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

Risk weighted bank capital requirements are anathema to neoliberalism

Sir, Rana Foroohar writes “we have spent decades of living in the old reality — the post-Bretton Woods, neoliberal one.” "Markets are adjusting to a turbulent world" August 19.

There are many definitions of neoliberal policies out there but they always include a large role for the hands of the free market and the reduction in government spending in order to increase the role of the private sector in the economy.

In 1988, for the banking sector, one of the most important economic agents, credit risk capital requirements were introduced by means of the Basel Accord. It gave incentives that distorted the allocation of bank credit to the real economy. For instance lower risk weights for the sovereign (0%) and for residential mortgages (35%) signifies subsidizing the sovereign and the safer present, by taxing the access to credit for the riskier future, like to entrepreneurs (100%). So I do not know what neoliberalism Ms. Foroohar refers to.

Ms. Foroohar, speculating on the possible “impact of an Elizabeth Warren or Bernie Sanders victory in the US primaries?” mentions a 13D Global Strategy and Research note that holds that such event would “fit perfectly into the cycle from wealth accumulation to wealth distribution”, something that Foroohar also believes “will be the biggest economic shift of our lifetimes.”

Sir, at the very moment income, through the purchase of assets, is transformed into accumulated wealth; there cannot be any significant redistribution of it, which means having to sell many of those same assets, without any significant destruction of wealth. If you’re scared of a deep recession, as we all should indeed be, then the last think you’d want to do is to deepen it with a wealth redistribution cycle.

So we cannot redistribute? Yes, we can, but that’s best done getting hold of the income before it is converted into assets, and then, preferably, sharing it out equally to all, by means of an unconditional universal basic income.

@PerKurowski

When will the nonsensical talk about failures of the neoliberal system in the midst of runaway statism end?

Sir, Rana Foroohar writes: “Many progressive economists believe that the failures of the neoliberal system itself (which have been chronicled by even the IMF) have created a broad-based existential angst reflected in the new propensity of Americans to save rather than spend.” “The trust deficit is permanent” May 29.

Nonsense! Since 1988, Basel I, we have had regulations that for the purpose of setting the capital requirements for banks, have risk weighted the sovereign with 0%, and the ordinary unrated citizen, like any SME or entrepreneur, with 100%. That means banks can leverage their equity, and the explicit or implicit support they receive from taxpayers, many times more when lending to sovereigns than when lending to citizens. That means banks will obtain much higher expected risk adjusted returns on equity when lending to the sovereigns than when lending to the citizens. That causes banks to lend too much at too low rates to sovereigns, and too little or at too high rates to citizens.

What on earth has that to do with neoliberalism? Nothing! It is just the opposite. It is raving statism!

What we really have though are truly second or third class (or overly statist) progressive economists. They are unable to understand these bank regulations, by favoring so much the sovereign, the AAA-risktocracy and house ownership, over allowing the citizens to access that bank credit that could help them move up in life, is putting inequality on steroids.

There is no problem at all with high savings, if these can be efficiently channeled to the real economy, for instance by banks. But, if that is not the case, then these savings will not serve any good purpose… these savings will not even recover their original value when the real economy stalls and falls.

@PerKurowski

Why is obvious crony statism referred to as crony capitalism?

Sir, I refer to Martin Wolf’s “Why Xi cannot succeed with his reforms” December 14.

In it, Wolf quotes the following from Minxin Pei’s “China’s Crony Capitalism”: “The emergence and entrenchment of crony capitalism in China’s political economy, in retrospect, is the logical outcome of Deng Xiaoping’s authoritarian model of economic modernisation… because elites in control of unconstrained power cannot resist using it to loot the wealth generated by economic growth.”

But “Capitalism” (at least according to Wikipedia), “is an economic system based on private ownership of the means of production and their operation for profit. Characteristics central to capitalism include private property, capital accumulation, wage labor, voluntary exchange, a price system, and competitive markets. In a capitalist market economy, decision-making and investment is determined by the owners of the factors of production in financial and capital markets, and prices and the distribution of goods are mainly determined by competition in the market.”

Sir, so why does it refer to “crony capitalism” when it is clearly much more a case of “crony statism”? Could it be that the “unconstrained power of the elites” also cover the terminology we are to use? Like for instance when references are made to our economies being under the yoke of “neo-liberalism”, all while bank regulators gladly risk-weigh Sovereigns with 0%, and We the People with 100%. Or like when intrusive and complex bank regulations are mentioned to have happened in a period of "deregulation".

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

@PerKurowski

The Basel Accord’s statism and misregulation trumped all neoliberalism and deregulation

Martin Wolf writes: “banks remain highly fragile businesses. By their nature, banks are highly leveraged entities with ultra-liquid liabilities and far more illiquid assets…What remains disheartening is that shareholders and a few small fry among the employees have been punished, but the decision makers who ran these institutions have escaped more or less unscathed.” “Deutsche Bank offers a tough lesson in risk” October 5.

Wolf is totally correct on that! But, may I ask, what about the responsibility of regulators who, against all common sense, allowed banks to leverage their equity and the support they received from society; limitless when lending to its own or to a friendly sovereign; over 35 to 1 when financing residential mortgages; and 62.5 to 1 only because a human fallible agency rated a creditor AAA to AA?

There’s been absolutely nothing of holding those regulators accountable, worse yet they are still in charge of the most important monetary policy decisions.

And what about the responsibilities of leading opinion makers like Martin Wolf himself, when they refuse to acknowledge the extremely serious distortions in the allocation of bank credit to the real economy risk weighted capital requirements for banks produce?

I am currently reading Philip Ther’s interesting “Europe since 1989”. Already I do not how many times in the very first chapters I have seen neoliberalism and deregulation mentioned. What a difference a year makes! Had Ther began his history in 1988, he might have had to include the Basel Accord with its risk weights of 0% for the Sovereign and of 100% for We the People. Frankly, when all is said and done, the Basel Accord’s statism and miss-regulation has trumped all neoliberalism and deregulation.

As for the Deutsche Bank, its best chance for a sturdier future, lies in regulators telling all banks to abandon the business model of maximizing returns on equity by minimizing capital that their regulations promoted.

Let us pray, for our children’s and grandchildren’s sake, that banks return soon to earn their returns on equity by evaluating risk adjusted interest rates and size of exposures, without any considerations to capital requirements.

@PerKurowski ©

If IMF seems to favor the private sector, rest assure it is favoring even more its shareholders, the governments.

Sir you write “International Monetary Fund last week…published an article questioning its own neoliberal tendencies…concluding that “instead of delivering growth, some neoliberal policies have increased inequality, in turn jeopardizing durable expansion”. And you describe it, marvelously imaged, with that “In seeking to be trendy, the IMF instead looks as out of date as a middle-aged man wearing a baseball cap backwards”, “A misplaced mea culpa for neoliberalism” May 31.

My opinion though is that if a mea culpa should be forthcoming from the IMF that should have more to do with how they allowed the label neoliberalism to cover up for statism. For instance most public services privatized in Latin America were awarded based on who offered to pay the governments the most, not on who offered to charge the lowest tariffs; and so all money received became de facto tax advances to governments, to be later covered by customers having to pay higher tariffs. Neoliberalism? Hah!

John Williamson coined the term “The Washington Consensus” that was rightly or wrongly adopted as a stand in for neoliberalism, in 1989.

The year before, the Basel Accord, determined that for the purpose of setting the capital requirements for banks, the risk weight of sovereigns, at least those of the OECD, was zero percent, while the risk weight of citizens, the private sector, was 100 percent.

What neoliberalism can thrive along side such virulent statism as that displayed by the Basel Committee?

Let us not fool ourselves; IMF represents the governments, not the private sector, not the citizens. If it does something that seems to favor the private sector, the citizens, rest assure it is by doing so favoring governments even more.

@PerKurowski ©

Hayek and Keynes would have stood arm in arm against different capital requirements for bank assets based on perceived risk.

Sir, we have the world in financial turmoil as a direct consequence of regulators having allowed banks to hold extremely little capital, 1.6 percent or less, when lending or investing in what was officially perceived as “The Infallible” while requiring the banks to hold 8 percent against any exposure to “The Risky”. And yet five years after the crisis outbreak we can still read comments, by for instance Robert Sutherland Smith, that attribute this crisis to a universal banking which was supposedly freed in the “name of Hayekian neoliberalism”, “Bitter harvest of Hayekian neoliberalism”, December 27. 

In “free banking”, though there is of course different capital costs for different risk structures, there is no such thing as different capital requirements based on the perceived risk of the different individual assets of a bank, and Hayek would never ever have approved of such distorting regulatory stupidity. When will the underlying political agendas allow for that to be understood? 

And of course Lord Keynes, and who wrote “There is no objection to be raised against the classical analysis of the manner in which private self-interest will determine what in particular is produced, in what proportions the factors of production will be combined to produce it, and how the value of the final product will be distributed between them”; and who was an aggressive and able speculator on his own, would also fiercely have opposed such folly.