The 0% risk weighting of sovereigns and 100% of citizens, decreed fiscal irresponsibility.

Sir, Martin Wolf, discussing Trump’s tax cuts writes that America’s longterm fiscal position [has become] fragile”, “Trump’s boom will prove to be hot air” July 10.

Fragile indeed. In 1988 when the Basel Accord assigned America’s public debt a 0% risk weight, its debt was about $2.6 trillion, now it owes around $22 trillion and still has a 0% risk weight. 

Wolf opines “it is not too soon to note where the US is heading. It is hard to imagine anybody standing up for fiscal prudence. The choice is rather between rightwing and leftwing Keynesians. In the long run, that is likely to end badly.”

I fully agree but I must add that the risk weighted bank capital requirements, which so much favors credit to the sovereign over for instance credit to entrepreneurs, created such distortions that made it impossible for markets to send out their timely warning signals.

One can argues as much as one like that the credit risk of the sovereign is much less risky than that of an entrepreneur, but, the other side of the coin of that risk weighting, is that it de facto also implies a belief in that government bureaucrats know better what to do with bank credit they’re not personally liable for, than entrepreneurs.

For instance, does Wolf believe the current fiscal sustainability outlook of for the eurozone sovereigns would be the same if there had been just one single capital requirements for all their bank assets? Would he think French and German banks would still have lent to Greece/Italy as much and at the interest rates they did?

Does Wolf not think the immense stimuli injected by central banks in response to the 2008 crisis, would have been much more productive without the distortions in the allocation of bank credit produced by the credit risk weighing?

Sir, Trump’s tax cuts might not be helpful but, in the great scheme of things Trump is, at least for the time being, a really minor player when it comes to be apportioned blame for fiscal fragility. For instance how is the US be able to get out of that 0% risk weight corner its regulators has painted it into?

Sir, In November 2004 you published a letter in which I wrote: “How many Basel propositions will it take before regulators start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

@PerKurowski

For Greece (and other) to have a chance, it must free itself from the distortions of Basel bank regulations

Sir, Martin Wolf writes: “If the eurozone made it possible for Greece to borrow on triple-A terms forever, the debt would be sustainable. Otherwise, it probably would not be.” “Hope and fear in the endless Greek crisis”, December 23.

That entirely ignores that the origin of the Greek crisis was precisely that regulators allowed Greece to borrow on almost triple-A terms, something that proved to be irresistibly tempting for Greek governments.

What does Greece (and Europe, and America, and most of the rest of the world) need more than anything? As I have explained in thousands of previous letters to you, that would be the total annihilation of regulations that make the lending to SMEs and entrepreneurs less attractive for banks than the lending to what is supposed to be safer from a credit point of view.

In November 2004 in a letter published by FT I wrote: “We wonder how many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits. Please, help us get some diversity of thinking to Basel urgently; at the moment it is just a mutual admiration club of firefighters trying to avoid bank crisis at any cost - even at the cost of growth.”

When Wolf refers a reform package that does not include freeing the economy from Basel regulation distortions, and is capable of mentioning the possibility of it being able to generate a virtuous circle of reform and growth, I can only conclude Wolf is also a member of that mutual admiration club of technocratic statists.

@PerKurowski ©

All finance is great when debtors have a good plan… Force-feeding debtors is worse than feeding geese for foie gras

Sir, Martin Wolf writes: “Houston, we have a problem. We have a great deal of evidence that too much finance damages economic stability and growth, distorts the distribution of income, undermines confidence in the market economy, corrupts politics and leads to an explosive and, in all probability, ineffective rise in regulation. This ought to worry everybody.” “Why finance is too much of a good thing” May 27.

When I was an Executive Director in the World Bank 2002-2004 there were a lot of discussions about “debt sustainability”. I hated it… because it all sounded like a torturer calculating how much pain you could inflict before your tortured fainted.

I even left a blog titled http://unsustainabledebtsustainability.blogspot.com hanging around there out on the web.

Debt is great; there never is enough of it, as longs as you know what to do with it, and you truly believe you can repay it.

All other financing, forced down the throat of debtors…odious credit, is much worse than feeding geese to produce foie gras... something that at least has a purpose.    

It all comes down to the same problem, we are in hands of regulators who want to regulate more than what they want to know what they are regulating for. And it’s our own fault, more Martin Wolf’s than mine, for not calling their bluff.

PS. I have also alerted Houston:

Houston, we’ve got a problem: The IMF is lost in space

Houston, we’ve got another problem: Our central bankers’ are flying blind

PS. MartinWolf, absent conflicts of interest, and with perfect information, would there even be financial markets?

PS. Martin Wolf, besides our bankers, do we not have to trust our bank regulators too? I sure don’t

@PerKurowski

Failures and mistakes is something that needs to be nurtured in order to have a better future.

Sir, Gillian Tett is absolutely correct when she writes: “What is still missing, in many quarters, is a mindset – most notably a recognition by bureaucrats and bankers that failure is an inevitable part of the market system, and that it sometimes pays to wipe the slate clean rather than endlessly sweep problems under the carpet”, “Jingles that sound the beginning of recovery” October 24.

That is exactly what I referred to in a letter you published in August 2006 in which I wrote about “the long-term benefits of a hard landing” and the dangers of dabbling in topics such as debt sustainability ignoring the value of pruning or even, when urgently needed, of a timely amputation.”

But, I also think it is very important that the wiping-the-slate-clean, also applies to banks. As an Executive Director of the World Bank, in 2003, I told many regulators during a Basel II preparation conference: “A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.”

But no, the Basel Committee preferred to proceed down the road of nurturing the too-big-to-fail banks.

PS. By the way, Ms. Tett might be interested that in the US, the jingle she refers to, is not allowed when it comes to educational debt.

And citizens could sue agencies for too good credit ratings of sovereigns, which caused governments to borrow too much.

Sir, I refer to Stephen Foley’s and Guy Dinmore’s “Italy eyes €234bn suit after ratings groups failed to value la dolce vita” February 5. It reminded me of an Op-Ed of September 2002 titled “The riskiness of country risk”.

In it I wrote: “What a nightmare it must be to be risk evaluator! Imagine trying to get some shuteye while lying awake in bed thinking that any moment one of those judges, those with the global reach that have a say in anything and everything, determinates that a country has become essentially bankrupt due to your mistake, and then drags you kicking and screaming before an International Court, accused of violating human rights.

What a difficult job to be a rater of sovereign creditworthiness! If they overdo it and underestimate the risk of a given country, the latter will most assuredly be inundated with fresh loans and will be leveraged to the hilt. The result will be a serious wave of adjustments sometime down the line. If on the contrary, they exaggerate the country’s risk level, it can only result in a reduction in the market value of the national debt, increasing interest expense and making access to international financial markets difficult. Any which way, either extreme will cause hunger and human misery.”

And so what’s more to say. If the Italian Government sues the credit rating agencies for having given Italy too bad ratings, an Italian citizen might equally sue these for having given Italy too good ratings

And after that, what about suing the regulator who with their risk-weighted capital requirements for banks multiplied immensely any signal emitted by the credit ratings?

Since when can a mistake in a paper be used as evidence of an opposite conclusion?

Sir, Robin Harding reports “Reinhart and Rogoff publish errata to paper on public debt and growth”. May 9. In it Harding writes that the 2010 paper on public debt and growth, by pointing out a significant effect on growth when public debt reached 90 percent of GDP, was widely cited as an argument for fiscal austerity. Since the paper was thought to be correct, I guess that was a quite reasonable thing to do.

What I cannot lay my hands around though is how the existence of a mistake in the paper can suddenly be turned into evidence which supports the opposite conclusion. I say this because I have lately read more opinions advancing that the 90 percent is no limit, than what I ever read about the original paper stating it was.

That said, since all this type of debt-sustainability discussions often sound to me like a torturer debating how much torture his victim can take before fainting… I will, without any religious fervor invested in it, keep on opining that public debt at 90 percent of GDP is high… although that will of course also have to do with who are the holders of that debt, nationals or foreigners, friends or foes.

And also, if the 90 percent to GDP has been reached by incurring in distortions, like requiring banks to have more capital when lending to the citizens than when lending to the government, then my previous “high” becomes a “VERY HIGH”

Governments and politicians should feel much less smug.

Sir Martin Wolf shows us to be between a rock and a hard place in “Why dealing with the huge debt overhanging is so difficult” January 28. On one hand “liquidation” and bankruptcies would result in a depression and so “that option must be insane” but if, central banks are aggressive enough, we would “relapse into inflation [which] would be a huge policy failure”.

What are we to do? Just the realization of where we find ourselves is a better place to start. That way at least we will have a chance to avoid the push to spend and stimulate massively and fast, no matter how, and begin to behave more rationally in terms of the implementation so as to get the most effective stimulus of sustainable growth out of every cent of new public debt invested; and in terms of thinking about the taxes that will be needed to pay for it all.

But to have any chance to get it right we also need governments and politicians to stop feeling so smug about the current interest levels and to think that markets are brimming with confidence in their actions. If we disregard what markets are paying in premiums for access to a temporary safe haven in the midst of an initial confusion, many sovereign public debts might have already surpassed their long term sustainable levels.

Do you belong to an unkown sect of Austrian economists?

Sir in “A plan to spend – and to pay it back” January 9 you admonish that “Congress should not commit themselves to fiscal consolidation too soon”. Are you joking? Don’t you know Congress is composed by politicians?

Also I cannot understand why you egg on the announcement of even larger stimulus packages knowing that these will come, in due time, if there is room for them. Could it be that you belong to a sect of extreme Austrians economists that want Obama to spell out the real figure so that the markets are spooked right away from believing the dollar is a safe haven?

Après us le déluge?

Preventing a global slump is indeed a priority as Martin Wolf says October 29, but relying solely on government to do so could mean breaking the back of their finances, further inflaming “xenophobia, nationalism and revolution.”

We need to help governments to be able to help in ways that keep their credibility and therefore, instead of talking about tax cuts, knowing that so many new and urgent real life spending needs will knock on their doors soon, more than recommend tax cuts, as if those had no costs or as in let-our-grandchildren pay, we need to start thinking about new taxes that could be perceived as legitimate and interfering little with the economy.

I am floating around two new tax proposals. A special tax on all profits derived from intellectual property rights that will help to pay for the costs of enforcing those rights and a progressive corporate tax based on market share and that, among other, could help to keep in check the too big to fail risks.

Another possibility is that governments use very long term zero-coupon bonds when providing assistance buying up portfolios or mortgages, remember the Brady bonds?. That could at least buy them the time needed for economies to reflate back to where this new public debts can be duly serviced. Yes, “deflation is lethal for indebted economies” but so is public debt when it surpasses the level of what is perceived as manageable.

When in a panic, think, for a millisecond at least!

Jeffrey Sachs tells us: 1.- Extend swap lines to all main emerging markets. 2.- Have IMF extend low-conditionality loans to all countries that request it. 3.- Discourage big banks from withdrawing credit lines from overseas operations. 4.- China, Japan, and North Korea should undertake a coordinated macroeconomic expansion. 5.- Middle East needs to recycle all their cash. 6.- US and Europe should expand exports credits for low and middle income countries. 7.- US and Europe should follow an expansionary fiscal policy. According to Sachs "At the least it would put a floor on the global contraction that is rapidly gaining strenght. "The best recipe for avoiding a global recession", October 28.

Even if we would accept Sachs very optimistic view on the fiscal outlook as true, we should ask whether this is wasting aspirins or throwing real medicine at the problems? Compare Mr Sachs´ advice with what Michael Skapinker, on the same page tells us that Wal-Mart is doing to enforce ´sustainability, demanding "rigorous environmental and social standards", "An ethics lesson from an unlikely quarter".

The big question becomes then, should we now pull out all the stops in order to regain equilibrium on what might be a path to unsustainability or should we use this crucially decisive moment to provide the incentives to explore other perhaps more sustainable routes? In the panic it is still wise to take a brief time-out and think about what door to use. In fact our world at large is not only looking for an escape door for a financial crisis, it is looking for a door that can lead it to a better place. But, of course, neither do we have all the time to make up our mind… it is burning out there.

Do we dare to answer?

Sir Thrainn Eggertsson in his “Long-term consequences may be ruinous for Iceland” October 28, is really asking us… “Is Iceland not better off following the Argentina route? If our sons and daughters were from Iceland, do we dare to answer that question?

Vulture funds

Sir, I write to you with respect to Alan Beattie´s “'Vulture fund' in Zambia debt case gain”, February 16.

I might not like it too much if a vulture-fund-manager invited any of my daughters out to celebrate a killing in Zambia debt but, having said that, neither am I so sure that the world would be a better place without the vulture funds.

That some can find opportunities in buying uncollectible loans and squeeze fortunes out of them when others have decided to clean up their books, is just part of the circle of life, and part of the same market mechanism which signals how much, or how little, the loans are worth, since the price of a loan indicates the expectations of collecting on the loan and not the expectations of collecting on a “pardoned” loan. Yes, the vulture funds are into an ugly business, cleaning up among corpses, but, by their sheer presence, they might perhaps even help to reduce the number of corpses.

Most, or perhaps all of the scholar papers on the restructuring of sovereign debt, state as the explicit purpose of the whole exercise, that of enabling the countries to regain access to the international capital markets again (something like the torturer waking up his fainted victim) and so, if you really need to pick on one, you might also choose to do so at that moment in the circle when the new born debt-overhang-ridden countries gets thrown out to start defending itself again from the many dogs-of-finance out there.

There is so much written about freeing up the countries in order for them to access the markets while comparatively so little about how they should go about to avoid repeating the same mistakes that perhaps I should even frown when it is a regular investment banker who knocks on my door and asks for my daughter. I mean what is some hundred of percents on some few millions when compared to some basis point on a couple of billions.

PS. Nonetheless we should not allow vulture funds to be able to collect on really rotten odious credits

The Italian need to reflect more on their business model for their Italy

Sir, Martin Wolf argues that “Fiscal tightening and reform can rescue Italy’s economy” October 25, among others because Italy has a plentiful reserve of women not working, though it is not very clear whether having more women working is the type of reform he suggests or a response to the lack of other reforms. If the first, we guess the Italians themselves would like to have a say before going down Wolf’s reform path.

That said and in order for the whole suggested exercise to proceed smoothly Wolf also mentions the need for sustaining domestic demand, for which he neo keynesially recommends that since the government has run out of borrow and spend power, the private households should now have a go at it.

Presenting OECD figures that show that in 2004 the ratio to GDP of medium and long term-loans to household was “just” 37 per cent against 114 per cent in the UK, he thinks Italian household have ample room for more debt, though many of us humans would tend to react with some horror over the UK figure.

Whatever, before taking up Wolf’s suggestions about going into debt and given that globalization acts in many and strange ways, we believe the Italians should reflect a bit more on their business model for their Italy.

Martin Wolf Italy