President Trump seems to be on route to become one of the greatest “paga-peos” (scapegoats) in history.

Sir, Gillian Tett writes that for her “money, there is another, darker, way to interpret this week’s [extreme volatility in US equity markets]. Two years into Mr Trump’s presidency, global investors are questioning the administration’s financial credibility…Steel yourself to cope with further turbulence triggered by Mr Trump”,“Expect more turbulence from Trump’s Fed fight”, December 28.

Indeed, president Trump is to be blamed for some of it, but the truth is that had the markets been more normal, not so much bubbled-up, he would only cause some ripples never Tsunamis.

That Trump has given indications to fire Jay Powell, the Fed chair, is bad in as far as it interferes with the necessary independence and credibility of a central bank. But, that said, let me also hold that, if a central banker or a regulator believes that what bankers perceive as risky is more dangerous to bank systems than what they perceive safe, and therefore use credit distorting risk weighted bank capital requirements, as they’ve done for a long time, that is a clear justified cause for their removal.

Venezuelan historians sometimes recount that in old days the refined ladies of the society always used to keep a young slave close by. Whenever they let out noisy and smelly gases, they would hit the slave hard and loudly on his head spelling out “Boy/Girl!” whichever applied. These useful blame-takers, scapegoats, were known as “paga-peos”, literally “fart-payers”.

Sir, President Trump clearly produces some gases himself, but he could also go down in history as one of the greatest paga-peos ever.

When booming equity markets, house prices and unsustainable debt levels everywhere, built up with easy bank credit, huge liquidity injections and ultra-low interest rates come crashing down, as they must, sooner or later, those who are much more to blame for it, could all jointly point at President Trump and shout “He did it!” and Ms. Tett might smilingly nod in agreement.

PS. Though in Spanish here you will find more interesting details about the “paga-peos” tradition and about how it can be used with even worse intentions.

@PerKurowski

Day by day, the world is losing more and more, of that incredible valuable resource known as blissful ignorance.

Sir, Mohamed El-Erian writes: “These days, even small changes to market paradigms cause outsized price moves, contagion, and unsettling correlations among asset classes.” “Relying on central bank policy manoeuvres risks more volatility” March 8.

Indeed but that is not solely the result from what central banks do.

In 2001 in an Op-Ed I wrote: “The development of decision-making processes has benefits but also risks. Thus we see that the speed of information itself, which promotes quick and immediate response, can exacerbate problems. Before, those who took the problem home to study it, and those who simply found out late, provided the market a damper, which often might have saved it from hurried and ill-conceived reactions.”

When I was young and off to a boarding school in Sweden, with my parents living in Venezuela, I might have sent them one letter per year. They opened it and gladly determined that I was doing ok. Nowadays, if any of my daughters do not report to their mother sort of every six hours, all sort of possible volatility breaks lose.

@PerKurowski ©

When financing art, should Old Masters be credit rated based on their value volatility?

Sir, I refer to John Dizard’s discussion of “the business of lending against art collateral”, “Art world may be struggling but lenders are still happy to rely on an Old Master” February 6.

Dizard writes about a “an avalanche of loan applications from Europe” but “the banks that made lending facilities available in the past are not doing so any more” because the banks “are under tremendous regulatory pressure. Every European bank is scrambling for sufficient capital.”

It is a very interesting article. But, sincerely, should FT not be much more concerned with all the financing of SMEs and entrepreneurs that is not happening in Europe for precisely the same reasons… namely that capital scarce banks are allowed to hold much less capital against assets ex ante perceived or deemed as safe?

That said… might there be room for credit rating of art? That could allow banks to hold less capital against some Old Master that possesses less value volatility. Or would that only incentivize the production of more AAA rated Leonardo Da Vinci fakes?

@PerKurowski ©

We must stop building that mountain of dangerous elusive safety that is sure to crumble and fall on us.

Sir, I refer to Tracy Alloway’s and Michael MacKenzie´s “Finance: The FICC and the dead” August 12.

In October 2004, in a formal written statement delivered at the World Bank as an Executive Director, I warned

“I believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”

I have of course been much ignored ever since, as it is not considered comme il faut to be too right especially in the company of credited experts.

But Sir, now we are back to that period, and again… and it is not that the waves have disappeared… it is that the wave is building up… Just you wait ´enry ´igggins, just you wait, until it breaks.

When bank regulators with their risk-weighted capital requirements of Basel II basically ordered banks to stay away from what is "risky"… and now make those orders even more imperative with the liquidity requirements in Basel III, and when we now read about asset managers “steering clear of certain bonds, such as asset-backed instruments whose so-called secondary markets are not deep” one thing is clear… and that is… the world is trying to build a more and more, a higher and higher, mountain of safe assets.

Perhaps something on its very top and its very center might survive, but the rest is going to come crumbling down… sooner or later, there is just not enough safety material to go around for that kind of mountain.

They seek it here. They seek it there. Those Basel bank regulators seek it everywhere. Is it in heaven? Is it in hell? That damned elusive bank stability… (which does not even have the decency to rhyme!)

Undercover Economist Harford, instead of "the volatility express" the rest of us we have, thanks to regulators, the volatility ball and chain.

Sir, in October 2004, in a written formal statement at the World Bank, as an Executive Director, I warned: “We believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”

And so I believe that, whether you like it or not, few have such credentials to talk about volatility.

And today I refer to Tim Harford’s “The volatility express” July 5. In it, Harford correctly describes the dangers for the financial sector of low volatility, in that it can foster a false sense of security; and the benefits for the economy of low volatility, as it can provide for the stable environment investors need in order to take risks.

But what the Undercover Economist, and you yourself, fail to understand, is that regulators, with their risk-weighted capital requirements for banks create not only an artificial false low volatility which becomes extra dangerous for banks, while at the same time, with the same risk-weights, they block the access to bank credit to those most willing to take risks when volatility is low.

And so, instead of the volatility express the “rest of us” would all like to see, we now have, thanks to regulators, the volatility ball and chain.

My New Year’s wish for FT. Wake up to what the risk-weighted capital requirements for banks really signify.

Sir, if banks could measure and price risks perfectly, then there would be no need for bank capital, as all expected losses and capital cost would be covered. But, since the measuring and pricing of risk is by nature imperfect, there will always be “unexpected losses”, and so regulators need to impose capital requirements for banks.

Unfortunately, the regulators decided that the “unexpected losses” would occur mainly in assets perceived as “risky”, probably because they confuse “unexpected” with ex-ante perceived risk, or because they only concerned themselves with individual banks; while I contend instead that the kind of “unexpected” which could threaten the stability of our whole banking system, is most likely to be found in the “absolutely safe” category.

And, requiring banks to reserve more for “unexpected losses” on “risky” than on “infallible” assets, allows banks to earn much higher risk-adjusted return on equity on the latter.

And, by allowing so, the regulators introduced a distortion that makes it impossible for banks to allocate credit efficiently in the real economy.

Tom Braithwaite ends his December 31 New Year’s “Reasons [for the banks] to be cheerful, despite the threat in the shadows” with “Even as regulators tighten the screws on the banks they seem unsure as to how much they want to police their shadow risks”.

If I could have a New Year’s wish about something that FT could do in 2014, then that would be to notice more how these regulations which discriminate based on ex ante perceived risks, really “tighten the screws” on the access to bank credit for all those ex ante perceived as riskier.

And, consequentially, to notice how that increases inequality, and hinders the banks from taking those risks that could help our young to have a future… those risks that generations before us took through the banks, so that we would all have a future. 

And all for nothing, because at the end of the day, what those regulations guarantees, is that our banks are going to end up gasping for oxygen, in some dangerously overpopulated “safe-havens”.

PS. Reducing the risk of bank failures increases, exponentially, the risk of banking system failure.

God make us daring!

Too much longing for stability creates the perfect storm conditions for instability

Sir, Samuel Brittan refers to “artificial suppression of volatilities in the name of stability” “The follies and fallacies of our forecasters” May 27. That is precisely what as an Executive Director of the World Bank I was referring to when, in May 2003, in pre-Basel II days, I told a large group of regulators gathered for a risk-management workshop at the World Bank, the following: 

“There is a thesis that holds that the old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, was much wiser than today’s no burning at all, that only allows for the buildup of more incendiary materials, thereby guaranteeing disaster and scorched earth, when fire finally breaks out, as it does, sooner or later. 

Therefore a regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.”

The regulators did not understand what I was talking about… mostly because they wanted so much to believe in forever stable banks.

PS. As you can see here, the link to Brittan’s article is gone.

Why can’t you have sensible long term contracts in oil?

Just the sheer possibility of losing a tenure based on no particular fault of their own, could do wonders for the educational system, infusing it with a minimum required dose of uncertainty, and thereby allowing tenured professors to at least to understand the concept of anxiety.

Sir in “Double, or quit?” June 10, you say that “Volatile prices get in the way of sensible medium-term contracts to produce or deliver oil-intensive goods and services” June 10 and you are right but why on earth you cannot extrapolate that into the need for sensible medium-term or even long term contracts for oil itself, to bring down that uncertainty that hinders more investment is indeed very hard to understand.

But a share is still (mostly) a share… it’s attractive

Sir, John Plender in “There can be no return to ´normality´ of a freakish bubble” August 30, mentions that “in the midst of all this, many investors are baffled that equity markets have not been seriously damaged”. The explanation for this should be quite clear though, in this freakish market, at least for the time being, a share is still mostly a share, and you can see its value quoted daily, so when you compare it to all those fancy investments where your advisors is currently asking for more time to figure out what it could be worth, give and take 20%, no wonder a share looks attractive.

The world needs the cleansing and energizing forces of volatility

Sir, Tim Young in his letter on “How Japan’s investment was paralyzed”, April 16, asks the very relevant question “whether the cumulative loss of output [of following a conventional low interest rate policy] is less than might have been suffered if macroeconomic policy had allowed the asset price bubble to pop rather than deflate slowly.”

I certainly believe the losses of letting a problem fizzle out are in the long run, in average, always larger than having the bang and getting on with it, and so do you, for instance when in employment policies you commend the American styled labour flexibility that allows for easier firing so that resources can be better and faster reallocated. Sir, if you can lose your job, on the dot, because it is good for the economy, what would make losing 30% of the value of your house any different? What is better, keeping the high value of your houses or allowing your kids to afford a house?

It is time the world starts to think again about the cleansing and energizing forces of volatility and remembers that the absence of tremors could just mean a bigger earthquake in the making.