Where have all safe assets gone? Short time passing. Gone to banks and central banks. When will regulators ever learn?

Sir, Elaine Moore, with respect to ECB’s QEs writes: “From the moment the European Central Bank first announced plans to revive the eurozone economy with a mass bond-buying programme, financial markets have expected trouble. First the focus was illiquidity and mispricing — now it is scarcity”, “Mechanics exposed as debt pool starts to run dry” September 9.

How could scarcity not be? Basel II’s low risk weighted capital requirements plus Basel III’s liquidity requirements, have substantially increased the demand of banks for low 0% risk weighted sovereign debt. That together with Central Banks purchases of “safe sovereign debt”, for their own QEs, just had to create scarcity.

Now we can hear widows, orphans and pension funds ask: Where have all safe assets gone? And the answer is to banks and Central banks everyone. Indeed when will they ever learn.

The saddest part though is that, as a result of all this odious regulatory distortion, the 100% risk weighted SMEs and entrepreneurs, those who most need and could do good with bank credit, they are left out hanging dry.

Sir, if we do not finance the riskier future and only keep to refinancing the “safer” past, we’re toast… even if there is no global warming.

@PerKurowski ©

Regulators tell banks “Occupy what’s safe”; and so expel widows, orphans and pension funds, to handle what’s risky

Sir, Brooke Masters reports on how the Security Exchange Commission is making sure that private equity industry duly manages conflicts of interest and treats its clients fairly. “SEC enforcers must keep bearing down on private equity” August 27.

But Masters also writes: “Historically, PE clients have been highly sophisticated. So they are either well placed to decipher complex investment contracts or rich enough not to quibble about extra fees. But that is changing. Public pension funds are shifting more and more of their money into private equity as they chase higher yields. Pension fund managers are far less experienced with the sector.”

Why did this happen? When regulators, with their risk weighted capital requirements told banks they could leverage more, and therefore obtain higher risk-adjusted returns on equity with assets perceived as safe than with assets perceived as risky, they made banks occupy that area in which, without leverage, widows, orphans and pension funds used to dwell.

So see what they done. By trying to make banks safer they clearly made life for widows, orphans and pension funds much riskier. That is what happens when regulators regulate with no concern about the impact their regulations will have.

And the saddest part of it all is that it is all for nothing. Major bank crisis are never the result of excessive exposures to what is perceived as risky, but always the result of unexpected events or excessive leveraged exposures to what was ex ante perceived as safe, but that ex post turned out not to be.

PS. For the sake of our children and future pensioners, I pray we can reverse this, and that there are still some bankers out there who know how to be bankers, and not only how to be equity minimizers. 

@PerKurowski ©

Pension funds, widows and orphans have been told to keep out of what’s perceived safe, that’s now the banks’ domain.

Sir, Robin Wigglesworth writes about “an environment where many safer bonds still offer insultingly low rates” “Greed set to trump fear as high-yield bonds live up to their name” August 8.

Bank regulators, with their credit-risk-weighted capital requirements, allow banks to leverage their equity and the support received by deposit guarantees and similar, immensely, as long as they stick to lending to “The Safe”.

Consequentially the more regulators favor and therefore subsidize bank lending to “The Safe”, the lower will be the interest rates paid by “The Safe” and, of course, in relative terms the higher the rates “The Risky” need to pay.

Ergo… non-banks who have to evaluate the increased spreads between The Safe and The Risky, without counting with the regulatory bank-subsidies, are more tempted by, or are in more need of the higher rates paid by “The Risky”.

Pension funds, widows and orphans were the one investing in “The Safe” Now they have been told to get out of there… “That’s for the banks!”

The Risky, like the SMEs and the entrepreneurs they used to have access to the banks… now they are left out in the cold… desperately looking for some crowd-funding.

@PerKurowski

Banks were instructed to abandon risk and compete with pension funds, widows and orphans for “safe” sovereign bonds.

Sir I refer to FT Alphaville “This is nuts — all the eurozone bonds have gone” March 4.

Of course it is nuts. More than 10 years ago, in November 2004, before some egos got in my way, you published a letter in which I stated “bank supervisors in Basel are unwittingly controlling the capital flows in the world…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”

And after the crisis left banks with less equity and the regulators with more requirements that has only gotten worse.

The truth is that banks were told to abandon what they usually did and compete with the most risk adverse for whatever little “safe” there was and those “safe” havens are, as a result, becoming more dangerously overcrowded by the day... and those though more risky much more productive bays are becoming less explored by the hour.

That banks are instructed to push out pension funds, widows and orphans from safe havens is absurd, and immoral.

Sir, I refer to Percival Stanion’s “When prospect of certain loss unleashes risk-seeking impulse”, February 19.

There are two major types of risk directions: that of loans to those perceived as risky, and that of excessive exposures to what is perceived as “absolutely safe”. Regulators have instructed banks, in no unclear terms, by means of portfolio invariant credit risk weighted equity requirements, to stay away from the first type, but they have not said a word about the second.

As a result, and most specially in these days of scarce bank equity, European banks are entering more and more into that terrain that already in some places signify at its best “locking in a loss at redemption”. In fact, with pre-announced inflation targets you do not even need negative rates for that.

Today Roula Khalaf gives a nice illustrating account on what is happening to Russia, by means of looking at Russian tourism in Switzerland, “A slippery slope for Switzerland’s Russian skier”. How sad that the Financial Times does not ask its journalists to look equally look at what is happening in Europe, by looking at where bank credits in Europe have been traveling ever since Basel II was introduced in June 2004. At this moment those credits are going into sovereigns squeezing out widows and orphans. Is that not an absurd and even immoral state of affairs?

PS. I have been lately been calling those negative rates as “pre-agreed minimum haircuts” because that is what they are… and so not only does Greece want a haircut… Germany and others are already giving de facto haircuts.

PS. Sir I have also asked you whether a pension fund would be authorized to accept such haircuts in the name of the beneficiaries… but I have not yet been given an answer.

If banks and QE finance sovereigns, housing and AAAristocracy, who is to finance “the risky”? You and me? Widows and orphans?

Sir, I refer to John Authers’ “Side-effects that should call time on the QE medicine” September 23.

The market, as the compass that directs the allocation of financial resources, has been rendered useless by the introduction in its center of two big chunks of iron. The first is capital requirements based on ex ante perceived risk, the other is QE. If these sources of magnetic distortion somehow neutralized each other, for instance QE mirrored the deleveraging of the banks the economy might not head too much out of course. But, unfortunately, they just reinforce each other.

The capital requirements push banks to lend to sovereigns, housing and the AAAristocracy, and QE, buying sovereigns to ease the borrowing rates of government, and help housing, push in the same direction. The question which remains is then who is going to take care of financing the risky. Truth is that if we get out of this storm alive and are able to find safe harbor, we can count ourselves extremely lucky indeed. As is what is most probable is that we end up sitting in million dollar houses, without a job, to help us pay the utility bills.

How on earth did we end up discussing bank lending ratios of 25 or 33 to 1?

Sir, Alistair Darling, the former UK chancellor of the exchequer, refers to the Vickers proposal of bank capital of 4 percent, a lending ratio of 25 to 1 and to George Osborne’s proposal o 3 percent, a lending ratio of 33 to 1. He also rightly “suspects” that a requirement to hold more capital is a far greater buffer against calamities than a ringfence. “In a crisis, it will take a firewall not a ringfence” February 5.

And I must ask, how on earth have we ended up discussing bank lending ratios of 25 or 33 to 1? Don’t we all realize these lending ratios are sheer lunacy? Even if a bank loans are solely to “the absolutely infallible”? What funny thing happened on the way here?

No! Banks need to hold more capital, I would say between 8 or 10 percent, and, if they don’t have that capital, then help them get it for Pete’s sake, by for instance introducing special tax-exemptions on dividends produced by any banks willing to hold a basic 8 or ten percent in capital against all its assets.

That would not only help to make our banks safer, it would also reduce the distortions produced by different capital requirements based on the perceived risk of the bank asset, and it could also lead to attract a new set of shareholders, like some widows and orphans, who would be willing to accept lower bank returns in exchange for a much lower risk.

Sir, the simple truth is that the real economy cannot afford paying off those speculative shareholders who could be attracted to banks allowed to leverage 25 to 1. It is as easy as that!

Banks, please, go get yourselves a new class of shareholders

Sir, John Authers writes that bank returns on equity are projected to fall from around 20 percent to 7 percent, much because of new capital requirements coming up in Basel III, “Bank´s adjustment to the IT threat has barely begun” January 28.

And then he describes and analyzes some suggestion of McKinsey on how banks should confront this change. Strangely enough I do not see this change of return in bank equity viewed from the perspective of a change in its risk profile, or the suggestion of “go get yourselves a new class of shareholders”.

If the 7 percent on equity bank returns are perceived to derive from a much safer operation there is no reason why bank division currently valued at 60 percent of their book value by investors in search of big returns, could not be valued at least at one time book value by pension funds, insurance companies and widows or orphans in search of more stability.

In fact the real economy would probably very much welcome the banks becoming less of the biggest beneficiary of it.

The Martin Wolf Inconsistency

Sir, Martin Wolf ask for “Radical policies for rebalancing Britain’s economy” November 2. In it he again favors the government to be less austere, “the case for a reconsideration of fiscal policy remains strong” and the banking sector, even though loans have contracted immensely, to be more restricted, “the case for much lower leverage is far stronger than in normal times”. Why the inconsistency? The only explanation possible is that Wolf is a firm believer that government spending allocates the resources with more economic efficiency than what banks with their credits can do. 

And yes, in many ways Wolf is correct, because regulators, by means of their capital requirements for banks based on ex ante perceived risk, exerted so much influence favoring “The Infallible” and thereby discriminating against “The Risky”, that the banks have indeed not allocated their credits in an economic efficient way. But, the solution for that should be less government intervention, not more! 

“Rebalancing?” Yes! But, Sir Mervyn King, how about rebalancing first between “The Infallible” and “The Risky”?

In this respect, for the umpteenth time, Wolf would say “monotonously”, I hold that one of the most important challenges for the UK, Europe and America, is to work themselves out of that silly bank regulatory risk-aversion, which caused and causes the banks to dangerously overpopulate safe-havens and, equally dangerous, at least for the society and the economy, to under exploit the more risky but more productive bays, like small businesses and entrepreneurs. 

Martin Wolf, when he writes “Equity targets [for banks] should be set in pounds”, and although he probably loathes admitting it, shows that he finally begins to understand how the capital requirements for banks perceived on risk distorted the economy,. 

Unfortunately, to get rid of those distortions is not as easy as Wolf would like it to be, in order for that issue to go away fast. You simply cannot attract the so much needed new bank equity, by introducing prohibitions to pay dividends subjectively set by regulators. You need to design a credible transition plan so that any new bank investor knows what he can expect tomorrow. And, to do that, you need to put at work fresh regulatory minds not encumbered by past mistakes. 

And so, before messing with tools like depreciating a currency (buying foreign low-risk assets?), in a world were so many currencies wish for depreciation, I suggest that UK, America and Europe draw up a careful plan, acceptable to future bank investors, for how to allow the banks again to take a chance on “The Risky”, those that in truth made the UK, Europe and America what they are. 

To me that plan should pursue making banking more of a safer and lower rate of returns utility, and so able to attract more widows and orphans like funds. For the rest of the economy to prosper, we must make banks be a lower returns affair.

There is too much of getting back at the banks, and too little of getting the banks back on track.

Sir I refer to Wolfgang Münchau´s “Relentless austerity will only deepen Greek woes” October 8. It is yet an example of a push for public bureaucracy administered stimulus, which much ignores the essential role of the banks in helping out. 

Regulators stupidly allowed the banks to hold very little capital against assets which were ex ante officially considered as “not risky”. Now many of those assets, precisely because those low capital requirements and erroneous ex-ante risk perceptions inflated these into bubbles, ex-post they have turned out to be very risky. 

And, as a result the banks stand there naked with no capital, and in need of enormous capital injections, if they are to cooperate in the recovery and not be instead, as they mostly are now, a drag on the recovery. 

And regulators, by not being able to explain in credible terms when enough new bank capital will be enough new capital, insist in scaring away new capital and instead provides stimulus for counterproductive balance sheet contraction of the banks. 

This is so because the first thing you do not want to do as an investor is to put your money into a venture where you risk your money will not suffice, and you will have to beg others for mercy in the future. 

Münchau writes “The reform that would matter the most – the closure of the unprofitable banks and the consolidation of the entire sector – is not happening for political reasons”. That sounds more about having to do with wanting to get back at the banks, or to create more too-big to fail-banks, and less to do with getting the banks back on the right track. 

What would be needed for that? Simply, much more bank capital, much less bank leverage, and much less regulatory distortions, which means a complete different action plan for our banks.

We need more widows and orphans as shareholders of our banks

Sir, the capital of my homeland (Caracas, Venezuela), used to, for over a hundred years, have its electricity needs well serviced by a private company run by electrical engineers, and its shareholders were mostly widows and orphans. But then came the financial engineers and took it over, and leveraged it to the tilt, and the consumers were not longer its prime focus of interest, the speculative shareholders were. How we wish we could have the old company back. In this particular case that seems impossible because it has since then been taken over by the Petrostate. 

I mention this because John Gapper, though mentioning “the targets for returns on equity” leaves aside the issue that different shareholders might have different targets, “The financial incentives to behave badly will endure” September 13. For instance, if capital requirements for banks were substantially increased, that would of course diminish the returns on bank equity, but that could also help to make banks safer investments, and with that attract the widows and orphans who could be happy with lower but safer returns. 

As a client of any utility, whether electricity or banking, I would like its shareholders to be widows and orphans, and so should the regulators.

Support the real world and not to the virtual world.

Not long ago web-navigators were buying real estate in virtual cities. Great fun, but of course no one would dare to plea for a bail-out in order to cover for any losses sustained there. But, down here, on the earth, there are currently many investors in securities with very similar virtual characteristics that shamelessly ask for help. We must learn to ignore their pleas not because we do not want to help them but because we cannot afford to help them.

Sir Joseph Stiglitz comment “Chapter 11 is the right road for America’s carmakers” December 12 is correct and timely. The US has enough resources to retool and sustain its automobile industry, after a much needed restructuring, but not enough to maintain what currently exists and, if they tried to do so that could provoke a significant loss of confidence in the dollar. In this horrendous crisis the US, like all others, is better off playing on its real strengths than trying to maintain vivid the illusions of so many virtual realities.

Since Stiglitz also reminds us of the many widows and orphans that will need real and concrete assistance and not just the illusions of a trickle down on them somehow-somewhere I would similarly like to remind all pf the sobering fact that our current was not caused by speculative investments but by pure triple-A widows and orphan stuff.