Central banks seem not able to tell their magic porridge pot to stop

Sir, Robert Armstrong, Oliver Ralph, and Eric Platt make a reference to the fairy tale of the magic porridge pot writing “Every working day, $100m rolls into Berkshire — cash from its subsidiaries, dividends from its shares, interest from its treasuries. Something must be done with it all. The porridge is starting to overrun the house.” “‘I have more fun than any 88-year-old in the world’” Life&Arts, April 27.

And the magic porridge pot fairy tale ends this way on Wikipedia: “At last when only one single house remained, the child came home and just said, "Stop, little pot," and it stopped and gave up cooking, and whosoever wished to return to the town had to eat their way back”

Sir, the excessive stimuli injected by means of QEs, fiscal deficits, ultra low interest rates and incestuous debt credit relations, like the 0% risk weighting of the sovereign that provides credit subsidies to who provides banks with deposit guarantees, or loans to houses increasing the price of houses allowing still more loans to houses, against very little capital… all of that is the porridge of our time.

And it’s clear central bankers everywhere, have no idea of how to tell their pot to stop.

Will we be able to eat our way back? Not without sweating it out a lot at the gym. You see too much porridge, meaning too much carbs, and too little proteins, meaning too little risk taking, produces an obese not muscular economy. 

@PerKurowski

How many Greece will it take before the bank-sovereign doom loop is really discussed and then dismantled?

Sir, Isabel Schnabel, a member of the German Council of Economic Experts writes about a “contentious issue: the regulation of banks’ sovereign exposures. Currently, this benefits from regulatory privileges, being exempt from capital requirements and large exposure limits. The result is high volumes of sovereign debt on banks’ balance sheets, with a strong bias towards domestic bonds… it is up to the European Commission to shift this important issue to the top of the agenda”, “How to break the bank-sovereign doom loop”, August 29.

About time! It is now thirty years since regulators, with the Basel Accord, Basel I, introduced risk weighted capital requirements for banks; and thereto assigned risk weights of 0% to sovereigns and 100% to citizens, and so gave birth to the bank-sovereign doom loop.

It was European Authorities who assigned a 0% risk weight to Greece and thereby doomed it to its current tragedy.

If there is something the EC firsts need to come clear with, is how that happened.

When I first heard rumors about that regulatory statism, around 1997, I just did not believe it… I mean did not the Berlin wall fall in 1989? 

In a letter published by FT in November 2004, soon 14 years ago, I wrote: “We wonder how many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.” And of course that applies to developed nations too.

Why has this issue never really been discussed? How come the world has allowed itself to be painted into a corner with sovereign risk-weights it dares not change scared of that would on its own set off a crisis? Why did Greece have to pay for a EU mistake? Is that a way to treat a union member? And thousands of questions more.

Sir, how do we stop this "I guarantee you and you lend to me (against no capital)” incestuous relationship between sovereigns and banks?

@PerKurowski

Feeble regulatory minds, seeing risks in what’s perceived risky, doom our banks to die trapped in the last safe-haven

Sir, Robin Wigglesworth quotes Paul Singer of Elliott Management with: “Given groupthink and the determination of policymakers to do ‘whatever it takes’ to prevent the next market ‘crash’, the low-volatility levitation magic act of stocks and bonds will exist until it does not. And then all hell will break loose” “Calm waters raise fears of a leverage comeback” June 7.

Indeed, only an intellectual degenerating incestuous groupthink can explain current bank regulators fixation with what is perceived risky. Their risk weighted capital requirements are based on the perceptions of risk being correct, while as all logic screams for, these should be based on the possibilities of these perceptions being incorrect. The riskier something is perceived, the safer it is; and the safer something is perceived, the more dangerous it can become. “May God defend me from my friends, I can defend myself from my enemies”, Voltaire dixit.

Those regulations, by favoring so much what is perceived, (concocted) or decreed as safe, like assigning a 0% risk weight to sovereigns, cause sovereigns to be getting too much credit on too easy terms; and that banks could end up holding only sovereigns on their balance sheets. When that happens who is going to be able to kick the can forward to another safe-haven (gold?), sovereigns or their central bank agents?

Sir, our whole banking system is set on a path that with signs of “follow this safe route”, leads directly to a precipice.

You insist in keeping mum about that. There will come a day you, or at least your children, will deeply regret that.

When will regulators stop feeding us fake tranquilizers?

“Risk weighting” So we are to suppose risks have been duly considered?

“Living wills” So we are supposed to think that trustees are capable to enforce these?

“Stress tests” Tests that ignore the stress to the real economy because of what should be on bank’s balance sheets but is not, like “risky” loans to SMEs?

Dodd-Frank’s “Orderly Liquidation Authority” “Orderly”? No Sir, when the last safe haven runs out of oxygen, I assure you it is going to be anything but orderly… then all hell will really break loose.

Per Kurowski

@PerKurowski

For credit we now might need shadow-banks. For intellectual capital free from network incest, do we need shadow-universities?

Sir, Martin Wolf writes: “In its origins and still today, a university is a special institution: a community of teachers and scholars. Its purpose is to generate and impart understanding, from generation to generation. The university is a glory of our civilization.” “Running a university is not like selling baked beans”, February 19

Indeed but from this perspective does it really follow that “Four of the 10 top-rated universities in the world, five of the top 20 and 10 of the top 50 are British” makes UK a “superpower” in higher education? Could not the truth be that in much all universities everywhere are failing and need to be rethought?

For instance, how much of our universities is being used not to promote understanding but to self-promote those who understand? Current research clearly seems to suffer from cronyism: “I Reference You and You Reference Me”? And, excessive cross-referencing within small mutual admiration networks cannot produce much good.

Also, what university in the UK, or anywhere else for that matter, have really debated something so fundamentally important as bank regulations that could be fatally distorting the allocation of bank credit to the real economy? And where is the university that has questioned the whole (nutty) concept of a zero risk weight for the sovereign and a 100 percent risk weight for the private sector?

The Department for Business, Innovation and Skills, in a discussion document titled “Fulfilling our Potential”, presents the idea to “open up the [university] sector to greater competition from new high-quality providers”. And Martin Wolf expresses some well-founded concerns about that.

Banks are currently, because of regulatory risk-aversion, kept away from fulfilling adequately their most fundamental role in the economy. In this respect I have often said that our next generations might find among some shadow-banks their best chance to finance the risky future.

And so, in the same vein, who knows if not our best chances “to generate and impart understanding, from generation to generation” could be found among some new formal university competitors, or even among some shadow-universities?

@PerKurowski ©

At long last, the truth about the incestuous relation between banks and sovereigns, is coming out of the closet

Sir, at last someone in the highest spheres, Jens Weidmann, the president of the Deutsche Bundesbank, speaks out. In “Stop encouraging banks to load up on state debt” October 1, he dares to admit that the banks’ “Sovereign exposures are privileged by low or zero capital requirements”

What Weidmann now denounces is that viciously incestuous relation I have denounced for more than a decade and which can be described in terms of: “I government allow you banker to lend to me without capital, and I in my turn will guarantee your obligations to the market” 

And as Weidman daringly admits: “This undermines market discipline for governments and reduces their incentive to carry out the necessary reforms” and “banks, which can obtain unlimited cash against sovereign collateral from the central banks, are protected from discipline from investors who provide the funding.”

In this respect let me remind you of my letter to you, published on November 18, 2004, and which said:

“Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector (sovereigns)? In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits. Please, help us get some diversity of thinking to Basel urgently; at the moment it is just a mutual admiration club of firefighters”

As an Executive Director at the World Bank 2002-04, I also protested loudly against privileging the sovereign, but to no avail.

Over many years I have not seen anyone in the Financial Times even mentioning the issue of how privileging so much the sovereign, and others like the AAAristocracy, completely distorts the allocation of bank credit to the real economy. I must say that speaks quite badly about your journalists, unless of course you want to excuse them by having to push a political agenda.

So will some of them now, again, bash Jens Weidman’s rational arguments for being excessively austere?

Of course, Mr. Weidman seems to just recently be waking up to the problem, and is not yet totally clear about it. For instance when he states “No market participant would judge a French bond to be as risky as the Greek one: the riskiness of each is reflected in their prices” he is probably not aware that he is with that really explaining why the whole idea of setting capital requirements for banks, based on an ex ante perceived risks, as Basel regulations does, is so utterly dumb, and only dooms banks to overdose on perceived risk.

PS. Here is how the EU made Greece pay for EU's insane mistake of assigning Greece a 0% risk weight.

PS. Here is my letter to the Financial Stability Board (FSB) that was officially received. Will it be answered?

Sheer regulatory lunacy!

Sir Anousha Sakoui in “S&P in rating threat to covered bonds” December 16, writes that these bank issued will be rated among other based on “the likelihood of government support”. Given that governments appoint financial regulators who now use the credit risk ratings issued by the credit rating agencies to decide how much equity banks need to have, presumably so that the banks won´t fail and the governments will not have to bail them out, it is absolutely crazy that the credit rating agencies when rating the risk also measure the government´s willingness to bail out the bank. Is this dangerous and incestuous circle of opinions not sheer lunacy?

We need to diversify our portfolio of regulators.

Sir Walter Maatli and Ngaire Wood in “Who watches the watchdog?” November 24, and in reference to our current financial regulators say that “The Basel Committee is dominated by central banks. They do not represent the broad range of interests likely to be affected by bank failure. They are not politically accountable… many have a culture of discretion and secrecy, rather than of transparency and openness to public scrutiny.” This is indeed a source of problems. We cannot afford to have the regulations of our financial systems correlated exclusively to the risk-adverse brainwaves of one special brand of regulators.

But, when they suggest the use of the Financial Stability Forum (FSF) as the check-and-balance for the regulators I must alert that just widening its country representation could perhaps not suffice, since the sole fact that new members could come from different geographical areas does not guarantee any less correlation. Often the new are completely correlated with the old by means of having gone to exactly the same courses with exactly the same professors using exactly the same financial models and that rely on exactly the same financial data.

Worse than the admiration of the golden calf is the mutual admiration between the golden calves.

Sir David Bodanis in “How we were all blinded by the golden calf”, September 19, says “Raise an institution such as the unfettered financial world to the role of an idol and you are not critical of anything it does.” He is right though I would have to add that even more blinding than that is the mutual admiration between the golden calves.

Suffice to look at how all our financial regulators belong to the same club, with all the members having exactly the same set of mind and priorities in life namely “whatever… except for a bank-default, on my watch”; and where even those who are supposed to provide regulators with oversight overwhelmingly belong to the same club.

How is a club of mutual admiration born? One way is to create a debate forum reserved for “the world’s most influential economists” and then make sure that you never analyze why the members of the group did not help to influence in averting disasters like the current financial crisis.

Incest and irony

Sir, by reading your “CPDOs add more complexity”, March 30, that states “The rating agencies are key to creating the [financial] products” and that “The “agency is working with numerous banks on various deals”, one must realize how the rating agencies have in fact themselves become more and more a part of the same product they are rating. This does present the potential for some very incestuous relations and given that so much of the decision power about where the financial flows in the world should go has been (stupidly and arrogantly) deposited in the hands of very few credit rating agencies, this is without any doubt something extremely dangerous.

Now also, while observing the ever growing financial complexities, one cannot but reflect on how ironic it is that the whole financial world is currently holding its breath, just because some extremely primary and basic mortgage lending seemingly went haywire. Could it be time to ask all those experts that work so diligently in their financial laboratories, to take a short respite, and walk around in the real world for a while?