To get balanced economic growth using risk-weighted capital requirements for banks would require a miracle.

Sir yesterday, was the 10th anniversary of the G10 approving the absolutely senseless Basel II bank regulations. And here we are and still one of your star columnists, perhaps The Star, Martin Wolf, does not understand that getting a balanced economic growth with the distortions produced by the risk-weighted capital requirements, would require a miracle, “An unbalanced recovery is no cause for complacency”, June 27.

The risk-weight on a residential mortgage is 35%, but the risk weight for a loan to an SME or an entrepreneur is 100%. And bank capital can be leveraged 20 times more when financing the purchase of a residence, than when giving business those loans that could create the jobs that could help home buyers to pay their mortgage and their utilities.

Wolf correctly opines that the only way to regain balance “is via a huge (and extremely unlikely) investment surge”. Yes more than “extremely unlikely” while we allow bank regulators to play the Masters of Universe with their risk-management based on the same perceived risks that should already have been cleared for by banks.

PS. Sir, as always I leave it to you to decide whether to copy or not this comment to Wolf. I won´t since he has told me in no uncertain terms he does not want to hear more about this as he understands all there is to understand about the risk-weighted capital requirements… though clearly he does not!

Today marks the 10th anniversary of Basel II, Europe´s economic Waterloo, or financial Kristallnacht, and FT does not care.

Sir, on June 26, 2004 the G10 approved Basel II.

With those regulations some few unelected regulators who felt they knew more about risks than the rest of the world, and since they hated credit risks, decided to allow banks to hold much lower capital when lending to the absolutely safe than when lending to the risky.

And that meant banks would then be able to earn much higher risk adjusted returns on equity lending to the absolutely safe than when lending to the risky.

And so from that day on, all bank lending to medium and small businesses, entrepreneurs and start-ups started to dry up. And since it is precisely that kind of bank lending that which helps an economy to move forward, from that moment on the Western world economic bicycle started to stall and fall.

And all that, for no good “stability” reasons at all, since the real monsters that always threat the banking sector, are never ever those that look ugly and risky, but always those that look so adorable and safe.

And since Europe was the one who embraced Basel II the most from the moment go, to me, June 26, 2004, represent Europe´s economic Waterloo, or its financial Kristallnacht, a pogrom against the risky risk-takers, those who had helped Europe become what it had become.

And today June 26, 2014, it is with much sadness that I see Europeans do not really care. For instance, the Financial Times, presumably the most important financial paper in Europe, does not even mention the fact of the 10th anniversary of Basel II.

That same day the Basel Committee appointed a new financial Master Race... those stamped with an AAA rating, and gave it privileges... and you still wonder why inequality is on the rise?

For the banks to stay out of the shadows, their regulators must not hide in the shadows, or hide the sun.

Sir, in your “Banking must stay out of the shadows” June 21, you hold that “Regulators are better equipped institutionally to monitor risks and respond when threats arise”.

Sorry, the Financial Times, which has such a clear role to play as a critical observer, should never be allowed to make such a categorical statement.

The truth is that regulators are just as well capable of making everything so much worse, by means of how they monitor and respond to threats.

For instance current risk-weighted capital requirements for banks, is the consequence of regulators responding to their own monsters, with little considerations of what monsters could be dangerous for the banks; and so, by distorting the allocation of bank credit, their regulations turned into the real threat.

Could it really be that all you at FT fear the regulators so much you do not even dare to ask them… where they have found the causality between a borrower being ex ante perceived as risky, from a creditworthiness point of view, and a bank failing?”

Or is it that you are all ideologically programmed to favor regulators?

Yes, you do accept that “regulators must beware of creating new fragilities”, but that seems more like a simple salute of the flag, when you then write that “the authorities have done much to re-regulate banks”. That is not true … any re-regulation worthy of its name must begin with a full understanding of what went wrong… and that the regulators have until now refused to do… just as you at FT have refused to holding them accountable to do so.

Sometimes it is very hard to collect the money you win betting on where your mouth is

Sir, I refer to Tim Harford’s “Money where your mouth is” June 21. Suppose I had place money where my mouth was with the following:

“We have bank regulations that though requiring banks to hold 8 percent in capital when lending to businesses without credit ratings, allow banks to hold only 1.6 percent capital when lending to someone who has ex ante an AAA rating. And so I bet $1.000 on that, within the next decade, banks will lend much too much to some borrower ex ante rated as absolutely safe, but who ex post turns out to be very risky… and that this, aggravated by the fact that for that against that exposure banks had to hold little capital, will result in a major bank crisis.”

What would you had said about a bank regulator betting against me? And, if he had done so, would the current crisis not mean that I had won the bet, long before the decade ran out? But tell me…how would I collect my winnings?

I say this because banks regulators actually bet the whole banking system against my theoretical proposition, and I have not seen anyone paying up! On the contrary they have mostly been promoted. Like Mario Draghi, the former Chair of the Financial Stability Board, promoted to President of the European Central Bank. Like Jaime Caruana, the former chairman of the Basel Committee on Banking Supervision, promoted to General Manager of Bank for International Settlements.

Yes Tim Harford, “a world full of confident forecasts that nobody [including FT] never bothers to verify… is intolerable”. And so I would agree that “the world needs more wagers between pundits” but, before we start the betting, let us be sure there is a decent clearing house where these debts could be settled.

And when are investors to sue Blackrock and Pimco because of these experts lack of due diligence?

Sir, I read Camilla Hall and Luc Cohen reporting “Six banks sued over trustee roles” June 19.

What­? If Pimco or Blackrock had had any of those executives really deserving huge bonuses they hold they have, they should have know that if regulators authorized banks to hold securities rated as AAA, against a so meager 1.6 percent in capital, meaning they could leverage their own capital 62.5 times to 1, something very bad was going to happen, and so they needed to be very alert.

And so in this respect I ask, when are the Pimco and the Blackrock investors going to sue Pimco and Blackrock for the lack of due diligence?

If expert companies can try to get out of their buyer’s beware responsibility, why should not the small investors try?

Who brainwashed FT’s Sarah Gordon?

Sir, Sarah Gordon writes “The relationships between local lenders and their clients … were often too cosy, with loans handed over without the due diligence that should have accompanied them. Generations of family relied on one source of borrowing. Generations of banks asked too few searching questions about companies´ growth plans”, “Europe´s small companies get back in the funding picture” June 19.

Indeed Sarah Gordon, that is not good, but so what? Is that an excuse from locking out small businesses in general from access to bank credit, as the risk-weighted capital requirements for banks do?

Yes there has been many problems with some of these companies… but can you remember any one of them that caused so much damage as the AAA-rated securities backed with badly awarded subprime mortgages in the US, and which were so much in demand because regulators thought these to be so safe… only because credit ratings said so?

It is high noon for some intellectual honesty. Don’t you think so Sarah Gordon?

PS. And of course I am not picking on you specifically Sarah Gordon. In FT with respect to the distortions risk-weighted capital requirements produce, there are many much worse brainwashed than you! (As you know :-))

PS. And by the way, if it comes to too cozy relations, I much prefer those between banks and small to medium sized borrowers, than that between the banks and their infallible sovereign.

BoE, of course prudential bank regulations is not everything, especially when totally imprudent

Sir, Chris Giles writes “The Old Lady is right that prudential policy is not everything” June 19. Absolutely! And this is especially so when the prudential policy applied, is the wrong one.

Prudential bank regulations rule 1.

Whatever you do, beware of the dangers of distorting the allocation of bank credit in the real economy; precisely like what is being done now with the risk-weighted capital requirements for banks.

Prudential bank regulations rule 2.

Never forget that in the financial world what is perceived as “risky” is a thousand times less dangerous than whatever is perceived as “absolutely safe”; something which regulators have completely ignored with their current risk-weights in the risk-weighted capital requirements for banks.

If one gets ones prudential regulations right there is less need for monetary policies. If one does not get ones prudential regulations right, no monetary policy can make up for it… in fact it could make things much worse... adding to the distrust of the financial system the distrust in the currency.

For sturdy long term stability we need lots of short term instability, and bank regulations which do not distort.

Sir I refer to Paul Tucker´s “Financial regulation needs principles as well as rules” June 19,

Sir, I do not care much for stability in the financial system, if that stability impedes clearing out lousy banks or bankers, or if that stability is obtained by tools that hinder growth. In fact little can assure to bring on the sturdy long term stability we need, than the existence of a lot of short term instabilities.

And that is why I do get nervous when I read Paul Tucker asking regulators to go for “systemic stability” and to assign them “an explicit goal in preserving stability”… “Financial regulation needs principles as well as rules” June 19. Forget it! The unemployed European youth that could become a lost generation need moving forward more than they need stability.

But when Tucker writes “we need a clearer framework for the regulations of markets, articulated as a coherent whole and based on clear economic and policy principles addressed to real-world vulnerabilities” there I whole heartedly agree.

Problem is though that would indicate the importance of not distorting the allocation of credit to the real economy, which is precisely what the risk-weighted capital requirements do; and that out there, in the real financial world, what is most dangerous is not what is perceived as risky but what is perceived as absolutely safe, something which would point to that the risk-weighted capital requirements for banks are weighing risks 180 degrees in the wrong direction.

PS. Today in an Op-Ed in Venezuela I published “The capital control the IMF supports” you may want to have a look at it.

The capital requirements for banks based on perceived risk, distort the correct risk pricing that the market might have done.

Sir, Simon Johnson writes about the risk of “Concentrating risk with the laudable goal of reducing opaqueness”… “Chaos is brewing behind the clearing house doors” June 18.

Absolutely, that was precisely what happened when regulators decided to concentrate in the hands of very few human fallible rating agencies, so much of the risk perceptions in the banking system… and look at what happened.

But, when Johnson begins lining up AIG, Fannie Mae and Freddie Mac as causing big distortions in the pricing of risk, I do not agree. The most fundamental distortions in the pricing of risks are the result of the regulators, with their capital requirements for banks based on perceived risk, distorting the correct risk pricing that the market might have done.

Europe, don’t you wish your banks had been shadow banks, or at least were shadow banks now?

Sir, I refer to Patrick Jenkins’ and Sam Fleming’s analysis of shadow banks in Europe “Into the shadows – Taking another path” June 17. What a strange history telling!

First they quote Jean-Pierre Mustier, the former investment banking boss at France’s Societé Générale remembering “the dark days before the 2008 financial crisis” saying: “Before the crisis, there was a lot of ‘dark’ shadow banking… pushing chunks of loans… designed to dodge rules on excessive risk taking”, and write that “About $400bn worth of subprime loans and other assets… that had been coursing through the shadow banking”.

What? After Basel II was approved in June 2004, banks in Europe were allowed to hold AAA rated securities backed by subprime mortgages against only 1.6% in capital, signifying an authorized leverage of 62.5 to 1. The truth is that no shadow bank, no matter how defined, could never ever aspire to achieve such a leverage, unless in a fraudulent way.

Of course, a bank with a low risk portfolio could be allowed to hold less capital than a bank with a higher risk profile, but that would be one single capital requirement against its whole portfolio; and not as now, different capital requirements against different parts of the portfolio. Had it been like that the European banks would never had had the incentives to build up such huge exposures to the infallible sovereigns, the AAAristocracy or the housing sector, nor to abandon the “risky” small businesses the entrepreneurs and the start-ups.

Frankly, as is, the best chance that unemployed European youth has of not becoming a lost generation would seem to be for all European banks to run into the shadows.

Then the authors write that part of “the raison d’être of the shadow banks is arbitraging the regulated banking system”. Indeed but they should ask themselves first about who is serving up such incredible generous menu of arbitrage possibilities?

And we also read that “policy makers such as Mark Carney, governor of the Bank of England and head of the FSB, argue that some shadow banks will have to be supervised more like banks”. Europe, pray your shadow banks fast run deeper into the woods, way out of reach of these regulators who, with so much hubris, believe they should be the self appointed risk-managers of Europe.

For Europe to reduce the horrors of its house of debt, it needs to allow its risky-risk-takers to get going.

Sir, Wolfgang Münchau writes about a “balance sheet recession: the notion that indebted households and corporations do not care about cheap interest rates but just want to offload debt. When that happens monetary policy becomes ineffective” and then, salt on the wound, he quotes Moritz Kramer of Standards & Poor’s saying “The Europeans have barely begun to deleverage”, “Europe faces the horrors of its own house of debt” June 16.

Has Münchau ever heard that “when the going gets tough the tough get going”? If so I would ask him who he thinks might be the real tough in Europe. And I would advance that would be all those with a spirit of initiative who are willing to risk either their good name or whatever little capital they have, in order to take on a business venture.

And, if you agree, then reflect on that these are precisely those who are now locked out from having a fair access to bank credit by the sissy bank regulators and their risk-weighted capital requirements.

And so, if Europe is going to have a chance to reduce “the horrors of its own house of debt”, it must start by inducing banks to allow the risky-risk-takers of Europe, wherever you can find them, to get going. 

Given the real and urgent needs of Europe, the risk-weight on loans to “risky” medium and small businesses, entrepreneurs and start-ups, should be lower than that of their “infallible sovereigns.”

Mark Carney, do not use shadow banks to hide the mistakes committed by the regulators of the banks in the sun!

Sir I refer to Mark Carney’s “The need to focus a light on shadow banking is nigh” June 15.

Carney writes “In the run-up to the crisis, opacity in shadow banking fed an increase in leverage and a reliance on short-term wholesale funding. Misaligned incentives in complex and opaque securitisation structures weakened lending standards…The goal is to replace a shadow banking system prone to excess and collapse with one that contributes to strong, sustainable balanced growth of the world economy… As the G20 completes work on the core of the financial system, reforms to shadow banking must, and will, progress. Now is the time to take shadow banking out of the shadows and to create sustainable market-based finance."

Mr. Carney what on earth had shadow banking to do with the crisis? The current crisis was set off by an incredible misalignment of incentives caused by adopting risk-weighted capital requirements, in conjunction with assigning a risk perception monopoly to some very few human fallible credit rating agencies.

Does Carney really believe that the problem with the AAA rated securities backed with lousily awarded mortgages, the bubble of the real estate sector in Spain, the excessive loans given to sovereigns like Greece, and similar which could be financed by banks against basically no shareholders’ capital had much to do with the shadow banking?

No way José!

The only way G20 can do something worthwhile in terms of reform, is to accept with much humility that the risk-weighted capital requirements not only distort the allocation of credit in the real economy but are also, from a medium term financial stability perspective, utter nonsensical... since major bank crises never occur from excessive exposures to what is ex ante perceived as risky.

Most certainly Martin Wolf did not explain to Edmund Phelps how bank regulations are stacked against small banks and their clients.

Sir, Martin Wolf’s lunch with Edmund Phelps ends with Phelps saying “I would like to see the American economy go back to small banks rooted in communities where the banks know something about the local start-ups” "A romantic economist?" June 14.

Unfortunately Professor Phelps, that is impossible, because regulators have structured modern banking around the concept that those who are primarily to know the clients of the banks are not the bankers, but some credit rating agencies. And if by any chance the small bank would try to get to know his local client, and decided to trust him with a loan, then it would be required to hold much more capital since the Basel Committee seemingly believes that anything small and local has to be very risky.

Sir, most certainly Martin Wolf did not explain anything of this to Phelps, since he clearly thinks that this is of absolutely no importance.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as 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.

Fasten your seatbelts… according to the roads´ safety ratings?

Sir, I refer to John Kay´s “How the health and safety culture can curb moral hazard” June 11.

In it Kay writes “Fannie Mae and Freddie Mac would never have assembled such bloated balance sheets had those who lent to the US state-run mortgage finance companies not believed… that the government would protect creditors from any default” Why? If the mortgages were awarded correctly why should they not?

And I could equally say “Had it not been for regulators allowing banks to hold only 1.6 percent in capital against securities if rated AAA to AA, an authorized leverage of 62.5 to 1, there would never ever have been such a demand for such securities which drove everyone crazy and caused mortgages to be awarded badly.

When you tell people to fasten their seatbelts that makes sense… when you tell people that they have to fasten their seatbelts depending on the safety rating on the road… you are getting into very shady problems.

Kay also writes “If creditors are protected from risk, the long-term effect will be more risk in the system” Indeed but what if that more risk in the system serves a purpose, like loans to small businesses and entrepreneurs who could help to avoid our unemployed youth to become a lost generation?

As is, with the risk-weighted capital requirements for banks, we are only getting much more risk into the banking system by means of higher leverages on what is believed to be absolutely safe, something which is precisely the stuff that bank crises are made off and seemingly for no good purpose at all.

PS. With respect to the safety culture it can be taken too far. Yesterday in a row boat, in a small lake, probably surrounded by hundreds of security officers, we saw several European leaders sitting there with life vests on. I bet that Winston Churchill would never ever have thought of putting a life west on in such circumstances, much less if haven his photo taken.

The real hair-raising déjà vu is that risk weighted bank capital requirements of Basel II survive in Basel III.

Sir, John Plender refers to the Institute of International Finance and their looking at “the asset to GDP ratio” arguing “the risk that unless growth accelerates significantly in the future, economic growth will not create sufficient resources to service the developed world´s huge pool of assets, whose value will therefore have to correct at some point of time”, “Déjà vu as echoes of pre-crisis world mount” June 11.

Indeed but unfortunately there is not a chance in a million that growth will accelerate significantly in the future, if regulators keep discriminating against the fair access of “the risky” to bank credit.

In fact the real hair-raising déjà vu is seeing that Basel III still uses risk weighted capital requirements, those bound to discriminate against the “risky” risk-takers we risk adverse so much depend on.

When silencing my criticism of the distorting risk-weighted bank capital requirements, who were the Financial Times favouring?

Sir, Bilal Khan correctly explains in his letter some of the sad consequences of risk-weighted capital requirements, “Bank's reluctance on private lending is rational” June 11.

And Khan writes “We must ask ourselves why we continue with a regulatory system that failed to ensure any semblance of stability during the financial crisis… and now renders unorthodox monetary efforts to stimulate growth largely ineffective”

Well if Mr. Kahn would enter my blog TeaWithFT and review the several hundreds of letters that over many years I have sent the Financial Times on precisely this issue, he would have to conclude that one of the reasons we are beginning to hear about this problem only now in May-June 2014, is that the Financial Times decided to silence my voice of protest in order to favour… I do not who?

Just think of all the hundred thousands of bank loans that over this period could have been given to medium and small businesses, to entrepreneurs and start-ups, if only FT had helped me to argue on its pages about how immoral and outright stupid it is to distort the allocation of bank credit by discriminating against those whose access to bank credit is already sufficiently difficult because of being perceived as “risky”… and that even though no bank crisis ever has resulted from too much bank exposure to what was ex ante correctly or incorrectly perceived as being risky.

PS. I am sure the censuring treatment given to me must have made many of FT’s journalists quite uncomfortable.

If talking about the decline of morality of bankers, let us not forget that of their regulators... and of journalists.

Sir, John Plender referring to banks and bankers holds that “The crisis shows moral capital is in secular decline” June 10. And I am not going to argue about that, especially when I fully agree with his point of the need for retreating “from the obsession with punishing corporations rather than senior executives.

But when Plender writes about “the absence of an international regulator provided banks for ample opportunity for regulatory arbitrage”; and about how “banks shaped their business to minimise regulatory capital requirements”; and about the role of “lower capital requirements on mortgage backed securities relative to those on conventional mortgages” then he really ticks me off.

Mr. Plender if we are going to talk about morality in banking, those who have most breached it are the bank regulators who, with their capital requirements favored bank lending to “the infallible”, those who already were favored by bankers with higher loans at lower interest rates, and which translated into an outright discriminating against bank lending to “the risky”, those who already were being discriminated against by bankers with higher interest rates and smaller loans. That, in and on itself, was and is a truly immoral (and stupid thing to do)… as immoral it is for journalists and editors that should know better, to keep quiet about that.

Mr. Plender, it was the bank regulators of the Basel Committee, and no one else, who with their Basel II authorized banks to buy securities against only 1.6 percent in capital, if these were AAA to AA rated… and you should know that… or you should not be writing about these issues.

Central bankers and bank regulators are, no doubt about it, screwing up our economies.

Sir, I refer to Ralph Atkins and Michael MacKenzie’s first page report “Volatility ‘extinguished’ by moves from central banks” June 10, 2014.

In October 2004, soon ten years ago, as an Executive Director of the World Bank, I delivered a formal statement at the Board of Executives in which I wrote: “Phrases such as ‘absolute risk-free arbitrage income opportunities’ should be banned in our Knowledge Bank. 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.”

Perhaps no one at that time, in an international post as high as mine, warned as clearly as I did about what was happening.

Today, though now only as an insignificant citizen, I must say that the artificially induced low volatility has me even much more worried.

But, on the positive side of only being a citizen, is that you can spell out your opinions with less delicacy… and so let me put it like this:

Between the bank regulators, like the Basel Committee, telling the banks with their capital requirements where they can earn high risk adjusted returns on equity and where not; and as a result central bankers injecting funds which cannot go where they should go, these parties, acting with sublime hubris, believing themselves to be the masters of the universe, are really screwing up our economies.

When will regulators understand that it is only in what is ex ante “absolutely safe” that big systemic bank risks reside?

Sir Wolfgang Münchau approximates admitting to a problem of which I have written to him and to so many of FT´s other contributors over the years the years when he writes “Meanwhile, [European] banks want to reduce the amount risky lending so as to reduce the amount of equity they have to raise under new bank regulations” “Europe’s drifters wait but inflation never comes”, June 9.

I say approximate because first, the regulations of higher equity for what is perceived as risky are not that new… they took off in earnest with the approval of Basel II; and secondly, the real reason for which banks now need to raise new capital has really nothing to do with any lending to the “risky”, but with all the previous lending to some who ex ante were though as absolutely safe, and for which they were allowed to hold extremely little capital, but that ex post turned out to be very risky.

The day Münchau gets internalizes that bank lending to those perceived as risky has never been really risky, because of the high risk premiums collected and the usually very low exposures to them, that day he will put begin putting “risky” in quotation marks, and understand that what is really risky, without quotation marks, is what is perceived as absolutely safe… but could not be.

Of course, with the lack of capital and with the same risk-weighted capital requirements the chances for those unfairly considered “risky” for having fair access to bank credit are slimmer than ever.

Before there is a real and open discussion on who was it that authorized regulators to put the very short term stability of banks in the forefront, and distort the allocation of bank credit, and so endanger the medium and long term of Europe’s economy, and its banks, Europe will not get anywhere.

ECB, searching for inflation, while not allowing “risky” small businesses fair access to bank credit, is mindboggling silly.

We used to drill for the A-bomb threat… but got hit by the AAA-bomb.

Sir, I belong to that generation that Gillian Tett refers to and who in the 50s and early 60s crouched under tables preparing for the A-bomb threat, “From fire drills to firearm drills” May 31,

50 and some years later I am now wondering what drills could be useful for a society in order to avoid that kind of AAA-bomb the Basel Committee launched at our banks, when they allowed these to leverage their shareholder’s equity a mindboggling 62.5 to 1 times (or infinitely in the case of sovereigns) only because something got an AAA credit rating issued by humanly fallible credit rating agencies.