As long the mistake that caused a crisis gets to be treated as one that shall not be named, it is doomed to become a Groundhog Day event.

Sir, Martin Wolf writes “financial regulation is procyclical: it is loosened when it should be tightened and tightened when it should be loosened. We do, in fact, learn from history — and then we forget”“Why further financial crises are inevitable” March 19.

Yes and no!

Yes, it is procyclical especially when allowing banks to leverage more with those who, thanks to good times are perceived as safer, and much less in bad times with all those that then are perceived as risky, which of course includes many former very safe.

No, we have not learned from history, because there is too many interested in putting a veil on the mistake with the risk weighted capital requirements. And there is too many who do not want to admit they fell for the populist that told them to relax, because they have weighted the risks.

Even though a leverage ratio has been introduced, the following Basel II risk weights that which evidences an absolute lack of understanding of the concept of conditional probabilities have not been changed, and this even after a crisis that exploded in AAA rated territory.

AAA to AA rated = 20%; allowed leverage 62.5 times to 1.

Below BB- rated = 150%; allowed leverage 8.3 times to 1

Also, the distortion the risk weighting creates in the allocation of credit to the real economy is mindboggling. Just consider the following tail risks:

The best, that which perceived as very risky turning out to be very safe.

The worst, that which perceived as very safe turning out to be very risky.

And so the risk weighted capital requirements kills the best and puts the worst on steroids… dooming us to suffer from a weakened economy as well as an especially severe bank crisis, resulting from especially large exposures, to what was especially perceived as safe, against especially little capital.

Wolf writes: “The bigger the disaster, the longer stiff regulation is likely to last. [But] Over time, regulation degrades, as the forces against it strengthen and those in its favour corrode.” I agree, but I would have to add something to it, namely, the bigger the disaster the more the running away from responsibilities… and accountability. 

@PerKurowski

If QE seems to have turned into irreversible and the economy even needs a QE4, does that not point to something not going right?

Sir, Michael Howell writes:“Modern financial systems have grown dependent on huge central bank balance sheets… our concern today is a growing shortage of central bank liquidity caused by the deliberate unwinding of the QE policies put in place to replace the private sector funding that evaporated in 2007-08” “Liquidity drain will force central banks towards ‘QE4’” February 20.

What does this mean? That ever growing central bank balance sheets are now to be a standard feature in our economy? If QEs is to replace private sector funding, are we not heading into central bank statism?

What has QEs achieved? Because of the risk weighted capital requirements, the liquidity injected has resulted in way too little financing of the “riskier” future (entrepreneurs) weakening the real economy; and too much to the “safer” present (mortgages, buybacks, AAA rated securities and public debt) creating bubbles.

If it comes down to a QE4 let’s pray regulators admit their mistake and throw out forever the idiotic risk weighting.

Idiotic? Yes, consider the following tail risks.

The best, that which perceived as very risky turning out to be very safe.

The worst, that which perceived as very safe turning out to be very risky.

And the risk weighted capital requirements for banks kills the best and puts the worst on steroids… dooming us to suffer an weakened economy as well as an especially severe bank crisis, resulting from especially large exposures, to what was especially perceived as safe, against especially little capital.

PS. Here is a current summary of why I know the risk weighted capital requirements for banks, is utter and dangerous nonsense.

@PerKurowski

A tweet dedicated to all those in FT that write the column of "Tail Risk"

Two tail risks:

The best, that which perceived as very risky turns out to be very safe.

The worst, that which perceived as very safe turns out to be very risky.

Risk weighted capital requirements for banks, kills the first and puts the worst one on steroids.

http://subprimeregulations.blogspot.com/2018/08/risk-weighted-capital-requirements-for.html

Cheers

Does not “safe(ish) activities such as holding government bonds” contain the fattest most dangerous tail risks?

Sir, Gillian Tett writes “the Fed and the Office of the Comptroller of the Currency introduced proposals to “tailor leverage ratio requirements to the business activities and risk profiles of the largest domestic firms”. In plain English, this means banks can operate with a little less capital to absorb losses, provided they focus on safe(ish) activities such as holding government bonds.” “Trump’s mixed record on rolling back bank reform” April 13.

The Fed’s Governor Laid Brainard, in a recent speech “An Update on the Federal Reserve's Financial Stability Agenda”said: “The primary focus of financial stability policy is tail risk (outcomes that are unlikely but severely damaging) as opposed to the modal outlook (the most likely path of the economy).”

So let me ask: What is the tail risk of “safe(ish) activities” compared to that of riskier activities?

How fat or dangerous is the tail risk of what is rated below BB-? Very skinny indeed.

How fat or dangerous is the tail risk of what is rated AAA? Very, very fat indeed.

Government bonds? When in 1988 the regulators, with Basel I, decided to assign a 0% risk-weight to some sovereigns they painted themselves into a corner. If that risk weight is not increased, then sovereigns will become, sooner or later over-indebted, and their risk will grow until it hits 100%. If that risk weight is increased, ever so slightly, markets will be very scared. How to get out of that corner is the most difficult challenge central banks and bank regulators face. Let us not forget that in 1988 US debt that was $2.6 trillion. Now it is US$21 trillion, growing, and still 0% risk weighted.

PS. The only way to solve the 0% sovereign risk weight conundrum that I see, is to increase the leverage ratio applicable to all assets, until that level where the risk weighted capital requirement totally loses its significance.

@PerKurowski

Bank regulators have set their highest bank capital requirements for what poses the least dangerous tail risks

Sir, I refer to your “World economy of so-so growth and fat tailed risk” January 4, and your reporters “Unlikely suspects are in the wings for 2016” of January 2.

The latter states: “Some risks are quotidian. Will a company struggle to generate cash flow, or will a particular asset fall out of vogue. Then there are outcomes that exist in the narrow, far reaches of statistical probability distributions, known as “tail-risks”. A hefty blow to investments is usually the result when such shocks occur.”

And with respect to current bank capital requirements, those that are supposed help cover for unexpected losses I have two questions for your reporters.

First, what can cause more unexpected losses, quotidian risks like credit risks, or the kind of events that they exemplify as some possible dangerous tail risks?

Second, in the case of credit risks, what has the capacity to produce the most sizable unexpected losses, what is perceived as safe or what is perceived as risky?

The correct answer to those questions should indicate the absurdity of setting the highest capital requirements for that that in terms of a quotidian credit risk is perceived as risky.

Think of it. The risk weight for a private sector asset rated below BB- was set at 150 percent, while that of an AAA to AA rated was only 20 percent. Is below BB- rated, something which scares away any risk adverse banker, really more dangerous to the banks than what is AAA rated? 

Sir, how long will your reporters ignore this sad truth? Is there a tail risk they personally have to be afraid of?

Laura Noonan in “EU board budgets for 10 bank failures” December 4, writes that the Single Resolution Board is seeking €40m in accounting advice, economic and financial valuation services and legal advice, to be used in the resolution of struggling Eurozone banks from 2016 to 2020.

Sir, have any of the possible big shot candidates for that consultancy ever informed bank regulators that their capital requirements make no sense? Sorry, just asking.

@PerKurowski ©

How do we reduce the uncertainty on climate change risk with a higher degree of certainty? By taking risks!

Sir, Martin Wolf writes: “Framing the challenge of climate change as a problem of insurance against disaster is intellectually fruitful. It also provides the right answer to sceptics. The question is not what we know for sure. It is rather how certain we are (or can be) that nothing bad will happen. Given the science, which is well established, it is impossible to argue that we know the risks are small. This being so, taking action is logical. It is the right way to respond to the nature and scale of possible bad outcomes. “Why climate uncertainty justifies action” June 10. 

That is absolutely the right way to analyze it… though it does not necessarily make it easier, like Wolf also describes with: “It is increasingly evident that the answer has to be technological. Humanity is unwilling, possibly simply unable, to overcome the political, economic and social obstacles to collective action. The costs to current generations seem too daunting.”

And so I would retort asking: What uncertainty is riskier with a higher degree of certainty?

That we do not do anything about climate change waiting for new solutions to pop up?

That we do not do anything about climate change but also make it more difficult for new solutions to pop up?

I ask this because making it easier for new solutions to pop up requires risk-taking… and that is precisely that which our regulators have banned the world premier financiers, the banks, to take.

Right now we have purposeless and dumb bank regulations that allow banks to earn higher risk adjusted returns on equity by means of leveraging more by avoiding credit risks.

How much better would it not be to use capital requirements for banks based on weights derived from sustainability ratings (and job creation ratings), let us call these purpose weights, and allow banks to earn more when they serve a useful societal purpose… is that not why we support them so much that we even allow them to become dangerously too big too fail?

Or let me frame it all in the way that Wolf finds intellectually fruitful. Is not risk-taking, for instance by banks, the insurance premiums we must pay when we are striving for a better future for our children looking to avert stalling and falling? The current generation has not been willing to pay these... shame on it.

@PerKurowski