The coronavirus will unleash a horrific Minsky moment in our bubbled-up debt overextended economies

Sir, I refer to Martin Wolf’s “The virus is an economic emergency too” March 18. 

Indeed, more than a week ago I tweeted: “The world is prepared somewhat for the expected, but not enough for the unexpected. That’s why, worldwide, coronavirus will cause larger number of deaths because of its economic consequences, than because of its health implications”.

And for years I have also tweeted, “The current fake-boom, put on steroids by huge central bank liquidity injections, low interest rates, and Basel Committee’s pro-cyclical risk weighted bank capital requirements, will end in a horrific Minsky moment bust, equally put on steroids.”

Sir, bank capital requirements used to be a percentage of all assets, something which to some extent covered both EXPECTED and UNEXPECTED risks. But currently Basel Committee’s risk weighted bank capital requirements, those that operate over the silly low 3% leverage ratio, are solely BASED ON EXPECTED credit risks. So even if Wolf can write “The pandemic was not unexpected”, for banks and its regulators it sure was completely, 100%, unexpected. And all the banks will now soon stand there completely naked.

And what help can banks be expected to give entrepreneurs and SMEs when they are required to hold much more capital when lending to these, than when holding “safe” sovereign debts and residential mortgages? Will banks be able to raise the needed 8% in capital or will regulators lower that requirement?

Wolf writes, again, “Long-term government debt is so cheap”. Sir, when will Wolf dare think about what those rates would be, for instance in Italy, if its banks needed to hold the same amount of capital against loans to their government than against loans to their Italian entrepreneurs?

“Governments can just send everybody a cheque”. Yes, a perfect moment to build up an unconditional universal basic income scheme; but it needs to be well funded, not with public debts expected to be repaid by our grandchildren. Possible sources are high carbon taxes, something which would align the incentives in the fights against climate change and inequality; another possibility is to tax those advertising revenues generated by exploiting our personal data.

PS. As to USA it should immediately eliminate of all health sector discrimination in price, access or quality, between the insured and the uninsured.

PS. As to education all professors and administrative personal should have their salaries reduced, something which should be compensated by participating somewhat in their students’ future income streams.

http://subprimeregulations.blogspot.com/2020/03/the-basel-committee-for-banking.html

@PerKurowski

Any risk, even if perfectly perceived, cause the wrong reactions, if excessively considered.

Sir, I refer to Patrick Jenkins “In our warming world, stranded energy assets are a growing concern” March 3. It evidences the difficulties in understanding how bankers adjust to risks, before and after the introduction of risk weighted bank capital requirements.

The current risk weighted bank capital requirements, which are based on that what’s perceived as risky is more dangerous to our bank systems than what’s perceived safe, only guarantees too much exposures to what’s “safe” and too little to what’s “risky”. So now banks, while “goose herds and whaling ships” are perceived as safe, run the risk of building up too large exposures that are harder to manage when these begin to look risky. 

Therefore, in the old days, before these regulatory distortions, banks were able to handle much better than now any slowly becoming apparent perceived risks, like with “goose herds and whaling ships”. 

What was more dangerous then, and MUCH more dangerous now, is of course the unexpected… like coronavirus.

Again Sir, for the umpteenth time, before, for around 600 years, banks cleared for perceived risk by means of interest rates and size of exposures. But then the Basel Committee instructed banks to clear for exactly those same risks, in the capital too. Sadly Sir, any risk, even if perfectly perceived, cause the wrong reactions, if excessively considered.

@PerKurowski

If only bank regulators had taken their clues from fixed odds betting terminal regulators.

Sir, Henry Mance and Camilla Hodgson write about the reduction of The government announced last year that it would reduce “the maximum stake on fixed-odds betting terminals — such as roulette — from £100 to £2 to tackle problem gambling.” “Problem gambling shake-up set to be brought forward” October 15.

Of course that will operationally distort fixed odds betting terminal playing, slowing it down, but by keeping the odds as designed for the game, meaning every bet having exactly the same probability adjusted payout, it will not alter the nature of it. 

We can only wish our current bank regulators had used a similar route because these, by allowing banks to leverage assets differently based on their perceived (or decreed) credit risk, actually determined that banks would obtain higher risk adjusted returns on equity on assets perceived as safe than on assets perceived as risky… and that has clearly distorted the whole nature of banks, when fulfilling their expected role of allocating credit efficiently to the real economy. How long would the game of roulette have survived such regulations?

In terms of betting on horses at the racetrack that would be like handicap officials taking off weights from the stronger and faster horses and placing these on the weaker slower ones. How long would horseracing tracks survive such distortions?

In terms of our ordinary golf that would be like handicap officials giving more strokes to the better players than to lousy players like me. How long would our golf clubs survive such distortion?

What’s going to happen to our bank systems? If these regulations persist, they are going to implode on some especially excessive exposures, to what is especially perceived (or decreed) as safe, against especially little capital. No doubt about it!

@PerKurowski

Ex ante expected real rates of return and ex post real rates of return are apples and oranges

Gillian Tett referring to “The Rate of Return on Everything, 1870-2015” authored by Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick and Alan Taylor writes: “real rates are very low today compared with the peacetime years in the 20th century. But real returns on bonds and bills were much lower during the first and second world wars, tumbling to about minus 4 per cent (compared with 3 per cent for bonds in 2015, and zero for bills).” "Take the very long view on asset prices", December 22.

Sir, we cannot know the ex post real rates of return for bonds yet, and it must be very hard to gauge the ex ante expected real rates of return during the first and second world. Therefore it is not clear to me whether Ms. Tett refers in both cases to ex ante expected real rates or to ex post finally obtained real rates? If not she is comparing apples to oranges. Frankly, no matter how high patriotic willingness to contribute with war efforts could stimulate lending to it, I truly doubt investors accepted ex ante a minus 4 per cent real rate offer… so they must have expected a much lower inflation rate.

Sir, there is a lot of confusing ex post with ex ante going on. For instance, the Basel Committee regulators, when setting their risk weighted capital requirements for banks, used the ex ante perceived risk of bank assets as proxies for the ex post risks to banks… a horrible mistake that distorted the allocation of bank credit and that has not been corrected during soon 30 years.

PS. And now having read the paper I must also observe that risk free rates, and rates of returns on what is considered by regulators a safe assets, like houses, must be separated into those before the risk weighted capital requirement for banks and those thereafter, since the regulatory subsidy to the “safe” again makes apples and oranges of these.

@PerKurowski

Contrary to Gordon Brown, current bank regulators do not dare to take questions, they might not be able to answer

Sir, as truly responsible elite should behave, Lucy Kellaway takes society at task with her “There is nothing cute about innumeracy” May 8.

In it Kellaway refers to how a kid, almost 20 years ago, asked Gordon Brown, then Chancellor of the Exchequer, “what is 13 squared?” and got a correct answer.

I argue that the current risk weighted capital requirements for banks are dangerously nonsensical, and that is why I have been asking bank regulators many questions about these, during about 20 years too. I have not had that kid’s luck.

For instance, when I ask why they give what is AAA rated, that we know banks could be building up dangerous exposures to, a risk weight of only 20%, while the so innocuous below BB-, that which bankers would not touch with a ten foot pole, is handed a 150%, their eyes go blank, and they nod to each other either “what the hell is he talking about?” or “does he not understand that risky is risky and safe is safe?”

If I ask them how much they feel authorized to distort the allocation of bank credit to the real economy in pursue of an elusive financial stability, then they ignore me completely.

Frankly, how can a society allow its banks to be regulated by those that, knowing as they should that bank capital is to be there to cover for the unexpected, are so dumb so as to base their capital requirements on what’s expected?

Here follows a link to some of my many questions that have never received an answer.

http://subprimeregulations.blogspot.com/2016/12/must-one-go-on-hunger-strike-to-have.html

How is it that “Without fear” FT, contrary to that young kid who asked Gordon Brown, does not dare to ask bank regulators these questions?

@PerKurowski

What a shame Lucy Kellaway missed teaching her finance expert colleagues in FT, to spot bullshit at 50 paces.

Sir, Lucy Kellaway no matter how she has educated her daughters in other aspects, something which I father of three might discuss, has all the right in the world to be very proud to have helped them “to spot bullshit at 50 paces” “How I help my children navigate their life journeys” March 13.

If she had taught the same to her finance expert colleagues in FT then they, upon seeing a risk weight of only 20% for what is so dangerous to the banking system as what is AAA rated, and one of 150% for the so innocuous below BB- rated, would have stated “What a BS!” and then the world could have looked quite less messier than now.

@PerKurowski

Hardheaded bank regulators still believe they’re up against the expected while the real enemy is always the unexpected

Sir, Ben McLannahan discusses the consequences of changing “the current regime [in which] banks can hold off adding to reserves until the point at which losses on the loan become probable…[to one in which] banks will be made to log all expected losses over the life of the loan on day one, based on a combination of experience, their own forecasts and the state of the economy”, “Big lenders raise concerns over new loan loss rules” June 22.

One direct consequence of that is that those borrowers who are ex ante perceived as risky, will therefore force banks to recognize losses earlier than “when probable”. That might sound correct, but the real effect is that, when compared to those ex ante perceived as safe and which have lower probability of losses, it will discriminate against the risky.

And so when you layer this on top of the discriminations already produced by the risk weighted capital requirements for banks, the access to bank credit for those perceived as risky will only become more difficult. And all really without making banks much safer. The expected never causes major bank crises, it is always the unexpected losses for what had erroneously been perceived as safe that does.

McLannahan reports that Hal Schroeder, a board member at FASB, opines that the new rule — known as the Current Expected Credit Loss, or CECL — “aligns the accounting with the economics of underwriting, and the informational needs of investors”.

And to justify it Schroeder “noted that in the four years before the crisis, loans held by banks in the US rose 45 per cent, while reserves set aside for losses fell 10 per cent. That meant that loan-loss reserves as a percentage of gross loans were near a multi-decade low on the eve of the Lehman collapse.”

But why was that? That was the result of banks increasing their exposures to what was perceived as safe, because of lower capital requirements, and lowering their exposures to what was perceived as risky, because of lower capital requirements… and then being surprised when “super-safe” AAA-rated securities, backed with “super-safe” residential housing mortgages, and loans to sovereigns decreed as “super-safe”, like Greece, turn out, ex post, un-expectedly, against probabilities, to be very risky.

Sir, what’s being done here, especially without eliminating the risk-weighted capital requirements, evidences that the regulators still don’t understand that they are not up against the expected, their real challenge is the unexpected. Since what is perceived as safe has much more potential of providing unpleasant surprises than what is perceived as risky, their regulations just makes the bank system more brittle and fragile.

And to top it up by discriminating against the risky they hinder the banking system from taking the risks the real economy needs to move forward.

We need our banks to work for all, not just for the banks, and for those perceived as safe.

We need our banks to finance the riskier future of our young, not just refinancing the safer past of their parents.

@PerKurowski ©

Martin Wolf, the uncertainty of whether those who govern us really know what they’re doing is always upon us.

Sir, Martin Wolf writes: “Productivity is not everything, but in the long run it is almost everything… But the prospects for productivity are…the most important uncertainty affecting the economic prospects of the British people. Is it reasonable to expect a return to buoyant pre-crisis productivity growth? Will productivity continue to stagnate? Or will it end up somewhere in between?” “The age of uncertainty is upon us” March 18.

Mr. Wolf, for the umpteenth time, obsessively, I do not understand how you and so many other can so obsessively ignore that if you tell banks they can leverage their equity more with what is safe than with what is risky; so that they can earn higher expected risk adjusted returns on equity with what is perceived or deemed to be safe, than with what is risky; that then banks will foremost be refinancing the safer past while ignoring too much the credit needs of the always riskier future. And since then productivity is not been given the chances it deserves, the prospects for its improvement must be really lousy.

“The age of uncertainty is upon us”? Please when did we have an age of certainty?

Current regulators regulate banks without having defined their purpose, and base those capital requirements for banks that should cover for the unexpected, on the expected credit risk. Those facts evidence the major uncertainty we always face, namely whether those who govern us have the faintest idea of what they’re doing.

@PerKurowski ©

The Basel Committee for Tropical Forest Supervision fumigates “risky” creatures and thereby kills its biodiversity.

Sir, Lawrence Summers discusses “the challenges currently facing macroeconomic policymakers in the US and the rest of the industrial world”. He expresses concern that policies could be behind the curve and believes central bankers’ communicate “a sense that there was relatively little left that they can do to strengthen growth or even to raise inflation” “A world stumped by stubbornly low inflation” March 7.

Oh no! There is much to do. Urgently!

Rain forests provide ecosystem services that play an important role in maintaining biological diversity, global climate regulation, disease control, pollination and much more.

What would we opine about forest guardians eradicating scrub-itch mites, ticks, spiders, scorpions, centipedes, wasps, hairy caterpillars, leeches, snakes, stinging tree, lawyer vine and other of the natural habitat, only on account that these are dangerous creatures?

Well that is exactly what bank regulators, central banks, have been doing to our real economies. With their credit risk weighted capital requirements for banks, they fight the SMEs and entrepreneurs only on account these are risky from a credit point of view.

And they are so fanatical that they do not warn bankers about hidden unexpected ex post dangers, they act even when bankers ex ante perceive the scorpions they know they should expect to be dangerous.

And of course our real economies, lacking more and more in diversity, stop to function as they should. 

And so we must urgently get rid of the current dumb bunch of forest guardians who, when trying to save banks from “The Risky”, are dangerously fumigating our real economies. The fact that even the central bankers communicate there is little they can do, is just another clear sign it is hight time for that.

@PerKurowski ©

Banks are dangerously overpopulating the traditional save havens of widows, orphans and pension funds.

Sir, Attracta Mooney quotes Pascal Blanqué, deputy chief executive of Amundi, stating: “QE has proved a mixed blessing. It prevented a 1929-style depression after the collapse of Lehman Brothers in 2008. But it has also delivered unintended consequences for longterm investors. The challenge for policymakers is to address them.” “QE ‘acted like an opaque tax’ on pension funds” November 2.

Again someone is speaking about unintended consequences, instead of referring to what obviously should have been expected consequences.

With QEs injecting liquidity into safe investments; with bank regulations awarding huge incentives through the capital requirements for banks to finance what is safe; with bank regulations awarding additional huge incentives through liquidity requirements for banks to hold what is safe, and with sovereign debt having been decreed as ultra-safe and assigned a zero risk weight, there can be no doubt that the financial safe havens of the world are bound to become dangerously overpopulated. Where is a widow or an orphan to take refuge nowadays… in Argentinian railroad projects?

@PerKurowski ©

To manage risks our bankers are always better free, in God’s hands, than in hands of some hubristic sophisticated besserwissers

Sir, Martin Wolf writes: “Market liquidity is likely to disappear when one needs it most. Building our hopes on its durability is risky. That is correct, but when he argues: “the absence of regulation exacerbated the liquidity boom and subsequent bust”, his implicit message is… that regulators should do something about it. “Beware the liquidity delusion” October 7.

I on the other hand have always worried about that bank regulators, when they act on their own perceptions of credit and liquidity risk, in any sort of complex form, introduce distortions, systemic risks, which can make everything so much worse. 

What feeds our credulity to believe something is more safe just because we perceive that something to be more safe? Is it not so that the safer an asset is perceived, the more we can run the risk of everyone demanding it excessively, and thereby make that asset really risky?

What feeds our credulity to believe something is more liquid just because we perceive that something to be more liquid? Is it not so that the more liquid an asset is perceived, the more we can run the risk of everyone demanding it excessively, and thereby at one point make that asset absolutely illiquid… at absolutely the worst moment?

Wolf suggests: “It would be better if investors appreciated the risks of a freeze in market liquidity in riskier financial assets”. Yes, but one must also argue the importance for regulators to appreciate the risks of a freeze in market liquidity for “safe” financial assets. A freeze of those assets would obviously hurt much more. (Like what happened with the AAA rated securities collateralized with mortgages to the subprime sector)

Wolf suggests: “markets characterized more by longer-term commitments, and less by hopes of finding ‘greater fools’ willing to buy at all times, might be better for most of us. This will not be true for all assets — notably government bonds. But it will be true for many private instruments”. Indeed, more long-term commitments could be good, but why does Martin Wolf believe that government bonds could never become a dangerously overpopulated safe haven in which we all got stuck gasping for oxygen? Is it ideology?

Of course dangers surround us, our financial markets and our banks, all the times; many more than credit and lack of liquidity risks. To manage those risks I am convinced we are better of being free, in God’s hands, than in the hands of some sophisticated besserwissers suffering immense hubris. But that’s just me.

Does this mean I don’t want any regulations? Of course not! But keeping those simple, and essentially considering the unexpected instead of the expected, would go a long way. The expected always finds a way to take care of itself… though I must admit that sometimes that takes strangers going strange ways and using strange tools.

@PerKurowski ©  J

When risky things turn out risky, they turn out as expected. It is in what’s “safe” where the real unexpected dangers lurk

Sir Lucy Kellaway when referring to Sergio Ermotti, the chief executive of UBS, telling “all the bankers who work for him that henceforth it was OK for them to make mistakes” writes: “Mistakes are never OK. And they are particularly un-OK in banking” because… “The main point about risks is that they are risky — and risky things have a way of going wrong.” “Listen to brain surgeons, not bankers, for the truth on errors” September 27.

Not so. When risky things turn out risky, they are actually turning out right as expected… it is when safe things turn out risky, that things can really go wrong.

And Kellaway argues: “What Mr Ermotti should have made clear was that sometimes his employees must take risks, and sometimes things will go wrong. When that happens, no one must ever make light of their cock-ups. Instead they should carry the memory of all their mistakes as part of their own internal score sheet of how they have fared as a banker.”

Indeed, but the greatest cock-up in banking history, a cock up so big that it is being frantically ignored, was the one made by bank regulators. It happened when they allowed banks to hold much less capital against assets perceived as safe, meaning against those assets that precisely because they are perceived as safe, represent the biggest danger to the banking system.

Lucy Kellaway, I am sorry, I have no idea why we would need to listen to brain surgeons for the truth on errors… even a bank regulator who knew what he was doing, should know that.

@PerKurowski

You cannot ring-fence banks to live safe, in a vacuum, independent of the real economy.

Sir, Michael Barr and John Vickers argue that “Banks need far more structural reform to be safe” July 22, but as most navel gazing regulators, they seem to think banks could remain safe, as in a vacuum, effectively ring-fenced, independently of how the real economy is doing. Banks are more than some beautiful fishes to be looked at in an aquarium.

And in that respect, as long as ex-ante perceived risk of assets will allow for different capital requirements for the banks holding different assets, these will earn much different expected risk-adjusted earnings on their equity on different assets; which results in than the banks stand no chance of being able to efficiently allocate resources in the real economy; which results in that the real economy will falter; which will results in that banks, at the end of the day, are made unsafe, in a terminal way.