Bank regulators rigged capitalism in favor of the state and the “safer” present and against the “riskier” future.

Sir, Martin Wolf with respect to needed financial sector reforms mentions “Radical solution: raise the capital requirements of banking intermediaries substantially, while reducing prescriptive interventions; and, crucially, eliminate the tax-deductibility of interest, so putting debt finance on a par with equity.” “How to reform today’s rigged capitalism” December 4.

What has rigged capitalism the most during the last decades is the introduction of risk weighted bank capital requirements which rigs the allocation of credit in favor of the sovereign and that which is perceived, decreed or concocted as safe, and against the credit needed to finance the riskier future, like SMEs and entrepreneurs.

That distortion is no eliminated with general higher capital requirements like the leverage ratio introduced with Basel III, but only by totally eliminating the credit risk weighting.

Wolf expresses great concern “over the role of money in politics and way the media works” I agree. The reason why media in general, and FT in particular, have refused to denounce the stupidity with credit risk weighted bank capital requirements based on that what bankers perceive risky being more dangerous to our bank systems than what bankers perceive safe, is most probably not wanting to trample on bankers’ toes. As is, bankers are allowed to leverage the most; to earn the highest risk adjusted return on equity, on what they think safe. Is that not a bankers dream come true? As is, we are facing the dangerous overpopulation by banks of all safe havens, while the rest of us are then forced out to the risky oceans in search of any returns. 

“A ship in harbor is safe, but that is not what ships are for.” John A. Shedd.

http://teawithft.blogspot.com/2009/10/please-free-us-from-imprudent-risk.html

@PerKurowski

If there’s a re-vote on Brexit, what will the Remainers suggest Britain remains in?

Sir, Jeff Colegrave makes a well reasoned case of why, if there is a new vote on Brexit, it is on the Remainers’ shoulders to make very clear what they are supporting to remain in. “Remainers risk hubris without a positive case for the union” December 17.

The three outstanding problems Colegrave wants to have a clear definition on are:

How the Eurozone can avoid that a generation of youth becomes again sacrificed, on the altar of the common currency.

How the EU can avoid manifestly failing to adequately address the issue of migration. 

And “the lack of democratic political architecture within the European project, [which] cannot lightly be dismissed as some kind of arcane irrelevance. 

I could not agree more. I would be a committed Remainer, only if EU shows clear intentions to stop being such a Banana Union. You do not build a real United European States with a bureaucracy such as that currently present in Brussels.

Let me be clearer yet. If a Remain wins, the last thing British citizen, or all of their other EU citizens colleagues need, is for that to be presented as a triumph or an endorsement of Brussels.

PS: With respect to the sacrifices on the altar of the common currency, I have sent you many letters, in which I have blamed EU authorities for the tragic over-indebtedness of many euro sovereigns, when assigning to the public debt contracted in a currency that de facto is not their domestic (printable) currency, for purposes of bank capital requirements, a 0% risk weight. But of course these letters are ignored, because Per Kurowski suffers just an obsession about current bank regulations. 

@PerKurowski

Only a very dependent statist central bank would assign its sovereign a 0% risk weight.

Sir, Lord Skidelsky writes, “The failure of central banks to prevent — or even foresee — the 2008 financial crash stems directly from their acceptance of Eugene Fama’s efficient market theory, which implied that commercial banks needed only light regulation.” “Central banks should not set economic policy” December 13.

NO!

The risk weighted capital requirements for banks, by which banks, according to Basel II, could leverage limitless with sovereigns, 62.5 times with AAA to AA rated, and only 12.5 times with risky entrepreneurs and SMEs is anything but light regulation. It is a very heavy handed intervention.

Lord Skidelsky rightly says: “Most of the money pumped into the economy by quantitative easing leaked out into the financial and real estate sectors rather than stimulating the real economy”. Yes, but that was primarily so because some inept besserwisser regulators were/are convinced that what bankers perceive as risky, is more dangerous to our bank system than what bankers perceive as safe; and those having assets are usually perceived to be safer, something which ain’t necessarily so. 

Sir, also, let me be clearer yet; a central bank that agrees with a 0% risk weight of the sovereign is far from independent; it is a very dependent statist central bank.

@PerKurowski

Poor Italy! So squeezed between inept Brussels’ technocrats and their own redistribution profiteers.

Sir, I read Miles Johnson’s and Davide Ghiglione’s  “Italy’s welfare gamble angers Brussels and worries business” November 10, and I cannot but think “Poor Italy”, squeezed between inept Brussels’ technocrats and redistribution profiteers.

“Italy’s welfare gamble”? That welfare which Brussels’ technocrats, for the purpose of bank capital requirements have with their Sovereign Debt Privileges of a 0% risk weight helped finance? Italy’s public debt is now about €2.450 billion, meaning over €40.000 per citizen? 

That 0% risk weight is alive and kicking even though Moody’s recently downgraded Italy's debt to “Baa3”, one notch above junk status and that even though it might not have yet considered that the euro is de facto not a real domestic (printable) currency for Italy. If that is not a welfare gamble by statist regulators on governments being able to deliver more than the private sector, what is? Poor Italy.

But then I read about a government proposal that could increase welfare payments to poor and unemployed Italians to as much as €780 a month but which eligibility and distribution criteria remain unclear and again I shiver. That sounds just as one more of those conditional plans redistribution profiteers love to invent in order to increase the value of their franchise. Poor Italy. 

For me a way out that would leave hope for the younger generation of Italians would have to include a restructuring of their public debt with a big haircut for their creditors; hand in hand with an unconditional universal basic income, that starts low, perhaps €100 a month, so as to have a chance to be fiscally sustainable.

And if that does not help, then Italy will have to count (again… as usual) on its inventive and forceful strictly citizen based “economia sommersa”, something that is not that bad an option either.

PS. Oops! I just forgot that most of that Italy debt is held by Italian banks, so perhaps a type of Brady bonds EU version could be used. Like Italy issuing €2.4 trillion in 40 years zero-coupon debt, getting an ECB guarantee for a substantial percentage of its face value, and allowing banks in Europe to hold these on book on face value; all so that Italy can use it to pay off its creditors could be a shooting from the hip alternative… and then of course have all pray for some inflation to reduce the value of that debt.

PS. I am not the one first speaking about Nicholas Brady, then US Treasury Secretary, approach in 1989. Here is William R. Rhodes “Time to end the eurozone’s ad hoc fixes” in FT November 2012.

@PerKurowski

What’s a rule-based global system worth when the rules are crazy and rulers do not want to discuss these?

How would an ordinary European citizen answer the question: Is Greece a trustworthy borrower? Whatever his answer, what would you think he would say if he was then informed that the European Commission, for the purpose of bank capital requirements assigned Greece, and all other eurozone members, a 0% risk weight? As it is easy to understand that helped to cause the tragic over-indebtedness of Greece and of many other sovereigns, like Italy. 

Sir, you now write, “The Armistice anniversary is a time to reflect that the peace and stability of Europe will require responsible German leadership” “Drawing lessons from the inferno of 1914-1918” November 10.

So let me ask you do you really think The European Commission, the European Central Bank, the European Parliament, all of them, had, responsibly, the lessons of the Versailles Treaty in mind, when they imposed armistice conditions on that capitulating eurozone sovereign debtor of Greece?

Sir, you know that I consider requiring bankers to hold more capital against what they perceive as risky than against what they perceive as safe a total lunacy. Yet, those who imposed the risk weighted bank capital requirements global rule do not even wish to discuss it. Yet, “Without fear and without favour” FT has not dared to ask for an explanation.

The only explanation we have been given about the standardized risk weights imposed on bank by the Basel Committee; those that allow banks to leverage only 8.3 times with assets rated below BB-, and a mind-boggling 62.5 times with assets rated AAA, is “An Explanatory Note on the Basel II IRB Risk Weight Functions” of July 2005.

That document, which totally ignoring conditional probabilities equates ex ante perceived risks with ex post dangers also states, “The model [is] portfolio invariant [because] taking into account the actual portfolio composition when determining capital for each loan - as is done in more advanced credit portfolio models - would have been a too complex task for most banks and supervisors alike.”

Sir, I must tell you, if that’s the rule-based global system Donald Trump might now be threatening, we should at least be thankful for him shaking up many things that need to be shaken up.

I do not like autocrats in my country, but neither do I like them among the global order rules setter.

PS. In the case of the 0% risk weight of sovereigns in the Eurozone that is made even crazier by the fact that de facto the Euro is not their domestic currency.

PS. Where do I come from? Here is an extract of, “The riskiness of country risk”, September 2002: “What a difficult job to evaluate risk! If they underestimate the risk of a country, the latter will most assuredly be inundated with fresh loans and leveraged to the hilt. The result will be a serious wave of adjustments sometime down the line. If a country becomes bankrupt due to your mistake, it could drag you kicking and screaming before an International Court, accusing you of violating human rights. If I were to be in the position of evaluating country risk, I would insure that the process is totally transparent, even though this takes away some of the shine of the profession and obligates me to sacrifice some of my personal market value.”

@PerKurowski

Why should Donald Trump or Gillian Tett worry about US’s public debt when the experts, the bank regulators, assign it a 0% risk?

Sir, Gillian Tett, making it a Democrat vs. Republican issue, expresses anxiety about the US debt and suggests “a new version of the bilateral Simpson-Bowles Commission” “Investors start to fret about ballooning US public debt” November 9.

Sir, you know the regulators, for the purpose of bank capital requirements, assigned a risk weight of 0% to the sovereign debt of the USA and one of 100% to unrated American citizens (except when buying houses). That translates into that the interest rate politicians see is a subsidized interest rate, not its real cost. That dooms the US public debt to become, sooner or later, unsustainable… and especially so if markets begin to feel the US is losing its absolute military supremacy.

The bilateral Simpson-Bowles Commissionin 2010 presented many important recommendations that should be pursued, but it did not even mention the need to eliminate the regulatory subsidy to public debt.

Sir, unfortunately, getting rid of that distortion is no easy task, as regulators have really painted themselves into a corner. Can you imagine if regulators where to announce that the risk weight of US debt has been increased from 0% to 0.01%?

PS. In 1988, when with Basel I, statist regulators assigned that 0% risk weight the US debt was $2.6 trillion, now it is more than $22 trillion... but what has that to do with anything?

 

@PerKurowski

If not in US dollar notes under Warren Buffet’s mattress, what is Berkshire Hathaway’s “$104bn cash pile invested in?

Sir, you conclude that “Regulators and governments would do well to study whether the huge increase in repurchases has damaged business growth and capital formation” “Record share buybacks should be raising alarms” November 8.

Of course they should but let us be very clear, since that has been going on for quite some time so, if they have not done it yet, then shame on them.

For instance in July 2014 Camilla Hall, in “Bankers warn over rising US business lending” wrote, “Charles Peabody, a bank analyst at Portales Partners in New York, has warned that while it is hard to extrapolate what is driving commercial and industrial lending, if it is to fund acquisitions or share buybacks it may not indicate a strengthening economy. “It is loan growth, just not sustainable,” he said.” 

And therein Hall also wrote, “A banking lending executive at a large regional lender said ‘Traditionally banks have been very cautious of that’.”Of course, you and I know Sir that banker should not be throwing the first stone, since bankers too have morphed, thanks to the risk weighted capital requirements, from being savvy loan officers into being financial engineers dedicated to minimizing the capital their bank is required to hold.

Also, in 2017, when discussing IMF’s Global Financial Stability Report, John Plender wrote: “Low yields, compressed spreads, abundant financing and the relatively high cost of equity capital, it observes, have encouraged a build-up of financial balance sheet leverage as corporations have bought back equity and raised debt levels…Rising debt has been accompanied by worsening credit quality and elevated default risk.”

But what really caught my attention today was your reference to Berkshire Hathaway’s “$104bn cash pile [it holds] keeping its powder mostly dry for future deals — if, say, the market correction continues.”

How do you keep that powder dry? Since most probably it is not in dollar notes under Warren Buffet’s mattress, what is it invested in? We know that in accounting terms “Cash” includes a lot of investments, but in the real life, “Cash” does not always turn out to be real cash. In Venezuela you could now fill a whole mattress with high denomination bolivar notes, and still not be able to buy yourself a coffee with it. 

In a world in which regulators have assigned a 0% risk weight to for instance the already $22tn and fast growing US debt, which, if nothing changes, would doom that safe-haven to become very dangerous, is not Cash just another speculative investment?

@PerKurowski

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

EU authorities, assigning Italy, like Greece, a super duper investment grade status, are the original sinners.

Sir, Wolfgang Münchau writes,“The main instrument of coercion in the eurozone is not its fiscal rules, but the power of the European Central Bank to withdraw funding from national banks. This is not a discretionary power, but one that is automatically triggered once a country‘s sovereign debt loses investment grade status. If the banks have large holdings of their home countries’ debt, as is the case in Italy, they are setting themselves up for failure if their governments run an unsound fiscal policy” “Italy is setting itself up for a monumental fiscal failure” October 29.

“Triggered once a country‘s sovereign debt loses investment grade status”? Should in the first place Italy have gotten the super-duper investment grade status assigned to it by EU authorities? By mean of “sovereign debt preferences” they assigned it a 0% risk, which allow banks to hold Italian public debt against zero capital? Italy’s like Greece’s like many other and perhaps all other sovereign, the main problem is not losing that status but having been awarded it. 

And even if your 0% risk weight would be based on the nation being able, in nominal terms, to repay 100% of its debt, using the printer, the hard truth for Italy, and for all other eurozone countries is that though eurozone investors holding sovereign debt denominated in euros have the right to consider holding assets in their domestic currency, the eurozone sovereigns who owe such debt do not have  an absolute right to consider they owe it in their domestic currency.

In a 2002 Op-ed titled “The Riskiness of Country Risk” I wrote, “If the risk of a given country is underestimated it will most assuredly be leveraged to the hilt. The result will be a serious wave of adjustments sometime down the line.” That, which hit Greece, now awaits Italy, courtesy of EU.

Sir, it is not obsessive me again. September 2013, in FT, Jens Weidmann, the president of the Deutsche Bundesbank begged, “Stop encouraging banks to buy government debt”. What has EU done about that? Nada! 

Münchau ends with “The eurozone’s dysfunctionality has many origins. It would be unfair to blame it all on Italy. The rise in Italian spreads is evidence that the eurozone crisis never ended. It just fell dormant for a while.”

That is entirely correct, the saddest part though is that the challenges posed by the euro were known, from the get-go.

Sir, as I’ve told you many times before, it is truly mind-boggling how in all the overheated Brexit/Remain discussions that divide Britain, so little attention has been given to the EUs own very delicate conditions.

@PerKurowski

Those who fell for the “We will make your bank systems safer with our risk weighted capital requirements” populism should not throw the first stone

Sir, Martin Wolf reviewing three books related to the rise of populism writes “Populist forces are on the rise across the transatlantic world … It may also prove to be a historical turning point, away from liberal democracy, global capitalism, or both.”“The price of populism” October 27.

Indeed, but to me that started some decades ago when bank regulators, as if they where clairvoyants, told us they could make our banks systems safe by imposing risk weighted capital requirements on banks. “Wow, risk-weighted, that’s sure scientific!” 

Sir, if that’s not populism what is? The world, FT and even Martin Wolf fell for it, lock stock and barrel.

Referring to Robert Kuttner’s “Can Democracy Survive Global Capitalism?” Wolf agrees when Kuttner mentions the “incompetent deregulation of finance, especially the growth of short-term cross-border capital flows and the plethora of regulatory loopholes.”

Really? When regulators allowed with Basel II to leverage 62.5 times with assets human fallible credit rating agency have assigned AAA to AA rating, what more loopholes do you really need?

Kuttner also argues against “the disastrous counter-revolution of the 1980s and the relaunch of deregulated capitalism” NO! What “deregulated capitalism” can there be when regulators assign a risk weight of 0% to the sovereign and one of 100% to the unrated citizens? That Sir is regulated crony statism.

@PerKurowski

Italy’s mostly domestic debt is denominated and must be served, in a mostly foreign currency, the euro.

Sir, Isabelle Mateos y Lago informs that “the bulk of sovereign debt is owed to Italian residents rather than eurozone governments.” “Greek debt crisis echoes resound in Italy’s face-off with Brussels” October 25.

EU’s authorities assigned to all sovereigns using the euro, by means of something called “Sovereign Debt Privileges”, for purposes of the risk weighted capital requirements for banks, a 0% risk weight

The only way one could foreseeable defend such outright statist idiocy, is with the argument that nations are always able to nominally pay their debt by printing themselves out of too much debt. Unfortunately these euro nations do not have their own euro-printing machine.

The challenges with the adoption of the euro twenty years ago were immense and surely known by many. Myself, far away from Europe, in Venezuela, in November 1998 published an Op-Ed titled “Burning the bridges in Europe”. In it I wrote: 

“The possibility that the European countries will subordinate their political desires to the whims of a common Central Bank that may be theirs but really isn’t, is not a certainty. Exchange rates, while not perfect, are escape valves. By eliminating this valve, European countries must make their economic adjustments in real terms. This makes these adjustments much more explosive.”

So here we are with mindboggling little having been done to solve the euro challenges. Pushing more debt on needing sovereigns basically just kicked the can containing the euro’s problems down the road.

Mateos y Lago concludes: “Italy is too big and strong to be pushed around. So Italians will decide their own fate. The others should redouble efforts to survive this potential wrecking ball. This means adopting European Stability Mechanism instruments that would allow near instant access to OMT to well-run countries suffering from contagion, and provide some form of collective insurance against bank runs for institutions that meet agreed criteria” Indeed but that is again just pushing the euro challenge forward upon the next in line.

That, to me, sounds just like “Let’s kick the euro-problem can down the road again!”

Sir, as I’ve told you many times before, it is also mindboggling how in all the overheated Brexit/Remain discussions, so little attention has been given to the EUs very delicate conditions

@PerKurowski

Allowing banks to hold sovereign debt against the lowest capital is evil, as it dooms nations to unsustainable levels of public debt.

Sir, Miles Johnson, Kate Allen and Federica Cocco report “Italian bank shares were hit yesterday after the Fitch credit rating agency said banks’ balance sheets were under pressure because of their exposure to Italian government debt.” “Italy’s central bank warns of slowdown” October 21.

Here we go again!

In a 2002 Op-Ed titled "The Riskiness of Country Risk I wrote": “What a difficult job for those assigning credit ratings to sovereigns! If they overdo it and underestimate the risk of a given country, the latter will most assuredly be inundated with fresh loans and will be leveraged to the hilt. The result will be a serious wave of adjustments sometime down the line. If on the contrary, they exaggerate the country’s risk level, it can only result in a reduction in the market value of the national debt, increasing interest expense and making access to international financial markets difficult. The initial mistake will unfortunately turn out to be true, a self-fulfilling prophecy. Any which way, either extreme will cause hunger and human misery.

In his book The Future of Ideas: The Fate of the Commons in a Connected World” Lawrence Lessig maintains that an era is identified not so much by what is debated, but by what is actually accepted as true and so is not debated at all. In this sense, given the risk that the perceived country risk actually becomes the real country risk, it is best not to assign an AAA rating blithely to credit rating agencies—perhaps not even a two-thumbs-up.”

In 2004, in a letter published by FT I asked “How many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector?” 

Then by means of the “Sovereign Debt Privileges” or “Equity Capital Privilege” enacted by EU authorities, Greece was assigned, for the purpose of the risk weighted capital requirements for banks, a 0% risk weight... and consequently it went down the tubes.

A 2017 paper by Dominik Meyland and Dorothea Schäfer titled “Risk weighting for government bonds: challenge for Italian banks” and produced by the German research institute DIW Berlin states: “Although banks are required to document their equity capital for loans, corporate bonds, and other receivables, they are currently exempted from the procedure when investing in government bonds: they enjoy an “equity capital privilege.” As part of the Basel III regulatory framework redraft, the privilege may be eliminated in order to disentangle the default risks between sovereigns and banks. The present study examines how much additional equity capital the banks of the euro area’s major nations would require if the equity capital privilege were eliminated. At nine billion euros, the estimates show the highest capital requirement for Italian banks… The primary reason for this is that Italian banks hold relatively large amounts of Italian government bonds” 

That paper was written when “Italian government bonds had a Fitch Rating of BBB+, yielding a risk weight of 50 percent based on the [Basel II] standard approach.”On August 31 Reuters reported “Fitch Ratings on Friday cut Italy’s sovereign debt outlook to ‘negative’, citing expectations that the new coalition government’s fiscal loosening would leave the country’s high levels of debt more exposed to potential shocks.” If Italy’s rating drops further, those capital requirements would only increase… or worse losses having to be recorded.

I wonder if EU will put the blame solely on Italy as they did with Greece, ignoring they caused the tragedy with their “Sovereign Debt Privileges”.

The DIW Berlin paper also states: “German banks also exhibited a strong home bias, but German government bonds have an AAA rating. Unlike the Italian banks, the German banks’ home bias is thus inconsequential regarding the banks’ capital needs.”

So I would say that Germany is also on the same 0% sovereign risk weight road that took down Greece, and sadly, perhaps Italy too.

When will they ever learn? 

@PerKurowski

The dangers of the unknown unknowns are greater than those of the known unknowns.

Sir, Martin Wolf asks, “Is it possible to know the state of the UK public finances under present conditions?” He answers “No. The unknowns are too great.” “Some ‘known unknowns’ about the UK economy”, October 19.

Indeed, but to me, the most dangerous unknowns for the UK, and for much of the rest of the world, are the “unknown” unknowns. 

Like how much of the savings for the future, of those who are the least able to manage major upheavals, has been invested in houses; those homes that because of so much preferential finance increased their prices so much, that they were turned into also being risky investment assets?

Houses are good investments… until too many want to convert them simultaneously into main-street purchasing capacity.

Like how much of the illusion of public debt sustainability is solely the result of preferential regulations, like the Basel Accord of 1988 decreeing a 0% risk weight to sovereigns and a 100% risk weight to citizens?

Any sector given more preferential access to credit than other is doomed to unsustainable debt… just like Greece was doomed by the 0% risk weight some yet unknown EU authorities awarded it.

Sir, when compared to these in general unknown unknowns, the known unknowns, like Brexit or trade wars, are just peanuts. 

@PerKurowski

Many “independent” central banks, like the Fed and ECB, are behaving as statism cronies

Sir, Michael G Mimicopoulos, when commenting on your editorial “The long bull market enters its twilight period” (October 13), writes“The debt of non-financial companies in the US, which has risen to 73.5 per cent of GDP, an all-time high… Companies have been borrowing money to buy back their own stock, to increase earnings per share rather than pay down debt.” “Fed should be viewed against its record” October 17.

Absolutely and that has been going on in front of Fed’s eyes; just like banks have been shedding assets which require them to have more capital, in order to show better capital to risk weighted asset ratios.

Fed independence? Central banks that approve of a 0% risk weighting of their sovereign with a 100% for citizens, keep interest rates ultralow, and launch quantitative easing programs purchasing loads of sovereign debt, can hardly be called independent, much more statism cronies.

@PerKurowski

What we have is not by a long shot economic liberalism, it is much more statism, and of the crony kind.

Sir, Martin Wolf refers to Yascha Mounk of Harvard University arguing “that undemocratic liberalism, notably economic liberalism, largely explains the rise of illiberal democracy: ‘vast swaths of policy have been cordoned off from democratic contestation’, [carried out] by international agreements created by secretive negotiations carried out inside remote institutions.” “Saving liberal democracy from the extremes” September 25.

Hold it there! The Basel Committee for Banking Regulations, with Basel I of 1998 decided, without any real public consultation, that the risk weights for those risk weighted capital requirements it itself concocted, were to be 0% the sovereign and 100% the citizens. What has to do with “economic liberalism”? Nothing! To me it is pure unabridged statism… that is unless it is derived from pure unabridged stupidity.

Ignoring that allows Wolf to opine, “What is true is that poorly managed economic liberalism helped destabilise politics… and to argue, “Elites must promote a little less liberalism” 

Again, no! Mr. Wolf (for the umpteenth time), we are not living a time of “poorly managed liberalism”, we are living thru times of expertly camouflaged statism, that which is so beneficial to the redistribution profiteers and to those of the private sector who love to engage in crony statism.

Sir, all journalists, even those considered its elite, have a duty to denounce that; less they might be accused of covering it up. I mean should not journalists be the citizens’ frontline for any “democratic contestation”? 

How many times have I asked Martin Wolf to use his influence to ask the regulators: “Why do you want bank to hold more capital against what’s perceived as risky and is therefore less dangerous to our bank system, than what is perceived as safe and that, precisely because of that, becomes so much more dangerous to it? Hundreds? Has he dared to ask it? Not that I know Sir. Though perhaps he just did not like the answer or the non-answer 

@PerKurowski

The one most worthy and in need of a “teachable moment” is the European Union itself.

Gideon Rachman“fears that Britain is heading towards what counsellors call a “teachable moment”, otherwise known as a traumatic experience that forces people (or nations) into a fundamental reassessment.” “Britain is poised to learn a hard Brexit lesson” September 25

To that purpose Rachman mentions, “Greece experienced not triumph but humiliation – as its government was forced to accept the bailout that it had just rejected.”

Indeed, but the one who would best have been helped by a “teachable moment”, that would be the EU itself; which could have happened if only Greek citizens had sued EC, for allowing banks to lend to the Greek sovereign against zero capital of their own, which of course doomed the Greeks to their tragedy.

Does Britain or any EU nation really want to end up like Greece? I believe not. For that not to happen all Europeans need to call out their authorities on much more, instead of silently swallowing EU’s marketing efforts; thankful for being able to freely visit each other; something that when you get down to it does not really require a European Union for it, as neither does free trading, as neither does being able to work or reside in any EU nation for that matter.

How long will techno/bureaucrats, in EU or anywhere be able to extortionate more power for themselves, or increase the value of their redistribution franchises, by offering the citizens goodies these could obtain by other simpler means?

For instance the day an unconditional Universal Basic Income is adopted, that day we will be able to rebalance much more power in favor of citizens and lessen that of those all who engage in the crony statism that is killing us slowly. 

Does a teachable Brexit moment preclude something very good coming out from it? I don’t think so; I have too much respect for the Brits. Perhaps they can even help to save EU.

@PerKurowski

The pulmonary capacity of banks went from unlimited, through 62.5, 35.7 to 12.5 times of allowed leverage. Where do you think bubbles were blown?

Sir, I refer to John Authers review of “Ray Dalio’s” “A Template for Understanding Big Debt Crises” September 22, 2018.

I have not read the book, and something in it could apply to other bubbles but, if Dalio left out mentioning the distortions produced by the risk weighted capital requirements for banks, those that caused the 2008 crises, he would surely have failed any class of mine on the subject.

Sir, let me be as clear as I can be. 100%, not 99%, 100% of the bank assets that caused the 2008 crisis were assets that, because they were perceived as especially safe, dumb regulators therefore allowed banks to hold these against especially little capital. 

The allowed leverages, after Basel II, that applied to European banks and American investment banks like Lehman Brothers were:

AAA rated sovereigns, including those the EU authorities authorized, like Greece, had a 0% risk weight, which translated into unlimited leverage.

AAA rated corporate assets, were assigned a risk weight of 20%, signifying a permissible 62.5 times leverage.

Residential mortgages were assigned a risk weight of 35%, translating into a 35.7 allowed leverage.

Of course, after the crisis broke out, any few “risky” assets banks held, like loans to entrepreneurs, those that banks could only leverage 12.5 times with went through, (and still do), a serious crisis of their own, when banks began to dump anything that could help them improve that absolutely meaningless Tier 1 capital ratio.

http://subprimeregulations.blogspot.com/2016/12/here-is-succinct-but-complete.html

@PerKurowski

No coroner has asked for a postmortem examination of the global financial crisis to be performed by a truly independent pathologist.

Sir, Nouriel Roubini writes:“As we mark the 10th anniversary of the global financial crisis, there have been plenty of postmortems examining its causes, its consequences and whether the necessary lessons have been learnt” “Policy shifts, trade frictions and frothy prices cloud outlook for 2020” September 12.

Yes, many postmortems but none performed by a truly independent pathologist. 

Had that occurred he would have established that absolutely all assets that caused the crisis were those banks were allowed by their regulator to leverage immensely, because these were perceived, decreed or concocted as safe.

And from that he would have reported, not a lack of regulation but missregulation; and not excessive risk taking but excessive exposures to AAA rated securities, residential mortgages and 0% risk weighted sovereigns, like Greece.

And after such a report it is clear there would have been a total shake up of that group-thinking mutual admiration club known as the Basel Committee for Banking Supervision.

But since that report would have contained so many of truths that shall not be named, it never saw light, and consequentially the lessons have not been learned. 

Therefore the distortions in the allocation of credit have remained; something which has caused all the mindboggling large stimuli, like Tarp, QEs, fiscal deficits, growing personal debts that anticipate demand, and ultralow interests, to only result in kicking the crisis can forward and higher.

Sir, I have never been a bank regulator but from very early on I disliked much of what little I was seeing; and as an Executive Director of the World Bank I formally warned in 2003 against “entities such as the Basel Committee, accounting standard boards and credit rating agencies introducing serious and fatal systemic risks”

When later I discovered aspects like the runaway statism that was reflected into risk weights of 0% the sovereign and 100% the citizen; and the Basel II naiveté of allowing banks to leverage 62.5 times assets only because these had been rated AAA to AA by human fallible credit rating agencies, I could just not believe we had fallen so low.

Now, 10 years after the crisis, sadly, I am still waiting for any important authority to ask the regulators: 

“Why do you want banks to hold more capital against what by being perceived as risky has been made more innocous than against what by being perceived as safe poses so much more dangers to our bank system. Have you not heard about conditional probabilities?”

PS. Here is a somewhat more extensive aide memoire on the mistakes in the risk weighted capital requirements for banks.

@PerKurowski

What would happen to the yield curve if regulators dared to increase, ever so little, their current 0% risk weight for US Treasury debt?

Sir, Megan Greene discusses how the yield curve the spread between long- and short-term bonds may be influenced by, “The US Treasury is currently borrowing more money to finance predicted big budget deficits and it has mainly done so with short-term debt… and global quantitative easing has created a seemingly insatiable demand for five- to 10-year Treasuries, pushing down yields.” “How central banks distort the yield curve’s predictive power”, September 4.

But that’s not all the distortion in force. The risk weighted capital requirements for banks might distort even more; we recently saw how Greece was taken down by the 0% risk weigh EU authorities assigned to its debt, which caused European banks to drown in it, until they got rescued, by the victim Greece having to take on even more debt.

If the US, in face of its ever growing public debt, suddenly sees it as its responsibility to increase the risk weight of it, so that the interest rates send more correct signals, then I would hold that the rate on all longer term bonds would immediately shoot up, and many banks around the world would stand there with huge losses on their books. 

I here you “That will just not happen? Yes, they have with that 0% risk weight painted themselves into a corner but, sooner or later, there needs to be some adults in the room who start working against having to face a scenario of total collapse; this time with much less tools available than the last time they kicked the can down the road in 2007 2008 … or at least so we hope… or at least so we pray.

PS. Here on research that is still missing 

@PerKurowski

To really understand the 2007-08 crisis, it is the ex ante perceived risks that should be used, and not the ex post understood risks

Sir, Martin Sandbu, when reviewing Ashoka Mody’s “EuroTragedy: A drama in nine acts" writes: “Mody nails the biggest policy error of them all: the insistence that euro member states could not default on their own debt, or allow their banks to default on senior bondholders.” “A crisis made worse by poor policy choices” August 6.

That refers indeed to a great ex-post crisis policy error, but not to the biggest error of all, that which caused the crisis, namely the ex ante policy of the regulators, for the purpose of their risk weighted capital requirements for banks, assigning all EU sovereigns, Greece included, a 0% risk weight.

Mody (on page 168) includes the following: “If, for example, €100 of bank assets generate a return of €1, then a bank with €10 of equity earns a 10 percent return for its equity investors, but a bank with only €5 of equity earns a 20 percent return.” Though not entirely exact (because it might be slightly more difficult to generate that €1 with less capital) it shows clearly Mody understand the effect on returns on equity of different leverages.

But what Mody, and I would say at least 99.9% of the Euro crisis commentators do not get, or do not want to see, or do not dare to name, is that allowing banks different leverages for different assets, based on different perceived, decreed (or sometimes concocted) risks, distorts the allocation of bank credit to the real economy. In the case of the Euro, the two shining examples are: the huge exposures to securities backed with mortgages to the US subprime sector that, because they got an AAA to AA rating, could be leveraged 62.5 times; and the exposures to sovereigns, like Greece.

Sir, let us be clear, there is no doubt whatsoever that, had for instance German and French banks have to hold as much capital/equity against Greece that they had to hold against loans to German and French entrepreneurs, then they would never ever have lent Greece remotely as much.

The other mistake that Mody in his otherwise excellent book makes, and which is one that at least 99% of the crisis commentators also make, is that they fall into the Monday-morning-quarterback trap of considering ex post realized risks, as being the ex ante perceivable risks. Mody refers in the book to that George Orwell might have written about narrating history “not as it happened, but as it ought to have happened” In this case the risk referred to, are not the risks that were seen but the risks, we now know, that should have been seen.

Sir, Ashoka Mody’ EuroTragedy has so much going for it that it merits to be rewritten. Just reflect on what it means for the Greek citizens having to pay the largest share of sacrifices, for a mistake committed by European technocrats.

PS. Mody goes into the details of the demise of “the smallest of Wall Street’s five top tier investment banks” Bear Stearns. It “was an accident waiting to happen… it had borrowed $35 for every dollar of capital it held”. Had Mody added the fact that Bear Stearns had been duly authorized by the SEC to leverage this much and even more, the recounting of the events would have been different.

@PerKurowski