Before ECB does one iota more, we must get rid of the loony portfolio invariant credit risk weighted bank capital requirements.

Sir, Rick Rieder writes, “A thoughtful consideration of where and how capital is being applied could have a positive influence that lasts decades. The status quo cannot be satisfactory for anyone hoping to see the eurozone continue as a global economic force in the century ahead” “ECB’s conventional tools will not solve eurozone woes” August 9.

Absolutely but, before having ECB by buying equities entering further into crony statism terrain, what should be done, sine qua none, is to get rid of those risk weighted bank capital requirements that so dangerously, both for the bank system and for the economy, distorts the allocation of credit. 

Precisely because banks need to hold more capital when lending to the riskier future than when lending to the sovereign, and safer present “the return on debt is not matching the risk. So potential lenders have retreated, leaving more expensive equity financing as the sole source of funding. That increases the overall cost of project financing. As a result, growth-enhancing projects never get off the ground, exacerbating today’s negative economic velocity.”

Precisely for the same reason, we are not getting enough of “What is needed is to improved productivity, which comes from innovation and technology.”

Sir, if that immense source of distortion is not eliminated then whatever ECB does will only kick the can further down the road from which one day it will roll back with vengeance on all of us.

My letter to the Financial Stability Board

My letter to IMF

@PerKurowski

What about the moral responsibility of telling the whole truth about Greece’s debts?

Sir, Martin Wolf writes: ”Done correctly, debt reduction would benefit Greece and the rest of the Eurozone... Unfortunately, reaching such an agreement may be impossible… moralistic propositions in particular get in the way…[one being] that the Greeks borrowed the money and so are duty bound to pay it back, how ever much it costs them… The truth, however, is that creditors have a moral responsibility to lend wisely. If they fail to do due diligence on their borrowers, they deserve what is going to happen” “Greek debt and a default of statesmanship” January 28.

The problem with that is that it does not contain “the whole truth and nothing but the truth.” Had it not been for the fact that European regulators allowed banks to hold little or even zero equity against loans to sovereigns, like Greece; which tempted banks with extraordinary expected risk-adjusted returns on equity when lending to sovereigns, like to Greece, then banks would never ever have lent so much money to Greece.

What about the moral responsibility of bank regulators of not distorting the allocation of bank credit? What about the moral responsibility of journalists of telling it like it is?

I am sure that if this truth really comes out Greece’s debt problem could be looked at in a much more understanding light… and perhaps would allow Greece, in a first stage, to restructure all its debts in terms appropriate to the risk-profile regulators held it to fit… something like that of Germany’s.

What would Greece’s debt profile look like if it received terms like 30 years at 1 percent?

“Stay indoors where it is safe children, outside is much too risky” Nanny Basel Committee

Sir, Professor Jeff Frank refers to “driving with one foot on the throttle and the other on the brake” when explaining how QE “hasn’t done much for the real economy but has increased stock market prices and the wealth of the 1 per cent”, “‘Bold move’ will be to withdraw the money later” January 27.

I fully agree with Professor Frank’s analysis and conclusions. I would clarify though that “the brake” he refers to, is the “risk-weighed equity requirements for banks”, and which makes it impossible for equity strapped banks to reach out to the real economy.

Think of our banks as children instructed by their nannies to stay indoors all time, because out there it is much too risky.

Again, for the umpteenth time, the silly risk aversion of our bank nannies is bringing our economies down.

ECB’s Draghi’s “whatever it takes”, should be the subscription of hundred’s of billions in new European bank equity.

Sir, I refer to Wolfgang Münchau’s “Why the ECB should not water down a QE program” January 19.

But why would you pour QE on the Eurozone if, as Münchau says, it “is sick”? Should you not first figure out what it is that Europe needs? 

And it foremost needs, first to get rid of bank regulations that distort the allocation of bank credit in the economy; and then of course its banks would need immense amounts of fresh equity in order to be able to lend.

And so, let the Basel Committee decree, effective almost immediately, that banks need to hold for instance 8 percent in equity against any assets, including against loans to all infallible sovereigns, including against loans to the AAArisktocracy, and then have the ECB to be willing to subscribe all bank equity it takes.

ECB should, during some years, refrain from using any voting rights of that equity; and begin selling it to the market some years from now… unless of course banks offer to repurchase their own shares earlier. 

Is that legally or politically possible? I have no idea but that is what most would help Europe... as is pure QE cannot really be watered down, since to begin with it already basically is water.

Basel Committee, Financial Stability Board: Hear hear… Tim Harford’s "The Power of saying ‘NO’"

Sir, hear hear… Tim Harford’s, “The Power of saying ‘no’”, January 17.

“Please, please, dear bank regulator, allow us lower equity requirements on these ultra safe exposures and we promise that will stay away from what’s risky”

Absolutely NOT! The real bank crises have always occurred when something ex ante was considered as “absolutely safe” so I will not run the risk of next time that happens, you will, because of me, stand there with your pants down and no equity. Copy: finance.historians@gmail.com

Absolutely NOT! If I allow this, then I will not be able to look into the eyes of all those small businesses and entrepreneurs, who will be denied credit as a result of favoring the AAArisktocracy; or into the eyes of all those young unemployed, who could become a lost generation if I did so. Copy: risky.borrowers@gmail.com unemployed.youth@gmail.com

PS. But, unfortunately, bank regulators did not have it in them to say “NO!” to bankers.

Draghi does not deserve independence. The shackles that most need to come off are those of the European economy.

Sir, you write: “the European economy is still dependent on large troubled banks that have little ability or inclination to boost economic activity”, “Draghi fights a battle for independence at the ECB” January 15.

Why cant’ you say it like it is? European banks are instructed, in de facto very clear terms; by means of portfolio invariant credit risk weighted equity requirements, not to care about boosting economic activity, not to finance a risky future, but to stay put financing the safer past.

The best ECB could do to help boost economic activity is to make sure the discrimination against the fair access to credit of small businesses and entrepreneurs is eliminated. But, since that would best be carried out increasing the equity requirements on what is perceived as “safe”, it would leave a tremendous hole in the banks that cannot and would not be filled fast enough by the markets. And that is where the ECB could step in subscribing important amounts of interim bank equity that is resold to the markets over time.

To do so would require explaining how regulators create the problem, and Draghi, as a former Chair of the Financial Stability Board, does not seem a likely candidate for a sufficiently expressed and explained mea culpa.

Action on this front is urgent… think of all the loans that have not been given in Europe, to those Europe most need to have credit, since Basel II was approved in June 2004.

You end concluding that “It is high time the shackles came off” Indeed, but not those of Draghi, or so much those of the ECB, most urgently those of Europe’s economy.

If we want debt to earn the credit it merits, we need to get rid of current bank regulators.

Sir, I refer to Nigel Dodd’s, a professor at LSE, “Cast aside the moral judgment and give debt the credit it deserves”, November 1.

Unfortunately it seems that professor Dodd has not heard about the arguments against odious and stupid bank regulatory discrimination based on perceived credit risks. Had he done so, I believe his article would have taken a different form.

I say this, especially when reading his conclusion: “Credit is morally neutral. As an institution, it is neither good nor bad; and it is a grievous error to confuse creditworthiness with moral probity. Credit should be available to those who need it most. The price should be reasonable, and it should entail neither stigma nor penury.”

Indeed, professor Dodd, but one of the most important reasons for why this is not so, is the bank regulations that have been in place for about three decades; most especially since Basel II was approved in June 2004.

Those regulations order the banks to hold much more equity when lending to those perceived as “safe” than when lending to those perceived as “risky”; which of course allows banks to earn much higher risk-adjusted returns on equity when lending to the safe, than when lending to the risky.

And that means that regulators, on their own, without our approval, decided that bank credit should primarily be available to what from a credit risk point of view was perceived as “safe”, like financing house purchases, or lending to “the infallible sovereigns” or to the members of the AAAristocracy.

And which also means that anyone perceived as “risky”, would have to pay even more risk premiums, or have even less access to bank credit.

And that means denying fair access to bank credit to those we, who depend the most on the real economy, most need and want should have fair access to it, like the medium and small businesses, the entrepreneurs and the start-ups.

If we want debt to get the credit it deserves, we need to get rid of these regulators.

Warning: The “much more bank equity” puritans, while correct, if told to implement it, might be extremely dangerous

Sir, I refer to John Plender’s “Prospect of fund outflows puts banks in tricky territory” October 15.

In it he writes: “Bloomberg has estimated that the cost of equity of 300 large banks was 13 per cent at the end of March, 5 percentage points higher than its 2000-05 average. The authors [of The International Monetary Fund’s Global Financial Stability Report] reckon that the return on equity at banks accounting for 80 per cent of total assets of the largest institutions is lower than the cost of capital demanded by shareholders. This return on equity gap casts doubt on their ability to build up capital buffers to address the next crisis.”

That should be a clear indication of the difficulties that lie before the banks, and a warning sign of having to be very careful with all those puritans out there screaming for much more bank equity, no matter what, and not caring one iota about how to get from here to there.

PS. The first article I ever published, in June 1997, was titled “Puritanism in banking”. In it I wrote: “If we insist in maintaining a firm defeatist attitude which definitely does not represent a vision of growth for the future, we will most likely end up with the most reserved and solid banking sector in the world, adequately dressed in very conservative business suits, presiding over the funeral of the economy. I would much prefer their putting on some blue jeans and trying to get the economy moving.”… It seems like time has stood still.

Too well tuned?

Sir, John Plender in “It’s time to rewrite fashionable finance ideas”, May 4, refers to the need for some redundancy in the system so as to be able to respond better to unforeseen events. Below is how I addressed that issue in my Voice and Noise of 2006.

Too well tuned?: Martial arts legend Bruce Lee, whom many people regarded as immortal, died at the age of only 32 of a cerebral edema, or brain swelling, after taking some sort of aspirin. I have not the faintest idea whether that pill actually had anything to do with his death but I have frequently used (or misused) this sad death as an example of how an organism could be in such a highly tuned and perfect condition that it could not resist a small external shock. And I used this metaphor to explain why companies nowadays, pressured by the stock market’s expectations for the next quarterly results; the latest theories in corporate finance as to how squeeze out the last drop in results; and, perhaps, even some bit of creative accounting, might be so well-tuned (no little reserve fat left) that they would not be able to withstand any minor recession. (Whenever I expose this theory, I can see in my wife’s eyes that she believes this is just my preparing an excuse for my growing—ok, grown—midline.)

Let the American motorist pays 50 cents per gallon of gas for new equity in their automobile industry

Sir is Clive Crook panicking? It is hard to draw a different conclusion from his “A question of first things first” December 8. Of course we need some fiscal stimulus and of course we should not procrastinate getting it out on the street… but what is wrong about thinking on the future in terms of what the stimulus should stimulate and what not, and about how to pay for it all?.

The truth is the sooner the market gets a feel for the full circle, “this is what we spend and this is how we pay for it”, in ways that make sense, the faster it will regain the confidence it needs.

For instance I am proposing that the American motorists subscribe and pay for fresh equity in their automotive industry with 50 cents per gallon of gas, as a tax. That should help to raise more than 70 billion dollars a year to take care of the current problems of their industry and finance the green retooling they must embark on. If at the end of the exercise the equity is not worth what the motorists paid, it is still only right that those who drive should primarily carry the burden of rescuing the automobile sector.

But a share is still (mostly) a share… it’s attractive

Sir, John Plender in “There can be no return to ´normality´ of a freakish bubble” August 30, mentions that “in the midst of all this, many investors are baffled that equity markets have not been seriously damaged”. The explanation for this should be quite clear though, in this freakish market, at least for the time being, a share is still mostly a share, and you can see its value quoted daily, so when you compare it to all those fancy investments where your advisors is currently asking for more time to figure out what it could be worth, give and take 20%, no wonder a share looks attractive.

The public private matrix

Sir, strange how terms could seem to evolve! I say this because when reading the title of Gillian Tett’s article “Multi-layered finance a defence against private equity”, April 20, the first thing that comes to mind is who would have thought it possible that FT would imply that some defence against private equity could be needed? Of course, Gillian Tett’s excellent article is perfectly clear what is meant, but then again perhaps using the term “private-private equity” would lessen the chances for confusion, and perhaps even of having it quoted by those who like Hugo Chavez in Venezuela favour the public sector to take control of some private companies. That said, in the matrix of private-private; public-private; public-public; I believe we all agree that the worst, by far, is the fourth quadrangle, that of private-public.

On the article itself, and after we have seen how fairly simple facts such that mortgages should be issued on reasonably sustainable terms were mostly not caught by the rating agencies, perhaps covering it all in some sophisticated multi-layering-finance, contrary to what is said, could in fact make it easier to obtain a credit rating agency’s letters of approval. You see, the worse the tangle, the easier to talk yourself out of it when caught wrong; it is when things are really simple, that the going gets really rough.