To save the banks the regulators must admit their huge mistakes, and rectify these urgently and intelligently

Sir, Philippe Bodereau, the global head of financial research at Pimco writes: “To prevent… equity volatility [to] temporarily destabilise a large institution the European Central Bank must convince the equity market that rates will not go deeper into negative territory, capital requirements will not spiral higher in perpetuity and regulators will not move the goalposts on asset quality again.” “European banks’ crisis of earnings cries out for a quick Italian job” July 19.

I disagree because that is at best a very temporary solution. The banks and their shareholders in general, though specially the European, cry out for a real explanation of what is happening, and so that they can regain the trust in the future of banking.

This because the truth is that the current risk weighted capital requirements, those which allow banks to leverage their equity and the societal support they receive more with what is perceived as safe than with what is perceived as risky, are entirely unsustainable, for two reasons.

First, though they might allow banks to earn high risk adjusted returns on equity on what’s safe for quite some time, in the long run they will cause banks to dangerously overpopulate “safe” havens, which is precisely the stuff major bank crises are made of.

Second, as they impede the “risky”, like SMEs and entrepreneurs, to access sufficiently bank credit, the real economy will begin to suffer, and there is not a chance banks can expect to survive with a real economy in tatters.

Substituting a significant leverage ratio for the risk weighting, would eliminate the distortions.

That said it has to be done intelligently, so that the economy does not suffer an excessive credit squeeze. One way could be allowing banks to hold the capital originally required on all their current assets and have the new ones apply solely to any new assets.

Since that would, on the margin, reduce the demand of banks for safe assets such as loan to sovereigns, that would, on its own, help to avoid getting deeper and deeper into negative territory.

I would also suggest European finance ministers to look at Chile’s intelligent way of extricating its banks from very similar difficulties in 1981-1983

@PerKurowski ©

Might economists have spent too much time at their desks and too little on Main-Street to understand risks?

Sir, Tim Harford discusses how economists could have presented their case against Brexit more effectively. In doing so Harford refers to Dan Kahan, a Yale law professor, when arguing that “Giving people evidence that threatens deep beliefs is often counterproductive, because we start with our emotions and trim the facts to fit them”, “Economists face up to Brexit fail” July 9.

Interesting because that is very similar to what I have been asking myself:

How can I get my fellows economist colleagues to understand that, in banking, what is ex-post more dangerous, is what has ex ante been perceived as safe, and which therefore signifies that bank regulators are basically 180 degrees off the charts with their current risks weighted capital requirements for banks?

And how can I get my fellows economist colleagues to understand that if you allow banks to earn higher expected risk adjusted returns on equity when lending to what is perceived as safe than when lending to what is perceived risky, the banks will dangerously overpopulate the safe havens and, equally dangerously, under-explore the risky bays our real economy needs to be explored in order to move forward, so as to not stall and fall?

What deep beliefs do economists hold that block them from understanding risks? Might it only be they have spent too much time at their desks and too little on main street?

@PerKurowski ©

Where would Philip Tetlock or Robert Armstrong forecast the next bank system-threatening crisis to appears

Sir, I refer to Robert Armstrong’s lunch with Philip Tetlock, ‘It doesn’t matter how smart you are’, July 9.

How I would have loved being at that table and be able to ask them:

Gentlemen, where do you think the next major bank crisis resulting from excessive exposures to something really bad is going to happen, between something that was perceived as safe when incorporated to bank’s balance sheets, or between something that was ex-ante perceived as risky?

And applying simple common sense, and looking at empirical evidence, I would absolutely forecast the first, that what’s perceived ex-ante as safe is, ex-post, the much riskier.

And I ask this because our current regulators, with their risk weighted capital requirements for banks, forecast that what is ex-ante perceived as risky, is ex-post, what is truly dangerous.

In my mind they never heard of Voltaire’s “May God defend me from my friends [AAA rated]: I can defend myself from my enemies [BB- rated]”

And the biggest problem now is that, though the regulators were clearly proven wrong in 2007-08, they do not admit their mistake and they keep on forecasting the same.

Sir, if artificial intelligence is to help us, we must keep it free of weak human egos.

@PerKurowski ©

When compared to how risk adverse bank regulation help overcrowd safe havens, Brexit is but a small blip.

Sir, Gillian Tett writes about how the negative-yielding sovereign bond pile keeps swelling and argues that as a consequence “asset managers and insurance companies will see their earnings slide unless they start buying more risky debt — which will bring dangers of its own” “Now watch the shift in interest rates” July 1.

It is not “risky debt” that poses the largest risks, it is excessive exposures to what is perceived as safe that does. Just as Voltaire meant with his “May God defend me from my friends [AAA rated]: I can defend myself from my enemies [BB- rated]”

The current risk weighted capital requirements for banks, which drive banks out of what is ex ante perceived as risky, and into what is ex ante perceived as safe, only guarantees the safe havens to, ex post, become dangerously overpopulated; and the risky bays, equally dangerous to the real economy, to remain unexplored.

How many letters have I not written to FT over the years explaining that?

@PerKurowski ©