Regulators instructed banks to compete with small savers and insurance companies for whatever was perceived as safe.

Sir, Michael Mackenzie writes “the concern that investors will extend their embrace of riskier assets and of private markets that are far less liquid and transparent, in an effort to boost returns over time.” “Contrarians gain confidence amid fog of future predictions” September 7.

Of course, how can it not be? Small savers and insurance companies face huge new competition for what’s perceived as safe as a consequence of regulators, with risk weighted capital requirements, telling banks to stay away from what’s perceived as “risky”, and to maximize their risk adjusted returns on equity with what’s perceived, or decreed, or concocted, as “safe”. 

Out went the savvy loan officers, in came the equity minimizing financial engineers.

So what’s the threat now? A new crisis resulting from excessive exposures to “the safe”, like some 0% risk weighted Eurozone sovereigns deciding it cannot pay back debt that is not denominated in its own printable currency, or regulators waking up to the fact that what is really dangerous to our bank systems is that which bankers might perceive as safe.

Sir, when in 1988 bank regulators assigned America’s public debt a 0.00% risk weight, its debt was about $2.6 trillion, now it is around $22 trillion and still has a 0.00% risk weight. When do you think it should increase to 0.01%? 

http://subprimeregulations.blogspot.com/2019/07/risk-weights-are-to-access-to-credit.html

@PerKurowski

Regulators forced banks into what’s perceived safe, thereby forcing the usually most risk adverse into what’s perceived risky.

Sir, Robin Wigglesworth writes “Many investors such as pension funds and insurers [are] pushed towards the only other option: venturing into the riskier corners of the bond market, such as fragile countries, heavily indebted companies and exotic, financially engineered instruments. These are securities they would normally shun — or at least demand a much higher return to buy.” “Negative yields force investors to snap up riskier debt” August 16.

As an example he mentions “Victoria a UK-based company that issued a €330m five-year bond that drew more than €1bn of orders [because] the relatively high 5.25 per cent yield it offered, helped investors swallow misgivings over its leverage.”

Clearly liquidity injections, like central banks’ huge QEs, has helped to move interest rates much lower everywhere, but, as I see it, much, or perhaps most of what Wigglesworth refers to is the direct consequence of the risk weighted capital requirements for banks.

That regulations allowed banks to leverage much more their capital with what’s perceived (decreed or concocted) as safe, than with what’s perceived as risky, which meant that banks can more easily obtain higher risk adjusted returns on equity with the safe than with the risky… and those incentives were as effective as ordering the banks what to do. That made banks substitute their savvy loan officers, precisely those who would be evaluating and lending to a Victoria, with equity minimizing financial engineers.

As a result the interest rates charged to the safe… little by little forced those who did not posses savvy loan officers to take up the role of banks.

Will it stop there? Not necessarily. Banks, and their regulators, are now slowly waking up to the fact that the margins that the regulation benefited “safes” offer, are not enough for banks to survive as banks. 

But how to get out of that mess will not be easy. Solely as an example, when in 1988 bank regulators assigned America’s public debt a 0.00% risk weight, its debt was about $2.6 trillion, now it is around $22 trillion and still has a 0.00% risk weight. How do you believe markets would react if it increased to 0.01%? 

@PerKurowski

Yes, higher education must be much more of a joint venture, for all involved.

Sir, Sheila Bair is absolutely right that “proceeds from student debts go to colleges, while the risk of repayment falls on borrowers and, if they default, on taxpayers provides little incentive for schools to contain costs [which] provides little incentive for schools to contain costs.” As a solution she refers to “income share agreements” where universities provide some funding and students pay back a small share of their income over some years. “An investment model to put US students through college”, March 15. 

Since in a 2007 Op-Ed I asked whether higher education should not be more of a joint venture, I fully agree with the orientation of these proposals. 

That said I would not leave it solely as a student to college/university level. I believe that professors should also have skin in the game, and so perhaps their retirement plans should include a clear linkage to how their students did.

And why leave it at that? Why not think of securitizing those possible future participations in earnings so as to provide some upfront money to cover expenses? And what about insurance companies investing in these? And what about some students crowdfunding their tuition fees?

Where I do part though from Bair’s opinion, is on the concept that high earning students could/should subsidize the study costs of lower earning professions. That could cause some unexpected distortions, and it is much more a general societal responsibility, which the higher earning - higher tax paying already share.

PS. Sir, over the years I have written several letters to you on this subject... but 😒

@PerKurowski

We are suffering from a well-disguised creative financial statism of monstrous proportions.

Sir, Dan McCrum writes: “it seems so inherently weird for about a third of debt issued by governments in the developed world to be bought and sold at negative yields” “Negative rates reverse assumptions about financial decisions” April 15.

Not weird at all: a) take away all central banks purchases of public debt with QEs, which helped to keep the saving glut intact or even increase it; b) get rid of regulations that assign the lowest risk weights and thereby the lowest capital requirements for banks to the borrowings of the sovereign monarch; c) stop what McRum mentions about “pension funds and insurers [having to] buy safe government debt irrespective of the price; and d) stop central banks from paying negative returns… and you would not see public debt bought and sold at negative rates.

What we are really suffering from is a well-disguised and utterly creative and non-transparent financial statism of montrous proportions.

The cost of all that is partly borne by savers and future pensioneers, but primarily by our children and grandchildren since the real economy will not grow as it could, consequence of all the credit opportunities denied “the risky” SMEs and entrepreneurs

@PerKurowski ©

Britain, get the busybody besserwissers out of your Bank of England… fast!

Sir, I am shocked, and utterly concerned about my very dear Britain’s future. How on earth have you allowed yourself to be trapped by such besserwisser-busybodies hands, as is reflected in Pilita Clark’s by the “Bank of England seeks answers from insurers over climate change” October 28.

Truly mindboggling. If BoE is so concerned about climate change, then why does it not suggest that capital requirements for banks should be based on our planet-earth’s-sustainability ratings, instead of silly, purposeless, credit-risk ratings, those which are already being cleared for by banks with risk premiums and size of exposures?

Higher capital levels for banks need not to make it harder for bankers

Sir, Meredith Whitney writes “Higher capital levels are here to stay. Sure, they make operating a bank a lot less easy than it has been over the past 20 years.”, “US bank bosses must live up to their pay cheques” February 1. 

First, I am not sure that operating a bank has been in anyway easy over the past years, with bankers having to produce the returns on equity that keeps you from being eaten up by the ones on route to too-big-to fail status. And second, I do not think that higher capital requirements will make it harder for the banks, except of course that they will now have to find themselves new shareholders willing to accept lower returns as the price for lower risks. 

Whitney also writes that Banks will have to distinguish themselves through back-to-basics operating results. This will mean a welcome return for the sort of basic analysis by investor they apply to other companies”. She is way too optimistic. While there are regulations that require banks to hold different capital for different assets based on the ex ante perceived risk, it will always be very hard and confusing to analyze banks trying to figure out what will happen, ex-post. 

Can you imagine how it could confuse the life insurance industry if insurance companies were forced to hold more capital when lending to the unhealthy than when lending to the healthy, even after they have cleared for those risk differences by means of the premiums charged and amounts insured?

Banks, please, go get yourselves a new class of shareholders

Sir, John Authers writes that bank returns on equity are projected to fall from around 20 percent to 7 percent, much because of new capital requirements coming up in Basel III, “Bank´s adjustment to the IT threat has barely begun” January 28.

And then he describes and analyzes some suggestion of McKinsey on how banks should confront this change. Strangely enough I do not see this change of return in bank equity viewed from the perspective of a change in its risk profile, or the suggestion of “go get yourselves a new class of shareholders”.

If the 7 percent on equity bank returns are perceived to derive from a much safer operation there is no reason why bank division currently valued at 60 percent of their book value by investors in search of big returns, could not be valued at least at one time book value by pension funds, insurance companies and widows or orphans in search of more stability.

In fact the real economy would probably very much welcome the banks becoming less of the biggest beneficiary of it.