We might not end up homeless, but homes might be the only thing we end up with… and so how do we eat homes?

Sir, Rana Foroohar writes “Central banks can’t create growth by themselves. They can only funnel money around.” “What Trump gets right” April 15.

Indeed, but the way they funnel money around can also promote obese growth, and impede muscular and sustainable growth.

If you fill a financial irrigation system with huge amounts of liquidity, QEs, and ultra low interest rates, and some of its most important canals, like the financing of entrepreneurs are, because you consider these as risky, blocked with high risk weighted bank capital requirements, there’s no doubt bad things will happen. Among other, that those channels relatively wider because they’re perceived “safer”, like sovereign and the purchase of houses, will get dangerously much credit.

Sir, just consider the role of so much the credit for the purchase of houses has had in turning houses from being homes into being investment assets. I have not done the calculations but were we to deduct from the assets of the 99% less wealthy the worth of their houses, I am sure that we would be horrified about what little savings we would find. We might not end up homeless, but homes might be the only thing we end up with… and how do you eat a home?

@PerKurowski

President Trump seems to be on route to become one of the greatest “paga-peos” (scapegoats) in history.

Sir, Gillian Tett writes that for her “money, there is another, darker, way to interpret this week’s [extreme volatility in US equity markets]. Two years into Mr Trump’s presidency, global investors are questioning the administration’s financial credibility…Steel yourself to cope with further turbulence triggered by Mr Trump”,“Expect more turbulence from Trump’s Fed fight”, December 28.

Indeed, president Trump is to be blamed for some of it, but the truth is that had the markets been more normal, not so much bubbled-up, he would only cause some ripples never Tsunamis.

That Trump has given indications to fire Jay Powell, the Fed chair, is bad in as far as it interferes with the necessary independence and credibility of a central bank. But, that said, let me also hold that, if a central banker or a regulator believes that what bankers perceive as risky is more dangerous to bank systems than what they perceive safe, and therefore use credit distorting risk weighted bank capital requirements, as they’ve done for a long time, that is a clear justified cause for their removal.

Venezuelan historians sometimes recount that in old days the refined ladies of the society always used to keep a young slave close by. Whenever they let out noisy and smelly gases, they would hit the slave hard and loudly on his head spelling out “Boy/Girl!” whichever applied. These useful blame-takers, scapegoats, were known as “paga-peos”, literally “fart-payers”.

Sir, President Trump clearly produces some gases himself, but he could also go down in history as one of the greatest paga-peos ever.

When booming equity markets, house prices and unsustainable debt levels everywhere, built up with easy bank credit, huge liquidity injections and ultra-low interest rates come crashing down, as they must, sooner or later, those who are much more to blame for it, could all jointly point at President Trump and shout “He did it!” and Ms. Tett might smilingly nod in agreement.

PS. Though in Spanish here you will find more interesting details about the “paga-peos” tradition and about how it can be used with even worse intentions.

@PerKurowski

The interest rates on public debt are distorted by QEs and bank regulations. Seemingly no one dares to research that

Sir, Baroness Ros Altmann, when commenting on Martin Wolf’s (“Capitalism and democracy are the odd couple” of September 20, writes:

“Global central banks have artificially distorted capital markets for several years, by creating vast amounts of new money to buy sovereign debt. The supposedly “risk-free” interest rate, on which much of the system depends, has been undermined (and she concludes)… it is important to consider the democratic dangers to capitalism which prolonged QE may pose. ” “Disguised fiscal measures play role in democratic recession” September 22.

She is absolutely correct, and I have over the years written for instance Martin Wolf numerous letters on it.

But there is also the regulatory distortions provoked by the risk weighted capital requirements for banks introduced in 1988 with Basel I, and which assigned a 0% risk weight to sovereigns.

That meant at that time, and well into current Basel III times, that banks needed to hold little or no capital when lending to sovereigns; meaning banks were authorized to leverage immensely when lending to sovereigns; meaning banks could earn fabulous risk adjusted returns on equity when lending to sovereigns; meaning banks would lend too much and at too low rates to sovereigns.

So, when to QEs we add this through-the-back-door regulatory subsidies to government borrowings from banks (and now with Solvency II extended to insurance companies) it is absolutely clear we have no idea what the real cost of public debt is; and so we are all flying blind… and government bureaucrats having much easier access to bank credit than SMEs or entrepreneurs.

Last November, during IMF’s Annual Research Conference, I got at long last one of the major experts, in this case Olivier Blanchard, to agree with me in that “lets make sure that we have removed all the distortions which we can, which affect r (rates), so we have the right r”.

Sir, as of this moment that was the last time I have heard about it.

Why is there no response? Perhaps the answer is found in Upton Sinclair’s “It is difficult to get a man to understand something when his salary depends upon his not understanding it.”

PS Here is the link to my own response to that particular article of Martin Wolf

@PerKurowski

Has the SEC really shown such merits that Patrick Jenkins has to stand up in their defense against bullies?

Sir, Patrick Jenkins, in “SEC should stand up to asset management bullies on liquidity risk” of March 15, writes that some “even accuse the SEC of attacking the very essence of American free markets”

Those “bullies” are right! Risk weighted capital requirements is something totally incompatible with free markets, whether in America, Europe or anywhere else.

And let us not forget that the main reason the investment banks supervised by the SEC suffered more than the commercial banks supervised by the Fed and FDIC, was that in April 2004, the SEC gave in to the Basel Committees' capital requirements.

That some “blame the SEC’s poor regulation…for the risk that exists in the system”, is not something outlandish.

In November 1999 a began an Op-Ed titled “About the SEC, the human factor, and laughing” with: “A couple of days ago, SEC reported that their pension fund had also been the victim of a fraudulent stock-managing firm, and that they had lost a lot of money”. And I ended it with: “the possible Big Bang that scares me the most is the one that could happen the day…regulators… playing Gods, manage to introduce a systemic error in the financial system, and which will cause its collapse.

I have no idea why Patrick Jenkins goes out defending the SEC with his “415 pages of often technocratic proposals, the regulator suggest some sensible mechanisms to mitigate the fast-growing risks in the fast-growing asset management industry.”

Any regulators who have to write 415 pages to propose some partial solution, is only working for himself and for friendly regulation consultants. I am sure those 415 pages, which I have not read, contain all type of dangerous distortion and gaming possibilities.

@PerKurowski ©

The reason why banks “dance around tough capital rules” is that regulators play the music that invites them to do so.

Sir, I refer to Gillian Tett writing about hedge funds and banks moving into the P2P sector, “The sharing economy is a playground for Wall Street” September 25.

Ms. Tett writes: “banks used structured investment vehicles and collateralised debt… to dance around tough capital rules”.

That ignores that the reason why banks can “dance around tough capital rules” is that there are different capital rules. If for instance banks needed to hold for instance the basic Basel II capital requirement of 8 percent against all assets, there simply would be no music to dance to.

And Ms. Tett writes: “the system needs to provide more credit to the economy, in order to boost growth… If you ask bankers why they are moving into P2P lending, some will point to the high returns they hope to earn (since the average loan commands an interest rate of around 13 per cent, margins are high).”

Does Ms. Tett really believe that loans at 13 percent, in an almost zero rate environment, will help boost growth?

And Ms. Tett writes: “if you think that the main goal of finance should be to create safe, clear rules for capital flows… then the arrival of banks and hedge funds [to P2P sector]… might make you weep”

Ms. Tett still does not understand what is going on. Risk weighted capital requirements give banks the incentive of being able to leverage their equity immensely when lending to those perceived safe; and which forces the “risky” to have to pay both a bankers’ risk premium and a regulator’s risk premium. The natural result is banks will lend dangerously much to the safe and dangerously little to the risky… and that is what should make us weep.

And Ms. Tett writes: “[Banks] also took advantage of cracks in regulatory structures to create products that policymakers could not easily monitor or control (it was unclear, for instance, who was supposed to oversee mortgage derivatives).” 

What cracks? Basel II clearly spelled out that if a security was monitored by one of the few credit rating agencies, and obtained an AAA rating, then the banks could leverage 62.5 times to 1 their equity. 

And Ms. Tett writes: “unlike the pension funds which were exposed to mortgage-backed securities in 2006, for example, the banks and hedge funds understand the dangers of credit losses.”

I am not sure I would agree with that assessment. Too many banks, especially European had no understanding at all of the dangerous amounts of credit losses that could happen if the demand for mortgages to be packaged in securities, exceeded by much the capacity to rationally finance the purchase of houses.

Sir, since January 2007 I have written you around 150 letters in reference to articles by Ms. Tett; and of course copied her. Most of them have to do with explaining why credit-risk weighted capital requirements for a bank is such a flawed and dangerous concept. Even if I assume she has not read one single of those letters, she should have learned more about it after so many years.

Ms. Tett as the expert in anthropology you are: What would have happened with humans had some Basel Committee nannies given them so much incentives to stay safe in their caves and not venture out into the risky world? May I advance the possibility they would have ended up extinguished in their safe caves?

Per Kurowski

@PerKurowski

CDS were bought more for their capacity to reduce equity requirements for banks, than as insurance against defaults.

Sir, I refer to Joe Rennison’s report “Wall St looks to revive niche CDS” May 20.

It states: “single-name credit default swaps, a derivative contract that tracks the risk of default by a company that sells bonds. Regulators sought to clamp down on the market after the crisis because it was widely blamed for helping to inflate the credit bubble”.

That is not telling it like it really was!

According to Basel II, if a bank wanted to hold a bond that for instance was rated BBB+, it needed to hold 8 percent in equity… meaning it could leverage about 12 to 1.

But, if it bought a CDS for that bond from an AAA rated company, like from AAA rated AIG, then it needed to hold only 1.6 percent in equity and could therefore leverage about 60 to 1.

And that is what really drove the incredible artificial demand for these CDS that helped to inflate the credit bubble.

If CDS are to work, as they should, they need to be traded on their own merits of how they provide insurance against defaults, and not because of regulatory distortions.

Do not let failed regulators get away with their own favorite version of history!

@PerKurowski

Since development seems not really mean the same for UK than for China, why should UK join AIIB?

Sir, I am from Venezuela, and the United States has at least recently criticized what is happening in my country, while China in most non-transparent ways has mostly dedicated itself to finance and take advantage of what is happening in my country. And that I confess is one subjective reason for why I find it so hard to agree with Martin Wolf’s “It is folly to rebuff China’s bank”, March 24.

But that said I also feel that in order not to lose yourself in the new globalized world, you need to be able to reassert who you really are, now more than ever. And in that respect, few are so close as the US and Britain. In April 1999, feeling that the UK could become slightly uncomfortable with EU and with the Euro, and having heard about the ideas of Conrad Black and Paul Johnson, I even speculated in an Op-Ed about “A new English language empire”.

In essence I find no good reason why the UK should lend some credibility, against what is clearly no real influence, to an organization that does not really share its values. I am certain that, at least for the time being, when Wolf and I, UK and US, speak about development, we mean something quite different than what current China does… or at least so I hope.

PS. And, sincerely, I find Martin Wolf’s “As a former staff member of the World Bank” statement, indicating that as far as not living up to the “highest global standards”, AIIB and World Bank would stand on similar ground, to be clearly out of line.

PS. And by the way, to present oneself as a development buff, while at the same time not objecting to those credit-risk-weighted equity requirements for banks that clearly stand in the way of development, is sort of silly.

@PerKurowski

Sir, sorry to be disrespectful but…are you all in FT statists, communists or simply daft?

Sir, Claire Jones, in “Eurozone jobless outlook points up fears of persistent stagnation” March 24 writes of “ECB projections, highlighting deep scars left by the bloc’s financial and debt crisis”. What is wrong with you all? Have I not explained it to you all in hundreds of letters?

Again: It has been more than 25 years since Basel I redirected banks to lend more to the public sector than to the private sector; and more than 10 years since Basel II also within the private sector, redirected banks to lend to those perceived as safe and to avoid the “risky”.

And that means effectively the Basel Accord has ruled that government bureaucrats, because they represent “an absolutely safe borrower”, are more capable to efficiently use bank credit and generate jobs than what the so “risky” SMEs and entrepreneurs can do.

If you really cannot understand what that signifies for the medium and long-term potential of an economy to generate jobs… you are either statists, communists or simply daft… I hope it is the latter.

Jones writes: “ECB believes government can dent unemployment by pressing on with making their labor markets more flexible and competitive.” That would help, but before you get rid of the regulators’ heavy hand guiding where bank credit should go, there’s really little to do. Unfortunately, ECB’s Mario Draghi, as a former Chair of the Financial Stability Board, is one of the guilty of the regulatory distortion… and so there is a reputational conflict.

PS. Do you still not understand that if bank regulations had not been tilted so much in favor of “the infallible sovereigns”, then Greece, no matter how much it shaded its accounts, would not have been able to rack up as much public debt as it did? Do you not know that if European banks had not been allowed to leverage their equity, and the taxpayer support they receive, more than 60 times to 1 when investing in securities that carried an AAA rating, that the subprime crisis might never have happened? And of course that same line of arguments explains much of the mishaps when lending to Icelandic banks or financing real estate in Spain. 

Sir, again, no bank lending to what was not perceived as safe and therefore did not allow banks’ to hold little equity, had anything to do with causing the crisis. Of course, after the crisis has broken out all suffer, and, so unfairly, the innocent “risky” usually suffer most of all. But that has to do with ex-post consequences and not with ex-ante perceptions.

@PerKurowski

Bank nannies decided banks should avoid risk and solely play it safe, and thought nothing bad would come of that

Sir, I refer to John Stroughair’s letter “Stress test assumptions were not particularly stressful” November 4. In it he writes:

“The current weights enshrined in the Basel formula, which give preferential treatment to sovereign debt and residential mortgages [to which I would add the AAAristocracy], may make sense at the individual bank level. But at the level of the banking system they lead to a gross misallocation of credit, in particular to the excessive holdings by banks of supposed risk-free sovereign debt and to the fact that less than 10 per cent of the loans made by UK banks support productive businesses.

What is needed is a genuine debate regarding how we can move forward to regulation that will mitigate systemic risk and possibly even nudge the industry to support gross domestic product growth rather than house price bubbles.”

As you understand from my more than 1.000 letters to you about precisely this issue and this concern, I wholeheartedly agree with Stroughair.

One day it is going to be clear for all what our bank regulators, with their risk aversion did to our economies and to our society

In real terms they acted similar to as if educators decided to evaluate children better for dedicating themselves to playing piano, only because they think that is safe, than for engaging in sports they perceive as risky… and thinking that our society would be better for that.

We need liquidation and inflation and growth

Sir, Martin Wolf in “Central banks must target inflation” May 6 writes: “for clearing up the mess and designing a new approach to monetary policy... we have three alternatives: liquidation, inflation; or growth”, though he knows, of course, that we need all of them all: liquidation so that we stand on firm ground; inflation to grease the wheels; and a lot of hard and clever work at growth. 

Wolf also considers the possibility that our children “in despair...will even embrace... the absurdity of gold”. I do share Wolf’s feeling since they, and we, deserve more than that; in fact one of the most worrisome aspects of this crisis is how often one finds oneself on the side of those gold-bugs one has always considered being somewhat nuts. 

Now, what I do not agree with Wolf is when he writes of “inflation targeting”, as a holy gray, since one of the problem could be that the inflation was not adequately targeted. 

In a letter published by FT in May 2006 I wrote “inflation as they, our monetary authorities know it, is just obtained by looking at a basket of limited consumer goods chosen by bureaucrats and that although they might be highly relevant to the many have-nots, are highly irrelevant to measure the real loss of value of money. For instance, who on earth has decided for that the increase in the price of houses is not inflation? And so what should perhaps be argued is that really our monetary authorities have not been so successful fighting inflation as they claim they have been.” 

And then of course we have the financial regulations, and that Wolf does not even want to mention. Would a runner be a bad runner just because someone trips him up and he falls? In just the same way must a monetary policy be wrong, just because some financial regulations, risk weighted bank capital requirements, went haywire?