When banks earn more on what is “safe”, than on what is “risky”, the real economy suffers.

Sir Philip Stephens correctly writes “Europe faces a bigger threat than German caution”, December 13, and he correctly identifies that threat as “risk aversion”.

But there is an enormous difference between the consequences of natural risk aversion, like that which “comes with relatively higher standards and ageing population” and the consequences of an institutionalized pathological risk aversion… like that reflected in the risk-weighted capital requirements for banks.

If a society structures it in such a way that banks are allowed to earn much much higher risk-adjusted returns on equity when lending to what is perceived as “absolutely safe”, than when lending to “the risky”, banks will not allocated credit efficiently, and the real economy will wither away.

And the saddest part of that stupid risk-aversion is that it will anyhow bring down the banks (and perhaps the sovereigns with it) as banks will as a result, dangerously overpopulate all “safe havens”.

And what about the “pension mugging” produced by low interest rates produced by monetary policy?

Sir you write that Britain must make sure that the conversion of lifetime saving into decent retirement incomes is performed with total honesty, “Act now to prevent pension mugging” December 13.

But the number one factor which determines the amount of the annuity, at the moment of conversion, is the interest rate that insurance companies can earn long term on the “lifetime savings” received. And so now, when monetary policy is officially manipulated, so as for interest rates to be artificially low, especially the long side, the question is who is going to be responsible to the retired for the low annuities they receive?

How would you to explain to a retiree who converts into an annuity today if his neighbor, converting the same amount at a future time, receives a much higher annuity?

ECB, hard-cheese, first you need to test the credibility of the bank regulators

Sir, I refer to Sam Fleming´s and Alex Barker´s “ECB: Credibility test” December 12.

You must be perfectly aware that absolutely all bank crises in history, including the current one, have resulted from excessive lending to something that was ex ante perceived as absolutely safe, but that ex post turned out to be very risky. And no major crisis ever, has resulted from excessive bank exposures to assets that which ex ante considered risky.

And so therefore, allowing the banks to have extraordinarily little capital when exposed to something “absolutely safe”, can only guarantee that when shit hits the fan, all banks will stand there naked, with no capital to cover themselves up with.

And, to top up that mistake, that also allows banks to earn much higher risk adjusted returns on their equity when exposed to “The Infallible” than when exposed to “The Risky”, and which of course creates the distortion that makes it impossible for banks to fulfill their societal role, of allocating bank credit as efficiently as possible.

And so if there is a real credibility test that needs to be carried out first, that is the one of the bank regulators themselves since, honestly, I do not think they know what they are doing, and I consider them being about the largest producers of systemic risks in the financial system.

And with respect to the test of the banks… even more important than what´s on their books, would be to understand all the loans to medium and small businesses, entrepreneurs and start-ups that are NOT on their books, as a direct result of the capital requirements, because that is what can lead to the failure of the whole real economy… and when that failure happens, not even the safest bank stands a chance to survive.

ECB, I know it is hard for you to test your boss, Mario Draghi, the former chairman of the Financial Stability Board, but, what can I say, other than hard-cheese.

Paul Volcker and John Reed, our jobless young, more than a safer, need a more functional financial system

I cannot fully agree with Paul Volcker and John Reed about having a 6% cross the board capital requirement “standard alongside a robust system of risk weights” unless there is more clarity about what risk are to be weighted, “A safer financial system is now within our grasp”, December 12.

I say this because the problem with the current risk weighting used is that it weighs that risk of the assets which is already weighted, by means of interest rates, size of exposure, duration and other terms. And so, re-clearing for the same risk in the capital, causes banks to earn much higher risk adjusted returns on equity for assets perceived as “absolutely safe” than for assets perceived as “risky”; and this makes it therefore impossible for banks to allocate bank credit efficiently in the real economy. 

At this moment, when a generation of young people without jobs risk becoming a lost generation, the limited objective of a safer financial system needs urgently to be superseded by the much more comprehensive objective of banks becoming more functional.

Sir FT Bank regulations were not lax at all. They were, and still are, extremely dangerous.

Sir in your “A weak hand on casino banking”, December 11, you write “Lax regulation did little to discourage rash behavior”

No! You are wrong Sir. Allowing banks to leverage 60 times or more their equity with assets only because these are perceived as absolutely safe, has nothing to do with lax regulations, and all to do with dangerous regulations that encouraged rash behavior.

With the laxest regulation of them all, meaning no regulation at all, some other crisis might have happened but not the current one, a really free market would never ever have permitted such leverages.

And since you make a reference to casino banking, let me remind you that it was the regulators who, with their risk-weighted capital requirements, altered all the pay-out ratios on the different casino bets, and thereby created the distortions in the allocation of bank credit to the real economy that led to the current chaos.

And where do you get to know that “the financial system is now safer that it was four years ago”? Do you mean you think so because it is holding more infallible sovereign assets against less capital?

Mr. Kay. It is necessary to place bets that risk bankruptcy so as to have a chance to avoid bankruptcy.

Sir I refer to John Kay’s “Is it better to play it safe or to place bets that risk bankruptcy?” December 11.

In it Kay asks “Did mothers warn their daughters that marriage to brave hunters might end in widowhood, or urge them to seek husbands who would enable them to breed well-fed grandchildren?” That would in any case all be a matter of individual decisions. But, if there was a council of mothers which decided they had all to be extraordinarily nice to the sons in laws who stayed safely home and pester badly those who dared go hunting that society would definitely not prosper.

As cannot prosper an economy or a society where banks are given the incentive by their regulators to obtain much much higher risk adjusted returns on equity on assets perceived as “absolutely safe” than on assets perceived as “risky”.

And so the answer to Kay’s title question is that it is necessary to place bets that risk bankruptcy so as to have a chance to avoid bankruptcy.

How can the west have faith in its own future when its banks are hindered to finance it?

Sir, Gideon Rachman writes “The west is losing faith in its own future” December 10.

Absolutely, but how could the west not? Capital requirements for banks that are much much lower for assets perceived as absolutely safe, than on assets perceived as risky, allow banks to earn much higher risk-adjusted returns on what is “safe” than on what is “risky” and that stops banks from financing the future and makes these concentrate on refinancing, while its worth something, the safer past.

Rest assured, with its current castrated banking system, the west would never ever have become what it became.

Does FT´s capital markets editor really believe that in free markets banks could leverage equity 50 times or more?

Sir, I refer to Ralph Atkins´ review of Costas Lapavitsas´ “Profiting without producing”, “A Marxist take on economic meltdown” December 9.

In it Atkins writes “The resulting financial turmoil and global economic slump cast doubt on the ability of free markets to provide sustainable growth and employment in advanced economies”. I truly marvel at how one can call the current financial turmoil a result of “free markets” when for instance there can be no doubt that in really free markets banks could never ever have leveraged their equity 50 times or more. That was only made possible by extremely intrusive bank regulations that were based on such nonsense as risk-weighted capital requirements for banks.

It also argues that “financialisation”, which can indeed be corrosive, “has forced the retreat of labor and exacerbated income equality”. But again that is not the consequence of free markets but of regulations that so much favor the access to bank credit of “The Infallible” over that of “The Risky”.

Atkins correctly holds that “when it works, finance discipline governments and companies” but then he blithely ignores the fact that for instance, with Basel II, banks were authorized to lend to “infallible governments holding no capital at all. What a disciplining!

And as to "a Marxists take on economic meltdown", that is precisely what I would first ask the author… what is not Marxist about requiring the banks to hold substantial capital when lending to the private citizen and zero capital when lending to a central government?

“Lazy banking” is not just an Indian phenomenon. The Basel Committee has decreed it to rule everywhere.

Sir, James Crabtree in his interview of Arundhati Bhattacharya “Toughest job in Indian banking for head of state-backed behemoth”, December 9, refers to the challenge “to shake off India´s reputation for what is known as ‘lazy banking’, a system in which stolid lenders, led by cautious bureaucrats, park deposit in ultra-safe government securities”.

I am sorry, described that way “lazy banking” does not solely happen in India. In fact the Basel Committee, with their risk weighted bank capital requirements, which allow banks to earn much higher risk-adjusted returns on assets perceived as “absolutely safe”, than on assets perceived as “risky”, have in fact decreed lazy banking to rule everywhere.

The Basel Committee and the Financial Stability Board have also some questions of ethics they should grapple with.

Sir, if a boy listens to the weatherman, and dresses up accordingly, but then comes his mommy and, having listened to the same weatherman, and ignoring what clothing the boy already has on, orders him to put on or take off additional layers of clothes, you can bet that boy will end up having too much or too little on, even if the weatherman turns out to be absolutely right about his forecast. And of course, and especially if the weatherman was wrong, as happens sometime, real tragedy could ensue with the boy dying from either excessive cold or heat.

That is precisely what happens when regulators, ignoring how banks have adjusted to the perceived risk of the asset through interest rates, size of exposure, duration and other terms, order banks to also adjust for the same perceived risk in the capital they are required to hold. 

Even if the risks have been perfectly perceived, the bank will as a consequence lend too much in too generous terms to those perceived as “absolutely safe” and too little in too harsh terms, to those perceived as “risky”. The introduction of this regulatory distortion puts both the banks and the real economy at serious risk.

And artificially favoring the borrowings of some bank clients over others, just to satisfy I do not what, is a highly unethical to do. And so Sir, in reference to Andrew Hill´s “Bankers grapple with question of ethics” December 9, I wonder if Dan Ostergaard, the managing partner of Integrity By Design and who is mentioned as advising on ethical training, might have a program for the Basel Committee for Banking Supervision and the Financial Stability Board. If not it seems urgently needed.

By the way it might also have to do with ethics when financial journalists refuse to make any reference to this regulatory distortion, for reasons of their own. Think of it, “Five years on, Lehman still haunts us” and the fact that it was the extremely low capital requirements allowed by the SEC to the investment banks under their supervision, when holding AAA rated securities, that most tempted Lehman into perdition, is not even discussed.

It is not voluntarily that European banks are abandoning the private sector in order to take refuge in the government.

Sir, I refer to John Dizard’s “Risk of a European break-up has not marginally disappeared”, December 7.

In it Dizard writes about “the collapse of private sector lending, which in the euro area as a whole has declined for more than a year and a half. That money had to go somewhere… ‘risk-free’ government paper has been a perfect place for the banking system to stuff the cash they are not lending to companies”. Dizzard makes it sound like this was a voluntary normal market based rational decision by the banks. It was not!

It is only the result of extremely distorting bank regulations which require banks to have a lot more of that capital they are currently so lacking of, when lending to the “risky” private sector, than when lending to the “infallible sovereign”.

Dizzard argues the European banking system is being “renationalized” but the sad reality is that banks are de facto being turned into statist government agents… and unfortunately we all know what happens to economies when their financing goes down that line.

Any self-respecting serious buyer on the web will surely like to have her own pick-up drone.

Sir Tim Harford writes about “How delivery drones could transform the world” December 6, and I just have to wonder whether it might not as well be “pick-up drones” which could transform the world.

And I say this because, looking only at some of my family´s members, I have an inkling that any serious purchaser on the web who respects herself, would want to have her own drone… at least for the last mile… just in order to be free to buy from anyone… yes even from Walmart.

I can see all those big houses, next to their cars, having a stand for the latest shiny pick-up drone model… and which, as a complementary service, has a built in camera so as to be able to better see what the neighbor is buying… and send that data to the local data-purchasing agent.

When are they going to fine the bankers and not, suicidally, fine the banks?

Sir, right now, when the European banks are leveraged to the tilt and unable, because of faulty capital requirements and lack of capital, to finance those in the real economy most in need of bank credit, we read, reported by Alex Barker and Daniel Schäfer that “Brussels poised to announce hefty rate-fixing fines on global banks” December 4.

When are they going to fine the bankers and not the banks? Don´t they know that in these days of so little bank capital, derived from regulators requiring so little bank capital with Basel II, that every fine a bank pays, translates into less bank credit… primarily to those medium and small businesses entrepreneurs and start-ups we most need to have access to bank credit in competitive terms?

Bank of England´s and Financial Stability Board´s Mark Carney, is nothing but a housing dove

Sir, John Plender writes that “UK must be more alert to housing bubbles risks” December 4, and comments that “to his credit, Mark Carney, the governor of the Bank of England, has been making suitable hawkish noises about housing.

But let me remind Plender that Mark Carney is also the Chairman of the Financial Stability Board. And as such Carney approves of risk-weights which allow banks to earn much higher risk-adjusted returns on equity when financing houses than when financing, for instance the entrepreneurs and start-ups, those that could get the house owners the job incomes with which pay their utility bills.

So please do not tell us that Mark Carney is nothing but a housing dove.

For a starter Carney does not even understand this

We need personal drones more than Amazon or Google, to get spare keys, and to buy anywhere we please, like in Walmart :-)

Sir, everywhere we read reports on Amazon using drones in the future to deliver us goods, like in Tim Bradshaw´s “Amazon delivers boost to drone pioneers”, December 4.

As I see it the real question is whether we citizens should all have our personal drone instead, so that for instance we could send it home for a spare if we lost our car key… or buy anywhere we please… like in Walmart :-)

The monstrous distortion in the allocation of bank credit to the real economy that regulators do not know they cause

Sir, Tom Braithwaite reports on “Counting the cost to customers of banking regulations” December 3. And he refers to facts such as regulators tightening the standards of capital requirements for banks, for instance against commitments such as those of letters of credit.

But nowhere does he discuss the cost to some customers, some borrowers, of bank regulations that discriminate among the customers. Might it be that he, like the regulators, has not yet understood it?

Let me explain it all to him again.

If there was no risk weighing of Basel II’s 8 percent capital requirements for banks, then the banks would allocate their credit in the real economy, based on who produces the highest risk-adjusted return on eight units of bank capital for each 100 units of loans.

But there is risk weighing in Basel II, and so banks allocate their credit, for instance to the private sector, in terms of:

For those rated AAA to AA, risk weight of 20%, based on who produces the highest risk-adjusted return on 1.6 units of bank capital for each 100 units of loans.

For those rated A+ to A, risk weight of 50%, based on who produces the highest risk-adjusted return on 4 units of bank capital for each 100 units of loans.

For those rated BBB+ to BB-, and those unrated, risk weight of 100%, based on who produces the highest risk-adjusted return on 8 units of bank capital for each 100 units of loans.

For those rated AAA to AA, risk weight 20%, based on who produces the highest risk-adjusted return on 1.6 units of bank capital, for each 100 units of loans.

And so of course those perceived as safer produce the banks a much higher risk-adjusted return on equity than those perceived as riskier.

And that causes banks to lend more than what they should to those perceived as safe and much less, sometimes nothing, to those perceived as risky… like to medium and small businesses, entrepreneurs and start-ups.

And amazingly… the regulators… xxx… do not even understand they are distorting the economically effective allocation of bank credit in the real economy.

What are we to do with them?

When the autopsy on Europe’s economy is performed, the cause of death will be sissy and dumb bank regulatory risk aversion.

Sir, Wolfgang Münchau writes “Lending by banks to the private sector is contracting at accelerated rates… Unsurprisingly the banks are trying to minimize the amount of capital they need to raise by scaling back their risky exposures to private creditors.” “Germany’s coalition will have to break promises”, December 2. And then he writes that “It is rational to expect the credit crunch to continue for as long the adjustment in the banking sector takes place – all the way through to 2014.

Yes, “unsurprisingly” and “rational” are the correct terms, but they are related to the completely irrational capital requirements for banks based on perceived risks.

Before these regulations came into being a bank looked at how to maximize the return of each euro by lending all over the spectrum of perceived risks… and that is what can lead to an efficient allocation of bank credit in the real economy.

Not now. Now a banks looks at the risks of an AAA rated, and since its regulatory risk weight is 20 percent, it uses only 20 percent of a euro when comparing its return to the return of a loan to a “risky” small business, and for which it has to use the full 100 percent of a euro. And, if lending to an “infallible sovereign”, then it can basically measure its returns on equity use 0 percent of a euro as equity.

No! When the autopsy on Europe’s economy will be performed some years from now, these loony and sissy risk adverse regulation virus is going to be identified as the prime cause of its death, and FT and its journalist, by having kept mum on it, will be among its contagion agents.

God, make us daring!

Brother you who do not have a dime, or a job, can you spare me a dime or a job, so that we can grow together?

Sir, I am not taking a position for or against a minimum wage but, when Edward Luce writes that increasing “it would inject a much-needed stimulus into the anemic recovery without involving a dollar of taxpayer money”, something definitely does not sound right, “Avoiding poverty pay is the tonic America needs”, December 2.

If the company ends up paying for it, then we might have less employment and that of course nobody wants. And so, if the taxpayer is not paying for it…who is going to pay for it? Could it perhaps be mostly those who are not taxpayers because they earn too little? And so, if a stimulus, is it not in fact a quite regressive one?

And then Luce mentions that these minimum wage increases will affect “sectors where the bulk of new jobs are being created” and which in fact would point to the plan as being somewhat suicidal.

Honestly I do not think America needs a recovery stimulated by an increase in the minimum wage and Luce would do himself a favor looking at how economies where there is no minimum wage are doing.

Do I have an alternative plan? No, but I would of course start by eliminating immediately the odious regulatory discrimination which makes it so much more difficult for those perceived as “risky” to access bank credit in competitive terms. The growth in America and in Europe has, as in their past, to be based upon risk-taking and not risk-avoidance.

God, make us daring!

PS. Sincerely it is also a bit surrealistic reading that Luce feels that the unions “have reasons to hate” Walmart, the largest employer in the USA, and all this operating on a 3 percent margin, in the poorer sectors of the real economy. Don't we wish we had such banks!

Force bank regulators to answer the question they do not dare to discuss.

Sir, Henny Sender asks: “As the disconnect between the rising prices of financial assets and the real economy continues, is it possible that even the most aggressive easing has its limits?”, “End point for runaway stocks rally comes in sight”, November 30.

The answer is… Yes! Moreover its limits have already been shown. I am sure that if the Fed only researched how much of all QEs and fiscal stimulus has translated into more bank credit to those on the margins of the real economy, and who are most in need of credit, like small businesses, entrepreneurs and start ups, they would be shocked at how little they would find.

But they won´t do that because if so they would have to ask themselves “why?” and that would lead to having to admit how seriously flawed or outright dumb the capital requirements for banks based on perceived risks are.

You see the question that the regulators dare not to discuss is:

If the perceived risks are cleared for in interest rates, size of exposure and other terms, does not re-clearing for the same perceived risk cause a serious distortion in how bank credit is allocated in the real economy?

It just compensates bankers´ love of chocolate cake (the safe) with ice cream, and their loathing of broccoli (the risky) with spinach.

Why and how are medium and small businesses, entrepreneurs and start ups, and normal citizens, ruled to be a systemic danger to the financial system?

Sir, Gina Chon reports that some senators are questioning how the Financial Stability Oversight Council might rule some non-bank financial institutions to represent a systemic risk to the financial system; and which among other could lead these to face higher capital requirements, “Senators warn over non-banks regulation”, November 29.

And again I must ask, for the umpteenth time, why and how are the medium and small businesses, entrepreneurs and start ups, and normal citizens, ruled to be a systemic danger to the financial system?

And I ask this because all higher capital requirements demanded from any financial institutions, when subjected to risk-weighing, naturally impacts the most those against which businesses the most capital is required, and which is of course those who have a high risk-weight.

Others, like the sovereign and the AAAristocracy, are often even favorably impacted by these higher capital rulings since, as the song goes, when capital gets to be scarce the low risk weighted get going.

Chon comments that “the senator’s criticisms could delay the council’s assessment of asset managers, giving them more time to lobby for the regulation to be watered down”. How sad no senator, in the home of the brave, seems interested in watering down the completely unwarranted and odious discrimination against those though correctly perceived as risky, have precisely because of that, never ever caused a major financial crisis.

If I were an asset manager, I would remain in the shadows. But, if one of “the risky”, I would scream my heart out.

Sir, Gillian Tett, referring to the opinion of Helena Morrisey, the head of Newton, writes “Asset managers told to come out of the shadows” November 29. 

And Ms Tett agrees with it, though I do not understand why. If I were an asset manager, having been saved from utter disgrace by generous quantitative easing programs, as so many of them have been, I would probably lay very low… hiding even deeper in the shadows.

No! If there is anyone who should come out of the shadows screaming their hearts out that should be all The Risky. And I refer to those who because they are perceived as risky, and are therefore already naturally being discriminated against by banks and markets, are now also being odiously discriminated against by bank regulators, by means of capital requirements for banks based on perceived risk.

But, perhaps since these “risky” are never invited to Davos and similar high strung places, Ms Tett might not have the same interest in them. And this is sad, and dumb, because if these “risky” were given a fair access to bank credit, they might very well turn out to be the safes of tomorrow who can provide Ms Tett´s pension fund with the income needed to keep her in style, in older days.

No! Anjana Ahuja, academicians can be completely flawed too…like those used by the Basel Committee.

Sir, Anjana Ahuja writes that “Academics know precisely what it means for a study to be ‘flawed’”, “Politicians have learnt to lie in the language of scientists” November 28.

No, not always! When I see capital requirements for banks based on studying the failure rates associated with the assets of a bank and not on studying what made the banks fail, then I simply cannot be so sure about the quality of the academicians, at least not those used by the Basel Committee or the Financial Stability Board.

FT if this is the way European banks “derisk”, there is no doubt that Europe is getting to be much riskier.

Sir, Patrick Jenkins writes “banks have derisked since the crisis, cutting loans to companies and individuals…amplified their investment in sovereign bonds” “Time to force banks to kick their easy money habit” November 28.

To me anyone calling a reduction in loans to citizens and private sector and an increase in loans to the sovereign as a process of “derisking”, is either a communist or has no idea what he is speaking about.

And the “Funding for Lending” schemes that Jenkins refers to as a way of solving the “weak supply of credit to smaller business”, will not make a dent to a problem which derives from those insane capital requirements for banks where these, in marginal terms, under Basel III, need to hold 7 percent in capital when lending to a European, but zero percent when lending to its sovereign.

No Sir, if European banks are “derisking” this way, there is no doubt that Europe is getting to be a much riskier place.

Don´t you find something to be very wrong when banks are given so many incentives by the Regulator of Nottingham to lend to King John and not to Robin Hood?

Is not a failed planet earth worse than a failed bank? Do not hinder banks from financing green growth only because it is “risky”.

Martin Wolf´s “Green growth is a worthwhile goal” November 27, is a non strident account about how the world seems to be entering a very critical stage with respect to climate change, and it just can´t seem to get its act together. And this type of balance approach are much needed since climate change political activists, and rent seekers, are blocking action just as much as extreme climate change skeptics are.

I have no complete solution, but one thing I am certain of. If we are going to stand a chance, we must allow banks to be able to allocate bank credit efficiently to projects which could help us, and not be kept from doing so only because of higher capital requirements based on that these projects could be riskier from a financial perspective.

Let me just give one example. Currently when banks lend to projects like the failed solar panel producer Solyndra, they need to hold much more capital than if they lend to the government so that it in its turn lends to the Solyndras out there. And that does just not make any sense… unless you are a communist off course or in other ways a fanatic believer in the capacity of government bureaucracy.

On a personal level I have been trying to sell the concept that if bank regulators absolutely feel they must distort in order to earn their keep, they should at least align better the incentives to some social purpose. One way would be to allow banks to hold slightly less capital when lending to projects which meet certain sustainability (or job creation) standards.

I have sent out the proposal above to the UN’s Sustainable Development Solutions Network, and I hope it gets there… and is understood there. But since the fact that different capital requirements for banks for different assets distorts the allocation of bank credit in the real economy is not even something debated, I hold no major expectations that will happen.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.

The question is not whether SMEs are risky but whether risky SMEs pose a threat to banks. They don´t!

Sir, Patrick Jenkins, on the issue of the SME not getting sufficient access to bank credit writes: “Compounding is the reality of global capital regulations which makes it far more costly to lend to smaller businesses. Bankers say a typical SME loan may absorb $5 of capital for every $100 of loan, compared with about $1.50 for an average mortgage”, “Policy makers need to refresh their approach to SMEs” November 26.

What “realities of global capital regulations” is he talking about? Those are not God given realities, those are regulations made by human fallible regulators and, if these had been forcefully questioned, among other by your journalists, these could have been changed years ago.

After so many letters over so many years I have written to you, and Jenkins, how come it is only now that Your Banking Editor acknowledges that “Global regulators should look again at the system of risk weighting ascribed to SME lending”? And why did it take a “Bundesbank research paper…convinced that SME default data are not as bad as everyone thinks” for him to do that?

And besides, that is not even important. The real question to be answered by bank regulators is not whether the SMEs are risky or not, but whether the SMEs ever pose a threat to banks? The answer to that is of course they do not, precisely because SMEs are perceived as risky.

If fighting groupthink, start with the worst, with bank regulators, Basel Committee and Financial Stability Board

Sir John Authers asks and answers “Can globalized capital markets coexist with democracy and the nation state? It is reasonable now to fear the answer is “no”, and that means reforming the investment industry should be a far higher priority”, “Fund management reform will help avert groupthink” November 25.

I have no idea why Authers goes after the fund management’s groupthink first and not after bank regulators’ groupthink which has been so much more perverse.

Let me just ask:

What kind of smartass idea is it to require banks to hold capital based on the same ex ante perceived risks which have already been cleared for by markets and banks by means of interest rates, size of exposure and other terms? Could the group of regulators not figure out this dooms the banks to overdose on perceived risks and the risk-price equation to go haywire?

And what democracy approved that for instance a bank in Spain needed to hold 8 percent in capital when lending to a Spanish medium or small business, entrepreneur or startup but could lend, for instance to the government of France, holding zero capital?

No! Globalized market cannot coexist with the dumb groupthink produced by that small mutual admiration club comprised by the Basel Committee and the Financial Stability Board.

Good for you, Commodity Futures Trading Commission

Sir, Tracy Alloway writes that “last week the Commodity Futures Trading Commission upset many traders when it announced it would require cash to backstop Treasuries used as collateral for derivative trades, “Asset price ‘security alerts’ can mask complex risk”, November 23.

And Alloway follows up on that opining that “if the markets cannot agree on the value of one of the most liquid and relative safe assets in the world – an $11tn – then it is tempting to believe than even the most basic assumption are open to interpretation”.

This is an opening to clarify precisely what has gone wrong with bank regulations. In a nutshell, the Commodity Futures Trading Commission is NOT the market, it is the regulator, and should therefore always be open to believe in that all assumptions in the market are open to interpretations.

Stupid were the bank regulators because, in their capital requirements based on perceived risk, they followed the opinions of the same credit ratings market and banks followed.

Yes the Homeland Security Advisor System, with its different colors ranging from green to red to indicate risk levels that Alloway also refers to, might indeed be “A classification system that offers little differentiation provides only limited information value”… but the nightmare would not be much the passengers relying on the colors, but Homeland´s security personnel doing so too.

And, by the way, an $11tn market, of just one borrower…might very well be the systemically most important and therefore the most dangerous market in the world.

Mario Draghi has no moral right to speak about discrimination among Europeans

Stefan Wagstyl reports that Mario Draghi, reacted against “nationalistic undertones” and stated “We are not German, neither French nor Spaniards, nor Italian: We are Europeans”, “Draghi hits at rate policy critics”, November 22.

Sir, Mario Draghi has no moral right to speak about discrimination among Europeans. As the chairman for many years of the Financial Stability Board, he approved of that banks need to hold much much less capital when lending to an “infallible” European than when lending to a “risky” one.

That caused of course banks to avoid lending to those were they could leverage their equity much much less, and thereby not obtain the high expected risk-adjusted returns on their equity the “infallible” offered them.

Talk about exclusion! Talk about increasing inequality gaps! Go home Mario Draghi! Europe was not built upon risk-aversion!

FT, perhaps you should incorporate “and with humility” in your motto, just as a reminder

Sir, in “After Rev Flowers”, November 20, you write that “UK bank’s woes have lessons for politicians and regulators”. You forgot to include financial journalists in that list. 

For instance, you write that Mr Flowers “overestimated a key capital ratio by a factor of two”. Do you really want me to list all of your journalists who at the outset of this crisis wrote of bank capital ratios seeming to be in line with historical ratios, ignoring that the current were based on risk-weighted assets and not as previously on total assets? Doing so your own journalists (and politicians and regulators), often underestimated European bank capital ratios by a factor of five. 

Be sincere… when did you yourself discover that in fact European banks had real asset to capital leverages of way over 30 to 1 sometimes even over 50 to 1? 

John Gapper was one of the very first to understand what was happening with his “How banks learnt to play the system”; but it took a long time for many others to do so, and some might not even have done so yet. 

But Sir, do not be ashamed, you are not alone. Other actors like the IMF reported on Iceland in December 2008 the following “The banking system’s reported financial indicators are above minimum regulatory requirements and stress tests suggest that the system is resilient.” And that clearly shows IMF had no real idea either about what risks risk-weighing could be hiding or causing. 

But, Sir, perhaps you should incorporate “and with humility” in your motto, just as a reminder.

Regulation ordering brutish and silly risk avoidance by banks, only guarantees a sluggish future.

Sir, when you allow banks to hold much much less capital when lending to The Infallible than when lending to The Risky, this allows banks to earn much higher risk adjusted expected returns on equity when lending to the former than when lending to the latter.

And so those actors who we find on the margins of the real economy and who we most need to have access to bank credit, namely medium and small businesses, entrepreneurs and start ups, will get the least of it. And since the future is built upon risk taking and not upon risk avoidance that is the most important cause for “Why the future looks sluggish”. 

That does of course not diminish some of the other explanations put forward by Martin Wolf on November 20. When Wolf correctly writes that we need to “facilitate capital flows to emerging and developing countries” he shows he has failed to understand that there are many emerging opportunities waiting to be developed in developed countries, only because of these bank regulations.

Sir, when Wolf concludes “It will be better to risk mistakes than accept the costs of an impoverished future” he shows some indications of being on the right track but, in his world, he clearly prefers the public sector to take risks, for instance with “a surge in public investments”, before banks doing so.

And I do not. I firmly believe in the banks being the prime agents appointed by society in order to, with reasoned audacity, take the needed risks on its behalf.

But in order for our bankers to take risks on The Risky, we must of course get rid of regulation which de facto prohibits them to do so.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he has already understood it all… at least so he thinks.

I may be right, and I may be wrong. But do you not find it in at least curious that what I argue is not even discussed?

Sir, Henny Sender writes “Five years after the meltdown, it is clear the Fed´s quantitative easing is not about a real economic recovery, it is only about generating the liquidity that gives rise to incomes for the rest of us are not rising at all”, “Fed easing fuels growth in wealth over real economy”, November 19.

As you know very well I hold that is because the financial transmission channel is totally damaged. Capital requirements for banks based on ex ante perceived risks, more risk more capital, less risk less capital, make it completely impossible for banks to allocate credit efficiently in the real economy.

I may be right and I may be wrong, but do you not find it curious somehow that the possible distortion these capital requirements might produce is not even discussed?

And that is not because I am a complete loony. As you know very few, much less in high places, like as an Executive Director of the World Bank, warned in such clear terms about the problems.

Boy you sure seem like a very complacent bunch of journalists to me.

The quality of its unemployed is also vital for the strength of a nation

Sir, Janan Ganesh refers to the relative political tranquility that has prevailed in Britain over the last years, even in the face of 21 percent unemployment among young people, and other hardships resulting from the current crisis/recession, “The British have met crisis with understatement”, November 19.

That is of course extremely valuable and commendable, as long as it is of course much more the result of stiff upper lips, than of a feeling of resignation or sheer apathy, especially in coming generations.

In June 2012 in an Op-Ed I wrote “The power of a nation, and the productivity of its economy, which so far has depended primarily on the quality of its employees may, in the future, also depend on the quality of its unemployed, at least in the sense of these not interrupting those working.”

Can we have some more trigger-happy bank regulators please?

Sir, Alex J Pollock, of the American Enterprise Institute, comments on John Kay’s article “The design failures that lead to financial explosions” saying that when Kay holds that “attempt to design a system for zero failure is impractical” that he would suggests it being “a mission impossible”. And as an argument for this, Pollock correctly writes “The greater the belief in their success grows, the higher the probability of their failure becomes.

And I would also have to add that the larger and more dangerous those failures also become.

In 2003 addressing some hundred bank regulators who were learning about what was being planned by some few regulators for Basel II, I said: “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.”

What Europe and America need is to return to straightforward conventional bank regulations

Sir, I refer to Wolfgang Münchau’s “Why Europe needs to try unconventional policy” November 18.

In it Münchau writes, with respect to a further cut by ECB of the interest rate that “We are in a situation of diminishing marginal returns”. And later he observes that “Since small and medium-sized companies in the eurozone are heavily reliant on bank finance, they are beyond the direct reach of a [QE]”.

Why is it so hard for some to connect the dots? Are they afraid of the picture they might find?

Those who can provide the highest marginal returns are the small and medium-sized companies, entrepreneurs and start ups, and who are in fact heavily reliant on bank finance, more so in Europe than in USA. And so the reason the returns are dropping, in Europe and in USA, is that those previously mentioned and who are in fact heavily reliant on bank finance, more so in Europe than in USA, have seen their access to bank credit seriously cut off by the risk-weighted capital requirements for banks.

Risk weighing capital requirements, which translates into banks being able to earn much much higher risk adjusted returns on their equity when lending to what is perceived as “absolutely safe” than when lending to what is perceived as risky is a loony unconventional concept that has only been around for about three decades but that really went crazy with the approval in 2004 of Basel II.

What Europe and America most need is instead return to what is really conventional, namely allowing the banks to discriminate on their own based on perceived risks, without the regulator reusing the same perceived risks for the purpose of determining the capital requirements.

No Europe! Don’t listen to FT. Your only chance is to explore more productive bays, even risking more hitting hidden rocks.

Sir, you write “Steer Europe away from hidden rocks”. November 16… and there you hold: “The tide of cheap money that is lifting all boats will soon be on the ebb. Britain and Europe should navigate their economic challenges now, or risk being beached on the same shore.”

First the tide of cheap money has not and is NOT lifting all boats. “The Risky”, like medium and small businesses, entrepreneurs and start ups, those Britain and Europe most need to get into action, are immobilized for the lack of bank credit, only because bank regulators require banks to have more capital for exposures to them.

Second you are NOT risking being beached on the same shore, you are risking dying gasping for oxygen in the same dangerously overpopulated safe havens, those to which banks can have exposures to against minimum capital.

Britain and Europe, your only chance is to explore more productive bays, even though you risk more hit hidden rocks. Future is only built upon risk-taking, never ever on risk avoidance.

We need capital requirements for banks based on saving our planet and creating jobs ratings

Sir, Jeffrey Sachs writes “the system of financial intermediation is broken” and therefore the financial needs for the many infrastructure investments required to face climate change challenges, cannot be satisfied. “We risk more Haiyans if we ignore climate change” November 17.

I agree. For more than a decade I have argued that capital requirements based on perceived risks, only distorts the allocation of bank credit in the real economy, favoring “The Infallible” and odiously discriminating against the risky. And to top it up, for no purpose, since never has a major bank crisis resulted from excessive exposures to what was perceived as “risky”, they have all originated in excessive exposures to what was perceived as absolutely safe.

And in this line I have proposed that if bank regulators must distort (to earn their keep or satisfy their egos) they should at least try to do so in favor of what society needs, like safeguarding our planet earth (and creating jobs).

And that the regulators could to that by allowing banks to have less capital when financing based on an assets project’s sustainability (or potential-of–job-creation) ratings.

Because that, would allow the banks to earn their highest-risk adjusted returns on equity, where they can be the most helpful to the society.

I have sent out my proposal to the UN’s Sustainable Development Solutions Network, and I hope it gets there… and is understood there

http://ourpiedaterre.blogspot.com/2013/10/if-regulators-absolutely-must-distort.html

European savers, leveraging only once their capital, stand no chance to compete with banks for good rates on “safe” savings

Sir, I refer to Alice Ross’ “Central bankers seeks to quell rate anger” November 14. In it she refers to the problem of German savers finding extremely low returns when placing their money, into what is supposedly very low risk.

Jens Weidmann, the president of the Bundesbank, argues that there is no discrimination among European savers and that they are all equally affected. That may be… but there is an underlying regulatory distortion that discriminates strongly against all individual savers, in favor of the banks.

When European banks are allowed to leverage their capital 60 or more times for exposures to absolutely-safe havens, rates will be very low in these. And the poor individual saver, leveraging his own capital just once, stands no chance to compete for a decent rate.

We need much less incestuous processes for determining bank regulations

Sir with respect to bank regulation, you write: “As the crisis showed we should be humble about the limits of our knowledge. Excessive faith was invested in abstract mathematical models, while insufficient effort was made to link these to real-life experience…The recital of laws and ritual genuflection towards mathematical models may lend the subject a certain intellectual respectability but much of this is spurious. Substituting a little humility for pretention would be a welcome step”, “The new economics”, November 13.

Indeed, but what it mostly describes is the absolute necessity of stopping members of a mutual admiration club, who do not dare to criticize colleagues, or are to spineless to confess they do not understand one iota, from engaging in incestuous thinking processes, and then having the right to impose not duly vetted regulations on the whole world. I say this because the mistake that caused the crisis and stops us from getting out of it, is of a much deeper nature than trusting too much abstract mathematical models.

Here I go again: Banks and markets clear for ex ante perceived risks of default by means interest rates, size of exposure and other terms, like duration. Therefore to clear for the same perceived risks, like regulators do with risk weighted capital requirements, more risk more capital less risk less capital, is more than wrong, it is dumb.

First it upsets the whole risk-price equation and distorts all common sense out of the process by which banks allocate credit in the real economy. Banks make much higher risk adjusted returns on equity when financing “The Infallible” than when financing “The Risky”… and so banks stop to finance the future and mostly refinance the past.

And second, it is all for nothing since never ever have bank crisis resulted from excessive exposures to what was ex perceived as safe, these have always resulted from excessive exposures to what was perceived as absolutely safe.

We are now 5 years into the crisis and the distortion that risk weighted capital requirements for banks produce in the allocation of credit in the real economy… is yet not even recognized as an unforeseen consequence, much less is it on the agenda. And that by itself Sir, is an extremely serious problem.

By the way, the fact that you in FT decided to ignore the hundreds of letters I have written to you over years spelling out the mistake; and that you now champion The Institute for Economic Thinking, where failed regulator Lord Turner is now a Senior Fellow, as "charged with the task of restoring academic economics to its standing", only indicates that you might be a member of the same club and therefore also part of the problem.

Basel regulations make banks solely finance what is ex ante safe, and not what ex post could be vital.

Sir, Martin Wolf writes “If the ECB had moved rates decisively towards zero in 2010, it might have avoided at least some of today’s difficulties”, “Why Draghi was right to cut rates”, November 13. He is wrong.

What caused this crisis and keep us from resolving it, are the capital requirements based on perceived risks. That makes banks finance what is ex ante perceived as “absolutely safe” and stops them from financing what, ex post, could have been vital.

Wolf writes about unconventional measures. There is nothing more stupidly unconventional than for bank capital requirements reusing the same perceived risks that have already been cleared for by the markets.

And Mario Draghi, having been the chairman of the Financial Stability Board, is much responsible for it all.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.

Bank regulators, the Basel Committee, created a nuclear bomb, Basel II, the AAA-bomb, which exploded,

Sir, John Kay writes with respect to financial regulations that “Shorter, simpler, linear chains of intermediation are needed, and loose coupling that gives every part of the system loss absorption capacity and resolution capability.”, “The design failures that lead to financial explosions” November 13. I could not agree more.

And with respect to his nuclear simile let me just note that in 1999, in an Op-Ed, I wrote:

“The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system”.

And indeed, with Basel II, they fabricated a bomb; I have called it the AAA-bomb.

The Help to Buy scheme, has also something of a Help to Sell Expensively flair about it.

Sir, Janan Ganesh opines that “Britain’s flawed Help to Buy scheme is smart politics”, November 12. And this because it allows the Tories, to “connect with the many young to middle age voters priced out of the housing market”.

Yeah, yeah, that is as long as no one informs those many young to middle age voters that they are priced out of the housing market, precisely because of this type of assistance.

Was the government not helping or hindering with permits the housing market in any way, houses could actually be quite affordable. As is, it looks more like a diabolical design to help aging baby boomers get rid of assets, at great prices, sticking those to the generations after them.

FSB's rule is no deterrence for a bank wanting to become, globally, the most systemically important bank.

Sir, Tom Braithwaite reports “China’s ICBC joins banking risk list”, November 12. It should have been expected, as surely the Chinese government must have complained about not having one bank in the exclusive list of Global Systemically Important Banks.

Also in reference to JP Morgan Chase and HSBC, Braithwaite categorizes the 9.5 percent of capital based on risk-weighted assets as “punitive” and mentions the current empty10.5 percent capital bucket as “a deterrent to any banks that may think of getting bigger or engaging in riskier activities”. He is wrong.

First, as we all should now 9.5 percent or 10.5 percent of capital does not really mean anything if the risk-weights do not mean anything. And second… would a bank stop trying to be the globally most systemically important bank, just because of a risk-weighted capital requirement?

Forget it! If FSB really want to see some serious containment of the too big to fail they should require 9.5 percent of capital on all assets. Frankly the naiveté of FSB trying to frighten the banks with such a feeble bogeyman is just mindboggling.

PS. By the way the list just published is based on 2012 year end data. Does that sound speedy enough?

Europe, and the Western world, is spiraling down to its death, embraced by crazy "risk" adverse bank regulations.

How on earth can Europe regain internal balance with bank regulations which are based on the principle that the safer you ex ante look, like the more surpluses you have, like Germany, the less will the banks need to hold in capital lending to you, and so the more will banks expect to earn in risk-adjusted returns on equity when lending to you, and so the less will they lend to those perceived as riskier?

That is a death spiral that will make Europe and the whole Western world implode, as it only guarantees that banks will, naked with no capital, die because of lack of oxygen, in dangerously overpopulated “safe-havens” like Germany.

If you really want to have a future, then you need to give banks incentives to finance it, and not only like now, give these especial incentives to refinance the safer past.

Sir, Martin Wolf, again, in “Germany is a weight on the world” November 6, in spite of my so many letters to him on that issue, does not make a reference to this problem described above. 

Edward Dolnick, in “The Forger´s spell”, when looking to explain how those big experts that had considered some fake Vermeer paintings original, hang on to their beliefs until death, “despite incontrovertible proof to the contrary”, quotes the psychologist Leon Festinger saying: “A man with a conviction is a hard man to change. Tell him you disagree and he turns away. Show him facts or figures and he questions your sources. Appeal to logic and he fails to see your point”.

I believe that applies perfectly to Martin Wolf, but, then again, it could just the same really apply more to me. What do you think?

PS. In the article Wolf writes “just as others had a right to complain about past US regulatory failures”, but it is hard to figure out what he means with that.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.

FT, don't you get it, there is absolutely nothing so far away from laisser-faire, than capital requirements for banks based on risk weights

Sir, in “Save business from the businessmen” November 6, you write “More intrusive regulation should be reserved for special cases such as banking”, and you refer to “the laisser-faire approach of the past three decades”. Are you out of your mind?

We have bank regulations which, by means of using risk weights, allow banks to earn much higher expected risk adjusted returns on equity on assets that are perceived, ex ante, as absolutely safe, than on assets perceived, ex ante, as risky. And those regulations are de facto capital controls which direct the allocation of bank credit. Have you ever seen regulations so far away from laisser-faire than this?

I am sorry to say it but, FT, when history catches up to this you are certainly going to look like fools.

Damn you, you so risk adverse, baby boomer bank regulators

Sir, Satyajit Das, states clearly the fact that, if things go on the same, “Over time, financing will become concentrated in official agencies, the ECB and national governments or central banks. Risks will shift from the peripheral countries to the core of the eurozone, especially Germany and France”, “Debt crisis has left German economy vulnerable” November 5.

Of course, how could it be otherwise, with bank capital requirements that so much favor banks going to the “safe harbors”?

Unfortunately, what Satyajit Das, and the Financial Times, do not get is that the greatest cost of it all, for the eurozone and for the whole Western world, is all that adventurous, quite risky, but potentially extremely productive bays that were not explored, only because of such regulations, produced by such risk adverse bank regulators... and who only concern themselves with banks and not one iota with the real economy.

Will there be a real ECB audit of European banks, or just another nail in the coffin of a lost generation?

Sir you write: “By some accounts [the ECB audit] is expected to reveal that eurozone banks need between €50bn and €100bn”, “ECB needs help on its big bank audit” November 4.

No! That would be what European banks might need if they are just to survive, treading water, refinancing some of Europe’s at least for the time safer sovereigns. But, if banks are going to help to put Europe’s future on their books, like loans to medium and small businesses, entrepreneurs and start ups, then they need new regulations, and many times that amount of capital.

Frankly any ECB audit that does not also include understanding and calculating what also needs to be on European bank balances, will just amount to another nail in the coffin of a generation of young Europeans, lost by an insane and extremely risky regulatory risk aversion

And Sir, FT, for whatever reasons, withholding the truth, shares the responsibility for that tragedy.

Tim Harford, be very careful, regulators might wish to regulate baking more

Sir, Tim Harford ends his splendid “Why can´t banking be made more like baking” November 2, with, “I wonder if even Mr Carney will be able to make the market for pensions work like the market for croissants”.

Harford should be much more careful, because other regulators might be lurking in the shadows with desires to regulate baking. For instance they could come up with a tax on low fiber content in bread, in order to help the British people digest better, which would result in, sooner or later, in the British people only being offered fiber.

I say this because bank regulators, like Lord Turner, and like Mark Carney, the current chairman of the Financial Stability Board, considered that the only socially “useful” activity that a bank could engage in was to make certain it would not default. And, to that effect they concocted capital requirements for banks based on perceived risks.

And that regulation allows banks to earn much much higher risk adjusted returns on equity when lending to “The Infallible”, sovereigns, housing and the AAAristocracy, than when lending to “The Risky”, medium and small businesses, entrepreneurs and start-ups. And in this case we all see how, instead, all the fiber is being taken out of UK´s real economy.

Jacob Frenkel has his, and I have my own cross examination dream

Sir, Jacob Frenkel, a lawyer, dreams of “cross examining all the senior government officials… who begged JPMorgan to save the US and take over Bear Sterns and WaMu” with a “the government is asking you to find liable and impose massive fines on this institution, which tried to help, not hurt, the American economy”, “The madness of the $13bn JPMorgan settlement”, November 1.

I, as a grandfather, would dream instead of cross examining all the bank regulators asking them “Why do you require banks to hold more capital against loans to those perceived as “risky” than against those perceived as infallible, even though the first are already being charged higher risk premiums, get smaller loans, in harsher terms, and have never ever caused a major bank crisis?”

Don’t you know that those we most have to thanks for having some “absolutely safe” today are the “risky” of yesterday? Don’t you know that those who best stand a chance of helping my grandchild to find a decent and sturdy job tomorrow might very well be those “risky” most in need of access to bank credit in competitive terms, like the medium and small businesses, entrepreneurs and start-ups?

Don't you know that is against the Equal Credit Opportunity Act - Regulation B?

Regulators gaming regulations massively, is so much worse than banks gaming regulations somewhat

Sir, Sam Fleming reports that “Global regulators are cracking down on banks that try to game capital rules for their trading businesses by proposing new standards for the way lenders assess risk… The new system will require banks to calculate risks according to a standardised approach in addition to their own in-house methodology” "Banks set for tougher trading rules", November 1.

There are rules which can be gamed, and then there are those which cannot. For instance, if Basel II had required banks to hold 8 percent of well defined capital against any asset, that would not have been possible to game. But, instead regulators went for the risk-weighing system which are so easy to game… even for the regulators.

In fact, it was the regulators who really gamed the whole system, with such lunacies as assigning risk weights of 20 percent, or even zero, which allowed banks to hold some assets, like AAA rated securities and loans to infallible sovereigns, against only 1.6, or even zero, capital, while assigning 100 percent risk weights, to “riskier” loans, which forced banks to hold 8 percent in capital, 500 percent more, on loans to medium and small businesses, entrepreneurs and start-ups.

And so if you ask me, much worse than banks gaming regulations, is when the regulators do so.

And let me ask. Do you think the banks, on their own, without this regulatory assistance would have been able to game themselves into 40 or even 50 to 1 leverages? No way Jose!

FT journalists don’t be so lame. Dare to ask bank regulators to explain risk-weighted capital requirements to you.

PS. Regulators are suffering from the Annie Oakley syndrome, and we because if that.

With regulators like Mark Carney there is no future in finance for the City, or for the rest of the economy for that matter

Sir, John Gapper writes that Mark Carney, the new “Bank of England governor, has arrived from Canada with a dose of can-do spirit”, “Carney is wise to nurture the City´s future in finance” October 31.

“Can-do spirit”? Ha! There is nothing as far from a can-do spirit than capital requirements for banks which are higher for what is perceived as safe, than for what is perceived as risky. These not only guarantee that banks will not finance the future but mostly refinance the past, but also guarantee the kind of distortions that will make it impossible for the banks which are not in the shadows, to survive.

How can we have reached a point where we can write about “a knowledge industry that has been vital to growth and trade since the 19th century” blithely ignoring there is no way that 19th century banks could have done what they did, with current regulations.

Let me try to explain the regulatory lunacy again, in terms of knowledge. If banks know (or believe they know) the risks, and adjust for these in interest rates, size of exposures and other terms, what business have regulators adjusting for exactly the same “know” in the bank capital?

The role of a banker is to stop his bank from failing”, while the role of a regulator is to see how to stop bankers from failing to stop their banks from failing, and, if banks fail, to see that the hurt will be contained as much as possible. In other words: Though a banker might very well look at credit ratings, a regulator must not look at these, but at how bankers look at credit ratings. Why is it so hard for Mark Carney and his colleagues (and John Gapper and his colleagues) to understand that?

PS. From Edward Dolnick’s “The Forger’s Spell” I extract that the psychologist Leon Festinger once marveled: “A man with conviction is a hard man to change. Tell him you disagree and he turns away. Show him facts or figures and he questions your sources. Appeal to logic and he fails to see your point”. Does this apply to me, or to the bank regulators and Financial Times journalists, or to all of us?

Mark Carney. Risk-weighted bank capital requirements, is extremely improper regulatory behavior.

Sir, I refer to Martin Wolf’s “Carney’s risky bet on big finance” October 30.

According to Basel II, if a bank expected a risk adjusted margin of 1% on a loan to Greece, or on a AAA rated security then, since that was risk weighted 20%, it would be required to hold only 1.6% in capital, and so it would be able to earn an expected risk adjusted return of 62.5% on its equity.

But, also according to Basel II, if a bank expects a risk adjusted margin of 1% on a loan to medium and small unrated businesses then, since that is risk weighted 100%, it would be required to hold 8% in capital, and so it would be able to earn an expected risk adjusted return of only 12.5% on its equity.

Sir, what would you expect the banks to do in such circumstances? Is this the “organized properly, a vibrant financial sector bring substantial benefit” that Mark Carney was referring? If so, Carney has no idea of what “properly” means.

And the ex ante perceived risks-weighting of capital requirements remains the pillar of Basel III, even though, with its leverage ratio, a floor of 3% capital (equity), and a roof of 33.3 to 1 leverage, has been set as an AVERAGE for the banks.

Martin Wolf feels that “Far more equity is required”. I agree, though it has to be something achievable and not a pie in the sky request of 30%, but, before that, risk-weighting needs to disappear. With more basic capital required, unless of course it becomes close to 100%, the more distortions could the risk-weights produce.

Mark Carney states “our job is to ensure that [the financial sector] is safe” He is so completely wrong! His job is to help to ensure that the real economy is safe, and, for that, the health of the financial sector is only one part of the puzzle.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.

Europe, who should define what the non-core assets of your banks are? Regulators, or the needs of your real economy?

Sir, Sam Fleming reports that Richard Thompson, a partner of PwC, estimates that “European banks were sitting on €2.4tn of non-core loans that they plan to wind down or sell off.” “Troubled loans at Europe’s banks double in value”, October 29.

I tell you Sir, that should scare the shit out of Europe… because you can bet that the loans to be wind-downed or sold off, are just those for which bank regulators require the banks to have more capital; and which is something that has nothing to do whatsoever with how much the real European economy needs those loans.

ECB’s asset quality review will take place but, unfortunately, it will not even try to identify all the good opportunities for job creation for the European youth that should have had appear on European bank’s balances, but do not. And this only because regulators allow banks to earn much higher expected risk adjusted returns on equity when lending to “The Infallible” sovereigns, housing and AAAristocracy, than when lending to “The Risky” medium and small businesses, entrepreneurs and start-ups.

Why should banks’ willing spirits but weak flesh be able to resist extreme regulatory temptations?

Sir, I refer to Kara Scannell, Tom Braithwaite and Gina Chon’s report on how government is now, seemingly for political reasons, trying to make up for lost time, by laying it hard on those guilty of producing and packaging lousy mortgages into AAA rated securities, “The paper tiger roars”, October 26.

I am a firm believer that those guilty of it should have been fully prosecuted, from day one, but, what most angers me, is how no blame has been placed on those regulators who, by tempting willing spirits but weak flesh too much, caused the whole problem.

Basel II bank regulations, those which the US also signed up on in June 2004, stated that banks, against loans to unrated businesses, were required to hold 8 percent in capital (equity), but, that against AAA rated securities, 1.6 percent sufficed. And that meant that banks were allowed to leverage their equity 50 times more when holding AAA rated securities, than when holding loans to unrated businesses.

How could regulators have expected the banks to resist such extraordinary temptations? Prosecute, as dumb, and have them parade down avenues wearing dunce caps, those regulators who so tempted our banks.

Classic economics, models and free markets, stand no chance against arrogant intellectually sloppy regulators

Sir I refer to Gillian Tett’s interview of Alan Greenspan, October 26.

In it Tett writes that “There is a profound irony here. In some senses, Greenspan remains an orthodox pillar of ultraconservative American thought… And yet he, like his left-wing critics, now seems utterly disenchanted with Wall Street and the extremities of free-market finance – never mind that he championed them for so many years.”

What free market finance is Tett referring to? That which requires banks to hold reasonable amounts of capital (equity) when lending to medium and small businesses and entrepreneurs but allowed banks to hold basically no capital when lending to those considered absolutely safe like sovereigns housing and the AAAristocracy? Is that “free-market finance”? She´s got to be joking! 

And Tett also writes “Greenspan has had a change of heart: he no longer thinks that classic orthodox economics and mathematical models can explain everything… he thought – or hoped – that Homo economicus was a rational being and that algorithms could forecast behavior”

No Tett! And no Greenspan! The problems had nothing to do with faults in classic orthodox economics or of mathematical models per se, or with “The ratings agency failed completely”, the problem is to be found entirely in the sloppiness with which these were applied.

Simple common sense should have forecasted what was going to happen, namely too much easy bank credit to what was considered as “absolutely safe”, and too little to what was ex ante perceived as “risky”. Or, what would Tett, or Greenspan, think that I could be referring to, when in the Financial Times in January 2003 I wrote: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds.”?

If banks used “perceived risks”, which includes of course the perception of rating agencies, then why should the regulators reuse the same perceptions for the capital requirements? What the regulators had and need to do, is of course to base the capital requirements for banks on the possibilities and implications of those ex ante risk perceptions being wrong. And in that case, since what ex post turns out riskier than the ex ante perception was, is always riskier than what turns out safer, if anything, the capital requirements should be higher the safer the ex ante perception are.

It is sad to hear Greenspan admitting: “When I was sitting there at the Fed, I would say, ‘Does anyone know what is going on? ... I couldn’t tell what was really happening”.

But, that more than five years after the crisis began, Greenspan and the Fed (and Tett of course) seemingly do still not know what happened, and is happening, well that is truly scary stuff… especially for all those unemployed young who are going to pay for it.

Americans who sing about their “Home of the brave”, are clueless about what their bank regulators are up to

Sir in “A superpower at risk of slippage” October 26 you so correctly write “History is littered with solid objects – and risk-less assets – that have melted into thin air.” And yet, you keep mum about the fact that your own banks are allowed to hold exposures against minimal capital, sometimes even zero, only because these assets are perceived, by fallible humans, as “risk-less assets”.

But, if anything puts a superpower at the risk of slippage, that is when a superpower starts fretting more about what it has than about what it can get. And that happens when for instance it accepts regulations that basically instruct their banks to stop financing the “risky” future and concentrate on refinancing the “safer” past. Like what is done by means of the Basel Committee’s and the Financial Stability Board silly capital requirements based on ex ante perceived risk.

God make us daring!

Now is not the right time for European banks to make payouts to their shareholders.

Sir, Richard Milne reports “Shareholders press Swedish banks for payouts”, October 25.

According to recent indications from the Basel Committee, banks will have to publish their leverage ratios in January 2015, which means that their un-weighted assets to capital ratios will be seen.

If European bank shareholders only knew how important, for the competitive strength of their banks, it will be to then be able show up strong ratios, in the midst of that market panic that could result from unveiling the scary truths, they would not be asking for any payouts now.

Bank of England must allow its banks to finance UK´s future and not just make these refinance its seemingly safer past.

Sir, Martin Wolf writes “The job of policy…is to shift the economy on to the better path. This means taking risks.” “Why the Bank of England must gamble on growth” October 25.

For me, more important than that is for the Bank of England to get out of the way of avoiding private risk-taking, like it does when subscribing to Basel’s silly capital requirements for banks based on ex ante perceived risk, more risk more capital (equity) less risk less capital (equity).

That allows the banks to earn much much higher expected risk adjusted returns on equity when lending to sovereigns, housing and the AAAristocracy, than when lending to medium and small businesses, entrepreneurs and start-ups. And that has of course caused havoc in the allocation of bank credit to the real economy… which of course hinders the chances of sturdy growth.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks… or it just might be that he does only want the public sector to have the right to risk it.