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

Wake up Mr. Wolf!

Sir Martin Wolf holds that “The rescue of Bear Stearns marks liberalisation’s limit” March 26; as if we have had some true liberalisation. 

He is wrong. Much the contrary, never before have the financial markets been so regulated as they are now with the credit rating agencies, empowered by the regulators, deciding over how much each bank needs to pack their rucksack with reserves; and most of what has happened since imposing the minimum capital requirements imposed on the banks through Basel I, has been the result of regulatory arbitrage. 

Wolf quotes Ben Bernanke in a speech that “makes one’s hair stand on end” saying that much of the subprime mortgage lending of recent years was “neither responsible nor prudent”. 

Mr Wolf. You know what makes my hair stand on end? That all the market did was to follow the criteria of the credit rating agencies that felt that such mortgages were good enough to make up prime collateral. Wake up Mr. Wolf, before we can start to think about the limits of liberalisation we still have much to think about the limits of regulations.

PS. Credit ratings as a systemic risk

Where has financial liberalization taking FT?

Sir your editorial on "Where the financial liberalisation got us" December 29 contains a doubtful statement, some declarations of faith and a big dose of understandable financial sector partisanship.

First can we really speak about liberalisation while a fundamental part of the financial system, namely risk evaluation, is chained by the regulators to the limited criteria of a few credit rating agencies? Before, in banking, there was more of a "you banks you do as you like but only indoors" while now it is more of a "you banks can go out but remember always to do as your nannies the credit rating agencies say" and we could spend years discussing which is the most liberal of those two systems.

Second, among the credos you recite is that of "but before the first Basel agreement on capital adequacy reserves often bore little relation to a bank's risk", and this is something that we all hope is true, but not necessarily so when we see so many banks scrambling around for more capital. Also when you say that "capital [has] been allocated more efficiently" we have to wonder on what basis you are sure of that since most of us would only be able to come up with a "and let us so pray".

Finally, on partisanship, your "Whereas 40 years ago many millions of young people may have wanted to borrow against their future income, in order to go to university…" contains a whereas that might be a little too sweet for our taste when we now read about so many students struggling to repay their loans.