If only a cost benefit analysis had been performed on the risk weighted capital requirements for banks

Tim Harford while reviewing Cass Sunstein’s“The Cost-Benefit Revolution” mentions, “In 1981, Ronald Reagan signed Executive Order 12291, requiring administrative decisions to weigh the costs and benefits of action and maximise net benefits.”, “A valuable study of a quiet victory for technocrats”, September 17.

How sad the risk weighted capital requirements for banks were no subjected to such a cost benefit analysis.

On the cost side, one would have to include the possibility that, since it would impose a tariff, by means of higher capital requirements, on the lending to the risky, and therefore de facto create a subsidy for when lending to the safe, that this could seriously distort the allocation of bank credit to the real economy… financing too much the safer present and too little that indispensable riskier future.

And, when reviewing its supposed benefit, that of making the bank system safer, one would have had to consider the possibility that, since the risky would then have to pay higher relative risk premiums than usual, that this could make them even riskier; plus the possibility that since the safe would get more credit at lower rates, that meant the safe could get too much credit at too low risk adjusted premiums, and banks could build up that type of excessive exposures to the safe that has always been the stuff bank crises are made off.

Adding then to the costs these possible negative benefits would certainly have caused this silly and dangerous regulation to be rejected… and the 2007-08 crisis avoided.

Hartford mentions that “Hayek’s objection to central planning is that it cannot work because the planners will never have enough information” I agree, but I am also sure that central planning often fails, not for lack of information, but simply because of them not understanding they lack information; and all there planning carried out in a group-thinking mutual admiration club.

In the “The forger’s spell”, a book by Edward Dolnick about the falsification of Vermeer paintings, the author makes a reference to having heard Francis Fukuyama in a TV program saying that Daniel Moynihan opined “There are some mistakes it takes a Ph.D. to make”. And Dolnick also refers to George Orwell’s comment, in “Notes on Nationalism”, that “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” 

Sir, time and time again I find reasons to be reminded of that book.

http://subprimeregulations.blogspot.com/2011/08/no-ordinary-man-could-be-such-fool.html

@PerKurowski

Why should technocrats seemingly be exempt from U-turn requirements, even in the face of horrendous mistakes?

Sir, Tim Harford writes: “For many government policies, it’s important to have an emergency stop to prevent bad ideas getting worse”, “In praise of changing one’s mind” May 27.

The worst idea, of the last century at least, has been that of, in order to make the banks safe, one needs to distort the allocation of bank credit by favoring, as if that was needed, banks’ exposures to what is perceived safe over those to what is perceived risky.

That meant that when the ex ante perceptions of risk, of especially large exposures, ex post turned out to be very wrong, that banks would stand there with especially little capital.

That meant that those rightly perceived as risky, like SMEs and entrepreneurs, those so vital for conserving the dynamism of the economy, would find their access to bank credit much harder than usual.

The 2007/08 crisis caused by excessive exposures to what was perceived or decreed as safe, 2007/08, AAA-rated, Greece, and the economies lack of response to outrageous stimulus thereafter clearly evidences the above.

But nevertheless, the concept of risk weighted capital requirements for banks, although somewhat diluted, still survives distorting on the margin as much, and in some cases even more than before.

When one reads Basel II’s risk weight of 20% for what is AAA rated and 150% for what is below BB- rated, the only conclusion one who has walked on Main Street could come to, is that a 180 degree turn into the directions of the risk-weighting would seem to make more sense.

Sir, why is it so easy for journalists to mock changes of minds of public political figures like Trump and May, and not the lack of change of mind of for instance the technocrats of the Basel Committee, the Financial Stability Board, BoE, ECB, IMF, Fed and so on?

Could it be because the latter “experts” tend to find themselves more in the journalists’ networks? Or could it be because of NUIMBY, no U-turn, no changing my mind, never ever in my own back yard. 

Sovereigns were handed a 0% risk weight! Why do we have to keep on reading references to deregulation or light-touch regulations, in the face of one of the heaviest handed statist regulations ever? Could it be because most journalists are also runaway statists at heart?

Why do "daring" journalists not dare to even pose the questions that must be asked?

@PerKurowski

Trump, though there’s reason for concern, shares some basic qualities that made the “Final Five” and America great.

Sir, Gillian Tett describing a clearly inspiring show by the US Olympic women’s gymnastics team, the “Final Five” asks: “Do they demonstrate discipline and ambition? Undoubtedly: if you want to teach a kid about triumph in the face of adversity Simone Biles’s life story is a good place to start: she overcame the challenges of a very tough childhood to win five Olympic medals” “What Trump can learn from the Final Five” November 12.

But at least in this respect Trump, though born with a silver teaspoon in his mouth, has certainly already demonstrated a willingness to take risks, to make mistakes, to try it again, and that go-get-it spirit that made the Five Final, and that helped make America what it is. If anything some could hold Trump has demonstrated a bit too much of those qualities.

Personally I pray Trump, as a President will want to reignite the building of America based on those qualities, and not just based on unproductive cronyism, which is a much too frequent reason for why some less deserving make it “Great” though not really the Final Five.

PS. Whether popular votes or electoral votes, no winning side has the right to ignore the other almost-half, though unfortunately it seems both sides would want to.

FT, are you aligned with the interests of redistribution profiteers and besserwissers, or with citizens’?

Sir you refer to that “Next month, Switzerland will hold a referendum on whether to introduce an Unconditional Basic Income”, and then you opine “this measure seems premature today [though] it is worth running data-driven pilot projects to test the concept’s future viability. More effective tax regimes and smarter forms of wealth redistribution will be needed to ease our social strains.” “Bring on the robots but reboot our societies too” May 7.

I come from Venezuela, where the poor, from that so lauded 21st Century Socialism, have not received more than about 15 percent of what should have been their individual share of the fabulous oil revenues over the last 15 years, tops. So please don’t tell me an unconditional universal basic income, in this case funded by oil revenues, “seems premature”… it is way overdue.

And Sir, why do we really need to test the hypothesis that people know better what to do with their own resources than what the governments with other’s resources? Is that to find ways to help profiteers and besserwissers to keep control over the redistribution?

As I have written to you I support a worldwide gas/carbon tax which revenues should be paid out by means of a universal basic income, in order to align the incentives in the fight against climate change and against inequality.

And I also support a social pro-equality tax, which revenues should be paid out entirely by means of a universal basic income, from citizens to citizens, so as to avoid all the dangerous populist and demagoguery intermediaries.

Sir, if we can separate all the redistribution from governments’ normal functions, then we will also be able to make these perform better for us. For instance, we might suddenly realize that all tax evasion and tax avoidance put together could be less than government waste.

PS. And bring on the robots to bank regulations. These at least have smaller egos that stand in their way of admitting and learning from their mistakes. The robots would, long ago, have eliminated the risk weighted capital requirements for banks, which only dangerously distort the allocation of bank credit to the real economy, for absolutely no good reason at all. 

@PerKurowski ©

Artificial intelligence has a clear advantage over humans; a smaller ego standing in the way of admitting mistakes.

Sir, Murad Ahmed, writing about Demis Hassibis states: “At DeepMind, engineers have created programs based on neural networks, modeled on the human brain. These systems make mistakes, but learn and improve over time” “Master of the new machine age” March 12.

Ooops! I hope they do not use as models the brains of current bank regulators.

In 2007-08 we had a big crisis because AAA rated securities and sovereigns like Greece, perceived and deemed as safe, turned out to be very risky.

And what connected all that failure, was the fact that banks were allowed to hold very little, I mean very little, we are talking about 1.6 percent or less in capital, against those assets, only because these were ex ante perceived or deemed to be very safe.

Of course, anyone who knew anything about the history of financial crises would have alerted the regulators that to allow banks to have less capital against what is perceived as safe than against what is perceived as risky, was very dumb. That since major crises only result from excessive exposures to something ex ante perceived as risky but that ex post turns out to be very risky. And one of the main reasons for that is precisely that too many go looking for “safety”.

But now we are in 2016, and the issue of the distortion those capital requirements produce in the allocation of bank credit to the real economy is not yet even discussed. 

So before these human brain systems learn and improve over time from mistakes, they have to be able to understand these and, more importantly, to humbly accept these.

Frankly, artificial intelligence seems it could have an advantage over humans’, namely none of that human ego that so much stands in the way of admitting mistakes.

But also beware, were robots free of that weakening ego, they could conquer us!

@PerKurowski ©

Current capital requirements for banks are based on perceived credit risk… and on nothing more. That’s short-termism!

Sir, I refer to Lawrence Summers writing about “mandates or incentives to change business decision-making. The goal is for companies and shareholders to operate with longer horizons” and other ways to avoid short-termism, and risk aversion “Corporate long-termism is no panacea — but it is a start” August 10.

Again for the umpteenth time, there is nothing around the world that drives the allocation of financial resources based on short-termism, and avoidance of credit risk, as much as the risk weighted capital requirements for banks. These allow banks to earn higher risk adjusted rates of return on what is perceived as safe than on what is perceived as risky, without absolutely any other type of consideration.

Eliminating the distortions in credit allocation produced by those capital requirements should have the highest priority. Unfortunately that would require regulatory technocrats and similar to accept they are responsible for mindboggling mistakes… and we can’t have that… can we Mr. Summers?

@PerKurowski

Failures and mistakes is something that needs to be nurtured in order to have a better future.

Sir, Gillian Tett is absolutely correct when she writes: “What is still missing, in many quarters, is a mindset – most notably a recognition by bureaucrats and bankers that failure is an inevitable part of the market system, and that it sometimes pays to wipe the slate clean rather than endlessly sweep problems under the carpet”, “Jingles that sound the beginning of recovery” October 24.

That is exactly what I referred to in a letter you published in August 2006 in which I wrote about “the long-term benefits of a hard landing” and the dangers of dabbling in topics such as debt sustainability ignoring the value of pruning or even, when urgently needed, of a timely amputation.”

But, I also think it is very important that the wiping-the-slate-clean, also applies to banks. As an Executive Director of the World Bank, in 2003, I told many regulators during a Basel II preparation conference: “A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.”

But no, the Basel Committee preferred to proceed down the road of nurturing the too-big-to-fail banks.

PS. By the way, Ms. Tett might be interested that in the US, the jingle she refers to, is not allowed when it comes to educational debt.