By not asking all the questions that need to be asked, journalists also fail society.

Sir, Henry Manisty writes “financial journalism plays a vital role in upholding the integrity of financial markets”, “EU regulators have form on obstructing journalists” November 9.

Indeed, but in many respects, financial journalists have often failed society by not doing that. For instance, here are just three examples of questions that should have been posed directly to the regulators, long ago.

We know that those excessive bank exposures that can be dangerous to banks and bank systems are always created with assets perceived as safe, never ever with assets perceived as risky. Therefore, can you please explain your risk weighted bank capital requirements based on that what’s perceived as risky is more dangerous than what’s perceived as safe?

Before risk weighted bank capital requirements credit was allocated on the basis of risk adjusted interest net margins and a view on the portfolio. After that it is allocated based on risk adjusted returns on equity; which obviously those that banks can leverage less with, e.g. “risky” SMEs and entrepreneurs. Explain how this does not distort the allocation of bank credit?

Even though none of Eurozone sovereigns can print euros on their own, for your risk weighted bank capital requirements you decreed a zero-risk weight for all of their debts. What do you think would have happened in the USA if it had done the same with its 50 states?

Sir, paraphrasing Upton Sinclair one could say that “It's difficult to get a journalist to ask something, when his salary, or being invited to Davos, depends on his not asking it.”

PS. My 2019 letter to the Financial Stability Board (FSB)

Myths, and truths that shall not be told, is why so little has changed since the financial crash

Sir, Martin Wolf writes: “The financial crisis was a devastating failure of the free market… The persistent fealty to so much of the pre-crisis conventional wisdom is astonishing.” “Why so little has changed since the financial crash” September 4.

Myths and truths that shall not be told, so that regulators shall not be held accountable, is the cause of that, not the failure of markets that were not free by a long shot. Here follows some of the more important of these.

Lack of regulations: Wrong! Total missregulation. Regulators for their risk weighted capital requirements for banks used the perceived risk of banks assets, those that bankers were already clearing for, and not the risk that bankers would perceive and manage the risks wrongly. They seemingly never heard of conditional probabilities.

Excessive risk taking: Wrong! It was the regulators excessive risk aversion that gave banks incentive to build up excessive exposure to what was perceived safe.

Greece did it: Wrong! EU authorities did Greece in, when assigning a 0% risk weight to its debt.

But Wolf is correct when arguing, “Today’s rent-extracting economy, masquerading as a free market, is, after all, hugely rewarding to politically influential insiders”

Because yes, crony statism is all around us, beginning with the “We governments guarantee you banks, and then assign ourselves a 0% risk-weight so you need not to hold any capital when lending to us, and so then you can return the favor by lending to us. 

Sir, Wolf concludes: “If those who believe in the market economy and liberal democracy do not come up with superior policies, demagogues will sweep them away”. That is right! But let us not ignore that “We will make your bank systems safe with our risk weighted capital requirements” was and is pure unabridged besserwisser demagoguery.

PS. Of course journalists who refuse to ask regulators the right questions since they are scared that if they do they will never be invited to Davos and Jackson Hole gatherings are also part of the explanation.

PS. Here is an aide memoire on some of the mistakes in the risk weighted capital requirements for banks.

@PerKurowski

Europe has been way to blasé about how the divisive forces of a common Euro within a not fully integrated Europe could gather strength.

Sir, I refer to Martin Wolf’s “Italy’s new rulers could shake the euro” May 23.

On the eve of the Euro, November 1998, in “Burning the Bridges in Europe” I wrote:

“The Euro has one characteristic that differentiates it from the Dollar. This characteristic makes me feel less optimistic as to its chances of success. The Dollar is backed by a solidly unified political entity, i.e. the United States of America. The Euro, on the other hand, seems to be aimed at creating unity and cohesion. It is not the result of these.

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.”

One could have expected that the fundamental menace that the Euro poses to the EU should have been in the forefront of everyone’s mind, and that much more would have been done to mitigate the dangers. But that has not really happened as its authorities wasted their time in so many other relative minutiae.

But what I never saw or knew when I wrote that article, as I had really nothing to do with bank regulations, was that bomb that was implanted in the middle of Europe, and in much of the rest of the world, that which required banks to hold more capital when lending to the citizens than when lending to the sovereign. That had to cause that excessive public sector indebtedness, which has now set the Euro problematic on steroids.

Sir, looking at what lays in front, one cannot help to think about the possibility that Brexit ends up being for Britain a very timely blessing in disguise.

@PerKurowski

Martin Wolf, public borrowings are being subsidized by bank regulations

Sir, Martin Wolf discussing the UK government’s private finance initiative (PFI) and costs of capital writes: “A sophisticated counter-argument is that government borrowing enjoys an implicit subsidy from taxpayers. That represents an unpriced insurance contract… This subsidy makes government funding look cheaper. But this is an illusion. “Public-private partnerships have to change to be effective” January 26.

Illusion? Does Martin Wolf really think that if banks had to hold the same capital against sovereign debt, than for instance against loans to entrepreneurs, the interest rate on public debt would remain the same?

Or, in a similar vein, does Martin Wolf really think that if banks had to hold the same capital when financing houses, than for instance when lending to entrepreneurs, the price of houses would not be negatively affected?

Mr. Wolf: Do you really think it is the risks for the banking system that are being weighted in those capital requirements? If so, I am sorry to have to break the bad news to you, again, for the umpteenth time. The risks that are being weighted for are the risks of the assets per se, which is why regulator want banks to hold more capital against what is ex ante perceived as risky than against what is perceived as safe.

Which explains how they could assign a risk weight of only 20%, to what rated AAA could pose a terrible threat to our banks, and a whopping 150%, to what rated below BB- bankers won’t touch with a ten feet pole.

John Kenneth Galbraith, in his “Money: Whence it came, where it went” (1975) wrote: “What people do not understand, they generally think important. This adds to the prestige and pleasure of the participants” … and yes, Sir, “risk weighted capital requirements” sounds indeed so delightfully sophisticated… almost as much as “derivatives”.

@PerKurowski

Parent regulators, not even aware they were the ones blowing the bubbles, shamelessly put all the blame on their toddler banks when these burst.

Sir, Tim Harford writes: “As any toddler can attest, it is not an easy thing to catch a bubble before it bursts” “Forever blowing bubblemania” January 13.

That is entirely true. But though we should not expect our toddlers to know it, parents are fully aware that the bubbles their dearest are chasing, were blown up by them, in the clear expectation that these would burst, or delightfully disappear in the skies.

Harford concludes in that “It’s very easy to scoff at past bubbles; it is not so easy to know how to react when one may — or may not — be surrounded by one”

Not entirely true, because that should not excuse the case of parents not even being aware they’re blowing bubbles.

In the western world, regulators, for instance, by allowing banks to leverage their equity so much when financing residential houses, are, no doubt about it, blowing up a house credit bubble that will surely blow up in our face… even though we cannot exactly know when that will happen.

When with Basel II in 2004 regulators allowed banks to leverage a mindboggling 62.5 times their capital, only because an AAA to AA rating was present, it should have been clear to them that they were blowing a bubble. Seemingly they did not. Worse, when then the AAA rated securities backed with subprime mortgages exploded in their face, they should have been able to put two and two together, but no, they put all the blame on the banks, the toddlers in this case. Even to the extent of describing the excessive bank exposures to AAA rated assets, or to sovereigns like Greece who with a 0% risk weight they had decreed infallible, as an irresponsible excessive risk-taking by bankers. They should be ashamed!

PS. Like Harford’s senior colleague I was also very skeptical about Amazon’s valuation. In April 1999 I wrote in an Op-Ed that Amazon had “joined the rank and files of ‘tulipomanias’” Yes, I admit, it is now worth much more than it ever was at that time. That said, and though Amazon is now way more than about books, I still suspect that, long term, because of: “‘shopping agents’ will permit clients to quickly compare one company’s prices to those of its competition, which would seem to presage an eventual fierce price wars, would create an environment that is not exactly the breeding ground for profits that back the market valuations we are now observing”.

But then I also assumed institutional “efforts aimed at prohibiting any monopolistic controls of the Web”, and in this perhaps I could have been way to naïve.

@PerKurowski

In terms of causing the undoing of the west’s liberal democracy and global order, Trump (until now) is nothing compared to the Basel Committee

Sir, Martin Wolf holds that: “political developments have fractured the west as an ideologically coherent entity” “Global disorder and the fate of the west”, January 3.

I argue that much more than recent political developments the west, as we knew it, at least as I thought of it, was fractured in 1988 when regulators, with the Basel Accord, came up with risk weighted capital requirements for banks.

The following were Basel II’s capital requirements for banks on exposures to sovereigns according to their credit ratings: AAA to AA = 0%; A+ to A = 1.6%; BBB+ to BBB- = 4%; BB+ to B- = 8%; Below B- = 12%; Unrated = 8%.

What have that regulation to do with “A liberal democracy [where] the participants recognise the legitimacy of other participants common…[and] rests on a neutral rule of law”?

That someone like Walter Wriston could argue, "Countries don't go bankrupt," does not mean that some sovereigns have the right to declare themselves infallible. That was never part of any (recent) global order… nor was that those citizens who perceived as safe were already so more favored than those perceived as risky when accessing bank credit, would gain additional advantages by generating lower capital requirements for banks.

The development of the west like all development does required a lot of risk-taking. The day regulators layered on their purposeless risk aversion on top of already risk adverse banks… they doomed the west to a standstill, a “relative decline”, which, with time, will turn into a fall unless we can stop that dangerous nonsense. God make us daring!

Sir, what Trump, until now at least, might be doing to cause the undoing of the west’s global order is chicken shit when compared to what the Basel Committee has done. Martin Wolf does not think so because he considers it the duty of bankers to do what is right and ignore the incentives they are given to provide a high risk-adjusted return on equity to their shareholders.

And talking about populism, is not “We have risk weighted the banks’ capital for you so that you can now sleep calm” pure outrageous technocratic populism?

@PerKurowski

More food for the hungry and less food for the less hungry sounds logical and decent, that is unless the hungry are obese and the less hungry anorexic.

Sir, Martin Wolf writes: “More equity capital would make banks less fragile.” “Fix the roof while the sun is shining” December 6.

That is only true as long as we get rid of the distorting risk weighted capital requirements for banks. Though “more risk more capital - less risk less capital” sounds logical, that is unless “The Safe” get too much credit and “The Risky” too little. If that happens, both banks and the economy will end up more fragile.

Wolf writes: “The world economy is enjoying a synchronised recovery. But it will prove unsustainable if investment does not pick up, especially in high-income economies. Debt mountains also threaten the recovery’s sustainability”. Let me comment on that this way:

First: “a synchronised recovery” is a way to generous description of what is mostly a QE high that has just helped kick the crisis can down the road.

Second: The investments most lacking in the “unsustainable if investment does not pick up” part, is that of entrepreneurs and SMEs, those which have seen their access to bank credit curtailed by regulators. It is high time we leave the safer but riskier present and get back to the riskier but safer future.

Third: The “Debt mountains [that] threaten” are either those for which regulators allow banks to hold much less capital against, like sovereigns and residential mortgages; or those consumer credits at high interest rates that dangerously anticipate consumption and leaves us open to future problems.

Sir, let me again make a comment on Wolf’s recurrent recommendation of “Public investment to improve infrastructure”. He usually argues this in order to take advantage of the very low interest rates. That ignores that those low rates are not real rates but regulatory subsidized rates. If banks had to hold the same capital against loans to sovereign than against loans to citizens, and if also central banks refrained from additional QEs, I guarantee that the interest rates on public debt would be much higher.

Besides, given the fast technological advances, we do not even know what infrastructure will be so much needed in the future so as to be able to repay the loans, instead of just burdening more our grandchildren.

@PerKurowski

When “Eurozone sovereigns rush to lock in rates”… whom are they locking out?

Sir, I refer to Thomas Hale’s “Eurozone sovereigns rush to lock in rates” March 20.

It reads like the sovereigns were totally disconnected from their subjects. Like if they are able to lock in low rates, this would not be paid by, for instance, those pension funds that will earn less?

And if sovereigns have some inside information that rates will shoot up, and still sells a long-term bond to a citizen (a bank or an insurance company) is that not stealing? Would a citizen not be fined and sent to jail if he did something like that?

Bank regulators decided for instance that banks and insurance companies need to hold less capital when lending to sovereigns than when lending to citizens. That of course leads to sovereigns being able to borrow at lower rates than what would have been the case in the absence of such regulatory favor. And who pays for that regulatory subsidy? The “risky” SMEs and entrepreneurs pay for it; by means of less and more expensive access to bank credit. 

Sir there is such an amazing disconnect between the sovereigns and its subjects. It is as if the sovereigns have totally forgotten that their future is absolutely dependent on the future of its subjects. Or is it that current technocrats are just too statists or too dumb to understand what they are doing.

It does not help of course when influential papers like the Financial Times refuses to ask the questions that should be asked… like these:

@PerKurowski

When are regulators grilling Citi to be grilled on their own responsibilities for causing the 2007-08 crisis?

Sir, Katie Martin reports: “Regulators to grill Citi over role in sterling flash crash” December 10.

That’s OK. Grill Citi! But when are regulators going to be grilled on the crisis they caused by allowing banks to leverage over 60 times to 1 their equity when investing in AAA to AA rated securities; or almost limitless when lending to sovereigns like Greece?

And when are they going to be grilled on how their nonsensical risk aversion impedes satisfying the credit needs of the real economy?

I say. Grill Regulators Too!

I suggest that grilling could begin with the following questions that regulators have steadfastly refused to answer me… because I am no one to have the right to ask them questions (and FT has refused to help me)

@PerKurowski

Sovereign debt risk weightings system, which assigns a zero risk weight, needs more than overhauling. Throw it out!

Sir, soon 30 years after regulators decided with Basel I in 1988 that the risk weights for the “infallible” sovereigns were to be zero percent, Patrick Jenkins now writes: “finding a way to overhaul the absurd assumption that all government debt carries zero risk, is pretty fundamental for the future health of European finance” “Sovereign debt risk weightings system needs overhauling” May 3.

Boy is he lost! The question is not whether “all” governments should carry a zero risk, but whether any government should carry a higher risk weight than those citizens that represent whatever strength the sovereign has, and that now are risk weighted at 100 percent.

Anyone who thinks that banks should be able to leverage more their equity when lending to sovereigns than when lending to citizens, must believe government bureaucrats know better what to do with other peoples’ money, than SMEs and entrepreneurs with their own money and with what they owe, and so they must therefore be statists.

Sir, I am amazed how many statists there seems to be at the Financial Times.

@PerKurowski ©

The Basel risk-weight for grand government projects is 0%; for an SME’s incremental development 100%

Sir, John Kay writes “A high proportion of the mooted benefits of grand projects could be obtained by incremental development at a fraction of the estimated cost of the world-beating schemes” “Grand projects are worthless if they do not work” April 27.

Yes but the Basel Committee, in order to make banks safer, decided to use risk weighted capita requirements. And when determining these they set the risk weight for “grand projects” carried out by government to zero percent, while that of any “incremental development” carried out by an SME was set to be 100 percent. So guess who has easier access to bank credit?

Considering FT’s total silence on this subject most, or perhaps all in FT, seem to think this is a smart way of making banks safer. I don’t. Since it impedes the best allocation of bank credit to the real economy, I think it is utterly stupid and unsafe, even for the banks.

@PerKurowski ©

The “risk” appetite that caused the 2007-08 crisis was for AAA-rated securities, residential mortgages and sovereigns.

Sir, Laura Noonan quotes Bank of England’s Andrew Haldane with: “I think the risk culture, not just from the regulator but from financial firms, is much different [than before the crisis], the risk appetite is much diminished.” “WEF group issues urgent call for fintech forum” April 19.

What risk appetite before the crisis? Was there any excessive exposure to something that was not perceived, decreed or concocted as safe? No, of course not!

In Basel II regulators assigned a 35 percent risk weight to residential mortgages; AAA-rated securities backed with mortgages to the subprime sector carried a 20 percent risk weight; and the risk weight for sovereigns rated like Greece, hovered between 0 and 20 percent.

Now, soon a decade later, regulators seemingly still think that ex post realities and ex ante perceptions are the equivalent. They keep on thinking that the expected is a good basis for estimating directly the unexpected.

The worse risk to a banking system derives from excessive exposures; and those excessive exposures are always built up with something ex ante perceived as safe… but which ex post could perhaps be risky. And that is currently made much worse, by the fact that those “safe exposures” require the banks to hold the least capital.

So NO, in terms of dangerous excessive exposures to “the safe” I would, contrary to Haldane, hold that the real appetite for real bank risk has not stopped growing for a second, it has even accelerated. 

Sir, again, for the umpteenth time, in Basel II the regulators set a 150 percent risk weight for assets rated below BB-. How on earth can anyone justify that assets that when booked carry a below BB- rating, are riskier for the banks than all other 100 percent and below risk weighted assets?

And how is it that, even after the evidence of the 2007-08 crisis, they still believe so? It is mind-boggling to me… and it should be to you too Sir.

Something is truly rotten in that mutual admiration club we know as the Basel Committee for Banking Supervision.

@PerKurowski ©

Sir, would you trust a columnist who refuses to acknowledge what produced Europe’s financial crisis?

Wolfgang Münchau asks: “would you trust with your own security somebody who cannot even contain a medium-sized financial crisis? I personally would not, which is why my own preference is for the Schengen system of passport-free travel to be suspended indefinitely” “A history of errors behind Europe’s many crises” March 28.

Sir, here are some of the Basel II’s risk weights that determined how much of the basic bank capital requirement of 8 percent banks were required to hold against some different exposures:

Loans to sovereigns zero percent; to the AAArisktocracy 20 percent; financing residential housing 35 percent; and loans to ordinary unrated citizens 100 percent

That meant banks could leverage equity unlimited times when lending to sovereigns; 62.5 times to 1 when lending to the AAArisktocracy, 35.7 times when financing residential housing 35.7, and only 12.5 times to 1 when lending to the unrated citizens.

And that allowed banks to earn different risk adjusted returns on equity not based on what the market offered, but much more based on what the regulators dictated.

So forget the Euro, forget bank unions, that distortion of the allocation of bank credit to the real economy had to provoke, more sooner than later, financial crises that will destroy Europe.

And so I ask you Sir, would you trust a FT columnist that steadfastly refuses to acknowledge such facts to opine on anything? I would not!

@PerKurowski ©

A Cloud should provide us with legally non-contestable statements of our investments, a nanosecond before a cyber-blackout.

Sir, I refer to Robin Wigglesworth “HFT chief warns of ‘hole’ in electronic system”, February 5.

Getting into the paperless, and the soon perhaps currency-less society, requires someone somehow to provide security for everyone… from the holder of a small savings account to the plutocrat with a billion-dollar portfolio.

I believe everyone would sleep better were they sure they had access to a legally non-contestable file that proved what assets they held since the last transaction recorded, and until that nanosecond before the horror of a blackout occurred.

Is that something a government should offer? They might contract it out, I don’t mind, but this is clearly among the security sovereigns should provide their citizens… although external auditing and extra guarantees would not be bad to have in the case of the so and so existing sovereigns… and in the case of the in waiting so and so sovereigns, which could, sooner or later, be all sovereigns.

@PerKurowski ©

Alan Greenspan is either blind to what caused the financial crisis 2008, or does just not want to admit it

Sir, I refer to Alan Greenspan’s “Higher capital is a less painful way to fix the banks” August 18.

Greenspan has either no idea about what happened, or does just not want to admit it. Suppose the base capital requirement had been the 30% he speaks of instead of that basic 8% required in Basel II. What would that have meant in terms of effective capital requirements using the risk-weights of Basel II. Banks, when lending to prime governments with a 0% risk weight, would then have had to hold, just as today, zero capital. Banks, when investing in AAA rated securities, or getting a default insurance from an AAA rated company, to which a 20% risk weight applied, would then need to hold 6% in capital instead of Basel II’s 1.6%; while for loans to SMEs and entrepreneurs risk-weighted 100% they would then be required to hold 30% in capital instead of the 8% they must currently hold.

Would that have created more or less distortions in the allocation of bank credit? No way Jose! The current crisis has resulted much more from the existence of different capital requirements than by their standard level. Just reflect on the fact that all assets that caused the crisis have in common they originated very low capital requirements for banks compared to other assets. To fix the banks, much more important than the size of the basic capital requirement is getting rid with of the risk-weighting.

Greenspan is also guilty here of serious misrepresentation. He writes: “Bank equity as a percentage of assets, for example, declined from 36 per cent in 1870 to 7 per cent in 1950 because of the consolidation of reserves and improvements in payment systems. Since then, the ratio has drifted up to today’s 11 per cent.” The 36 percent in 1870 and the 7 percent in 1950 was bank equity based on all assets, while today’s 11 percent is based on risk weighted assets… and are therefore absolutely not comparable. Besides, analyzing bank equity without considering other security factors, like reserve requirements that have fluctuated considerably, cannot tell the whole story.

FT, may I suggest you ask all experts writing on capital requirements for banks the following two questions, before allowing him space in your paper:

First: Why are the bank capital requirements, those that are to cover for unexpected losses, based on the perceptions of expected losses?

Second: Why do you believe government bureaucrats can use bank credit more efficiently than the private sector, as your risk weights of 0% and 100% respectively de facto imply?

If they can’t give you satisfactory answers to those questions do you FT really think they have the necessary expertise to opine on this issue?

@PerKurowski

The best Sovereign Debt Restructuring Mechanism (SDRM) is the one that most reduces the need for it.

Sir I refer to your discussions about a “holy grail… a sovereign debt restructuring mechanism (SDRM) — a bankruptcy procedure for states.” “To err is human, to forgive is statesmanlike”. July 27

Even though I agree with the need for a SDRM, we citizens need to be very alert to how it is designed. Bank regulation’s bureaucrats/technocrats, behind our backs, have already given public borrowings an enormous unearned/undue advantage, by allowing banks to hold much less capital against public debt than what they are required to hold against private sector debt. 

If on top of that we now also make it easier for government bureaucrats/technocrats, hiding behind the mantle of “sovereignty”, to get out of the debt they contracted, then we have really messed things up for ourselves.

In this respect I believe any acceptable SDRM should begin with:

First and foremost by eliminating all incentives that can help governments contract too much debt.

And then by defining clearly what, when compared to ordinary credit to the public sector, should be  deemed as odious credit. For instance, credit not awarded in a transparent way, or awarded when it was clear that the resulting debt might not be sustainable, and was therefore of speculative nature, should not receive the same treatment in a SDRM, as public credit awarded transparently and when there was no doubt about the sovereigns capacity to serve it.

Let us be very clear about that the best SDRM is the one that reduces the need for it.

And of course it is human to err… but that does not mean that bank regulators should not admit their mistakes and be held accountable for it. Pseudo-statesmen forgiving behind curtains their own mistakes... really?

How can you ask creditors, or taxpayers, to take a hit on Greece, while pardoning, even promoting, bank regulators?

@PerKurowski