Compared to regulators’ manipulation of bank credit, Libor manipulation is as peanuts as peanuts come

Sir, I refer to Katie Martin’s “Scrapping of Libor benchmark leaves $500bn of bond contracts in limbo”, October 11.

I repeat what I’ve written you many times before.

I’ve been on both sides of Libor, as a lender and as a borrower. I have never thought it a precise instrument, but good enough, sometimes you lose, sometimes you win, especially when any implied manipulation is done by speculators who are indifferent to whether Libor is too high or too low. What matters to them is their position in Libor futures, at any time. 

In the long run, for all other Libor dependent, its manipulation ends up in a big wash.

The big hullaballoo around it, and forced search for substitutes, are just a big distraction from the real dangerous manipulations. 

Current credit-risk weighted capital requirements for banks pushes credit towards dangerous excessive exposures to the safer present, and away from what is required by the riskier future. Sir, for both borrowers and lenders, that is an extremely costly manipulation. As less capital allows for larger bonuses, only bankers win.

PS. Here is the current summary of why I know the risk weighted capital requirements for banks, is utter dangerous nonsense.

@PerKurowski

The access to bank credit manipulation costs us infinitely more than Libor and all other manipulations put together

Sir, Michael Skapinker, referencing a traders working conditions, gives a well reasoned and heartfelt explanation of why he feels sorry for at least one of those recently found responsible for manipulating the Libor rate. I sure hope it will be read before any sentencing, “The Libor trial and how to deal with a bullying, dishonest boss” July 7.

But let me add to that the following:

I am absolutely convinced that the risk weighted capital requirements for banks, introduced by the Basel Committee in 1988 signifies an outright manipulation of the access to bank credit. By favoring what is perceived, decreed or concocted as safe, like sovereigns, the AAArisktocracy and residential housing, these sectors have received way too much bank credit on way too easy terms. And, as a consequence, those perceived as risky, like SMEs and entrepreneurs, those upon much of the future economic growth and job creation depends, have received way too little credit, in way too harsh relative terms.

If we add the costs of having dangerously overpopulated safe havens like AAA rated securities and Greece, and around the world hindered millions of small loans to be given to those who most needed it, the costs of this distortion for the society are mind-blowing. These exceed thousand fold whatever damages might have been produced by all other recent manipulations put together.

And what has happened to the bank credit access manipulators? Absolutely nothing, in many ways they have even been promoted.

And what has happened to whistle blowers like me. Not much, except for having to suffer seeing my arguments ignored, while being sure this will affect negatively the future of my own constituency, my children and grandchildren; as well as the future of those of the baby-boomer generation about to retire.

The costs of a Libor manipulation, winners and losers, these net out.

The costs of distorting the access to bank credit do, medium and long term, only produce losers, and so they are boundless.

And even though all that access or bank credit manipulation implies absolutely no criminal act, I believe it was done unwittingly and with only good intentions, and only pure innocent stupidity prevailed, it sure help to put all other manipulations in a different perspective. 

@PerKurowski ©

No casino roulette game would survive a Basel Committee kind of manipulation of the winnings of different bets

Sir, Adam Kucharski writes: “When math students at MIT discovered a lottery loophole in 2005, they formed a company — By the time the lottery was discontinued, they had… brought in a pre-tax profit of $3.5m.” “Investment and betting require similar skills — and luck” May 6.

The expected payout for every bet in roulette is exactly the same, and that’s why roulette has not been discontinued. So how long would Kucharski expect roulette to last if some regulators decided to multiply by some factor the winnings on the low paying “safe” bets, so that player could play for a longer time? Not long eh?

But that is exactly what bank regulators did when they allowed banks to leverage their equity more with what was perceived, decreed or concocted as safe, like when playing a color, than with what was viewed as risky, like when playing a number.

And so when Kucharski writes: “The boundaries between luck and skill, and gambling and investment, are not defined by industry or activity, but rather by the person playing, and who they are playing against”, we need to add, “and by the regulators”… especially if the regulators with hubris think they can distort for the better.

Unfortunately the bets of the banks are much more important than the bets in a casino. A bank, when it does not play a “risky” number, is in effect not giving loans to risky SMEs and entrepreneurs, those who might find the way of helping us to move forward the economy, so as it does not to stall and fall. And the banks, when they play too much the safe bets, AAA ratings, housing finance and sovereigns like Greece, then they will dangerously overpopulate safe havens, and cause crisis like the 2007-08 crash.

PS. Sports? What would be of golf if the handicap commission awarded the great players more strokes than what the lousy ones like me got?

PS. Sports? What would be of horseracing if the handicap commission reduced the weight the fast running horses had to carry, as a reward, and increased that of the slower horses, in punishment.

@PerKurowski ©

The crash was not caused by casino capitalism but by bank regulators who manipulated the odds at the casino

Sir, Simon Schama writes of “a crash engineered by the worst excesses of casino capitalism”, “New revolutionaries generate much heat but little action” April 23.

That “casino” reference is so utterly wrong!

In roulette, absolutely all bets have the exact same expected value, and if not so, there would be no casinos in which to play roulette.

In the same way all bank credits used to have the same expected risk adjusted return. That is, before regulators came up with the risk-weighted capital requirements for banks. By allowing banks to leverage their equity more with what was perceived, decreed or concocted as safe, than with what was perceived as risky, suddenly banks made higher expected risk adjusted profits with The Safe than with The Risky.

It was that manipulation of the odds, which promoted the “safe” like AAA rated securities, sovereigns like Greece and mortgages, that caused the crisis 2007-08.

And it is that manipulation of the odds, which hinders the access to bank credit of the risky like SMEs and entrepreneurs that blocks the road for an effective recovery.

All other manipulations like that of Libor put together have not caused even a fraction of the damages the full of hubris and besserwisser manipulating regulators have caused.

@PerKurowski ©

The Banking Standards Board should also require bank regulators to uphold higher ethical standards

Sir, Patrick Jenkins’ discusses what the Banking Standards Board can do influencing the ethics of banks. “Banks gain help on the scandal-strewn road to better behaviour” March 8.

If I were the BSB then, in the case of the fatidical mis-sold mortgage-backed securities, I would come out swinging against the regulators stating:

How on earth did you allow us banks to buy AAA to AA rated securities against only 1.6 percent in capital, meaning we could leverage our bank equity 62.5 times to 1 with that kind of paper? Don’t you know there are very few human bankers able to resist such temptation because, if they did, they would find other banks earning much higher expected risk adjusted returns on equity, leaving them as the dumb kids of the block, or as those who refused to dance while the music was playing?

And now, should those who created the temptations, the devils in the play, be able to go free, while we who fell for the temptations, the weak in flesh, shall bear all guilt? No! That’s not acceptable!

And, if I were accused of the manipulation of Libor, I would at least declare in my defense that such manipulation was really quite harmless when compared to the regulators’ manipulation of the allocation of bank credit to the real economy. That manipulation, which regulators committed with their risk weighted capital requirements for banks, was and is also something completely unethical.

@PerKurowski ©

Who is to investigate how bank regulators manipulated markets in favor of US Treasury and similar sovereign debts?

In 1988, with the Basel Accord, bank regulators of the G20 countries decided that while the private sector should have a 100 percent risk weighing, their sovereigns, those represented by their bosses, the governments, were so safe so as to validate a zero percent risk weight.

That meant of course that, from that moment on, sovereigns have preferential access to bank credit… something that is of course paid by all those who do not count such preferential treatment.

Since de facto that also means regulators acted as if government bureaucrats could use bank credit more efficiently than the private sector, something that unless we are runaway statists or communists we know is absolutely false, the resulting distortion is also paid by future generations of unemployed.

And so, when compared to that manipulation, all the “potential manipulation of the US Treasury markets” referred to by Gina Chon and Martin Arnold” in “Probe into US Treasury markets” of September 10, is, excuse me, something like what is vulgarly known as chicken shit.

@PerKurowski

“The time it takes to react to a 'misdemeanor', will be in inverse proportion to its seriousness" Parkinson dixit

Sir, Matthew Vincent writes of the much speedier reactions to small time misbehaviors, like catching a ride on the corporate jet, compared to much more egregious behavior, like the manipulation of the Libor “Lessons from the Swedes on accountability" August 15.

It reminds us of Parkinson’s law that states: “The time spent on any item of the agenda will be in inverse proportion to the sum [of money] involved."

Look for instance at how fast the case against the Libor manipulators proceeded when compared to the immensely larger and more serious case with bank regulations. By means of risk weighted capital requirements, the regulators manipulated the allocation of bank credit on a global scale… and the experts have not yet given signs they have even detected their misbehavior… not even in Sweden, whose Stefan Ingves currently chairs the Basel Committee for Banking Supervision.

PS. 

http://subprimeregulations.blogspot.com/2014/02/mr-stefan-ingves-i-do-seriously.html

http://subprimeregulations.blogspot.com/2015/02/en-fraga-till-herr-stefan-ingves-som.html

@PerKurowski

Nobel prizes should be recalled if wrongly exploited & tenure of most professors of finance revoked for incompetence.

Sir, I refer to Tim Harford “Down with mathiness!” June 6.

ONE: Harford writes: Paul Romer holds “I point to specific papers that deserve careful scrutiny because I think they provide objective, verifiable evidence that the authors are not committed to the norms of science.” and suggests: “that Nobel prize winners should be ejected from academic discussion because of their intellectual bad faith.”

If Romer is right about the first he is obviously right about the second. But I would like to take it even further than that. The Nobel prize is often exploited to the tilt by some of its winners to further opinions that bear no relation to the specific achievement for which they won it. That could also qualify as intellectual bad faith. They got the prize, they got the money, but they did not get the right to sell other nonsense as of Nobel prize quality to innocent bystanders. If the winners do not make clear when they simply opine like any other professional, their Nobel prize should be recalled, for the good of society.

TWO: By allowing banks to hold different percentages of capital against different assets depending on their ex ante perceived credit risk, and therefore allowing banks to be able to obtain higher risk adjusted returns on equity with some assets than with others; the regulators completely distorted the allocation of bank credit to the real economy. And that clearly is not a minor thing… that can bring down an economy and a society.

And the explanation the regulators give for what they did can be found in a mumbo-jumbo document where some monstrous mistakes can be identified, even though these hide behind what would be too much mathiness for any layman. As far as I know, tenured financial professors have not questioned it… and that alone should be reason enough to revoke their status.

Think of it this way. Suppose those who fabricate compasses did not like that ships where navigating western waters and decided to introduce some weights which tilted the directions more in favor of ships going to eastern waters. What would happen if teachers in seamanship did not even refer to this distortive compass manipulation when educating the captains to be licensed? Should those teachers not have their own license revoked?

@PerKurowski

Martin Wolf, besides our bankers, do we not have to trust our bank regulators too? I sure don’t.

Sir, Martin Wolf writes: “morality matters. As Prof Luigi Zingales argues, if those who go into finance are encouraged to believe they are entitled to do whatever they can get away with, trust will break down. It is very costly to police markets riddled with conflicts of interest and asymmetric information. We do not, by and large, police doctors in this way because we trust them. We need to be able to trust financiers in much the same way.” “Why finance is too much of a good thing” May 27.

But, do we not need to be able to trust our bank regulators too? I certainly don’t!

Anyone setting the weight for the capital (equity) requirements for banks when lending to government at 0%, and at 100% when lending to SMEs, must know that means that banks will lend more and at lower relative rates to the government than to SMEs. And that de facto means they believe that government bureaucrats are more productive using bank credit than SMEs.

Well, I refuse to believe that. I believe that if you believe something like that, you are either extremely dumb or a communist… in either case you’re not trustworthy. 

PS. Martin Wolf, absent conflicts of interest, and with perfect information, would there even be financial markets?

PS. All finance is great when debtors have a good plan… Force-feeding debtors is worsethan feeding geese for foie gras

@PerKurowski

Let us not ignore the criminally bad bank regulators who manipulated and distorted the bank credit markets.

Sir, Paul Robinson writes in his letter “The story unraveling before us is one of criminal minds working together to circumvent and deceive regulatory authorities that would leave any normal industry”

I will not discuss that but, in the same breath, it must be also be said that regulators, for whatever reasons, stupidity or ideology, criminally manipulated and distorted the bank credit markets in favor of the governments and against the citizens.

In 1988, with the Basel Accord (Basel I), regulators adopted the use of credit-risk-weighted capital (equity) requirements for banks and set the following risk weights: Lending to the government was given a Zero percent risk weight; and lending to the citizens’ SMEs and entrepreneurs was awarded a 100 percent risk weight… what more is there to say​?

@PerKurowski

Who’s going to fine bank regulators for manipulating credit markets?

Sir, Caroline Binham quotes Martin Wheatley, head of the Financial Conduct Authority with opining that fines are working in order to stop foreign exchange manipulations, “Bank fines credited for culture shift”, May 22.

We will see if that’s so, cross your fingers. But, much more important though, for all of us, is to stop bank regulators from manipulating the credit markets with their credit-risk-weighted capital (equity) requirements for banks.

With that they distort the allocation of bank credit to the real economy, for absolutely no reason… since major bank crises never result from excessive bank exposure to what is ex ante perceived as risky.

@PerKurowski

Corporations are not part of the community... and should not be allowed to dilute citizens´ tax representation

Sir, Michael Skapinker holds that “Business has lost its place in the community” August 14, and frankly I wonder if business ever had a place in the community. I mean, when a corporation does good things for the community, that is not really out of a sense for the community but because it is building up its image… a sort of clever advertising expense.

No, communities should be about people, and in this respect the tax on corporations should be 0%, because corporations should never have the possibility to dilute the tax representation of the citizens. In other words it is for the owners of the corporations to have a sense of community.

And with respect to Skapinker´s comments on bankers and their manipulations I agree…slap them hard on their fingers. But, Skapinker should not ignore that the manipulation of how bank credit is allocated in the real economy, performed by regulators with their risk-weighted capital requirements for banks, has been and is much more harmful for the society than any of the other bank manipulations currently spoken of… and in this respect Mark Carney´s behavior, as the current chairman of the Financial Stability Board, is “highly reprehensible” too.

http://perkurowski.blogspot.com/2012/03/my-tax-paradise.html

Besides setting the target for bank capital, we need to think about how to get there.

Sir, Anat Admati and Martin Hellwig write that “capital ratios in Basel III rely on a complex, distortive and manipulable system of risk-weights”, “Banks are not a special case on debt-equity ratio” May 21.

They are absolutely correct, on all three counts, and that is applicable to Basel II too. But what I would like to mention is the curious fact that the “distortive” element, and which to me is the most serious flaw of Basel regulations, as it affects not only the banks but the whole market too, has received the least of attention.

There is no doubt that we need to go down the route of substantially increasing the capital requirements of banks, whether to the 8-12 percent level I favor, or the 25-30 percent level Admati and Hellwig favor. But, when considering the fact that bank capital is going to be extremely scarce while travelling on the route to the final bank capital that is needed, we should not forget that the distortive effects of the risk-weights will be more important than ever.

In this respect I opine that regulators, more than thinking about how to force bank capital increases, need to think in terms of how to help these increases to happen as fast and as smooth as possible. There might be many other ways, but personally I favor either large public sector capital injections in the banks accompanied by clear rules as to how current shareholders could repurchase that capital in order not to be diluted, or some strong tax incentives awarded to any bank that achieves a capital increase which in the short term meets the final long term target.

And now, let’s find and publish the trail of all sophisticatedly mistaken bank regulator talk

Sir, Kara Scannell and Brooke Masters quote some of the shameless exchanges that took place among traders with respect to the manipulation of Libor, Tibor and what have you. “Trail of casual trader talk comes back to haunt RBS”, February 7

I wish they would be equally willing to find and publish the certainly much more sophisticated sounding arguments which led bank regulators to allow banks for instance to hold securities with an AAA to AA rating, or lend to Greece, against only 1.6 percent in capital, meaning authorizing a 62.5 to 1 leverage on those exposures.

It would also be interesting reading how they defended a concept like that when a German bank lent to a German entrepreneur it needed to hold 8 percent in capital, but when lending to the German government it could do so against zero capital.

I ask all this because, without the slightest doubt, this most certainly totally unwitting interest rate manipulation carried out by the bank regulators, has de facto caused immensely more damages than all other scandalous interest rate manipulations we have been reading about lately, put together.

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.

There’s also a need for a profound change in the culture of regulations

Sir, Sir Mervyn King, the Bank of England Governor lashes out with “From excessive compensation to deceitful manipulation of one of the most important rates, we can see we need a change in the culture of the industry”. Sorry, as a regulator he is not really one to speak about the need for a culture change.

Only because of the capital requirements based on perceived risks, the regulators caused the banks to charge hundred and so basic points in higher interest to those perceived as “risky”, like small businesses and entrepreneurs, and hundred and so basic points in lower interest to those perceived as not risky, like infallible sovereigns. If that is not manipulation of the most important rates, I do not know what that is.

And besides, most of the excessive compensations to bankers arose from the fact that regulators freed the bankers from having to compensate shareholders by requiring so little bank equity. By the way, on that issue, it might be better for Sir Mervyn King to lie low, because there could be calls for claw-backs on all types of compensation.

And when regulators manipulate interest rates, is that ok?

Sir, when regulators set the capital requirements for banks based on perceived risks, even though these perceived risks are already priced in by the bankers in the interest rates, they are though perhaps unwittingly, effectively manipulating the interest rates. The direct consequence of it is that those officially perceived as not-risky, have to pay much less in interests than what would have been the case without this distortion, and those officially perceived as risky need to pay much more… and all for absolutely no good reason at all. 

And so when reading “Barclays fined a record $450m” for manipulating interest rates, my first thought was, “well done, but where can the “risky” small businesses and entrepreneurs also sue the regulators for all the monstrously excessive interests they have had to pay over the years? 

Simple calculations indicate to me that a not-rated bank client, exclusively on account of this odious regulatory discrimination, has to pay about 270 bp (2.7%) more in interest rates when compared to an AAA rated bank client… or, like now, in times of extremely scarce bank capital, suffer the consequences of being excluded from access to bank credit.