Bank systems’ “Fifth Risk”: When shit really hits the fan, banks will be holding especially little capital.

Sir, Brooke Masters reviews Michael Lewis’ “The Fifth Risk”, a book that got its titled when John MacWilliams, a former Goldman Sachs investment banker told the author about the “fifth risk”, referring to ‘project management’, the risk society runs when it falls into the habit of responding to long-term risks with short-term solutions.” “Why boring government matters”, November 3.

Well-intentioned bank regulators, wanting to make our bank system safer, and came up with risk weighted capital requirements based on the perceived credit risks. If the perceived credit risks (those that bankers saw and used to adjust to with size of exposure and risk premiums) do not represent the most immediate short-term outlook on risk for banks what does? 

The real long-term risk is obviously that something that was ex ante perceived as safe, and with which banks could therefore build up large exposures, suddenly, ex post turned out very risky. The regulators with their short-term solutions only guaranteed that when shit really hit the fan, banks would stand naked with especially little capital.

Brooke Masters quotes Ronald Reagan with “the nine most terrifying words in the English language are ‘I’m from the government, and I’m here to help’ ”.

Indeed! Just like when regulators told us “we credit rating agencies know all about risks so, with our regulations, we will make your bank systems safer”. As a result they gave us the 2008 crisis, way too much credit for house purchases, and mountains of 0% risk weighted sovereign debt around the world. If only they had stayed home.

Sir, “good boring government” is indeed needed, but beware, few things as dangerous as bored bureaucrats… they’re truly frightening.

@PerKurowski

If you want to fight short-termism, you have a better chance doing so by appointing teenagers instead of workers to the boards.

Sir, Prof Louis Brennan welcomes Senator Elizabeth Warren’s Accountable Capitalism Act proposal that “requires companies with more than £1bn in annual revenues” that which would require the largest corporations to allow workers to choose 40 percent of their board seats … “a welcome counterforce to the inherent logic in shareholder value that necessarily results in short-term decision-making”, “Humans will do things for which they are rewarded”, August 31.

In that respect I don’t understand why workers would be lesser humans and not so only do things for which they are rewarded. If you want to have a better chance for adding some long term views why not appoint some savvy teenagers to the board. They are the ones who have to live the longest with their decisions, and they are who probably are by means of social media those most held accountable to their peers.

If Senator Warren is really serious about fighting short termism, and is not only engaging in some redistribution profiteering, then she should be up in arms against the regulators’ risk weighted capital requirements for banks. These subsidize the access to bank credit of the safer present, and impose tariffs on the riskier future.

@PerKurowski

In terms of a short-termism that harms the long run, few are as guilty as current bank regulators.

Sir, Jonathan Ford quote US academic Lynn Stout with “The pressure to keep share prices high drives public companies to adopt strategies that harm long-term returns: hollowing out their workforce; cutting back on product support and on research and development; taking on excessive risks and excessive leverage; selling vital assets and even engaging in wholesale fraud.” “Shareholder primacy lies at heart of modern governance problem” March 5.

Indeed, but I hold that low investments and poor productivity is also the result of regulators’ risk weighted capital requirements for banks based on ex ante perceived risks. These focuses on making the banks safe today, at the price of making it all worse off tomorrow, ex post. How? Because they dangerously push banks to overpopulate, against especially little capital, those safe havens that have always been the main threats to our banking systems; and because they keep banks from exploring those risky bays, those with entrepreneurs and SMEs, those that could give us the growth and the jobs of tomorrow.

@PerKurowski

Low interest rates stimulate laziness in project execution and in revision of investment decisions

Sir, Izabella Kaminska is not going to be much loved today as she bravely points out to many the very uncomfortable possibility that they might have fallen head over heels “for fanciful narratives or investor cults”. Well done! That is going to generate a lot of soul-searching. “Cultish long-termism can hobble investors” September 13.

I would though like to remind Kaminska that much of “investors’ forgiving attitudes” could be explained by current extraordinary low interest rates. Just like these introduce much laziness in the execution of projects these can also provoke fewer revisions of investment strategies. Also, do not the sheer existence of negative interest rates help fuel the “grandeur of the futuristic visions being touted”?

PS. I would not refer to Andrew Haldane as a great champion for long-termism. As a regulator he has supported the extraordinary short-termism imbedded in the risk weighted capital requirements for banks. These keep banks from financing the “riskier” future our grandchildren need to be financed, having them basically just refinancing the “safer” present.

@PerKurowski

Patrick Jenkins, in banking, its current regulators lie out of their teeth’s, or are just incredibly dumb and inept.

Sir, Patrick Jenkins writes: “No sector, though, can compete with banking for the scale, depth, longevity or variety of lying that has infected a whole way of doing business.” “Bank bosses have to ensure that honesty is the best policy” March 14.

Perhaps but if so that lying is shared with its regulators.

Not a week goes by without at least one major financial media referring to Basel ratios that indicate banks are well capitalized. A responsible regulator should be out there answering such affirmations by reminding everyone that these ratios are; first not at all comparable with historic capital ratios based on non-weighted assets; and that they mean nothing if the risk weights are wrong. But the regulators don’t! They just play along. 

And to state that those rated AAA, those who regulators assign a risk weight of 20%, are more dangerous to the bank system than those rated below BB-, those who regulators assigns a 150% risk weight to, is a mindboggling blatant lie, or a stupidity out of this world… have a pick!

Jenkins concludes among other with “More important still is that bank bosses themselves prioritise long-termist decency over short-termist profit-chasing”

Few things are more short-termist, or less long termist, than allowing banks to leverage more their equity, which means earning higher risk adjusted returns, with what is “safe”, usually the past and present, than with what is “risky”, usually the future.

Just think of it, a 35% risk weight on residential mortgages, and one of 100% for SMEs. That would seem to doom our young to have to live without jobs, forever in their parents’ basements… or, if there is a reverse mortgage on it, until the house is repossessed by the bank.

And Sir, if not directly lying, is not keeping mum on it at least sort of withholding the truth?

@PerKurowski

More safer drones now- less risky feet on the ground. That’s great for now… but what about tomorrow?

Sir, Simon Kuper writes: “Every society tries to make the trade-off between security and freedom… According to Google, mentions of “freedom” exceeded mentions of “security” in English-language books every year from about 1830 through to 1985. In 1985, mentions of “security” surpassed “freedom” in books… We entered an era of compulsory seatbelts, bans on public smoking and laws against drink-driving.” “Safety first: the new parenting” October 1.

To which I would add that we also entered into the era of the risk weighted capital requirements for banks (1988 Basel I); with which regulators cared more about the short term safety of banks than about the long term safety of economy.

So when Kuper writes: “Every society tries to make the trade-off between security and freedom”, I would hold that de facto more often that represents a trade-off between short and long term security. That is because unfortunately, c'est la vie, security weakens and freedom strengthens. Simon Kuper, having cycled alone to school at age of eight, and comparing that to his daughter’s (perhaps even supervised) walk of one block to the bakery, knows what I mean.

And one major security issue is that security measures are not all equally applied. Out there, in the real world, there are still “savages” living in strengthening freedom, while we subject our young to suffer debilitating security. What that is going to mean to their future no one really knows… but while our kids are more comfortable [and “safer”] in their rooms socializing on computers, the “abandoned” are perhaps getting stronger and making the streets ever more insecure.

Don’t we wish we had the strength to allow our kids to be more savages? That strength can only come out of fully understanding and accepting the implications… we must allow them to take more risks. But it is so hard to gain acceptance for the concept that there’s nothing as risky as excessive risk aversion… especially when so many nannies are in charge.

Here we are, soon 10 years after a crisis that should have laid bare the stupidity of bank regulations that only lead to dangerous overpopulation of some safe havens (AAA rated securities and Greece) and equally dangerous under-exploration of risky bays (SMEs and entrepreneurs)… and the issue of the distortions it produces in the allocation of bank credit is not even discussed.

Sir, I do fret we, as a society, are slowly drowning ourselves in oceans of imagined security. Even our war capabilities are security driven… more safe drones - less risky feet on the ground. That’s great now… but what about tomorrow?

If our sons are not allowed to lose themselves, how on earth will they learn how to find themselves?

PS. I just refer to “sons” as I had only daughters, and both my grandchildren are girls, and you know it is not easy to live as you preach.

@PerKurowski ©

Martin Wolf should be careful throwing stones at “short-sighted elites”. He is part of it.

Sir, Martin Wolf writes of the “failings of short-sighted elites” “An elite at the mercy of its own creation” May 17.

I fully share the serious concerns Wolf expresses, though I do believe he points the finger way too much at the Republican elite, forgetting that it really takes two to tango.

But, that said, when it comes to blaming short-sighted elites, I must point out that Wolf himself should be very careful with throwing stones

Banks are currently required to hold more capital against what is perceived as risky than against what is perceived, decreed (sovereigns) or concocted (AAA securities) as safe. And that allows banks to leverage more their equity with what is safe than with what is risky. And so that allows banks to earn higher risk adjusted returns on equity with what is “safe” than with what is “risky”.

That sets up the banks to dangerously overpopulate existing safe havens; and that stops banks from exploring risky bays where new sources of growth and job opportunities for the next generation could be found. And if that is not short-sighted what is?

And Martin Wolf, one who we can guess considers himself as part of the elite, has preferred to ignore or to keep mum on the dumb credit risk aversion of the absolutely useless bank regulators hauled up in the Basel Committee.

Had Wolf helped to point out the dangers of such shortsighted regulations; the QEs and other such stimulus would not have been so wasted; the economy could evidence some signs of hope; and so there could be much less of that discontentment that facilitates the job of demagogues.

PS. In case Martin Wolf needs a refresher on Basel madness this aide memoire might be helpful

@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

Bank regulators are the most important pushers of shortsighted short-term capitalism

Sir, Sebastian Mallaby writes: “The US presidential frontrunner, the boss of McKinsey, and the chief economist of the Bank of England declare that capitalism is misfiring” and quotes Dominic Barton of McKinsey with: “the continuing pressure on public companies from financial markets to maximise short-term results”, usually at the expense of research and investment”, “Shortsighted complaints about short-term capitalism” August 7.

If companies cannot use investable resources, they should simply return those to the economy… and once there, the banks are the most important agents to recirculate those resources, to those who want to do something with these.

And that is where the real problem starts. Because now, with the current capital requirements for banks that are much higher when lending to what is perceived as risky than when lending to what is perceived as safe, regulators have de facto ordered banks to recirculate those resources to the old and existent economy, which is usually perceived as safer, and stay away from financing the future economy, which is usually perceived as riskier. And, if that is not short-termism, what is?

@PerKurowski

Current regulations impose on banks investment guidelines adequate for pensioners with very short life expectancy.

Sir Gillian Tett writes “Ms Yellen stressed on Wednesday that, if you want to understand monetary policy now, you have to take a long-term view” most probably taking refuge in Keyne’s principle of that in the long run we are all dead. “A bloated Fed prepares to shape up” June 19, 2015.

But what is sure is that regulators are applying strictly the short-term view. They make banks lend almost exclusively to what is perceived as safe, and thereby rewarded with ultralow capital requirements… is about the shortest termism one can think of. Like imposing on the banks portfolio investment guidelines adequate for a pensioner with very few expected years (or months) of life left.

Tett also writes: “When future historians write the story of finance in this decade, the current feverish debate about whether rates rise in September or December may appear a mere footnote in the great battle to make the Fed more “normal” again.”

That may be but let me assure you Sir, that future historians will marvel at the stupidity of the current capital requirements for banks… and of how most of the financial world, Ms Tett and you included, decided to ignore that.

@PerKurowski

The Financial Stability Board, one of the Great Distorters, goes at it again

Sir Brooke Master and Tracy Alloway write about how the Financial Stability Board is focusing on securities lending, like the “repo” market. “Shadow banks face fresh limits to trading” August 30.

The FSB wants to impose: “a minimum .05 percent haircut for corporate debt securities with maturity of less than a year – so a $100 security could be used to raise $99.50. Equities and securitizations made up of debt with durations of five years and longer would be hit by a 4 percent haircut” allowing consequentially these latter only to be able to raise $96 for each $100,

Here one of the great distorters goes at it again. Do they not understand that by differentiating between short and long term they are distorting how the markets will allocate financial resources.

Come on FSB, in general terms of stability, what is wrong with long term debt? In terms of needed liquidity... does not long term debt need that perhaps even more than short term debt?

And I sure hope that Mark Carney, the Bank of England governor, and the FSB chairman, was joking when he called the proposal “an essential first step towards… transforming shadow banking into market-based financing” If not… “Houston we’ve got a problem”

Regulators should take the beam out of their own eyes

Sir, Richard Lambert makes a reference to a research paper by Andrew Haldane, the Executive Director for Financial Stability, and Richard Davies of the Bank of England where they evidence an increasing short-termism in the pricing of company shares and conclude by blaming it all on a market failure, “Sir Ralph´s lessons on how to end short-term capitalism” May 23.

Short-termism is indeed a serious problem that derives from human weaknesses, but Messrs Haldane and Davies should start by taking the beam out of their own eyes. The mother of all short-termism is how the bank regulators, on top of how the market favors those perceived as less risky, also, by means of their risk-weights which determine the effective capital requirements for banks, shamelessly layer on their own favoritism of the same.

For a starter that regulatory short-termism created our current crisis by pushing our banks excessively into sovereigns and triple-A rated business. Also those regulations make it much more difficult harder and much more expensive for our small businesses and entrepreneurs to access bank credit… and if that is no short-termism what is?

http://subprimeregulations.blogspot.com/2019/03/my-letter-to-financial-stability-board.html