Do we know of a display of hubris greater than “risk weighted bank capital requirements”?

Sir, Gillian Tett in “Economists can’t predict the future — policy should reflect that” July 1 wrote: “Robert Rubin, Peter Orszag and Joseph Stiglitz called on economists to embrace ‘copious amounts of humility’ when projecting the future.”

One of the magnificent displays of hubris, the antonym of humility, came into being when bank regulators imposed, risk weighted bank capital requirements, as if they, from their desks, have any real bankable notion, of what the future really entails.

And on that, this trio, as the rest of the Academia, as Gillian Tett, as FT too, have all kept total silence.

Will this tweet be ignored by FT?

How much hubris is needed for regulators to impose risk weighted bank capital requirements, as if they know what the risks are?

How much wishful hoping is needed when even Nobel Prize winners in Economic Sciences believe that the regulators do know?

http://subprimeregulations.blogspot.com/2019/03/my-letter-to-financial-stability-board.html

Current risk weighted capital requirements for banks are a stand out example of “garbage in garbage out”

Sir, when discussing artificial intelligence and “how much power should be ceded to the machines” you mention: First. “the need to overcome limitations in machine learning techniques”; Second. “garbage in, garbage out…the need for better quality control”; and Third. “the need to develop a clear and transparent governance structure for AI”, “The paradox in ceding powers of decision to AI” December 30.

Sir, human intelligence is quite often in need of all that too.

When bank regulators used intrinsic risks of bank assets as inputs for developing their risk weighted capital requirement, they could not produce anything but garbage out. What they should have used is unexpected events or the risk those assets could pose to our bank system, namely the risk that bankers would not be able to adequately manage perceived risks.

And little evidences the need for a transparent governance structure for human intelligence too, as current regulators refusal to answer the very basic questions: “Why do you require banks to hold more capital against assets made innocous by being perceived as risky than against assets becoming dangerous by being perceived as safe?”.

Humans must also also overcome some technical limitations: An Explanatory Note by the Basel Committee on the Basel II IRB (internal ratings-based) Risk Weight Functions” expresses: “The model [is] portfolio invariant and so the capital required for any given loan does only depend on the risk of that loan and must not depend on the portfolio it is added to.”

And the explicit reason for that mindboggling simplification is: “This characteristic has been deemed vital in order to make the new IRB framework applicable to a wider range of countries and institutions. Taking into account the actual portfolio composition when determining capital for each loan - as is done in more advanced credit portfolio models - would have been a too complex task for most banks and supervisors alike.”

Sir, finally, I would add a fourth requirement, namely to make sure artificial intelligence is kept free from that excessive hubris and besserwisserism that too often affect humans. Like that which kept regulators from even having to define the purpose or banks before regulating these,

@PerKurowski

In terms of creating systemic risks for our banking system, current regulators are the undisputable champions

Sir, former banker and banking lawyer Martin Lowy writes: “Dodd-Frank and Basel III capital rules have made banks and their holding companies stronger.” “How the next financial crisis won’t happen”, June 10

Well I sure know that the next financial crisis will absolutely not be the result of excessive bank exposures to something perceived as risky, as to what is rated below BB-, that to which regulators assigned a risk weight of 150%. Much more likely it will be from excessive exposures to something rated as safe as AAA, that to which regulators only assigned a meager 20% risk weight.

Really big bank crises, except from really extraordinary unexpected events, are the result of the introduction of something that can grow into a systemic risk.

What systemic risk do I see?

I see credit ratings, like when in 2003 in a letter published by FT I wrote: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is”

I see risk weighted capital requirements, like those that allow banks to leverage more with what is “safe” than with what is “risky”., and therefore distorts, for no good reason, the allocation of bank credit to the real economy.

I see standardized risk weights that impose a single set of weights on too many.

I see regulators wanting to assure that banks all apply similar approved risk models, thereby again ignoring the benefits of diversification.

I see stress tests by which regulators make banks test against the some few same stresses, as if real stresses could be so easily identified.

I see living wills, as perfectly capable to create systemic risks that at this moment are hard to see.

In all, in terms of creating dangerous systemic risks, hubris filled bank regulators aee the undisputable champions.

The main cause for that is that our bank regulators find it more glamorous to concern themselves with trying to be better bankers, than with being better regulators.

Regulators, let the banks be banks, perceive the risks and manage the risks. The faster a bank fails if its bankers cannot be good bankers, the better for all.

Your responsibility is solely related to what to do when banks fail to be good banks.

And always remember these two rules of thumb:

1. The safer something is perceived to be, the more dangerous to the system it gets; and the riskier it is perceived, the less dangerous for the system it becomes.

2. All good risk management must begin by clearly identifying what risk can we not afford not to take. In banking the risk banks take when allocating credit to the real economy is precisely that kind of risks we cannot afford them not to take.

As in 1997 I wrote in my very first Op-Ed. “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, but presiding over the funeral of the economy. I would much prefer their putting on some blue jeans and trying to get the economy moving.”

@PerKurowski

Even the best sovereign wealth fund, like Norway’s, will in the long run degenerate. Sorry, but that’s life.

Richard Milne comments that the Norwegian sovereign wealth fund, “has become a more active investor, trying to use its growing heft to influence company behaviour “Norway sovereign wealth fund flexes shareholder muscles” March 8.

Sir, I tell you, there will come day, you can bet on it, when a majority of Norwegians will opine “we would have been much better off managing each one of us his share of the net oil revenues, than handing these over to a sovereign wealth fund”. And they will be right.

How do I know? Well that’s how it goes when too few decide on so much wealth… it goes to their heads, and they start doing things for which they have never really been authorized, and then something happens, and then there is nothing to be done about it.

Do I mean that it was wrong of Norway to set up this fund? Not at all, I even wish Venezuela had done that… which it did… but

In 1974, as a recent young MBA, I became the diversification manager of the first Venezuelan Investment Fund set up to manage the nations fast growing oil revenues. It took me only two weeks to understand that it would not work, and so I resigned.

Norway was much further advanced than Venezuela when, in 1990, it set up its fund, and it has clearly done a lot better. Well-done Norway!

Nonetheless, the degenerative forces imbedded in such a fund are just too powerful, even for Scandinavians. The introduction of new objectives, without a clear explanation of what that could entail in reduced returns, is just one example of such forces.

Why do I make this point? Because in my Venezuela, again I hear the voices of those interested in its management, clamoring for something like the Norwegian Sovereign Wealth Fund. And Sir, I trust a thousand times more the citizens to know what to do with their share, than some few experts with everyone’s share.

@PerKurowski

The populism of bank regulators like Mario Draghi, has hurt Italy much more than Berlusconi’s

Sir, Wolfgang Münchau, discussing a “centrist populist. Take Silvio Berlusconi”, writes that he “left a legacy of economic devastation. Italy’s economic growth is anaemic, its debt burden too high and the banking system too weak…. The euro-zone lacks a joint government and is premised on economic convergence and rules-based governance. Its survival depends on the absence of populism” "Centre-ground populists pose the real threat" February 27.

Again,Münchau says not a word about that during the last decades nothing has been as destructive for the Western world of our grandchildren, than those hubris filled populist technocrats who with their risk weighted capital requirements, offer us to deliver stable and safe banks… at no cost. 

A 0% risk weight for the sovereign, in this case “safe” Italian politicians and bureaucrats, and a 100 % risk weight for “risky” Italian SMEs and entrepreneurs, could never have produced anything but anaemic growth, and the dangerous overpopulation of some supposedly very safe havens.

When will FT and all its famous columnists understand that denouncing the regulatory distortion in the allocation of bank credit is vital to our future?

@PerKurowski

The 2007-08 crisis and the relative stagnation thereafter would not have happened without current bank regulations

Sir, Ed Crooks writes “Trump has threatened to “do a number” on Frank-Dodd banking regulations aimed at preventing another financial crisis.” “Populists push to roll back rules” February 22.

Well no! Except for the intent of eliminating overreliance on credit rating agencies, something that has yet to happen, the Dodd-Frank Act did not eliminate those populist bank regulations that caused the last financial crisis, or the relative economic stagnation thereafter.

Some real runaway populism, that happened when hubris filled technocrats thought they could, and at no cost, diminish the risks for the banking system with their risk weighted capital requirements for banks.

What did and does that regulation cause?

That the banks create dangerously large exposures to what is perceived, rated, decreed or concocted as safe, e.g. AAA rated securities and Greece. 

That the banks award too little credit to what can supply dynamism to the real economy, e.g. SMEs and entrepreneurs.

Crooks also writes: “In a 2012 OECD expert paper, David Parker of Cranfield University and Colin Kirkpatrick of the University of Manchester reviewed the state of academic knowledge and concluded that there were large gaps in our understanding of the effects of regulation policy”

I have not read that paper, but I am sure the conclusions must be absolutely correct. For instance, when regulators stress test banks, they do not even care to look at what should perhaps have been on their balance sheets, in order to satisfy the credit needs of the real economy.

It is amazing how the Financial Times insists on keeping all this hushed up.

Does that mean FT agrees with the regulatory statism reflected in assigning to the sovereign a risk weight of 0% while hitting us “We the People”, with 100%?

Does that mean FT finds nothing dumb in assigning a 20% risk weight to the so dangerous AAA rated, while hitting the innocuous below BB- rated with 150%?

Sir, here between you and me, what favours do you owe the bank regulators, or why are you so afraid of them?

PS. The Dodd-Frank Act is so surreal that in its 848 pages it does not even mention the Basel Committee

PS. I dare you to read an Op-Ed I wrote in 1999 about the dangers with regulations

PS. I dare you to read the remarks I gave to bank regulators in 2003 while being an Executive Director of the World Bank.

@PerKurowski

Post-Crash Economics Society: Risk models & credit ratings are not wrong, the credence bank regulators give these is

Sir, since I was travelling I missed David Pilling’s “Crash and learn: should we change the way we teach economics?” October 1.

It discusses the Post-Crash Economics Society that was created by students at Manchester university, mostly in response to “glaring failure of mainstream economics [that failed] to explain, much less foresee, the financial crash of 2008.”

In it Pilling quotes Andrew Haldane, chief economist at the Bank of England: “We all became overly enamoured of a particular framework for thinking, or a modelling approach… It became something of a methodological monoculture [that] was not well equipped for dealing with economies or financial systems close to, or at, breaking point.”

That sounds about right. It was not the models’ faults, but the fault of those using the models.

For instance bank regulators, with mindboggling hubris, and blind faith in the models, using only knowledge, decided that the capital requirements for banks should be based on risk models using ex ante perceived risks. That was dumb. Clearly any regulatory wisdom would have indicated that those capital requirements, should be based on the so much more dangerous consequences to the bank system that could be caused if those risk models or risk perceptions, like credit ratings, turned out to be wrong.

The faster that is understood, the faster we can bridge the differences between those who, like Angus Deaton, though accepting that “economics is a broad church” yet argue that it “needs to be kept rigorous”, and those who, like Joe Earl, want it to be “more an exploration of ideas, and less a training in the economic priesthood.”

Of course, that will require bank regulators to declare much mea-culpa, or in other ways upsetting a lot the cozy relations in their mutual admiration club.

Here a more extensive aide memoire on some of the monstrosities of such regulations.

@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

Niall Ferguson, watch it, the technocrats can be as populists, and as violent, as any other populists can be.

Sir, Niall Ferguson writes: “Politically, most of the world has never been more boring. Instead of the alarms and excursions of the past, we now have technocrats versus populists. Any violence is verbal and the technocrats nearly always win.” “The nasty Greek outcomes that democracy precludes” July 4.

Hold it there! The technocrats can be as populists, and as violent, as any other populists can be. It is hard to visualize the possibility of any Congress or Parliament proposing to favor with regulations bank lending to the government, or to those perceived as “safe”, and thereby create a violent regulatory discrimination against the fair access to bank credit of those perceived as risky, like SMEs and entrepreneurs.

That is what the technocrats of the Basel Committee did with their credit risk-weighted capital requirements for banks. With hubris and populism, they convinced some they could distort credit allocations to the real economy with no downside risks.

@PerKurowski

PS. Europe, remember, between 2004 and 2009, ECB’s technocrat Mario Draghi was OK with banks leveraging more than 60 to 1 lending to Greece.

Basel Committee, Financial Stability Board, you are dangerously devoid of any common sense

Sir, I refer to Lucy Kellaway’s courageous and important “How insecurity and preening kill corporate common sense” January 19.

Kellaway, from a conversation “with a man who used to be one of the most senior bankers in the UK”, deducts: “Complexity mostly destroyed what little common sense there used to be and regulation has outlawed the rest. Try understanding any bank’s annual report. It cannot be done. Even the senior bankers who put the figures together admit as much. Worse still, try to comprehend Solvency II. If there is anyone reading this who fully grasps the fiendish vicissitudes of these new capital requirements for insurers, I’d like to hear from them.”

And I call it “courageous” because with that she actually implies that her colleagues write about nonsense as if it made sense; or that they do not dare to show they do not understand whether it is nonsense or not.

And I call it “important” because truths need to come out, and powerful nonsense manufacturers brought down, if our children and grandchildren are to stand a chance.

Hear us out you the members of the Basel Committee and Financial Stability Board… little is as stupid and dangerous as the current portfolio-invariant-credit-risk-weighted-equity requirements for banks you concocted. Not only do these not make our banks safer but, worse yet, these distort the allocation of credit to the real economy.

Answer us: How risky can borrowers perceived as risky really be for the banking system? Is it no so that what is really risky for the banking system is what is perceived and treated as “absolutely safe”?

I dare you to debate me on that wherever and whenever. If you feel more comfortable with some support, you can even bring along any FT journalist fan of yours you wish… and I will bring along Lucy Kellaway.

In terms of dangerous hubris, Bill Gross is nothing when compared to bank regulators.

Sir, I refer to Gillian Tett’s “Hubris, politics and finance make a toxic mix”, October 4.

She makes many good points and I am sure a Daedalus Trust can play a very important role as a hubris buster…that is as long as it can keep the hubris of its own hubris slayers in check.

But here the center of Ms. Tett’s concerns on excessive hubris is Bill Gross, ex-Pimco, and he is really nothing compared to the hubris that is still rampant among bank regulators. Their mind-boggling hubris caused them to believe they could, with their risk-weighted capital requirements for banks, even act as the risk-managers for the whole banking world.

Ms. Tett reminds us of slaves who walked alongside victorious Roman generals reminding them they were mere mortals. That is exactly the role for a FT, and with its motto FT shows it knows it, but, over the recent years, it has too often instead fed the hubris of some of those most at risk, like for instance "whatever it takes" Mario Draghi… in whom it trusts so so much.

For the last decade I have diligently walked along FT, trying to un-requested perform the role of such a slave. Unfortunately those at FT seem not to be anything like a Roman general wanting to hear the truth.

Ever more complex finance requires denser and duller, bordering on brain-less, hard-headed stubborn bank regulators.

Sir, Tracy Alloway writes “If the institutions which create these [sophisticated financial] products cannot correctly asses their value, then what hope is there for us?”, “Ever more complex finance parts way with economic reality” May 3.

Indeed but it is worse than that… because what hope can we have that our bank regulators understand those products? In 2003, when Basel II was being discussed I told some hundred regulators during a workshop the following: “Let me start by sincerely congratulating everyone for the quality of this seminar. It has been a very formative and stimulating exercise, and we can already begin to see how Basel II is forcing bank regulators to make a real professional quantum leap. As I see it, you will have a lot of homework in the next years, brushing up on your calculus—almost a career change.”

The truth is that regulators did not know what they were doing with simple Basel II and they know of course much less with Basel III, which is about a hundred times more complex and technical.

And this should lead us to the truth of regulations… the more complex the issue is the more dumb must the regulators act, like refusing trying to understand it all, and stubbornly holding to some simple rules of thumb… like 8 percent of shareholder’s equity against any asset.

The role of the regulators is not to control the banks for the perceived ex ante risks, the expected losses, that is the job of the bankers and, if they can’t do that they should not be bankers. The role of the regulator is to safeguard against eventual ex post risks, unexpected losses, and since the unexpected cannot be calculated, they can for instance allow themselves not having any knowledge of calculus.

God save us from the hubris driven intelligent besserwisser spread-sheet equipped regulators trying to outsmart bankers.

If banks had self-regulated, current extreme high bank leverages would never existed. Basel Committee´s regulations enabled these.

Sir, in “Barnier’s revolution”, September 23, you write that “Brussels is right to end self-regulation” in this case of benchmarks, like the Libor. But we should forget that having other selves regulating, does not guarantee by a long shot better results.

For instance, if the banks had been self-regulating, instead of falling in the hands of the Basel Committee the current financial crisis would not have happened. I say this because there is no imaginable way banks would allow each other to hold capital in accordance to ex ante perceived risks, since they would all have been asking each other… “What if those ex ante perceptions, ex post turn out wrong?”

For instance can you imagine European banks with 30 to 50 times to 1 debt equity ratios, if there had not been a regulator who vouching for these enabled it all?

And in the case such as the Libor, I would still believe that self-regulation which explicitly accepts responsibility is still the best way to go. The quotes of Libor which created the scandal were quotes lower than the real Libor, which implied that the interest rates banks could charge their borrowers were lower than what they should be, and so any bank, sufficiently aware now of what shenanigans were going on, would most certainly raise all hell if that was repeated.

And besides, since some regulators did not mind at all low Libor quotes, since these inspired tranquility, one should also be highly suspicious of what other types of selves can be present in non-self-regulation.

God save us from regulator hubris!

Regulators did not trust the market and imposed their own judgments on the banks.

Sir, having Lunch with FT´s Edward Luce, April 6, Michael Sandel, when discussing his book “What Money Can’t Buy: The Moral Limits of Markets” says:“Right at the heart of the market is the idea that if two consenting adults have a deal, there is no need for others to figure out whether they valued that exchange properly. It’s the non-judgmental appeal of market reasoning that I think helped deepen its hold on public life and made it more than just an economic tool; it has elevated it into an unspoken public philosophy of everything”.

"Everything"? sorry, that is not true. Had it been, we would most certainly not be having the current crisis. You see the bank regulators, they did not trust the deals the consenting adult of bankers and borrowers did, and so they imposed their own judgments.

To make sure there was not too much risk-taking going on, they designed capital requirements which allow banks to make a much higher expected risk-adjusted return on equity when doing business with “The Infallible”, than when engaging with “The Risky”.

And of course, under such distorted conditions, banks are overdosing on sovereigns, AAA rated constructions and what else is officially considered safe-haven, and lending too little to “risky” small businesses and entrepreneurs the real forces of the real economy.

Edward Luce most splendidly comments: “There is a thin line between promoting virtue and practicing tyranny.” And I would say that line might be crossed by even trying to define what the virtues should be.

Sir, the arrogance of bank regulators believing they could substitute for the market is just unbelievable. And Sir, excuse me for saying it, but the foolishness of so many, including FT, to believe they can, is just astonishing.

When regulatory madness is just that

Sir, Gillian Tett writes about “When political madness works” October 13, and in it refers to Lord Owen’s neurology paper “Hubris syndrome”, 2009. She also refers to Nassir Ghaemi’s “A first rate madness” which holds that some imbalances like depression, bipolar syndrome and hyperactive manias” could help leaders to better manage crisis. 

Hold it there! Before these imbalances become prerequisites of leadership let me state the following: 

Independently of what imbalances they suffered from, when bank regulators engaged in one of the greatest hubris exercises ever, that of believing themselves to be fully equipped to act as risk managers for the world, they utterly, and totally, failed… and their madness has not served them or us later either. 

Their regulatory discrimination in favor of The Infallible and against The Risky is killing our economies, and there is no way Gillian Tett is going to convince me they are doing us some Winston Churchill good.

And by the way... what about the hubris and or madness of some journalists? Is it good or bad?