Major bank crisis, are they most likely to result from excessive exposures to what’s perceived risky than for what’s perceived safe?

Izabella Kaminska ends her fun “Festive inefficiencies would be missed in Big Tech’s perfect world” of December 20 with “Since inefficiency has a way of popping up no matter what we do, it is human experience that should be prioritised before all else.”

Sir, let me phrase some questions:

How long could it take for a bank system to suffer a major crisis because of excessive exposures to what is perceived risky?

How long could it take for a bank system to suffer a major crisis because of excessive exposures to what is perceived safe?

Do our bank regulators care at all about human experiences when they require banks to hold more capital against what is perceived as risky than for what is perceived as safe?

Sir, do you really care about what human experiences teaches us?

@PerKurowski

God, help my descendants live out of reach of high priests of complacency, like Basel Committee’s bank regulators

Sir, Martin Wolf writes: “China can help give Mr Trump what he wants. The US president wants greenfield industrial investments in parts of his country damaged by deindustrialisation. This can never be reversed. But Mr Xi can surely find Chinese businesses happy to invest in the US. Mr Trump likes such announcements. Mr Xi should help him.” “An odd couple doomed to co-operation” March 22.

What? Is the future wellbeing of America now beholden to China? Would Wolf really like this opinion of his to be quoted during a Trump rally?

If I were to give a recommendation of how to promote any type of greenfield investments in America, I would start with, of course, by telling America to get rid of those disastrous risk weighted capital requirements for banks that orders complacency with what we have, and de facto blocks bank lending to whatever smells as risky unknown future.

That regulatory risk aversion, which so odiously discriminates access to bank credit in favor of “the safe”, like the sovereign, the AAArisktocracy and residential housing; and so disfavoring the lending to risky SMEs and entrepreneurs… has no place in any country that wants to build future… much less in one that prides itself of being the Home of the Brave.

But there is much more to it.

On March 10, in “British business is starting to look more Italian” Martin Wolf drowned us in growth projections statistics that most probably are not based on an acceleration of any of those profound economic changes the world is going through. Sir, I wrote you a letter commenting on that.

On March 14, Wolf discussed the horrors of bilateralism and the blessings of multilateralism, trade agreements and globalization, reminding us of oldies like the Marshall Plan, “The folly of bilateralism in global trade”.

Today it is China and America, with Wolf referencing the “reform and opening up” proposed in 1978 by Mao Zedong’s successor, Deng Xiaoping.

Sir, about a month ago I had the chance to visit a wonderful small regional museum in Sweden, the Blekinge Museum. It lies very close to my recently deceased mother’s family house, in which I spent a lot of time in my youth. It was a shocking and a humbling experience. It was not a museum of very old times gone by; it was a museum of so much of my (1950), (and Wolfs) times gone by.

Images of heavy horses pulling carriages full of hay, Olivetti accounting machines, telephone exchanges with hundred of cables, old bicycles, wrinkled by rough seas rowing boats, and hundred similar items that I have lived with, but that mostly no longer exists, and are much less used, shouted out… “Per, what on earth do you know about tomorrow… what does anyone know?”

Coming out of the museum, more than ever, I felt like praying “God make us daring”; or at least God make my children, grandchildren and their descendants daring, so that they are not among the so many to be left behind… doomed (by automation and robots) to end up like the heavy horses of my time. God let them live free of that complacency Tyler Cowen writes about in “The Complacent Class”… faraway from the high priests of complacency.

And as for me, and as for Martin Wolf, as economists, as citizens, as parents and grandparents, if we only look back, and do not do our utmost to imagine what lies around the corners of tomorrow then, like old soldiers (and heavy horses) we might perhaps better fade away.

Does all what we older have lived not mean anything for the young? Of course it should signify a lot… but much more in terms of wisdom, than in terms of knowledge.

@PerKurowski

I don’t envy editors nowadays being forced to flexibilize journalistic ethics more than ever, in order to survive

Sir, John Thornhill describes many amazing innovations. “Bold claims for AI are hard to compute for economists” of February 21.

Without expressing the slightest doubt about Thornhill’s integrity one could still ask: are these innovations true, fake-news, or just one of those stories designed to sell you an investment? 

Sir, how extremely difficult it has to be an editor nowadays. If you’re too severe with the facts, you might loose the juiciness of your stories that your readers might demand; if you’re too generous, you will loose your paper’s reputation sooner or later. I surely don’t envy you.

But when Thornhill refers to that a “Master Algorithm”, named so by Pedro Domingos, a computer science professor at the University of Washington “will be the last invention that man makes. And that “It will be able to derive all knowledge in the world — past, present, and future — from data”, then I have to reply, as I often did to the former President of the World Bank James Wolfensohn, one who loved to refer to the bank as the “Knowledge Bank”, that knowledge means nothing if it is not tempered by wisdom.

@PerKurowski

Post-Crash Economics Society: Risk models & credit ratings are not wrong, the credence bank regulators give these is

Sir, since I was travelling I missed David Pilling’s “Crash and learn: should we change the way we teach economics?” October 1.

It discusses the Post-Crash Economics Society that was created by students at Manchester university, mostly in response to “glaring failure of mainstream economics [that failed] to explain, much less foresee, the financial crash of 2008.”

In it Pilling quotes Andrew Haldane, chief economist at the Bank of England: “We all became overly enamoured of a particular framework for thinking, or a modelling approach… It became something of a methodological monoculture [that] was not well equipped for dealing with economies or financial systems close to, or at, breaking point.”

That sounds about right. It was not the models’ faults, but the fault of those using the models.

For instance bank regulators, with mindboggling hubris, and blind faith in the models, using only knowledge, decided that the capital requirements for banks should be based on risk models using ex ante perceived risks. That was dumb. Clearly any regulatory wisdom would have indicated that those capital requirements, should be based on the so much more dangerous consequences to the bank system that could be caused if those risk models or risk perceptions, like credit ratings, turned out to be wrong.

The faster that is understood, the faster we can bridge the differences between those who, like Angus Deaton, though accepting that “economics is a broad church” yet argue that it “needs to be kept rigorous”, and those who, like Joe Earl, want it to be “more an exploration of ideas, and less a training in the economic priesthood.”

Of course, that will require bank regulators to declare much mea-culpa, or in other ways upsetting a lot the cozy relations in their mutual admiration club.

Here a more extensive aide memoire on some of the monstrosities of such regulations.

@PerKurowski ©

In order to revive the pioneering spirit of America, start by kicking out dangerous risk adverse bank regulators

Sir, Gillian Tett writes: “The US used to be renowned for having a more flexible and mobile workforce than Europe; in previous centuries millions of people travelled in search of land, riches and jobs. But mobility has declined… [and] if mobility keeps falling, the sense of political polarisation and rage in [some] places will rise”, “The pioneering spirit America would do well to revive” October 21.

Ms Tett argues that this is all a bit counterintuitive since “the internet is supposed to have created a hyperconnected world that makes it easier to connect workers with far-flung jobs”.

Not necessarily, for instance we do not know how many can thanks to Internet be working somewhere else, without having to move. Also, much the same way internet can inform about existing job opportunities, it can make it much harder to sell those illusions of other green valleys that stimulated much mobility in the past.

As a possible countermeasure Tett advances that “The next president may also need a 21st-century version of the 1862 Homestead Act — which offered land to settlers who went west — and find new ways to encourage workers to relocate.”

Ms Tett should not forget that “land” to settlers is just a resource, just like bank credit is; and that we live in a world where mindless risk adverse regulators, with their risk weighted capital requirements, have de facto hindered credit mobility; telling the banks to stay where it seems safe, and not to go where it could be risky.

For the umpteenth time I quote from John Kenneth Galbraith’s “Money: whence it came, where it went”,1975:

“For the new parts of the country [USA’s West]… there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business...[jobs created] 

It was an arrangement which reputable bankers and merchants in the East viewed with extreme distaste… Men of economic wisdom, then as later expressing the views of the reputable business community, spoke of the anarchy of unstable banking… The men of wisdom missed the point. The anarchy served the frontier far better than a more orderly system that kept a tight hand on credit would have done…. what is called sound economics is very often what mirrors the needs of the respectfully affluent.”

Clearly, the Basel Committee and the Financial Stability Board represent Galbraith’s “men of economic wisdom… [who serve] the needs of the respectfully affluent”.

So, if Ms Tett really wants the pioneering spirit of America to revive, then she should start by wanting to also allow credit to move freely; condemning the dangerous mumbo-jumbo preaches of the Basel Committee and the Financial Stability Board. That would in essence mean using one single percentage capital requirement for all assets, no matter in which risk-land these assets reside.

Unfortunately Ms Tett (and you too Sir) has been steadfastly mum on the issue of the regulatory distortion of bank credit, no doubt defending (“without favor”) her choice of “wise men” with their affluent and mostly Davos settled constituency.

“Wise men”? To know that unrated SMEs are risky to banks, is of knowledgeable men; but to understand that AAA rated assets are dangerous to bank systems, is of wise men.

@PerKurowski ©

I would not shed tears for the Basel Committee for Banking Supervision’s demise. Neither would millions of SMEs.

Sir, Caroline Binham and Jim Brunsden, with help of Laura Noonan, report that the Basel Committee for Banking Supervision is introducing reforms that include a contentious “output floor” that would limit banks’ ability to use their own internal models to assess risk. “In many cases this will effectively raise the amount of capital that banks have to hold” “Basel group warns of call for lenders to ramp up capital” October 8.

What do they mean with “in many cases”? How can anyone believe all banks authorized to use internal models do not use these to minimize the capital they need to hold …so that they can maximize their returns on equity?

Sadly, what is really contentious with all this, is how on earth we ended up with such infantile regulators.

Anyhow the authors report these reforms are creating some discord between the US and Europe; to such an extent it “tests the viability and purpose of the Basel group, founded 41 years ago to harmonise banking rules around the world.”

Sir, if that would signify the end of the Basel Committee, you know I will not shed a tear. Neither would the millions of SMEs and entrepreneurs who over the years have been denied fair access to bank credit, if they finally came to realize that was a direct consequence of Basel’s regulatory discrimination. 

Knowledgeable bank regulators know below BB- rated assets are risky. Wise ones know what’s AAA rated is dangerous. The world is overdosing on information and knowledge and it sorely needs more wisdom.

PS: Here is an aide memoire on the regulatory monstrosity of the risk weighted capital requirements for banks.

@PerKurowski ©

No! We can’t accept markets know more than we the experts do, can we?

Sir, I refer to John Kay’s “Crowd-pleasing theories are no substitute for wise regulations” December 17.

In it he writes “The wisdom of crowds becomes a pathology when the estimates of the crowd cease to be independent of each other, and this is likely when the crowd is large, ill-informed or both. It is in the nature of a crowd to turn on anyone who dissents from what is already an average opinion”.

I fully agree with that but, when the crowd is too small, then the groupthink risks really sets in, and it is in the rules of a mutual admiration group not to dissent in such a way that it could reflect badly on a member of it.

And so that is why “wise” regulators are certainly no perfect substitute for crowds either.

Just look at what our current bank regulators did:

They automatically decided that risky is risky, safe is safe, and therefore banks should be required to hold more capital against risky assets based on perceived risks.

And they ignored any deliberations on that what is risky might not be risky if it is perceived as risky, while what is perceived as safe might be really dangerous if it turns out to be risky, and therefore perhaps banks should be required to hold more capital against what is perceived as safe, than against what is perceived as risky.

Why? Because that would mean that there in their club of great experts regulators they would have to admit that they really do not know much about risks, and that the market could be better at determining it, and of course “We can’t have that… can we?

What is the purpose of our banks?

Samuel Brittan in “The financial crises of capitalism” May 9 says that “The beginning of wisdom is to recognize that boom and busts have been a feature of capitalism from the start”. Let us hope our bank regulators read it since instead of regulating so as to maximize the benefit from the boom and minimize the cost of the bust, ever since the Basel Accord in 1988 they have been set exclusively on avoiding the bust and which is clearly unwise.

How long has it been since any bank regulator has asked himself the question of what is the purpose of the banks? It cannot be simply that of avoiding a bank crisis as that is just stupid.

Tons of knowledge for a gram of wisdom!

Sir we are experiencing how prime credit rating agencies pointed us toward clearly subprime directions; not knowing where the risks and the losses of the current financial turmoil are; and sometimes finding out that your highly sophisticated investment banker, whom you pay well, cannot tell you how much your investment is worth, not even on a give and take 20 percent basis.

Since we also so frequently hear references to the concept that our economy has become more knowledge-based, should we not, if only out of modesty, start to downplay that illusion?

Having been an Executive Director of the World Bank a couple of years ago I was of course bombarded with the concept of the Knowledge Bank, then and now my reaction was the same… “Forget your tons of knowledge and please give me a gram of wisdom!”