FT, on banking and finance who are you to believe, Francis Fukuyama or Paul Volcker?

Sir, Francis Fukuyama in “The war on liberalism” FT March 5, writes:

“Liberals understand the importance of free markets — but under the influence of economists such as Milton Friedman and the “Chicago School”, the market was worshipped and the state increasingly demonised as the enemy of economic growth and individual freedom. Advanced democracies under the spell of neoliberal ideas trimmed back welfare states and regulation, and advised developing countries to do the same under the “Washington Consensus”. Cuts to social spending and state sectors removed the buffers that protected individuals from market vagaries, leading to big increases in inequality over the past two generations.

While some of this retrenchment was justified, it was carried to extremes and led, for example, to deregulation of US financial markets in the 1980s and 1990s that destabilised them and brought on financial crises such as the subprime meltdown in 2008.”

Paul A. Volcker in his autobiography “Keeping at it” of 2018, penned together with Christine Harper, with respect to the risk weighted bank capital requirements he helped to promote and which were approved in 1988 under the name of Basel I wrote:

“The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages. Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011. The American “overall leverage” approach had a disadvantage as well in the eyes of shareholders and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return US government securities."

Sir, in reference to advising developing countries with the “Washington Consensus”, in November 2004 you kindly published a letter in which I wrote:

“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? 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.”

So, there are two completely different bank systems:

Before 1988, one in which banks needed to hold the same capital against all assets, credit was allocated based on risk adjusted interest rates and the market considering the bank’s portfolio, accurately or not, values its capital.

After 1988, one risk weighted capital requirement banks where credit is allocated based on risk adjusted returns on equity, something which clearly depends on how much regulators have allowed their capital to be leveraged with each asset... clearly favoring government credit, which de facto implies bureaucrats know better what to do with (taxpayers') credit than e.g., small businesses and entrepreneurs. Communism!

Sir, I am of course just small fry, not even a PhD, but, if you have to choose between describing what has happened in the financial markets since 1988 as a “deregulation”, as Fukuyama opines, or an absolute statist and politically influenced misregulation, as Volcker valiantly confesses, who do you believe?

Sir, is this topic taboo… or just a too hot potato for the “Without fear and without favour” Financial Times?

PS. In Steven Solomon’s “The Confidence Game” 1995 we read: “On September 2, 1986, the fine cutlery was laid once again at the Bank of England governor’s official residence at New Change… The occasion was an impromptu visit from Paul Volcker… When the Fed chairman sat down with Governor Robin Leigh-Pemberton and three senior BoE officials, the topic he raised was bank capital…”

@PerKurowski

It’s not the role of regulators and central banks to help governments fund their operations, behind the back of citizens

Sir, Kate Allen writes that “euro-area financial institutions” have reduced their holdings of public debt “17 per cent in the past two years [but] the ECB made nearly €1.5tn of cumulative net purchases of eurozone public sector bonds through its quantitative easing programme — effectively replacing the purchasing role that banks had played. “Post-crisis reforms force European governments to curtail size of debt sales” January 5.

It all forms part of the same statist subsidizing of public debt. 

What would sovereign rates be if banks had to hold the same capital against sovereign debt than against loans to citizens; and if ECB had not purchased “eurozone public sector bonds through its quantitative easing programme”? The answer would have to be rates much higher, which would send quite different risk-free-rate signals.

In 1988, with Basel Accord, statist regulators, with their 0% risk weighted bank capital requirements, began subsidizing immensely government borrowings. When the 2007/08 crisis came along, central banks, perhaps in order to hide own their regulatory failures, with their quantitative easing purchases generated, wittingly or not, new sovereign debt subsidies.

This has dramatically changed the economical relations between governments and private sectors. It amounts to statist hanky-panky behind the backs of citizens. Since besides needing servicing it consumes, for nothing really special, sovereign indebtedness space that could be urgently needed tomorrow, it might become deemed as high treason by future generations. Where this is going to end is anyone’s guess, but it sure won’t be pretty.

@PerKurowski

High interests do not solve any retirement problems, if there is no real economic growth to pay for these

Sir, Jonathan Ford writes of how “The Bank of England’s decision to cut interest rates and resume quantitative easing” is creating all sort of expected deficits in retirement plans, and specifically to “UK’s 6,000 still existing defined benefits schemes” “Real change in attitude is needed to solve the issue of fund deficits” August 22.

Ford also mentions the responsibility of the “existing generation…to strive to provide for the obligations to workers they have inherited”. That is very correct, but the possibilities of it will also very much depend on the health of the real economy.

If there were no low or even negatives interest rates, but only high positive interest rates, in order for these to translate into real positive rates, the interests would, in the medium and long term anyhow, have to be paid by real economic gains.

And that is why, once again, I insist that the most egregious thing that is happening to that future economy on which we all will depend, is the risk aversion that has been introduced into the allocation of bank credit by means of the risk weighted capital requirements for banks.

It is just amazing this is not even being discussed.

@PerKurowski ©

Risk adverse bank regulation, anathema to a “Home of the Brave”, has imposed a curse of slow growth on the US economy

Sir, you write: “With every month that passes, the decision of the Fed’s open market committee (FOMC) to raise interest rates in December looks more like a mistake. The US economy clearly decelerated around the turn of the year” “The curse of slow growth afflicts the US economy” April 30.

That increase you refer to is was from 0.25% to 0.5%. Frankly, no matter what it could have signaled to the markets, to believe such minimum minimorum rate increase plays any major role in the difficulties the US has reigniting its economy without huge fiscal or monetary stimulus, seems, excuse me, quite dumb to me.

Much more importance play the risk weighted capital requirements for banks, which have introduced, in the Home of the Brave, a credit risk aversion that seriously distorts the allocation of bank credit to the real economy.

If you need an aide memoire about how idiotic that regulation concocted by the Basel Committee here is one

@PerKurowski ©

What? “Historic gamble for Yellen as Fed makes quarter-point rise” Has the world gone bananas?

Sir, “a quarter-point increase in the target range for the federal funds rate to 0.25-0.5 percent”… and that is what you title a “Historic gamble for Yellen”? Unbelievable, it sounds like a something taken out of a Bird & Fortune sketch, or a Lilliput vs Blefuscu war.

Sam Fleming writes that the “Move comes amid lacklustre global growth”. Of course, as I have explained to FT in more than 2.000 letters, there is no way to achieve anything different than lackluster global growth, if you allow banks to earn much higher ROEs on assets perceived as safe than on assets perceived as risky. Risk-taking is the oxygen of any forward movement of the economy.

As is banks are mostly refinancing the safer past and safer houses, and staying away from financing the riskier future and job creation.

@PerKurowski ©

Show steel and lower the capital requirements for banks when lending to the risky, or the economy will collapse

Sir I refer to Avinash Persaud’s “Show steel and raise rates or the financial system will fracture” August 25.

Though I do not disagree with what Persaud writes, I would argue that before the rates are increased, we should get rid of the credit risk weighted capital requirements for banks. These artificially lower the interest rates on what is perceived as safe, and artificially increase the relative interest rates paid by those perceived as risky... like SMEs and entrepreneurs.

By getting such distortions out of the way, it would be so much easier for the real economy to adjust to any interest rate adjustment. By leaving these in place, the distortions in bank credit allocation could be dramatically amplified when adjusting the rates.

I hear you: “Kurowski are you crazy? Lowering the capital requirements for banks on risky assets?”

Why not? “Risky” assets present much less risks of unexpected losses than those perceived as absolutely safe… and are not unexpected losses the prime reason for which banks are required to hold equity?

@PerKurowski

Never have so few central bank and regulatory technocrats done so much damage with pseudoscientific mumbo jumbo.

Sir, James Grant writes: “We live in an age of pseudoscience. The central banks’ forecasting models have failed to predict the future. Quantitative easing and zero per cent interest rates — policy centrepieces of the post-2008 era — have failed to restore what we used to call prosperity.” “Magical thinking divorces markets from reality" July 21.

Absolutely, but that pseudoscience has its roots in other even worse mumbo jumbo, namely the Basel Accord’s credit risk weighted capital requirements for banks.

With these requirements silly regulatory experts thought they could make banks safer, by allowing these to leverage more their equity for what is ex ante perceived as safe than for what is perceived as risky… as if those perceptions were not already cleared for by other means.

That distorted the allocation of bank credit to the real economy… and sent banks to build up against very little capital, huge exposures to what is ex-ante perceived as safe, precisely the material of which major bank crises are made of… and stopped the banks from lending to those most in need of bank credit like SMEs and entrepreneurs.

The quantitative easing and the zero interest could even have been somewhat effective, had only Basel’s regulatory distortions been removed. Unfortunately that would have made it necessary to admit what was done wrong, and since it is basically the same little group of members in a mutual admiration club that are responsible for both QEs zero interests and bank regulations, we can’t have that… can we?

History will be clear about that never before have some so few technocrats done so much damage. And history will of course not be kind to those who having been informed about it, like FT, nevertheless decided to keep mum.

@PerKurowski

Interest rates must go up… but that must also be compensated eliminating the distortions of bank regulations.

Sir I refer to Sam Fleming’s “Fed loses ‘patience’ and opens way to first rate rise in a decade” March 19. All the hullaballoo, by so many actors, around the Fed’s intentions, as if it was all up to the Fed to make the economy work, is just mind-blowing. 

I have no doubt interest rates should be increased, considerably, because rates lower than what the authorities are targeting the inflation rate, in your face, isn’t natural, in any financial market.

But, in order for that not to cause excessive recessionary impact, absolutely all the regulatory discrimination against the fair access of “the risky” to bank credit needs to be eliminated.

Please regulators, let the SMEs, the entrepreneurs, the start-ups ride to the rescue of our real economy, before its too late... these "risky" borrowers never ever caused a major bank crisis... as bankers are more than enough scared of their credit risk. 

How? There are different options… here is a link to one I suggested for Europe.

@PerKurowski

Government spending should be based on transparent tax revenues, not on regulatory scheming.

Sir, Lawrence Summers’ admonishes to “Only raise rates when the whites inflation’s eyes are visible”, February 9. Since inflation is such a fuzzy variable, no one can be really sure though about what we are seeing when the whites of its eyes are not visible.

But one thing is for sure; Government’s do not deserve the current low interest rate on their borrowings… that is a hidden tax.

It is urgent we eliminate those risk-weighted equity requirements for banks which translate into a tax on the borrowings of small businesses and entrepreneurs, and a subsidy of the public sector’s. That leads to something much worse than deflation, namely to highly ineffective allocation of bank credit.

It all started when innocent foolish technocrats, or dangerous terrorists, with the Basel Accord, came up with the idea that banks needed to hold much less equity against loans to their governments than to citizens. That translated into requiring banks to hold much less equity against loans to be managed by bureaucrats not subject to such limitations as having to feel the money as theirs, than against loans in the hands of small businesses and entrepreneurs.

That was, de facto, to invite communism to come in through the backdoor. And so, if we need to keep interest rates low in order to stimulate the economy, let those apply to all and not especially to the public sector.

How do you price bank credit for sustainable growth having to consider both risk profiles and capital requirements?

Sir, Axel Merk writes “sustainable growth comes from pricing credit correctly according to the risk profile of the borrowers, not merely cheap credit”, “The missing fear factor will return to haunt Yellen”, July 10.

Absolutely… but how do banks do that when they also must price credit according to the capital requirements ordained by the regulators for different borrowers? Impossible!

And Merk also refers to that “Forward-looking indicators, such as the yield curve, are less reliable as the Fed itself has actively managed those gauges”. Yes and here also by means of the risk-weighted capital requirements for banks, which being the smallest or even zero for “infallible” sovereign debts, has helped to convert treasury bills and bonds into a proxy of a subsidized risk-free rate.

We must indeed fret the possibility of some fundamental lack of character at the Federal Reserve

Sir, Henny Sender makes a well argued call in “The Federal Reserve must not linger too long on QE exit” July 5; concluding with opining that “The Fed wants to have its cake and eat it too”, and asking “Might it be that the Fed has everything in reverse?" It is truly scary stuff! 

On August 23, 2006, you published a letter I sent titled “Long-term benefits of a hard landing”. Therein I wrote:

“Sir, While you correctly argue (“Hard edge of a soft landing for housing”, August 19,) that “even if gradual, a global housing slowdown would be painful” you do not really dare to put forward the hard truth that the gradualism of it all could create the most accumulated pain.

Why not try to go for a big immediate adjustment and get it over with? Yes, a collapse would ensue and we have to help the sufferer, but the morning after perhaps we could all breathe more easily and perhaps all those who, in the current housing boom could not afford to jump on the bandwagon, would then be able to do so, and take us on a new ride, towards a new housing boom in a couple of decades.

This is what the circle of life is all about and all the recent dabbling in topics such as debt sustainability just ignores the value of pruning or even, when urgently needed, of a timely amputation.”

And now Sir, soon eight years later, we can only observe how the Federal Reserve, even when facing clear evidence all what their liquidity injections and low rates have achieved is increasing or maintaining value of existent assets, and little or nothing has it done for the creation of any new real economy… are unwilling to cut the losses short, and keep placing more and more bets on the table… with our money!

Sincerely, no matter how we look at the Greenspan-Bernanke and incipient Yellen era at the Fed, we have reasons to fret the existence of some fundamental lack of character.

PS. Of course, when it comes to banks, the regulators have already evidenced plenty lack of character with their phobia against “the risky”. And so now they also have our banks placing ever larger bets on what is “safe”, blithely ignoring that in roulette, as in so many other aspects of life, you can equally lose by playing it too safe.

As is, €400bn of cheap ECB Mario Draghi loans would only end up financing “infallible sovereigns”, not small businesses.

Sir, I refer to Claire Jones reporting and You and other opining about the announcements by Mario Draghi on lower ECB interest rates and of “up to €400bn of cheap loans for eurozone banks in an attempt to boost lending to the regions credit-starved small businesses”, June 6.

Again, for the umpteenth time, it is not money to lend European banks lack, it is capital… as in shareholders’ equity… since these are severely undercapitalized as a result of regulators like Mario Draghi, against all empirical evidence of what causes bank crises, having allowed them to hold almost no capital at all, when lending to the housing sector, to “infallible” sovereigns like Greece or investing in securities rated AAA.

And because of that the banks do now not have the shareholder’s capital required to lend to “the risky” small businesses, especially since regulators like Mario Draghi, again against all empirical evidence of what does not cause bank crises, decided banks need to hold much more capital when lending to these. And Sir, we do not need a ECB’s Asset Quality Review to know that!

And so to ignite lending to small businesses and other “risky”, so that the unemployed European youth is not doomed to become a lost generation, and so that all €400bn of cheap loans do not end up as more easy money for “the infallible”, requires getting rid of the bottleneck that the risk weighted capital requirements signify.

The problem with that though is that this requires a mea culpa from high fliers like Mario Draghi (Ex-FSB), Mark Carney (FSB) Stefan Ingves (BCBS) and others (perhaps of you too Sir) … something which is not likely to happen… since they clearly still believe they are the masters of the universe.

“Little people”, do not listen to Chris Giles, if they finance you at a too high rate, try to keep your consumption low

Sir, Chris Giles writes “It is also deeply patronizing for those with reasonable comfortable incomes to fret that the little people are consuming too much for their good and for that of the wider economy”, “In economics consumption is for life not just for Christmas” December 19.

That might be easy for him to say, he who probably either pays off in cash his credit cards or has the benefit of a reasonable financing rate. If Mr. Giles simply looked at what the “little people” paid in finance costs for their financed consumption, he might think differently.

One of the problems is that much of what the “little people” could spend in consumption, for their good and for that of the wider economy”, goes to pay bonuses to bankers… would Chris Giles by any chance be a banker or a shareholder of a credit company?

And what about the “pension mugging” produced by low interest rates produced by monetary policy?

Sir you write that Britain must make sure that the conversion of lifetime saving into decent retirement incomes is performed with total honesty, “Act now to prevent pension mugging” December 13.

But the number one factor which determines the amount of the annuity, at the moment of conversion, is the interest rate that insurance companies can earn long term on the “lifetime savings” received. And so now, when monetary policy is officially manipulated, so as for interest rates to be artificially low, especially the long side, the question is who is going to be responsible to the retired for the low annuities they receive?

How would you to explain to a retiree who converts into an annuity today if his neighbor, converting the same amount at a future time, receives a much higher annuity?

The “convenient myth” which supports current bank regulations, needs to be debunked.

Sir, Tom Braithwaite and Patrick Jenkins, in their analysis “Balance sheet battle”, August 15, refer to bank executives and some [regulatory] officials holding that “not using risk-weights when calculating capital requirements for banks can tempt banks to move towards riskier loans that earn higher returns but are more likely to result in losses.” 

Baloney! That so “convenient” for some banks myth, needs urgently to be debunked.

And for that we need first to understand that any “perceived risk” can be cleared for by bankers by the interest rate they apply, the size of the exposure and other contracting terms. 

And so the truth is that lower capital requirements, permitted for something perceived as “absolutely safe”, and which allows the banks to achieve a higher expected risk-adjusted return on equity on those assets, will only help to push the banks to create excessive exposures, while holding very little capital, to precisely that type of exposures which have caused all the bank crises in history, namely assets which were ex-ante perceived as safe but that ex-post turned out to be risk. And, if in doubt, just try to find one single major bank crisis that has resulted from excessive exposures to what was ex-ante, not ex-post, perceived as risky.

The different capital requirements based on perceived risk which so much favors the access to bank credit of The Infallible and thereby discriminates against The Risky, also completely distorts the allocation of bank credit in the real economy. What would for instance a regulator, in the US or in Europe, answer if asked: Sir, why are the capital requirements for our banks lower when they lend to a foreign sovereign, than when they lend to our national small business and entrepreneurs, those who have never ever set off a major bank crisis?

Central bankers, more than setting targets and aiming, should make sure their objectives can be reached.

Sir Samuel Brittan wishes for the Bank of England to state their objective rate for nominal gross domestic product under which they will keep interest rates low, “The real target that Carney should be aiming for” July12.

That is all fine, if low interest rates were all it took to achieve that objective, but is it not! 

As is, with banks instructed by regulators to extract profits from the past, by lending to “The Infallible” against very little capital; and not lending to the future, “The Risky”, by means of requiring banks to then hold much more capital, the real economy will not be able to achieve non-inflationary growth, unless, miraculously, bureaucrats get all other incentives absolutely right.

Getting rid of these immoral and stupid risk-adverse regulations that is what Carney and his colleagues should be doing, but, admitting they were so wrong, might be requiring too much humility of these besserwisser bureaucrats.

Bank should be ashamed feeling “bruised” by new capital ratios. Really bruised, still, are those borrowers perceived as “risky”.

Sir, Patrick Jenkins’ reports “Banks feeling bruised by new capital requirements” July 5.

Indeed banks may need to raise more capital, which will lead to reduced returns on equity, but they really have nothing to complain about, since never ever have banks been able to work with as little capital as they have been able to do during the last decade… as a result of the senseless risk weighting of their capital requirements.

If only bankers would ask themselves how much capital they would need, if they had to operate in a free market without regulations and without implicit guarantees, they would have to shut up and just count their blessings.

No, the really bruised ones, by old and new capital ratios, Basel II and III, are the small and medium businesses and entrepreneurs. Since they are unjustly perceived as “The Risky”, unjustly because they have never ever caused a bank crisis, banks are required to hold more capital when lending to them than when lending to “The Infallible”. And, as a direct consequence of that, they not only have less access to bank credit but must also pay higher comparative interest rates, than what would have been the case in the absence of regulations which discriminate against them.

So now Mario Draghi and Mark Carney want the huge tax on savings to be kept for a longer period

Sir, Michael Steen and Chris Giles, referring to declarations by Mario Draghi and Mark Carney, report that “Central Banks send clear signal on low interest rates” July 5.

So now these two gentlemen have publicly announced they think on behalf of the European Central Bank and the Bank of England respectively that the huge de-facto tax which low interest rates impose on savings signify, should be extended.

If only this tax could help, but, having with capital requirements based on perceived risk corked up the channels for bank credit to “The Risky”, like to small and medium businesses and entrepreneurs, it will not serve any useful purpose.

And did not Mario Draghi recently say “it is important to acknowledge that there are limits to what monetary policy can achieve”?

And now all us who worry that, as a consequence, the officially perceived safe-havens, “The Infallible”, will as a result become dangerously overpopulated, must take refuge in assets of almost any kind.

If the cost of a shirt goes up that is inflation and that is bad, while, if the price of assets, like a house or the P/E ratio of a stock, goes up, that is not inflation and that is held to be good. Sounds strange, eh?

Distortion is not free, current low public interest rates are an illusion and could be the highest real rates ever

Sir, during the two years I had the fortune to have a voice as an Executive Director at the World Bank, 2002-2004, there were a lot of discussions on the issue of debt sustainability for poor developing countries. I hated those. They always sounded like a torturer calculating how much he could go on before his victim fainted. No doubt much of the ongoing, and I would have to say much less civilized debate between the austerians and the profligarians, reminds me of that.

And I also remember when some years ago some environmental austerians fouled up some research, which was immediately interpreted as a great go ahead by the environmental profligarians.

I do pity Kenneth Rogoff and Carmen Reinhart, for probably having been too interpreted by vested interests, hand having to end up in the eye of the current storm on debt. They do a good job of fixing their positions in “Austerity is not the only answer to a debt problem” May 2. Of course it is not a question of either or… and it is not even necessary for them to call on Keynes to testify in their defense.

That said, what they entirely miss, probably because it has never been an area of research or concern to them, is how current bank regulations, which so immensely favor sovereign borrowings, leads to the illusion of low rates.

Just one example: Banks in Europe lending to Germany do not need to hold any capital, something which implies an authorized infinite leverage of their equity. But, if they lend to a German small or medium business or entrepreneur, then they need to hold 8 percent in capital and can only leverage the risk-adjusted returns of that loan on their equity 12.5 times to 1. 

Anyone who does not understand that translates into a direct subsidy of Germany´s borrowing rate, paid by taxing the more “risky” and the real economy losing out of opportunities, has little idea about how banking and capitalism work. 

If some real game changing opportunities are thereby lost by Germany, it could in fact currently, and quiet unwittingly, be paying they highest interest rates ever on their public borrowings.

Interest rate spreads should not be analyzed in absolute but in relative terms.

Sir, you know that I hold that regulators with their capital requirements for banks, manipulated the relative risk-adjusted return on bank equity to be much higher for what was officially perceived as absolutely safe, than for what was perceived as risky. That, pushing the banks to hold excessive exposures to some of “The infallible” that later turned out to be fallible, and against holding minuscule capital, was the prime cause for the crisis. That, reducing the incentives for the banks to lend to “The Risky”, those actors who on the margin are the most important for the real economy, is hindering the recovery.

And so of course I am amazed to see one of your star writers, Martin Wolf, writing “A perilous journey to full recovery” January 30, without even touching base on this issue.

But, that said, what I wanted to comment on today is the ease with which so many, like Wolf, use the concept of interest spreads between “yields on sovereign bonds of vulnerable eurozone sovereigns and those on German Bunds” to point in some direction, without adjusting for changes in the base rate. For instance is a 2 percent spread when the base rate is 3 percent, higher than a 1 percent spread when the base rate is 1 percent? As I see it, not really, in the first case there is a 66 percent difference, in the second 100 percent. Interest rate spreads, as most in life, is quite often not something absolute but something relative.