August 16, 2014
Sir, Gillian Tett asks “So what inspires the ‘aha’ moment? And can anybody set out to replicate moments like this in other areas?”, “How to ignite creative spark” August 16.
I would say that even as that is an important question, even more important is the one of “How do we not forget or ignore the creative sparks of the past?”
Frank H. Knight, in 1921, in “Risk, uncertainty and profit” reminded us of that Hans Karl Emil von Mangoldt, in 1855, gave the example of how “the bursting of bottles does not introduce an uncertainty or hazard into the business of producing champagne; since in the operations of any producer a practically constant and known proportion of the bottles burst, it does not especially matter even whether the proportion is large and small. The loss becomes a fixed cost in the industry and is passed on to the consumer, like the outlays for labor or material or any other.”
And yet, around 150 years later, our too creative bank regulators decided something akin to that if a bank was going to produce champagne using “risky” champagne bottles, it needed to hold much more capital (equity) than if it was going to produce milk using safer milk bottles… and all as if the banks did not already internalize in their interest rates, the size of exposures and other terms, the ex ante perceived credit risks of their borrowers.
And so, ignoring von Mangoldt’s spark, meant that regulators forced the banks into a double consideration of perceived credit risks, something which of course distorted all common sense out of the allocation of bank credit in the real economy.
August 02, 2014
Sir, Tim Harford writing about crimes and incentives after the London riots mentions how “a mugger or a burglar in an area… entirely unaffected by the riots might still feel conscious that the mood of the judiciary had changed”, “When crime stops paying” August 2.
In 2002, just 48 hours after arriving to Washington, I was robbed at knife point, about four blocks away from the Whitehouse. I asked the policeman who helped me out whether it was not safe there, and he replied that since visitors don´t go so often to where these muggers reside, they have to come to where the market is. And as an economist I understood it… but it also comes to show that in terms of law enforcement it is not that easy to pinpoint down which are the really relevant areas.
For instance bank regulators have clearly difficulties with that. As they become obsessed with banks lending too much to where it was risky, they told the bankers that, if they insisted in doing so, they would have to put up a lot more capital, which meant less return on their equity and, consequentially, of course, smaller bonuses.
But unfortunately, when doing so, regulators confused the ex ante and the ex post risks areas, and so this only exasperated what bankers have always done which gets them into trouble… namely to lend too much to something perceived as absolutely safe.
And so regulators, in retrospect, only aggravated the crisis by having the banks being caught by bad news in the ex post area with their pants really down… I mean with especially little capital. And besides, since banks stopped visiting the areas considered ex ante as “risky”, the whole economic region started to suffer and crumble.
PS. I explained to the kind policeman who even instructed a close by liquor-store to “give him something strong”, that unfortunately I was not used to this type of events, since I came from Caracas Venezuela. I immediately felt better… and not just because of the “something strong”.
June 24, 2014
Sir, Emiko Terazono quotes Derek Chambers of Sucres & Denrés saying “If you’ve got a piece of land, do you grow cocoa which needs a lot of labor and is prone to disease, or something [like palm oil and rubber] that doesn´t need a lot of work and produces money every couple of months”, “Cocoa deficit puts squeeze on chocolatiers” June 24.
Holy moly! He better not tell that to the bank regulators in the Basel Committee since then, consistent with their actions, they would, even though banks already have cleared for those risks, immediately impose higher capital requirements on banks when financing cocoa than when financing palm oil, rubber or arabica coffee… because “it is oh so risky and we can’t have our banks financing that”, and then we would really see a squeeze being placed on chocolatiers.
April 30, 2014
Sir, John Plender writes “Beware the onset of bank industry complacency”, April 30. Of course, we always should beware of that… though let us not forget that “complacency” is based on the assumption that their exposures are absolutely safe, when in fact that is precisely when things get truly dangerous. In other words it is not possible for banks to be complacent when they think they are doing something risky.
Plender describes a period where there was bank stability, even though bank capital was not that high, and that everything went haywire after “Capital regulation arrived with the Basel Accord of 1998”. That should point directly to that the real “new” problem that occurred with bank stability was when it was decided that the capital requirements should be different based on the ex ante perceived risks. And that completely distorts the allocation of bank credit creating dangers to the banks and to the real economy. And yet, that problem is not understood,, or stubbornly ignored… and it is really hard for me to understand the why of that.
Could it be because Plender and others really believe that risk-weighted means risk-weighted? Wow, the power of words!
Let me put it this way…what we must really beware of is regulators adding on a similar, or sometimes an even identical complacency to that of the bankers… both based on the same risk perceptions. Our current regulators are focusing on the expected risks, those that bankers are supposed to be able to take care of on their own… completely forgetting that their role is to think about the unexpected risks. That is what is so terribly wrong.
March 03, 2014
What’s the added value of bank regulators who only concern themselves with the risks bankers already perceive?
Sir I refer to Martin Arnold´s “Foreign banks scramble to calculate potential losses if crisis deepens [in Ukraine]", March 3, just to remind you of the fact that these are the type of “unexpected losses” against which bank regulators, in excess of their quite low leverage ratio, do not require banks to have capital against.
In other words poor us, our banks are in hand of regulators who are primarily concerned with the risks we, or at least our bankers, should all be able to perceive. What’s the added value of that?
February 19, 2014
FT’s silence makes it unwittingly a lobbyist for “The Infallible” accessing bank credit on preferential terms
Sir, I refer to Sarah Gordon’s Analysis on a serious lack of bank-credit to SME’s in Europe, “Give them some credit” February 19. And how bad things are is not really clear, because for instance “Published interest rates do not take into account potential borrowers who have been offered loans with high interest rates that they then decline, those who have been refused credit, or those who have simply become discouraged and stopped asking.”
Gordon writes “Banks have become more risk-averse since the crisis, not just to protect their bruised balance sheets but also to meet demands from regulators to improve capital buffers”. And the article also quotes Daniel Cloquet, director of entrepreneurship and SMEs at Business Europe, stating “At the moment, the capital requirement rules basically favor [banks holding] government debt.”
So clearly one of the main obstacle for the SMEs accessing bank credit, something about I have been writing you innumerable letters, are the risk-weighted capital requirements. By favoring so much bank lending to the “The Infallible”, like to some sovereigns and the AAAristocracy, these discriminate against the bank borrowings of “The Risky”.
But even though Gordon refers to a serious of other initiatives to help financing SMEs, some of which, like online crowd-funding mechanisms sound truly marginal… again there is not a word about the need of changing the risk-weighted capital requirements, so as to eliminate the distortions they produce in the allocation of bank credit to the real economy. And, this even though FT must be aware by now that never ever has a systemic bank crisis resulted from excessive exposures to SMEs and similar.
And so I have to conclude that for one reason I cannot really comprehend, the Financial Times does not really care about that capital requirement banks makes it harder for SMEs, and similar “risky”, to access bank credit.
And the truth is that FT’s silence on this issue makes it effectively a lobbyist for “The Infallible” accessing bank credit on preferential terms. I assume it is not on purpose.
February 14, 2014
Sir, the LEX Column, February 14, when referring to French banks, writes about how hard it is to provide a shareholder’s return when “pesky exceptionals keep butting in”.
But, the reality of “pesky exceptionals”, is the primary reason for which banks need to hold capital because if any ordinarily perceived risks are not adequately managed then the responsible banker should be fired or the bank must fail… or both.
Unfortunately that is precisely the big mistake of Basel Committee’s bank regulations… the capital requirements were set not based on the possibility of unexpected “pesky exceptionals”, but based on the ordinary perceived risks of the expected losses.
In other words, with Basel II, we had the misfortune to run into exceptionally pesky regulators; who we now have unfortunately allowed to keep on working on Basel III. In this respect not holding regulators accountable, is also turning us into pesky exceptionals.
February 05, 2014
Income derived from protected intellectual property should be taxed at higher rates than income obtained from competing naked.
Sir, Martin Wolf refers to “the role of rental income, particularly from intellectual property” as one explanation of “rising inequality of labor income and of the distribution of income between labor and capital”, “If robots divide us, they will conquer” February 5.
In this respect I would just want to note that for years I have argued that all income which results from an intellectual property that is being protected should be taxed at a higher rate, than any income that is produced by competing in the markets naked.
But I need also to express certain uneasiness with the concept of capital getting more and more rewarded than labor, because the truth is that, currently, because of artificially low interest, very much capital is almost not being rewarded at all. Many pensioners are not receiving what they should be receiving for that capital they worked and saved so hard to obtain.
Finally, with respect to the prospect of robots conquering us, I would hate that to happen, but, on the other hand, these would never ever come up with such crazy notions of basing the capital requirements for banks, those that should primarily be there to cover for unexpected losses, on the perceptions about the expected losses, and much less on these perceptions being correct.
January 18, 2014
What contains “expected losses” can also contain the “unexpected profits” we need for increased productivity.
Sir, in “Two challenges for the global economy”, January 18, with respect to a decline in economic productivity, you mention: “The solution lies in structural reforms aimed at allowing the most innovative sectors to expand”. That is correct. What is not correct is to believe that you can so easily, so besserwisser, identify what are the most innovative sectors… and so the market needs to be free to collaborate doing that.
But regulators currently impose on banks risk-weighted capital requirements, which wrongly, and stupidly, assumes that what is perceived to risk more expected losses, also risks more unexpected losses. And that is monumentally wrong. Not only does history show us that the worst “unexpected losses” most often derive from what was considered to have the smallest expected losses… but it also implicitly assumes that what risks a lot of expected losses, cannot contain huge unexpected profits, and that more than pay for any losses incurred.
And that double consideration for perceived risk discriminates all what is perceived as risky from fair access to bank credit… and impedes the markets invisible hand to operate freely.
While that regulatory mistake stays in place, our chances to produce the unexpected profits needed to change the current gloomy productivity outlook are indeed slim.
How on earth can regulators be so daft so as to believe that our future lies in the hands of banks playing it safe?
How on earth can regulators be so daft so as to ignore that asking our banks to play it excessively safe is truly dangerous for the economy and for the banks?
January 09, 2014
Sir, in “Europe must avoid false optimism” January 9, you recommend: “Mr Draghi should show more urgency, extending for example new liquidity to the banking sector via a fixed-rate longer-term refinancing operation”. For what purpose Sir?
You must know that given the scarcity of capital in the European banking sector, and the risk-weighting of capital requirements, that liquidity would not flow to where it is most needed, and would therefore only worsen the imbalances, like even strengthening “the lethal embrace between sovereigns and lenders”.
December 31, 2013
My New Year’s wish for FT. Wake up to what the risk-weighted capital requirements for banks really signify.
Sir, if banks could measure and price risks perfectly, then there would be no need for bank capital, as all expected losses and capital cost would be covered. But, since the measuring and pricing of risk is by nature imperfect, there will always be “unexpected losses”, and so regulators need to impose capital requirements for banks.
Unfortunately, the regulators decided that the “unexpected losses” would occur mainly in assets perceived as “risky”, probably because they confuse “unexpected” with ex-ante perceived risk, or because they only concerned themselves with individual banks; while I contend instead that the kind of “unexpected” which could threaten the stability of our whole banking system, is most likely to be found in the “absolutely safe” category.
And, requiring banks to reserve more for “unexpected losses” on “risky” than on “infallible” assets, allows banks to earn much higher risk-adjusted return on equity on the latter.
And, by allowing so, the regulators introduced a distortion that makes it impossible for banks to allocate credit efficiently in the real economy.
Tom Braithwaite ends his December 31 New Year’s “Reasons [for the banks] to be cheerful, despite the threat in the shadows” with “Even as regulators tighten the screws on the banks they seem unsure as to how much they want to police their shadow risks”.
If I could have a New Year’s wish about something that FT could do in 2014, then that would be to notice more how these regulations which discriminate based on ex ante perceived risks, really “tighten the screws” on the access to bank credit for all those ex ante perceived as riskier.
And, consequentially, to notice how that increases inequality, and hinders the banks from taking those risks that could help our young to have a future… those risks that generations before us took through the banks, so that we would all have a future.
And all for nothing, because at the end of the day, what those regulations guarantees, is that our banks are going to end up gasping for oxygen, in some dangerously overpopulated “safe-havens”.
PS. Reducing the risk of bank failures increases, exponentially, the risk of banking system failure.
December 30, 2013
Since risk-weighted capital requirements are still in place, nothing is really new on the dangerous bank regulatory front
Sir, Wolfgang Münchau quite remarkably writes “Don’t fret about asset prices – this time is different” December 29. For that he refers to “all the changes in global bank regulations”. What changes? The capital requirements for banks are still risk-weighted and so these still give banks huge incentives to dress up as absolutely safe what might not be.
And given that the banks have less capital after the crisis, and must therefore go to where capital is required the least, banks are most probably building up huge dangerous exposures to what is officially ex ante considered as “absolute safe”, like in Europe to the “infallible sovereigns”.
The Basel Committee has ordered the banks to report in January 2015 the leverage ratio, that which is based on not risk-weighted assets… and that could become a really scary report.
And frankly are we not to fret what could happen to asset prizes if a retreat of the quantitative easing is declared?
December 28, 2013
Sir you discuss capping pension fees in “Plug the deficit on pension regulations” December 27.
In it you hold that “workers need to save more… but they also need to invest wisely”, that “Vigilant regulation is needed to make sure that unsuspecting savers do not end up being pickpocketed”, and that “Savers should be grateful if business ideas that depend on charging unreasonable high fees never see the light of day”.
And solomonically you end holding that “Regulators cannot ensure that every provider charges a fair price. But they should give consumers the means of looking after themselves.”
How good of you! But why do you not dare to care more about how the future of current and future pensioners, like that of so many young without job, is pickpocketed by distortive bank regulations? These certainly cause much more damage than some unreasonable high fees.
“Invest wisely?” In an economy in which the capital requirements for banks are based on perceived risks already previously cleared for? In an economy where banks are therefore investing on preferential leverage terms in what is perceived as “absolutely safe”? Where are then pension funds to go? To finance railroads in Argentina perhaps?
December 27, 2013
Sir, of course “Insurers may be at the centre of the next big crisis” as Patrick Jenkins writes, December 27.
But when Jenkins describes AIG´s collapse in terms of it becoming “diversified so fast that it became impossible to manage and regulate”, he does not explain with sufficient clarity what really happened.
AIG, by having an AAA rating, was granted by bank regulators the gift of by lending its name, being able to reduce immensely the capital requirements for the banks. And that was worth so much in the market, that the banks went crazy borrowing AIG´s name and AIG lending it out… and no credit rating agency was fast enough to pick that up.
Had not Basel II been approved, something else bad could have happened to AIG, but not what happened. And I just wonder why this insistence on shielding the regulators from the truth that they were (and are) the party most responsible for the crisis, because of how they distorted all bank resource allocation, with their stupid capital requirements based on some perceived risks which are already cleared for by other means.
The members of the Basel Committee should be made to parade down our avenues wearing dunce caps. If there is one single spot where total accountability must be absolutely required, that should be in those committees that take upon them to design global rules for all.
The thought of having the same failed bank regulators given some powers to also regulate the insurers, “now a crucial part of the so called shadow banking sector” is as scary as can be.
Ms Tett. Not having a clue, “conventional blissful ignorance”, should not be confused with having an idea, “conventional wisdom”.
Sir, Gillian Tett writes “Ideas must adjust to new ‘facts’ of finance”, December 27. But as I see it therein she refers to what mostly had nothing to do with ideas, and all to do with simply not knowing. What Tett calls “conventional wisdom” is nothing but “conventional blissful ignorance”.
For instance “Before 2008 [leverage] seemed irrelevant”. Well go to all the initial reports on the 2007-08 crisis, and you will only be able to read about reasonable leverages… and that is because markets, and reporters, had no idea, most still do not have, of how much leverage could hide behind the risk-weighting of assets. Most of those compliant with “stricter Basel III capital rules” are still today, in not risk-weighted terms, leveraged over 30 to 1.
Tett also writes “Before 2008, it was almost outlandish to suggest policy makers might deliberately shape the direction of finance with policy interventions”. Really? What if not an extreme policy intervention is capital requirements based on perceived risks? That, which allows banks to earn much risk adjusted returns on their equity on assets deemed ex ante as “absolutely safe” than on assets deemed as “risky”, is for instance what drove the banks into the arms of those AAA rated securities which detonated the crisis.
And surprisingly Tett also states “Before 2008, policy makers liked to think they could mop up after excesses, if necessary, rather than intervene in advance. No longer.” What? Is not all Quantitative Easing going on based on the basic assumption that they will be able to mop it up before it all overflows into inflation?
Happy pondering Ms Tett!
December 21, 2013
QE is a drug that has been applied by the Fed in an emergency without going through any FDA type testing procedures
Sir, Barry Eichengreen considers that “The Fed’s monetary tweak is a tempest in a teapot” December 20.
But, considering the fact that the monthly reduction of $10bn in QE gets so much more attention than the $75bn that the Fed will keep on injecting in the economy, in a quite distortive way, all on the long side of the market, all for the treasury and the housing sector, then perhaps a teapot being in a tempest, could be a more adequate simile.
Eichengreen also holds that “the central bank has signaled that it is not prepared to return to normal times until a normal economy has returned”. Sorry, then we might never get there.
A normal economy will not return until regulators stop using risk weighted capital requirements for banks. Because these allow banks to earn much higher risk-adjusted returns on equity financing the infallible sovereigns and the AAAristocracy than when financing the “risky” medium and small businesses, entrepreneurs and start-up, they do the facto guarantee the market to be abnormal.
And Eichengreen ends by referring to Hippocrates… “It has at least done no harm” What? Is that not something yet to be seen?
December 20, 2013
FT, Martin Wolf, be brave, dare pickup the lessons of the crisis’s keys lying there under the lamppost.
Martin Wolf in “We still need to learn the real lessons of the crisis” December 20, refers to the search for the keys under the lamppost, only because that is “where the light falls”.
I would hold that with respect to what is currently happening, or not happening, with the economy and the banking sector, the keys have been there under the lamppost, for quite some time. The fact though is that very few seem to be willing to pick these up… and that could be because it would shine light on the sad fact that our magnificent global bank regulators, the Basel Committee and the Financial Stability Board, are just clueless.
Those keys are the risk-weighted capital requirements for banks based on perceived risks; those which allow banks to earn much more risk adjusted return on equity, when lending to the “infallible sovereign” and the AAAristocracy, than when lending to the “risky” like medium and small businesses, entrepreneurs and start-ups.
Those capital requirements being much lower for what was perceived as “absolutely safe” also guaranteed, when shit hit the fan, as always happens, and something ex ante very safe ex post turns out to be very risky, that banks would stand their naked with no capital.
In January 2003, while an Executive Director at the World Bank, FT published a letter in which I wrote: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors to be propagated at modern speeds”.
Of course if credit ratings are already being used to determine interest rates, size of exposures, duration and other terms, to re-clear for the same ratings in the capital, condemned banks to overdose on these.
And in November 2004 FT also published another one of my letters which stated “We wonder how many Basel propositions it will take before they start realizing the damage they are doing by favoring so much lending to the public sector”
And it is still happening, banks are searching for refuge in the arms of sovereigns all the while out the in the real economy those credit needs that could hold the jobs for our youth remain unsatisfied.
No, a world where banks are told not to finance the “risky” future but only refinance the “safer” pasts is in a death spiral. And on imprudent risk aversion I wrote on the FT’s Economists’ Forum blog in October 2009.
And so Martin Wolf, be brave, and pick the keys up! Let’s get rid of those dumb innovative bank regulations the Basel Accord brought us.
PS. Sir, I leave it to you to copy or not Martin Wolf with this. He has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.
December 18, 2013
You, not so old journalist of @FT, say something! Help take the economy out of the respirator and to send it to rehabilitation
Sir, Mr John Riding in “Negative rates will not help investment spending” December 18, comments on Larry Summers’ “thesis of secular stagnation”.
Riding writes: “It seems to me that the impediments to stronger investment spending in the US are not monetary in origin and forcing negative real or nominal interest rates would distort asset markets further without providing meaningful stimulus to the economy”.
And he is absolutely right. What is needed to promote stronger investment spending is to get rid of those senseless risk-weighted capital requirements which allow banks to earn much higher expected risk-adjusted returns on equity on “absolutely safe” exposures, than on “risky” exposures.
That stops banks from financing the “risky” future and to concentrate instead on refinancing the “safer” past… as if what is safe today was not quite often very risky yesterday.
Sir, again, though you have clearly shown you prefer to turn a blind eye to it, you must know for sure that, in order to become and remain strong, an economy requires a lot of risk-taking, as dumb risk aversion will only make it a weakling.
And while that risk-adverse bank regulation is in place, any type of outside assistance, be it fiscal stimulus or quantitative easing, will just put the economy in a respirator, instead of having it go to rehabilitation.
Any sign of growth you might see in the interim, is pure froth… or let´s say pure fat no muscles… in other words the economy turning dangerously obese.
How curious FT does not want that to be discussed. Might it be that most of its journalists are soon to be retirees and who all fit an ultraconservative investment profile?
I sure hope that at least some of FT's younger members find it in themselves to further the cause of astute risk-taking. For that they should just perhaps reflect on the fact that any investment adviser who provided them, at their ages, with the kind of advice the Basel Committee provide the banks, would soon be prohibited to give any financial advice… and would have any professional certification revoked.
December 16, 2013
If banks do well but the real economy falls, we will all fall… at the end including the banks. It is as easy as that!
Sir, it is hard for me to get a grip on what John Authers really means with heavily regulated when writing “Banking is complex, and must be heavily regulated”, “Volcker rule is doing its job despite Kafkaesque turns” December 16.
I say this because one single line of regulations, “capital requirements must be 10% of all assets”, would in my opinion be a more comprehensive regulation than the ten thousands of lines that will be derived from Basel III, Dodd-Frank Act and the Volcker rules.
Also, again, there is not a word about the purpose of the banks.
If the real economy does well, we will survive any bank crisis. If banks do well but the real economy goes down the drain, we will all fall… at the end, including the banks. It is as easy as that!
And in that respect I can also guarantee that my single regulatory line will distort the allocation of bank credit to the real economy, a thousand times less than the other referenced regulatory concoctions.
More than a new normal, stagnation has been decreed, by risk adverse regulators, as the new structural standard.
Sir, Lawrence Summers writes “The risk of financial instability provides yet another reason why pre-empting structural stagnation is so profoundly important”, “Why stagnation might prove to be the new normal” December 16.
And I do not know what to say to that. It was precisely well intended but horribly executed efforts to avoid financial instability which basically has decreed stagnation as the new standard.
When regulators risk-weighted capital requirements for banks, they allowed banks to earn much higher expected risk adjusted returns on assets perceived as “absolutely safe”, than on assets perceived as “risky”.
And that translates into bank credit, one of the most important drivers of growth, not going any longer go to finance the “risky” future, but only to refinance the “safer” past.
And how you can avoid stagnation with that kind of misplaced risk-aversion beats me.
Does Professor Summers really believe that the economies of West would have become what they are with that kind of bank regulations?
Any economy growth based solely on “easy money”, and not based on astute risk-taking, is doomed to solely become froth on the surface.
And all for nothing as the current financial instability has, as usual, been created by excessive bank exposures to what was officially perceived as “absolutely safe”, like AAA-rated bonds, real estate in Spain, loans to Greece etc.