressure on them has abated, they mistakenly returned to a model of monetary policy rooted in the pre-crisis era.” “Central banks have a duty to come clean about inflation” September 23.

Sir, since the global financial crisis have really central banks achieved extraordinary things for most? I am not so sure. In many ways it seems they have only dangerously kicked the crisis can forward, while leaving in place the regulatory distortions that caused the crisis

But indeed let’s come clean about inflation. What would the inflation be if:

Most stimuli had not gone to increase the value of what is not on the Consumer Price Index

If there had not been so much credit overhang resulting from anticipating demand for such a long time.

If there had not been an ongoing reduction in the costs of retailing much of what is recorded on CPI.

If non-taxed robots and other automations had not put a squeeze on costs

Then the inflation could have been huge… so what are central bankers so fixated on the CPI?

PS. What would the inflation be, if the I-phone was in the CPI? J

@PerKurowski

How did the world get into such a mess, and will it happen again? Here is why, and yes, as is, it will happen again!

Sir, Patrick Jenkins quotes Lord King — now a professor at the LSE and New York University with: “it was inevitable that a crisis was going to occur… The banking system as a whole was very highly leveraged. It had on its balance sheet a large volume of assets that were very difficult to value and no one could work out what the exposure of one individual bank was” “Financial crisis: 10 years on Where are we now?” September 2.

“How had the world ended up in such a mess — and has enough been done to stop something similar happening again?”, asks Jenkins.

First: The crisis resulted from: Basel II of 2004 allowing banks to leverage capital (equity) more than 60 times if only there was an AAA-to AA rating presents or if the exposure was to a friendly sovereign, like Greece. 

Jenkins writes “When the 2007 crisis broke, fingers of blame were pointed in all directions…. at policymakers for presiding over an environment of low interest rates and lax regulation” Lax regulation? No! Extremely distorting regulations. Had banks not been regulated by means of risk weighted capital requirements for sure some other crisis could have happened… but not that one that is here referred to.

Second: Since the risk weighing of some capital requirements is still used that guarantees that sooner or later, some safe-haven, like that of sovereign debt, will become dangerously overpopulated. Add to that the fact that risky bays, like SMEs and entrepreneurs, will not, as a result have sufficient access to credit, which will debilitate the real economy… and you can only come to the conclusion that, yes a crisis of the same nature is bound to happen again.

How can we stop it! To begin by removing all those who had something to do with current bank regulations because, as Einstein said: “No problem can be solved from the same level of consciousness that created it”.

To not debilitate the banks with fines and go after those responsible for any misbehavior would also help.

What would I do? Impose a straight 10% capital requirement against all assets; and if that puts a too big squeeze on bank capital, I would go a Chilean route of having central banks take on loans in order to capitalize the banks; and thereafter prohibiting banks from paying dividends before those shares that would have a preferential dividend have all been repurchased from the central banks. But that’s just me.

@PerKurowski

The outsized bank revenues and the crash were caused by the monstrous huge leverages authorized by their regulators

Sir, Patrick Jenkins writes: “The outsized revenues and profits that banks and other financial groups made in the run-up to the crash, much of it inflated by mis-selling and manipulation, have given way to lower income” “Banks can become an engine of productivity instead of a brake” July 11.

Jenkins just does not get it. “The outsized revenues and profits that banks and other financial groups made in the run-up to the crash” were the direct result of regulators allowing banks to leverage their balance sheets tremendously. For instance Basel II of 2004 authorized banks to leverage 62.5 times to 1 if an AAA rating was present, and a lot of times more when lending to a “safe” sovereign. Had banks been allowed to leverage with all assets only 12.5 times, as Basel’s 8% basic capital requirement implied, there would not have been outsized bank revenues and profits, nor the crash. Capisci?

How could banks become an engine of productivity again? Stop discriminating against the “riskier” future and in favor of the “safer” present.

@PerKurowski

No Ms. Tett! It was bank regulators clear lack of testosterone that caused the 2007 crisis and the current slow growth

Sir, Gillian Tett seems to argue that the 2008 bank crisis resulted from excessive testosterone. “Traders on a hot streak risk a double fault”

Not so Ms. Tett! I do not if he really said it but Mark Twain has been attributed opining that bankers lend you the umbrella when the sun shines and want it back as soon as it looks it could rain.

And never ever has there been a bank crisis caused by excessive exposures to something perceived as risky when placed on banks’ balance sheets.

But that did not stop scared lack of testosterone bank nannies to also require banks to hold more equity when lending to the risky than when lending to the “safe”.

So what happened? As banks earned much higher risk adjusted returns on the safe they could not resist the AAA rated securities backed with mortgages to the subprime sector, or sovereigns like Greece. And so a typical bank crisis, that of excessive exposures to what was ex-ante perceived as safe but that ex post turned out very risky ensued. In this case made specifically worse, by means of the lower equity banks had been authorized to maintain. For example in the case of the AAA rated securities Basel II, because of the standardized risk weights, banks were required to only hold 1.6% in capital, meaning an authorized leverage of 62.5 to 1. 

And since banks now find it harder to earn higher risk adjusted ROEs on more capital, they have abandoned lending to risky SMEs and entrepreneurs, those who open up roads on the margins of the economy, and so of course slower economic growth results.

The lack of testosterone is not a fundamental value of the Western civilization. On the contrary in churches we sometimes sang, or at least used to sing, “God make us daring!”

@PerKurowski

The Sovereign’s footmen, the regulators, are force-feeding the economy public debt. When will the liver explode?

Sir, Sam Fleming and Robin Wigglesworth report: “The Fed will need to operate with a much larger balance sheet than before the crisis — at least three times as big, say some investors — in part because of regulatory and other changes governing institutions’ appetite for safe assets” “Fed edges towards paring back its balance sheet” May 2.

Of course, in 1988 the Sovereign had his bank regulation footmen declare him risk free, 0% risk weight, while the citizens, they got a 100% risk weight.

When kicking with QEs the 2007/08 crises can down the road, the Fed as well as some other central banks, purchased enormous amounts of public debt.

With Basel III the regulators kept going at it introducing liquidity requirements that much favored “marketable securities representing claims on or guaranteed by sovereigns”.

Insurance companies’ regulators, with their Solvency II, are closely following the same path.

Now when they are thinking of reeling the 2007/08 can in, to sort of prepare for the next crisis, how is the Fed to do that? Well the authors report that accordingly to Mr Rajadhyaksha, head of macro research at Barclays: “Assuming that it wants to get rid of all its $1.8tn of mortgage bonds as it retreats from the home loan market, it may have to start buying Treasuries again at the tail-end of the process” which means more sovereign debt will be purchased.

In other words the Sovereign’s foot soldiers are de facto force-feeding public debt down the economy’s throat. When will the economy’s liver explode?

And the craziest thing is that most experts still take the interest rates on such debts to be market fixed, and to reflect the real risk-free rate.

How could so much statism have been injected in our system without it being noticed?

This statism de facto presumes that government bureaucrats know better what to do with credit than the private sector. That presumption leads of course to disaster. 

We now read in IMF’s Fiscal Monitor 2017 (page x), with IMF acting like the Sheriff of Nottingham for King John, that “the case for increasing public investments remains strong in many countries in light of low borrowing costs” and that “the persistent decline in the interest rates may have relaxed government budget constraints in advanced economies; if the differential between interest and GDP growth were to remain durably lower than it has been in past decades, countries could be able to sustain higher levels of public debt.” “Low borrowing costs” IMF? Do your research and dare to figure out why. Others are paying for that by having less access to credit.

Sir, IMF has the galls to title 2017 Fiscal Monitor as “Achieving More With Less”, while completely ignoring that over the last decades, Sovereigns, have been Achieving So Much Less With So Much More.

@PerKurowski

The 2007-08 crisis and the relative stagnation thereafter would not have happened without current bank regulations

Sir, Ed Crooks writes “Trump has threatened to “do a number” on Frank-Dodd banking regulations aimed at preventing another financial crisis.” “Populists push to roll back rules” February 22.

Well no! Except for the intent of eliminating overreliance on credit rating agencies, something that has yet to happen, the Dodd-Frank Act did not eliminate those populist bank regulations that caused the last financial crisis, or the relative economic stagnation thereafter.

Some real runaway populism, that happened when hubris filled technocrats thought they could, and at no cost, diminish the risks for the banking system with their risk weighted capital requirements for banks.

What did and does that regulation cause?

That the banks create dangerously large exposures to what is perceived, rated, decreed or concocted as safe, e.g. AAA rated securities and Greece. 

That the banks award too little credit to what can supply dynamism to the real economy, e.g. SMEs and entrepreneurs.

Crooks also writes: “In a 2012 OECD expert paper, David Parker of Cranfield University and Colin Kirkpatrick of the University of Manchester reviewed the state of academic knowledge and concluded that there were large gaps in our understanding of the effects of regulation policy”

I have not read that paper, but I am sure the conclusions must be absolutely correct. For instance, when regulators stress test banks, they do not even care to look at what should perhaps have been on their balance sheets, in order to satisfy the credit needs of the real economy.

It is amazing how the Financial Times insists on keeping all this hushed up.

Does that mean FT agrees with the regulatory statism reflected in assigning to the sovereign a risk weight of 0% while hitting us “We the People”, with 100%?

Does that mean FT finds nothing dumb in assigning a 20% risk weight to the so dangerous AAA rated, while hitting the innocuous below BB- rated with 150%?

Sir, here between you and me, what favours do you owe the bank regulators, or why are you so afraid of them?

PS. The Dodd-Frank Act is so surreal that in its 848 pages it does not even mention the Basel Committee

PS. I dare you to read an Op-Ed I wrote in 1999 about the dangers with regulations

PS. I dare you to read the remarks I gave to bank regulators in 2003 while being an Executive Director of the World Bank.

@PerKurowski

Martin Wolf, I totally agree it is not nice where we find ourselves, but you’re part of how we got here… I am not!

Sir, Martin Wolf writes: “Who would have imagined that primitive mercantilism would seize the policymaking machinery of the world’s most powerful market economy and issuer of the world’s principal reserve currency? The frightening fact is that the people who seem closest to Mr Trump believe things that are almost entirely false… Protection just helps some businesses at the expense of others… The rhetoric of “America First” reads like a declaration of economic warfare.”"Trump and Xi battle over globalization" January 25.

Indeed but then again: “Who would have imagined that primitive statist technocrats would seize the regulatory machinery of banks of the world? And the frightening fact is that the people who seem close to the Basel Committee, like Martin Wolf, also believe things that are entirely false, like that what is perceived as very risky is very risky to our banking system… which only helps to protect the access to bank credit of “the safe”, at the expense of “the risky”…The rhetoric of “We Regulators must make our banks safe” reads like a declaration of economic warfare.”

Sir, I am sure that had the world not silently accepted the risk weighted capital requirements for banks in 1988, which introduced such obnoxious statist concepts of assigning a risk weight of 0% to the Sovereign and 100% to We the People; and then in 2004 going on to assign a such a meager risk weight of 20% to what was AAA rated… the subprime crisis would not have happened… Greece would not have received so much in loans, and Trump would still busy himself with hotels and casinos.

Martin Wolf, I understand you are also a victim of that confirmation bias that have swept the regulatory circle, but your silence on the distortion in the allocation of bank credit to the real economy, makes you, ever so little, an accomplice of Trump’s rise to the presidency of America… so don’t just wash your hands like any Pilate.

PS. “rules-based trade” is not really “open markets”

PS. I did what I could.

@PerKurowski

The pro-cyclical tsunami machinery

Sir, Sir Samuel Brittan starts his “An ancient Greek approach to modern economics” July 20, taking about cycles and ends it with the need for “removing distortions at the micro level”. He might be interested in the following macro micro distortion that is taking economic cyclicality to unimaginable levels. 

A European bank was authorized to lend to Greece holding only 1.6 percent in capital, which meant being able to leverage Greece’s risk-adjusted margins 62.5 times, and so it did, but, unfortunately, so did too many other banks, and Greece went bust. 

And now, when the bank has lost all its capital, it is required to hold many times more capital if lending to Greece, and so the European bank has no other choice but to lend to Germany, as so must all other banks do, something which does not require it to hold any capital. In fact, if lending only to the infallibles, then the bank would not even need shareholders, and could retain all bank profits for bankers’ bonuses. 

If this bank regulation is not a machine for creating a tsunami of pro-cyclicality, what is?

Crises occur when what was thought to be low risk turns out to be very high risk

In July 2012 in “Seven ways to clean up our banking ‘cesspit’” Martin Wolf wrote: “In setting these equity requirements, it is essential to recognise that so-called ‘risk-weighted’assets can and will be gamed by both banks and regulators. As Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk. For this reason, unweighted leverage matters. It needs to be far lower.”

We are climbing a ladder made of whipped cream

Sir Martin Wolf writes “After the storm comes a hard climb” July 15, and the title is indeed optimistic as it seems to imply as a first Hurrah! that we already hit bottom and as the second that we have got ourselves a good ladder. I am not at all sure the first Hurrah is true, let’s pray it is, but what I do know is that the ladder we are currently using is not solid enough for any sustainable growth. I would say the current ladder looks and feels like made out of whipped cream, and most probably is.

The US, sooner or later, has to start paying for what it consumes.

Martin Wolf in for “Choices made in 2009 will shape our destiny” January 7, describes very accurately our starting point saying that “relying on vast US fiscal deficits and expansion of central bank credit is a temporary – albeit necessary- … will not deliver a durable return to growth. Fundamental changes are needed”. Wolf also points out the problem of the “persistent external and internal imbalances in the US and the world” that result from the US and a number of other chronic deficit countries” having “structurally deficient capacity to produce tradable goods and services.

Unfortunately, after such a clear diagnosis, Wolf proceeds hinting at the need of even higher fiscal deficits without giving much clues as of to what those required fundamental changes could be; and so let me then suggest one truly fundamental change, that of the US starting to pay for its own spending spree instead of having the world finance it.

One aspect conspicuously absent in the discussions is the need for the US to come up with a new generation of taxes that are appropriate to the current conditions and that work in a globalized setting. One type of these taxes, namely a tax on gas, has at least started to be discussed in Washington.

Absent the willingness of the US to pick up the bill for their own consumption, they might buy themselves some time if China buys up a million of houses in the USA so as to get some more real backing for their dollar investments; and which by the way would also be a great alternative for China to get the US economy going again for the benefit of their own business model.

As I see history playing out its ironic hand housing finance created a perfect storm which forced everyone into the safe harbour of the US treasuries, until it got so crowded there that everyone started swimming again to the house-wrecks.

If the game is over, aren’t we being better off starting anew?

Sir Martin Wolf in “Global imbalances threaten the survival of liberal trade”, December 3, tells us that savers must turn into spenders and spenders into savers, in order for all to balance out and allow us to keep on playing the same game, or we “must prepare for dire results.”

Unfortunately the fact that it all sounds so reasonable, does not make it one iota more possible to achieve, especially considering that in order for the rebalancing act to produce the desirable effects, the new savers would have to save in an already harsher environment and the new spenders would have to take on new-debt instead of consuming their old savings that have already been invested in somebody else’s past spending.

And so the real question is whether we believe there is sufficient willingness to work down the global imbalances and therefore insist on playing a game that might already be irreversible over, and which to the suffering that must ensue will only add the fastidiousness of a useless prolongation; or we call it quits, honour the winner, ceremoniously, with a trophy, and begin a fresh new game.

If I were young, healthy and reasonably capable there is no question that I would choose to start afresh and have the crisis behind me, especially if for the next round we could agree upon some changes in the rules; like the imposition of immense carbon taxes that would help us all to avoid environmental disasters. For all of the rest the dwindling hopes of a le déluge, après mois, seem more valid.

Could the world hope to be able to reach a peaceful start-afresh? Well that is the real challenge for a truly new and much improved Bretton Woods.

Sir this reasoning also agrees with your “Not a time for hoarding bullets” December 3. If we are going to be buried under a déluge we might as well have a full go at it since if even if we fail this could perhaps help to get it over faster, while enjoying some half-decent music.

Have a nice cuppa tea.

Sir Gillian Tett gives the best and most timely advice I have yet heard in these days of financial turbulence… “have a nice cup of tea”, “Calm must prevail in war of psychology” September 22, good for her. If Paulson could benefit from reading up on the Swedish model of handling a bank crisis he would also do well by mustering a very British stiff upper lip.

P.S. Living in the US I am fed up though with the word “prevail”