If regulators artificially favor the access to bank credit of “the safe” “the safe” will turn risky, more sooner than later.

Sir, Gillian Tett writes “post-crisis regulatory reforms have forced financial institutions to load up with “safe” assets, too, to be used as collateral for deals… The net result is a dire squeeze on safe assets” “What pawnbrokers can teach central banks” April 29.

That is correct but, what about pre-crisis regulations? These allowed banks to leverage much more their equity with “safe” assets; and thereby earn much higher expected risk adjusted returns on equity with “safe” assets than with “risky” assets; and which therefore caused banks to lend too load up on “safe” assets, something that can be very risky.

So if you do not allow markets to allocate credit unencumbered by regulations, but favor the banks to lend to the safe, “the safe” havens are doomed to turned into dangerously overpopulated havens, sooner or later. And from what Ms Tett writes it seems that the “sooner” applies.

@PerKurowski ©

The Parable of the Talents and the self inflicted curse of excessive regulatory risk aversion.

Sir, we live in a world where those who are perceived as “risky” from a credit point of view; those who always include small businesses and entrepreneurs; those who with their dynamism help to seed the future of an economy, are negated fair access to bank credit. And that is done by means of regressive and distorting bank regulations that allow banks to hold much less capital, meaning equity, against assets perceived as absolutely safe.

And tragically, that is not deemed to be a problem, like we can for instance see when reading Martin Wolf’s “The curse of weak global demand” of November 18. In it, as usual, this central problem is not even mentioned

Of course the world has many problems but since risk-taking is the oxygen of any development, one of the most serious one is the self-inflicted curse of excessive regulatory risk aversion.

I was recently reminded of “The Parable of the Talents”, Matthew 25:14-30 and we would all be well served if regulators read it and understood it. We the taxpayers are underwriting many of the risks in banking, “the Talents”, which we hand over to regulators to manage, and we do not do that just in order for banks to obtain higher returns on equity or to only lend to those perceived as absolutely safe. We do that so that banks can allocate credit efficiently, and daringly, to the real economy.

Mario Draghi… you are personally responsible for any ECB liquidity injections in Europe being just wasted away.

Sir, I refer to Stefan Wagstyl’s “ECB presses on with securities plan” September 10.

Mario Draghi, as the former chairman of the Financial Stability Board must be aware that, because of the risk-weighted capital requirements, all those borrowers who have the misfortune of ex ante being perceived as risky from a credit point of view, independently of how important they could be for the European economy, and for European job generation, will not have fair access to bank credit.

And so therefore banks will by means of their credits not be able to allocate any ECB (or fiscal deficit) liquidity injections efficiently to the European economy.

And one of the reasons for why this distortive regulatory lunacy introduced 10 years ago with Basel II survives, is the quite natural but still highly irresponsible reluctance of regulators to admit their mistake.

And that is why, I at least, hold Mario Draghi personally responsible if any ECB liquidity injection in Europe is just wasted away… and this even though he might not care one iota about it, as he sure must be surrounded by so many other who support his ego by daily reaffirming his magnificence.

The survival of Spain and Italy (and Portugal) is day by day being more in the hands of their respective shadow economies, their respective economia sommersa

Sir, no matter where you look in the developed world, you will find dangerous obese bank exposures to what was or still is officially perceived as absolutely not risky, like what was or is triple-A rated and the “infallible” sovereigns; and for the society equally dangerous, anorexic bank exposures to what is officially perceived as risky, like small businesses and entrepreneurs. Nevertheless the bank regulators insist on discriminating against ex-ante perceived risks. 

In this respect, when Robert Zoellick in “Europe is distracted by endless talk of firewalls” April 17, writes that “the survival of the eurozone now depends on Italy and Spain”, but, instead of trying to figure out how their private banks could help out, he recommends a minor capital injection in the European Investment Bank, I can´t help but to feel that the real survival of Italy and Spain (and Portugal) will, in its turn, depend on what the Italians and Spaniards (and Portuguese) can manage to do in their more real and less distorted shadow economies... their respective economia sommersa.

PS. That is specially so when in the official economy regulators apply perceived credit risk weighted bank capital requirements, which so much favors the access to credit of the sovereign over that of entrepreneurs and SMEs.

US, and the Western World, is becoming “the home of the risk-adverse”.

Sir, I, as most humans, am extremely risk-adverse, and that is why I have always appreciated the role of designated risk-takers that the banks perform for the society. We cowards were used to worry our bankers were too cowards to, with their lending of the umbrella while the sun shines and taking it away when it rains. But then came the bank regulators and with their capital requirements that discriminate fiercely based on perceived risks made it all so much worse. 

Martin Wolf comments on the “Great Stagnation” by Tyler Cowen of George Mason University, December 21. What they both fail to identify is that requiring banks to have a lot of capital when the perceived risks are high, and allowing them to hold minuscule capital when the perceived risks are low, stacks the returns on bank equity against what is perceived as risky. And that has nothing whatsoever to do with what made “the Home of the brave” big. The US is now, as is most of the Western World, becoming the Home of the risk-adverse. 

Not taking risks is about the most dangerous things a society can do… as the only thing that can result from that is the overcrowding of the ex-ante safe-havens

The odious and arbitrary regulatory discrimination of risks must stop… now!

Sir Jeffrey Sachs in “It is time to plan for the post-Keynesian era” June 8, in his list of proposals, ignores the fundamental change that must occur in our financial regulations.

It just cannot be that our regulators allow banks to lend to fancy AAA rated sovereigns with zero capital requirements, or to sovereigns rated like Greece the last five years with only 1.6 percent of capital, while requiring the banks to hold 8 percent in capital when lending to the small businesses and entrepreneurs.

That odious and arbitrary regulatory discrimination must end now; the coward market discriminates more than enough when pricing for risks; and our financial regulators should immediately be removed as they seem absolutely incapable to understand that there are other risks in life than “the risk of default”.

Where did the regulators get their risk weights from?

Sir John Kay extends “A royal invitation to raise the debate on finance” May 19. Knowing that the value of those commissions lies primarily in how the questions are phrased, since quite often the questions are too general or too many, which tends to obscure the answers, let me suggest one single line of question.

Current capital requirements for banks were established at 8 percent, adjusted for risk-weights. A loan to a small business is risk-weighted at 100%, and the bank needs to hold 8 percent in capital when lending to it. But since a loan to a corporation rated AAA, or to a country like Greece, which until quite recently was rated A, would be risk-weighted at 20% and so then only 1.6 percent in capital would suffice when lending.

So ask the commission… where did the regulators get those 100% or 20% risk-weights from?

We know that the Basel Committee has published for example “An Explanatory Note on the Basel II IRB Risk Weight Functions” but reading the paper only reinforces the urgent need of introducing outsiders to this close circle of regulatory insiders, who are now circling their wagons defending themselves, so successfully that they allowed to dig us even deeper in the hole they placed us in.

The Explanatory Note, prepared in July 2005, states that the risk-weights were developed with a “confidence level of 99.9%, meaning a bank is expected to suffer losses that their capital on average once in a thousand years” How come that confidence level did not last for two years? Who authorized that confidence level? I for one know perfectly well that, if the world would regulate their banks under the assumption that they would fail only once every thousand years… it might as well be dead and buried.

PS. What’s more reproachable? A young girl believing a palm reader’s prediction in a county fair; or grownups believing the self-selected Basel Committee fortune tellers when, for bank capital/equity requirements, they give us their weights of the risks for our bank systems?

It is low capital requirements that generate the type of yield of which great bonuses are made of

Sir Tony Jackson writes that the reason why “banks are up to their eyebrows in dodgy sovereign debt” is they have “fasten to instruments with investment-grade rating and junk-grade yields”, “Politics remains the biggest barrier to bank regulations” May 17. At this point of the crisis it is astonishing how wrong Jackson can be. Where has he been?

These sovereign debts did not pay junk-grade yields they paid relative low rates but these rates were made especially attractive for the banks because these were required to hold very low capital requirements against them.

For example a bank holding debt of Greece, between mid 2000 and December 2009, needed only to have 1.6 percent in capital… which allowed it a 62.5 to one leverage. Take any small margin and multiply it 62.5 times and you will get the type of yields of which great bonuses are made of.

It is not politics but the Basel Committee, who remains the biggest barrier to rational bank regulation.

The Champions of the Basel Committee

Sir there is not one regulator capable to stand up and with a straight face look us into our eyes and tell us why a Sovereign rated A to A+, like Greece was from mid 2000 to late 2009, were risk-weighted 20% which allowed banks to lend it with a capital requirement of only 1.6 percent in equity meaning being able to leverage 62.5 to 1, while the small business in our neighborhood was risk-weighted 100%, meaning for banks, 8 percent in equity and 12.5 to 1 in leverage.

But luckily for those regulators, they will never be asked those questions, as long as they can count on Champions like Martin Wolf, Paul de Grauwe, and so many others, insisting on blaming just the private financial sector, “Governments up the stakes in their fight with markets”, May 12. How long will it take to hear a proposal to define all European sovereigns as de-jure rated AAA, so that they can be risk-weighted at zero percent, so that banks do not require any capital at all when lending to them, so that their leverage can be infinite?

We had a monstrously dumb and stupid, government failure

Sir, Samuel Brittan in “A credo for a revived capitalism” May 7 reminds us that we need to discuss more about “government failure”. He is absolutely right.

In October 2004, as an Executive Director of the World Bank, I who am not an investment banker, nor a financial regulator, presented at the Board a written statement were I opined: “We believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”

And long before that and during my whole term as an ED I repeated, as much as I could, bordering on annoying, that the ratings issued by the credit agencies were just a new breed of systemic error to be propagated at modern speeds… and that we should not follow the money but follow the triple-As.

The real question now is what keeps the world from listening when the innocent child screams out “the emperor is naked”?

Look at the European governments, accepting the dictates of the Basel Committee and allowing their banks a 62.5 to one leverage when stocking up on Greek debts and alike… if that is just not a monstrously dumb and stupid government failure, what is?

Respectfully, may I express a doubt?

Sir in your “The case for change” May 4 you write that the Financial Times stands for a “liberal agenda: a small state...” May I respectfully doubt it?

No one that stands for a small state can agree that if his deposit in the local bank is loaned out by the bank to a small business the banks needs to hold eight percent in capital, but if his bank lends instead that money to the government it needs to hold no capital at all.

About this I have written you many letters during many years but you keep on ignoring the issue.

Financial Times is equally a promoter of “metaphysical presumptions”

Sir your ‘Faith in numbers” May 1 is truly odious in the way you arrogantly and ironically joke about religious beliefs while blithely ignoring how much you yourself have been helping to give credence to bank regulations that seem to be just the same or even more based on “metaphysical presumptions”.

Or what would you call having the capital requirements for our banks based on some opinions of the credit rating agencies and as arbitrarily weighted by the high priests of the Basel Committee? If that is not pure purposeless mumbo-jumbo or hocus-pocus, what is?

But what were the regulators smoking?

Sir in “Double or quits for the eurozone” April 29, you say that “Credit raters made things worse by again following the markets they are supposed to advise”. Would you care to expand a little bit on that?

To me it was really the regulators who made things worse by telling banks to have capital in accordance to what the credit rating agencies say... and for instance allowed the banks to stock up on Greek public debt with only 1.6 percent of capital... in other words authorizing the banks to have a 62.5 to 1 leverage when dealing with Greece! What were the regulators smoking?

I refuse to follow Martin Wolf down the road to financial obscurantism

Sir when comparing the ease or even gusto with which Martin Wolf has supported government spending to bail out the economy, imposing no public debt to taxpayers willingness ratios at all, with the way he now wants to strictly limit the banks’ lending activity, I am truly shocked, “Why cautious reform of finance is the risky option”, April 28.

Wolf, after years of receiving, acknowledging and ignoring my letters about the excessive leverage ratios allowed to banks on assets perceived as having low risk, like 62.5 to one on anything related to an AAA rating, now suddenly goes into full reverse and opines that “Leverage ratios of 30 to one are crazy. Three to one looks far more sensible”.

Well let me assure you that just even searching for a three to one capital ratio for banks world, would make us lose all our hopes of trying to solve the rest of the world’s urgent problems, and most certainly lead us to financial obscurantism with pure gold bartering and no credit at all. I refuse to follow Martin Wolf there!

In fact the 12.5 to one capital ratio, allowed to banks when lending to small businesses and entrepreneurs, and which of course had nothing to do causing this crisis, should perhaps even be increased slightly, now when we are in so much deer need of jobs.

But the AAA-ratings-bubble was the fault of very few!

John Authers is correct in that “Bubbles are the fault of the many – not the few” April 3, but that is of course with the exception of the AAA-ratings-bubble and which when it blew up caused the current crisis.

That bubble was the fault of only 3 credit rating agencies and of those very few regulators who empowered the credit rating agencies with so much credibility when they made their credit risk analysis of the clients of the banks, determine how much capital the banks should have… even to the extent of allowing the banks to hold a truly minuscule 1.6 percent in capital when lending to a private AAA client and, good grief, no capital at all when lending to a sovereign AAA.

What we need is to face up to the shattered myth of a rational regulator!

Sir here we stand before the ruins of a financial regulatory system that limited its purpose to avoid defaults and put too much trust in credit rating agencies allowing for minuscule capital requirements whenever AAAs were present… and mostly discuss the myth of a rational market? What about the myth of a rational regulator?

Justin Fox commences to hint at what we really need arguing in that “Cultural change is key to banking reform” March 26. I support a drive to simplify regulation and not to complicate them even further as is evidenced by the reforms currently suggested by the Basel Committee and the Financial Stability Board.

Justin Fox, though also supporting simplification, argues this might not be enough, as shown by Lehman Brothers´ faking the balance which is evidence of “ways to subvert even the clearest of the rules”. He is right but let us not forget that Lehman Brothers´ what they were up to was hiding and trying to redistribute the losses while the regulators, pushing so much toward supposedly risk-free land, were creating losses… and that is no doubt a lot worse.

Without understanding the regulatory arbitrage one cannot get the real measure of the banks

Sir John Gapper in “Volcker has the measure of the banks”, January 28, quotes Viral Acharya, a professor at New York University’s Stern School, saying that “the crisis was caused by a ‘general underpricing of risk’ that led many banks into taking on more trading and investment risk to boost their returns”.

“Underpricing of risk”... by the banks? No! Who really underpriced risk were the regulators when they allowed the banks to hold less capital when “holding triple-A mortgage-related derivatives”, and which thereby artificially increased the returns of these assets. In other words the banks were receiving what they perceived as good returns only because of regulatory arbitrage.

I am truly amazed how, now soon two years into the crisis, some experts can still not see what some of us knew was going to happen, before the crisis happened. Without understanding the role regulatory arbitrage had in the crisis, forget about Volcker, Acharya, Gapper or anyone else getting a grip on any real measure of the banks.

Should Snow White have known the apple was toxic?

Sir in “Shining a light on bank´s deep hole” October 1, you write about “bad bets on risky assets”. What risky assets do you refer to? To those AAA rated securities that carried so little risk that the regulators only required the banks to hold 1.6 percent equity against them?

When Snow White was offered the apple, was she supposed to have known Queen Regulator´s helpers, the credit rating agencies, had poisoned the apple?

The regulators, thinking themselves Gods, misinform the markets and the experts

Sir, when is FT going to do an “Analysis” on what the risk-weights signify for the reported bank-leverages. The sooner the better, since that could save many experts (including some of your own) from making fools out of themselves.

Andrew Kuritzkes and Hal Scott in “Markets are the best judge of bank capital” September 24 quite correctly state that “We need to complement regulation with more effective market discipline. This requires better information”.

But, in their discussion of bank leverage and even though they mention the possibility that “capital requirements are imperfectly linked to bank-risk taking” they seem unable to realize that the reason the capital requirements relative to risk-weighted assets turned out to be so faulty, had nothing to do with the basic 8 percent level established, and all to do with the risk-weights used.

The use of arbitrarily set regulatory risk weights, like those which give only a 20% weight to an AAA asset misinformed the market and experts like Kuritzkes and Scott, making them all unable to understand what was going. The sooner we free ourselves from regulators playing Gods calibrating risks, as if they possess the whole truth on risk, the better.

Mr Caruana and his fellow regulators deserve months of humbling community service and being banned for life from any regulatory activity.

Sir when a previous member of the Basel Committee like Mr. Jaime Caruana says “Basel II is evolving” and was not a contributory factor to the crisis, and that “You don’t see a correlation with the adoption of Basel II and the difficulties” as is reported by Patrick Jenkins in FT on September 21, this is indeed an insult to our intelligence and to humanity.

Mr. Caruana is well aware that when the Basel Committee demanded from the banks a capital requirement of only 1.6 percent, which is equivalent to authorizing a leverage of 62.5 to 1, when the banks were involved with a client or a security rated AAA by the credit rating agencies, they set off a world-wide race in search of the AAAs; and which, over just a couple of years, led trillions of dollars over the precipice of the subprime mortgages in the US, and created misery for hundreds of millions of people all over the world.

The least Mr Caruana and his fellow regulators deserve, is six months of a very humbling community service and, of course, being banned for life from any regulatory activity.