To stand a chance, UK must refrain from imprudent risk-aversion and embrace some prudent risk-taking.

Sir, I refer to Martin Wolf’s “The UK’s future depends on improving economic performance” FT, April 15 2023. 

Wolf at the end of it recommended the UK to “reform its pension system, in order to generate more risk-taking capital, create dynamic new businesses.” Why does Wolf not even mention the UK's banks?

From mid 1979 until mid 1980 I practiced at Kleinwort Benson, one of the truly old English Merchant Banks that has since then, as so many others, gone down, disappeared by globalized Basel Committee bank regulations. With the risk weighted bank capital (equity) requirements, knowledgeable and experienced loan officers were substituted by creative equity-minimizing / leverage-maximizing (dangerously creative) financial engineers.

October 2009, in his Economist Forum, Martin Wolf published my: “Please free us from imprudent risk-aversion and give us some prudent risk taking” It began it with “There is not one single reason to believe the world would be a better place because our financial regulators provide additional incentives to those who, perceived as having a lower risk of default, are already favored by lower interest rates, or punish further those who, perceived as more-risky, are already punished by higher interest rates. In fact, the opposite is most likely truer”

Sir, when comparing government debt and residential mortgages with loans to small businesses and entrepreneurs, in terms of how nutritive they could be for the economy, it is not that outlandish to describe it as demand-carbs vs supply-proteins.

In “Credit Suisse: the rise and fall of the bank that built modern Switzerland” FT, March 24, Owen Walker and Stephen Morris write the Schweizerische Kreditanstalt, later rebranded as Credit Suisse, was born out of Alfred Escher’s determination to develop a railway network across the Alpine nation that would link northern and southern Europe. 

Sir, would that Alpine railroad have been built, with a Basel Committee imposing risk weighted bank capital/equity requirements with decreed weights 0% government, 30% residential mortgages and 100% risky projects? 

Would the banks in the City of London have reached the stars with such regulations?

Sir, dare ask Martin Wolf to dare answer that.

@PerKurowski

Are British authorities more aware of risks than those in the US? Martin Wolf, dare find out.

Sir, Martin Wolf writes “The best pro­tec­tion against occa­sional huge bank­ing crises is fre­quent smal­ler ones.” “The UK must learn its own les­sons from the bank­ing crisis” FT April 3, 2023.

I could not agree more. During a World Bank workshop on Basel II in 2003, I opined:

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

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

Also, knowing that ‘the larger they are, the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size”

But Wolf begins with “Banks are the Achilles heel of the mar­ket eco­nomy. The com­bin­a­tion of risky long-term assets with liquid liab­il­it­ies redeem­able at par is a stand­ing invit­a­tion to illi­quid­ity and insolv­ency.” On that I would like to point out that in the case of SVB, those “risky long-term assets” were US Treasury bonds, assigned a 0% risk weight by the regulators. Current risk weighted bank capital/equity requirements are the real Achilles heel of the mar­ket eco­nomy. Had these not existed, and there instead had been one single capital requirement against all assets e.g., 10%, there’s no chance SVB (or other banks) would have so much ignored the interest rate risk, the duration risk, present.

Just think of what must be a modern bank risk manager’s risk dilemma: “What if my risk model shows the risks of the bank’s assets have increased a lot and therefore the bank’s capital/equity requirements will have to increase a lot too? What will the Board say?”

Wolf writes: “As Charles Good­hart of the Lon­don School of Eco­nom­ics has noted, man­agers who fail to man­age suc­cess­fully must share — and know they will share — in the losses”. I ask, should that not apply to regulators too? Should those who with so much hubris have/are betting our bank systems on that they know so much about risks, not at least be paraded down some major avenues wearing cones of shame?

Finally, Wolf hopes that “The Brit­ish author­it­ies appear to have been much more aware of the risks cre­ated by losses on the mar­ket value of port­fo­lios caused by higher interest rates than those in the US.” Why does he not investigate if its so? Is he scared he, like most, will have been duped/lulled into a false sense of security believing that risk weighted assets (RWA) is a sufficiently good reflection of bank risks?

More on this issue.

Creditworthiness should be grounded on what’s worthy of credit.

Sir, Martin Wolf writes “The vicious circle in which low creditworthiness begets unaffordable spreads, which beget debt crises and even lower creditworthiness.” “The threat of a lost decade in development”, Jan 11, 2023

NO! That vicious circle begins with too high decreed government creditworthiness. 

November 2004, the Financial Times published a letter in which I asked “How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector?”

Sincerely, anyone lending money to a developing country that has adopted Basel Committees’ bank regulations, based on that its bureaucrats know better what to do with that credit they’re not personally responsible for than e.g., its small businesses and entrepreneurs, deserves losing money.

When participating in the Sustainable Debt Levels (SDL) debate my opinion was always: “There cannot be a road more conducive to debt turning unsustainable, than to award credits just because they are sustainable.”

And what is development much about? The willingness to take risks. Where does Mr. Wolf thinks the western world would be with the current risk weighted bank capital requirements? In Nirvana or still among the emerging developing nations?

Friedrich List wrote that free trade was the means through which an already industrialized country “kicks away the ladder by which it has climbed up, in order to deprive others of the means of climbing up after it.” If we were to paraphrase List, if the high-income countries want to help, don’t kick away that ladder of risk taking that made them high-income.

1987, in reference to that credit risk aversion coming out of the Basel Committee for Banking Supervision, I ended my first Op-Ed ever with:

“If we insist on maintaining a firm defeatist attitude which definitely does not represent a vision of growth for the future, we will most likely end up with the most reserved and solid banking sector in the world, adequately dressed in very conservative business suits, presiding over the funeral of the economy. I would much prefer their putting on some blue jeans and trying to get the economy moving.”

Sir, I feel that paragraph being just as valid as then… and much worse, not only to developing nations.

PS. At the High-level Dialogue on Financing for Developing at the United Nations, New York, October 2007, this is the document I presented:

My first Op-Ed: http://subprimeregulations.blogspot.com/1997/06/puritanism-in-banking.html

My letter in FT: https://teawithft.blogspot.com/2004/11/basel-is-just-mutual-admiration-club.html

Five comments on Patrick Jenkins “Failure to learn lessons of 2008 caused LDI pension blow-up”

Five comments on Patrick Jenkins “Failure to learn lessons of 2008 caused LDI pension blow-up”. Not sent by a letter to the Financial Times.

“There’s no such thing as risk-free” 

Especially if you take into account that e.g., major bank crises always result from the build-up of dangerously excessive exposures with assets perceived or decreed by regulators as especially safe.

“Ultra-low interest rates have obscure side-effects”

Indeed, especially when those ultra-low interest rates are the result of manipulations. The current risk-free rate has nothing to do with the risk-free rate before risk weighted bank capital requirements and QEs.

“A leveraged bet — to ‘juice’ otherwise low returns”

“Assets assigned the lowest risk, for which bank capital requirements were therefore nonexistent or low, were what had the most political support: sovereign credits & home mortgages...A ‘leverage ratio’ discouraged holdings of low-return government securities” Paul Volcker

“In the UK, the government wants to make it easier for pension funds and life insurers to invest in riskier assets”

And it should be done, but only by removing the artificialities that have pension funds, life insurers and banks investing excessively in “safe” assets.

“Amateurish governance is dangerous. One of the lessons of bank failures in 2007-8 was that expertise matters”

No! Trusting too much the expertise, e.g., credit rating agencies, introduces a much more dangerous systemic risk.

And I could make many more similar comments.

Britannia, to have a chance to become its former self, needs to free its financial systems from its mis-regulators.

Sir, Martin Wolf asks: “Britannia is not ‘unchained’. It is instead sailing in perilous waters. Can the new captain and first mate even see the rocks that lie ahead?” “The economic consequences of Truss” FT September 21.

Wolf writes: “Thatcher and those who followed her allowed the search for safety in corporate pensions to shift portfolios away from the supply of risk capital to business to ownership of government bonds. This in effect turned the plans into state-backed pay-as-you-go schemes.”. 

Sir, more than three decades late Martin Wolf seems to notice that huge rock of Basel I that, for its risk weighted bank capital requirements, decreed weights of 0% government, 30% residential mortgages and 100% citizens. Better late than never… but really?

These bank capital requirements are based on that what’s perceived as risky, e.g., loans to small businesses and entrepreneurs are more dangerous to bank systems than what’s perceived as safe, e.g., government debt and residential mortgages.

That de facto translates into it being much more important for banks to hold government debt and residential mortgages than loans to small businesses and entrepreneurs. Something which, with Solvency II, applies to its insurance companies too. Really, is that how Britannia got to be strong?

Sir, the Western world’s banks were taken from the hands of savvy loan officers who knew their first duty was to know their clients and understand what their loans were going to be used for and placed into the hands bank own capital minimizing/leverage maximizing dangerously creative financial engineers.

“UK has a deregulated economy… in which the successful are well rewarded, but those who do less well are penalised. Such Thatcherite aims then are now a reality” No! Bank regulators reward those ex-antes perceived or decreed as safe over those perceived as risky. That has zero to do with their ex-post success. Has the UK's public debt been well employed?

Let’s hope someone like Liz Truss dares to set aside whatever mandates she might have, no matter how worthy these might be, in order to tackle a real financial regulatory reform.

Sir, what would Edmund Burke with his intergenerational social contract have opined about prioritizing the refinancing of the “safer” present over the financing of the riskier future?   

 

Why does the world ignore regulations that totally disrupt the allocation of bank credit?

Sir, I refer to Martin Wolf’s “Shocks from war in Ukraine are many-sided. - The conflict is a multiplier of disruption in an already disrupted world” FT April 27.

The concentration of human fallible regulatory power in the Basel Committee has, since 1988, resulted in bank capital requirements mostly based on that what’s perceived as risky e.g., loans to small businesses and entrepreneurs, is more dangerous to our bank systems than what’s perceived or decreed as safe e.g., government debt and residential mortgages; and not on misperceived risks or unexpected events, like a pandemic or a war. 

What can go wrong? I tell you Sir.

When times are good and perceived risks low, these pro-cyclical capital requirements allow banks to hold little capital, pay big dividends & bonuses, do stock buybacks; and so, when times get rough, banks stand there naked, just when we need them the most.

And of course, meanwhile, these capital requirements, by much favoring the refinancing of the safer present over the financing of the riskier future, have much disrupted the allocation of credit

Why has the world for decades ignored this amazing regulatory mistake?

Sir, perhaps you could ask Martin Wolf to explain that to us.

PS. Two tweets today on bank regulators’ credit risk weighted bank capital requirements.

What kind of banks do we want?

Banks who allocate credit based on risk adjusted interest rates?

Or banks who allocate credit based on risk adjusted returns on the equity that besserwisser regulators have decreed should be held against that specific asset?

https://subprimeregulations.blogspot.com/2021/01/and-academia-kept-silence.html

Bank events' matrix

What’s perceived risky turns out safe

What’s perceived risky turns out risky

What’s perceived safe turns out safe

What’s perceived safe turns out risky

Which quadrangle is really dangerous?

Covered by current capital requirements?

NO!

https://youtu.be/TUdKhm6_a8Y

Chile can also set a great example for the developed world.

Sir, in “Chile can set an example for the developing world” FT, March 10, 2022, you refer to “the risk of European levels of debt”

With bank capital requirements mostly based on perceived credit risks, not on misperceived risks or unexpected events, like a pandemic or a war in Ukraine, you can bet that, at any moment, many banks will stand there naked, precisely when they’re most needed. 

When that happens Chile could set a great example for the developed world… and FT could provide much help with a Big Read that describes better than I can, how Chile so intelligently managed their huge 1981-1983 bank crisis.

The main elements of Chile’s plan were, in general terms:

a. The purchase of risky/defaulted loans by the Central Bank by means of long-term promissory notes accruing real interest rates and with a repurchase obligation out of the profits of the banks' shareholders before those promissory notes came due, plus some limitations on the use of their operative income… e.g., limits on bonuses. 

b. A forced recapitalization of the banks, in those pre-Basel days one capital requirement against all assets, and in which any shares not purchased by current shareholders, would be acquired by the Central Bank, and resold over a determined number of years. 

c. And finally also an extremely generous long-term plan for small investors to purchase equity of banks. 

Just think about where e.g., Deutsche Bank could be, if the Bundesbank and Germany’s Federal Financial Supervisory Authority (BaFin), had applied a similar mechanism during the 2008 crisis?

Here's more details on Chile's handling of its bank crisis

PS. Not the first time I suggest this

@PerKurowski

FT, on banking and finance who are you to believe, Francis Fukuyama or Paul Volcker?

Sir, Francis Fukuyama in “The war on liberalism” FT March 5, writes:

“Liberals understand the importance of free markets — but under the influence of economists such as Milton Friedman and the “Chicago School”, the market was worshipped and the state increasingly demonised as the enemy of economic growth and individual freedom. Advanced democracies under the spell of neoliberal ideas trimmed back welfare states and regulation, and advised developing countries to do the same under the “Washington Consensus”. Cuts to social spending and state sectors removed the buffers that protected individuals from market vagaries, leading to big increases in inequality over the past two generations.

While some of this retrenchment was justified, it was carried to extremes and led, for example, to deregulation of US financial markets in the 1980s and 1990s that destabilised them and brought on financial crises such as the subprime meltdown in 2008.”

Paul A. Volcker in his autobiography “Keeping at it” of 2018, penned together with Christine Harper, with respect to the risk weighted bank capital requirements he helped to promote and which were approved in 1988 under the name of Basel I wrote:

“The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages. Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011. The American “overall leverage” approach had a disadvantage as well in the eyes of shareholders and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return US government securities."

Sir, in reference to advising developing countries with the “Washington Consensus”, in November 2004 you kindly published a letter in which I wrote:

“Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector? In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

So, there are two completely different bank systems:

Before 1988, one in which banks needed to hold the same capital against all assets, credit was allocated based on risk adjusted interest rates and the market considering the bank’s portfolio, accurately or not, values its capital.

After 1988, one risk weighted capital requirement banks where credit is allocated based on risk adjusted returns on equity, something which clearly depends on how much regulators have allowed their capital to be leveraged with each asset... clearly favoring government credit, which de facto implies bureaucrats know better what to do with (taxpayers') credit than e.g., small businesses and entrepreneurs. Communism!

Sir, I am of course just small fry, not even a PhD, but, if you have to choose between describing what has happened in the financial markets since 1988 as a “deregulation”, as Fukuyama opines, or an absolute statist and politically influenced misregulation, as Volcker valiantly confesses, who do you believe?

Sir, is this topic taboo… or just a too hot potato for the “Without fear and without favour” Financial Times?

PS. In Steven Solomon’s “The Confidence Game” 1995 we read: “On September 2, 1986, the fine cutlery was laid once again at the Bank of England governor’s official residence at New Change… The occasion was an impromptu visit from Paul Volcker… When the Fed chairman sat down with Governor Robin Leigh-Pemberton and three senior BoE officials, the topic he raised was bank capital…”

@PerKurowski

What if the State of Maryland USA, where I live, was treated by the Fed as Italy is by its EU bank regulators?

Sir, Tony Barber writes: “Paradoxically, as Italy’s debt has ballooned in size, it has become more manageable. Particularly over the past two years, the crucial factor has been European Central Bank support” “Reforms and ECB help are key to Italy debt sustainability” February 25.

Although already Maryland, as all other US states is already treated quite (too) generously by bank regulators, since it cannot print dollars on its own, the capital banks need to hold when lending to it, do at least depends on its credit ratings. 

Not so in the Eurozone. Though none of its sovereigns, like Italy, can print euros on their own, and independent of their credit ratings, the banks in EU can lend to all Eurozone sovereigns, against zero capital. Something much agreed by and pushed by Mario Draghi.

It’s been hard for me to understand, especially after Brexit, why FT has kept so much silence on this Eurozone’s sovereign debt ticking bomb.

@PerKurowski

For inflation, where the money supply goes, matters a lot too

Sir, I refer to Martin Wolf’s “The monetarist dog is having its day”, FT February 23.

Yes, the money supply impacts inflation, no doubts but, when it comes to how much, that also depends on where that money supply goes.

If central banks inject liquidity through a system where, because of risk weighted capital requirements, banks can leverage more, meaning easier obtain higher risk adjusted returns on equity with Treasuries and residential mortgages, than with loans to small businesses and entrepreneurs, does that not favor demand over supply?

It does, and you should not have to be a Milton Friedman to understand that sooner or later that can only help inflate any inflation.

Wolf holds that “Central banks must be humble and prudent” Yes, and that goes for bank regulators too.

“Humble” in accepting there are huge limits to their knowing what the real risks in an uncertain world are; and “prudent” as in knowing bank capital requirements are mainly needed as a buffer against the certainty of misperceived credit risks and unexpected events, and not like now, mostly based on the certainty of perceived credit risks.

@PerKurowski

Compared to more than three decades ago, what is the current leverage ratio of our banks?

Sir, Martin Wolf, in FT on July 12, 2012, in “Seven ways to clean up our banking ‘cesspit’” opined: “Banks need far more equity: In setting these equity requirements, it is essential to recognize that so-called “risk-weighted” assets can and will be gamed by both banks and regulators. As Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk. For this reason, unweighted leverage matters. It needs to be far lower.”Soon a decade since, are bank capital requirements much higher and really sufficient?

No! Though bank capital requirements are mostly needed as a buffer against the certainty of misperceived credit risks & unexpected events, in this uncertain world, these are by far, still mostly based on the certainty of the perceived credit risks.

Consequently, when times are rosy, regulators allow banks: to lend dangerously much to what’s perceived as very safe; to hold much less capital; to do more stock buybacks and to pay more dividends & bonuses. Therefore, banks will stand there naked, when most needed. 

The leverage ratio is also important because it includes as assets, loans to governments at face value, and thereby makes it harder for excessive public bank borrowers to hide behind Basel I’s risk weights of 0% government, 100% citizens. No matter how safe the government might be, those weights de facto imply bureaucrats know better what to do with credit they’re not personally responsible for than e.g., small businesses and entrepreneurs.

November 19, 2004, in a letter you published I wrote: “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector?” That this factor, in the face of huge government indebtedness, is not even discussed, as I see it can only be explained by too much inbred statism.

Before the Basel Committee Accord became operative in 1988, Basel I, banks were generally required to hold about 10 percent of capital against all assets, meaning a leverage ratio of 10.

Where do banks find themselves now? I know well it’s hard, and extremely time consuming, to make tails and heads out of current bank statements, but I’m absolutely sure most financial media, if they only dared and wanted, have the capacity to extract that information.

Should not such basic/vital data be readily available and perhaps even appear on front pages? It’s not! Why? Has media been silenced by capital minimizing/leverage maximizing dangerously creative financial engineers?

Sir, I’m not picking especially on financial journalists, the silence of the Academia, especially the tenured one, is so much worse.

@PerKurowski

How can you hold governments accountable, while their borrowings are being non-transparently subsidized?

Sir, Aveek Bhattacharya discusses various options to improve the productivity and effectiveness of public spending. “A future case for the ‘retro’ policy of public sector reform” FT February 18, 2022.

He fails to mention: Current bank capital requirements are much lower for loans to the government than for other assets. This translates into banks being able leverage much more their capital – and so making it easier for them to earn higher risk adjusted returns on equity when lending to the government than when lending to the citizens. That, which de facto implies bureaucrats know better what to do with credit they’re not personally responsible for than e.g., small businesses, turns into a subsidy of the interest rates government has to pay on its debts. Top it up with that the quantitative easing carried out by central banks is almost all through purchases of sovereign debt, and then dare think of what sovereign rates would be in the absence of such distortions.

Sir, if you really want to make your government more accountable, have them at least know what their real borrowing costs are.

Sir, in a letter you published in 2004, soon two decades ago I asked “How many Basel propositions will it take before regulators start realizing the damage, they are doing by favoring so much bank lending to the public sector?” Do you think this only applied to developing nations? If so, please open your eyes.

@PerKurowski

If we want public debt to protect citizens today and tomorrow, it behooves us to make sure it cannot be too easily contracted.

Sir, I refer to John Plender’s “The virtues of public debt to protect citizens” FT February 7, 2022.

Sir, as a grandfather I do fear debt burdens we might impose on future generations, but I’m absolutely not an austerity moralist. I know public debt is of great use if used right but also that the capacity to borrow it a reasonable interest rates (or the seigniorage when printing money), is a very valuable strategic sovereign asset, especially when dangers like war or a pandemic appear, and which should therefore not be irresponsibly squandered away.

In 2004, when I just finished my two-year term as an Executive Director of the World Bank, you published a letter in which I wrote “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage, they are doing by favoring so much bank lending to the public sector?”

1988 Basel I’s risk weighted bank capital requirements decreed weights of 0% the government and 100% citizens. It translates into banks being allowed to hold much less capital - being able to leverage much more, with loans to the government than with other assets.

Of course, governments, when their debts are denominated in the currency they issue, are, at least in the short-term and medium term, and in real terms before inflation might kick in, less risky credits. But de facto that also implies bureaucrats/ politicians/apparatchiks know better how to use taxpayer’s credit for which repayment they are not personally responsible for than e.g., small businesses and entrepreneurs. And Sir, that I do not believe, and I hope neither you nor John Plender do that.

Such pro-government biased bank regulations, especially when going hand in hand with generous central bank QE liquidity injections, subsidizes the “risk-free” rate, hiding the real costs of public debt. In crude-truth terms, the difference between the interest rates sovereigns would have to pay on their debts in absence of all above mentioned favors, and the current ultra-low or even negative interests they pay is, de facto, a well camouflaged tax, retained before the holders of those debts could earn it.

But of course, they are beneficiaries of all this distortion, and therefore many are enthusiastically hanging on to MMT’s type Love Potion Number Nine promises.

@PerKurowski

The Basel Committee blocks development

I refer to Aleksandr V Gevorkyan’s “Small economies require new development model” November 5.

What would FT opine on a development model that include bank regulations based on:

1.- Bureaucrats know better what to do with credit than entrepreneurs; 

2.- It is better to refinance the safer present than financing the riskier future, and 

3.- Residential mortgages are more important than small business loans?

I ask because that’s precisely what the credit risk weighted bank capital requirements ordain, those globally marketed by the Basel Committee and capital minimizing/leverage maximizing financial engineers.

Do you really think the developed world would have been able to develop as much with those regulations? Is not risk-taking the oxygen of all development?

On another topic Gevorkyan mentions “involving the entrepreneurial and investment potential of the large expatriate community (diaspora) that is now a feature of most small economies.” Absolutely but, let us not ignore the sad fact that in many countries it is the family remittances that help to keep in power the governments that caused the diaspora to have to emigrate.

PS. At the High-level Dialogue on Financing for Developing at the United Nations, New York, October 2007, I presented a document titled “Are the Basel bank regulations good for development?” Fourteen years later, that question is still not discussed

Martin Wolf, again, any good economic plan needs, sine qua non, to get rid of bank credit distorting regulations.

Sir, I refer to Martin Wolf’s “Without an economic plan, patriotism is Johnson’s last refuge” FT, October 18, 2021

In Martin Wolf’s Economist Forum of October 2009, FT published an opinion I titled “Please free us from imprudent risk-aversion and give us some prudent risk-taking” (The link is gone, I wonder why)

In that article, commenting partly on the 2008 crisis, I held that getting rid of the risk weighted bank capital requirements, that which distorts the allocation of credit to the real economy, was an absolute must. 

Now, 11 years later, I must still insist in that, without doing so, there’s no economic plan that can deliver sustainable results.

The history I’ll tell my grandchildren has little to do with Philip Stephens’ history.

Sir, Philip Stephens writes: “Twenty-five years ago… the world belonged to liberalism. Soviet communism had collapsed. Historians will record the 2008 global financial crash as… the moment western democracies suffered a potentially lethal blow. The failure of laissez-faire economics was visible before the collapse of Lehman Brothers.” “The west is the author of its own weakness” Financial Times, October 1, 2021.

The history I will be telling my grandchildren is quite different.

Thirty-three years ago, the world belonged to liberalism and Soviet communism was collapsing. Historians will record how in 1988, one year before the Berlin Wall fell, the western world’s bank regulators introduced risk weighted bank capital requirements that distorted the allocation of credit. That put an end to any laissez-faire economics. With risk weights of 0% the government and 100% citizens, as if bureaucrats know better what to do with credit than e.g., entrepreneurs, communism took over. 

The 2008 global financial crash resulted from banks being allowed to leverage their capital/equity/skin-in-the game a mind-boggling 62.5 times, with assets that human fallible credit rating agencies had assigned a AAA to AA rating.

Yes, the west is the author of its own weakness… it much renounced to the willingness to take risks that had made it great. 

Sadly though, there are way too many interested in not disclosing what really happened… and therefore our banks are still in hand of insane risk aversion. “Insane”? Yes, because those excessive exposures that could become dangerous to our bank systems, are always built-up with assets perceived as safe, never ever with assets perceived as risky.

PS. My 2019 letter to the Financial Stability Board

Do we know of a display of hubris greater than “risk weighted bank capital requirements”?

Sir, Gillian Tett in “Economists can’t predict the future — policy should reflect that” July 1 wrote: “Robert Rubin, Peter Orszag and Joseph Stiglitz called on economists to embrace ‘copious amounts of humility’ when projecting the future.”

One of the magnificent displays of hubris, the antonym of humility, came into being when bank regulators imposed, risk weighted bank capital requirements, as if they, from their desks, have any real bankable notion, of what the future really entails.

And on that, this trio, as the rest of the Academia, as Gillian Tett, as FT too, have all kept total silence.

The main ingredient of any safe pension system is a healthy and sturdy economy.

Sir, I refer to Martin Wolf’s “It is folly to make pensions safe by making them unaffordable” FT, June 28.

Wolf writes: “We also need true risk-sharing within and across generations, which is absent from today’s defined-contribution schemes”

But the current risk weighted bank capital requirements, with lower risk weights for financing the “safer” present, e.g., loans to governments and residential mortgages, than when financing the riskier future, e.g., small businesses and entrepreneurs, is a clear example of how that intergenerational holy bond Edmund Burke wrote about has been violated.

In order to have a jolly good time, boomers placed a reverse mortgage on the economy, and all, young and old, will pay dearly for it.

“Radical uncertainty”? Give me a more stupid radical certainty than credit risk weighted bank capital requirements.

And way back, when observing how many Social Security System Reforms were based on the underlying assumption that they will be growing 5 to 7 percent in real terms, I also warned, time and time again, that it was not possible for the value of investment funds to grow, forever, at a higher rate than the underlying economy, unless they are just inflating it with air, or unless they are taking a chunk of the growth from someone else. In this respect the 'chickens are only coming home to roost'.

PS. Historically, through all economic cycles, there is nothing that has proven so valuable in terms of personal social security as having many well-educated loving children to take care of you, and that, in real terms, you can't beat with any social security reform.

https://voiceandnoise.blogspot.com/2006/08/my-insecurities-about-social-security.html

A letter to Martin Wolf in 2015. An essential component of an Edmund Burke intergenerational holy bond, must be the willingness to take risks.

A letter on this issue published 2015 in the Washington Post

Another letter on this subject sent to Martin Wolf in in 2017

And another letter on the Covid response intergenerational conflict of monstrous proportions, also published by the Washington Post in 2020

@PerKurowski

Spurn bank regulators' false promises.

Sir, Martin Wolf makes a good case for “We should not throw liberal trade away for the wrong reasons and in the wrong way”, “Spurn the false promise of protectionism” FT June 16.

Yet, when regulators, decades ago, decided to throw liberal access to bank credit, by imposing credit risk weighted bank capital requirements, something which completely distorted the access to bank credit, Wolf and 99.99 percent of those who should have spoken up, kept mum.

Though I’ve no idea whether they read it, in a 2019 letter I wrote to the Executive Directors and Staff of the International Monetary Fund, I argued that these risk weights are to access to credit, precisely what tariffs are to trade, adding “only more pernicious” 

Wolf writes that “the US economy has suffered from high and rising inequality and a poor labour force performance” and includes among other explanations the “rent-extracting behaviour throughout the economy”

But anyone who reads “Keeping at it” 2018 in which Paul Volcker’s 2018 valiantly confessed: “The assets assigned the lowest risk, for which bank capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages”, should be able to understand that rent-extraction also occurs by means of cheaper and more abundant access to credit.

And boy did regulators throw away unencumbered access to credit in “the wrong way”

Here follows four examples: 

To establish their risk weights, they used the perceived credit risks, what’s seen “under the street light” while, of course, they should have used the risks for banks conditioned on how credit risks were perceived. 

By allowing banks, when the outlook was rosy, to hold little capital, meaning paying high dividends, lots of share buy backs, and huge bonuses, they placed business cycles on steroids.

Very little of their capital requirements cover misperceived credit risks or unexpected events. Therefore, just as in 2008 with the collapse of AAA rated mortgage back securities, and now with a pandemic, banks were doomed to stand there with their pants down.

With risk weights of 0% the sovereign and 100% the citizens, which de facto imply bureaucrats know better what to do with credit they’re not personally responsible for than e.g., entrepreneurs, they smuggled communism/statism/fascism into our banking system.

“We will make your bank systems safe with our credit risk weighted bank capital requirements” Sir, what amount of wishful thinking must have existed for the world, its Academia included, to so naively have fallen for the hubristic promises of some technocrats.

@PerKurowski

Central banks and regulators cancelled the creative part of destruction.

I refer to Martin Wolf’s comments on Philippe Aghion, Céline Antonin and Simon Bunel’s “The Power of Creative Destruction”, “The innovation game” FT June 11, 2021 

John Kenneth Galbraith in “Money: Whence it came where it went” of 1975 wrote: “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]” That’s creative destruction in action.

The current risk weighted bank capital requirements allow banks to earn much higher risk adjusted returns on equity when financing what’s perceived (or decreed) as safe e.g., loans to the government and residential mortgages, than when lending to the “risky” small businesses and entrepreneurs. That’s creative destruction inaction. 

Would the development Galbraith describes have been possible with these regulations? No! Such risk-averse regulations do not help promote innovations.

Sir, in august 2006, in reference to an FT editorial mentioning the possibilities and impact of a “global housing slowdown”, you published a letter I wrote in which I referred to “The long-term benefits of a hard landing.” When the global financial crisis erupted in 2008, there was too much interest in trying to avoid collecting any of these benefits, and the crisis-can was kicked forward... and then much upward with QEs. 

The result? Way too little creative destruction and way too many surviving zombies… and here we are, on a much higher mountain of public and private debt. That will cause pure destruction.

“Risk weighted bank capital requirements”. Sir, if that’s not sophisticated technocratic demagoguery, what is?

Bank regulators never considered the unexpected, like a pandemic

Sir, Angela Merkel, Justin Trudeau and Erna Solberg opine: “The Covid-19 pandemic has taught us that the costs of prevention and early response are small compared with the consequences of under-investment.” “G7 should pay lion’s share of costs to help end the pandemic” FT June 10.

That’s correct but it should not have taken a pandemic to understand that banks need also to have sufficient capital so as to be able to respond to unexpected events. Unfortunately, instead of basing their bank capital requirements on such possibilities, or on that of misperceived credit risks e.g., 2008’s AAA rated mortgage-backed securities, bank regulators, the Basel Committee, doubled down on perceived credit risks, those which were already being cleared for by banks. 

The result? Though so many don’t want the innocent child to be heard, the banks now stand there naked.

Sir, again, if what’s perceived as safe is safe, and what’s perceived as risky is risky, would banks need capital. Not much. 

Bank regulations need a complete overhaul, meaning going back to the humbling reality of risks being hard to measure; instead of digging us down even deeper in the hole with Basel IV, Basel V and so on.

PS. July 12, 2012 Martin Wolf wrote: “Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk.” Martin Wolf clearly heard me, but he did not listen.

@PerKurowski

It’s sad when we need to remind regulators to prepare for the unexpected

“The time to prepare for the next threat is now”, that’s how Bill Emmott ends his “How to build global resilience after the pandemic” FT, May 25.

Sir, Mark Twain, supposedly, said: “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it looks to rain”

Today, if alive, with respect to Basel Committee’s risk weighted bank capital requirements, Mark Twain would have opined: “A bank regulator is a fellow who allows banks to hold little capital when the sun shines, so these can pay lots of bonuses and dividends and buy back lots of stock, but wants banks to hold much more capital, the moment the rain starts”

PS. Emmott writes “But there must be an international accord on debt restructuring, akin to the Brady Plan in the early 1990s.” I lived through that restructuring. It was made feasible by developing countries being able, because US$ interest rates were high, to very inexpensively purchase US$ 30 years zero coupon bonds issued by the US, in order to guarantee the repayment of the principal of their debts. In a world of ultra-low, even negative interest rates, what’s the price of such bonds?

@PerKurowski

Should the Louvre, a homage to inequality, have to be culturally cancelled?

Sir, I refer to Ruchir Sharma’s “The billionaire boom” FT Weekend, May 15.

In this case, as so often happens in articles about the wealthy, it is illustrated with yachts.

As likewise always happens, the fact that the wealthy froze their earned in “good or bad industries” money, or their outright ill-gotten money, by handing it over to those building or selling the yachts, and most probably committing to employing a yacht crew, is an issue of no interest. 

Just as with respect to taxes on wealth the question of what assets and to whom are the wealthy to sell these in order to raise the money to pay for the taxes on wealth it, is scrupulously avoided by the tax proponents.

Where the wealthy’s money flows, should be an integral part of the overall analysis. Then we would be more alert to the possibility that taxing it, and handing over the money to bureaucrats, for them to decide on its use, could lead to the most unproductive use of wealth.

Sir, a personal anecdote. Walking around the museum Louvre in Paris I suddenly saw an 1560 by Pierre Reddon for King Charles IX. I then asked myself who in his sane mind would request this type of absolutely useless shield? Clearly it had to be someone extremely wealthy and powerful, someone who did not care one iota about his own security being threatened on a close range, or about its enormous costs.

https://collections.louvre.fr/en/ark:/53355/cl010117233

In that moment it suddenly dawned on me that basically nothing of what I was seeing at the museum would exist, if it had to be produced by a society where income and wealth was equally distributed. In other words, all this art around me, to have become a reality, has actually required a very unequal society. 

In other words, Shhh... just between you and me Sir... since the museum of Louvre is, unwittingly, a homage to inequality, should it be cancelled?

PS. Sharma writes “Sweden has long abandoned central elements of the social democratic agenda, including wealth and inheritance taxes, as impractical.” There might indeed have been certain policy intermezzos, but legend holds that when Otelo Saraiva de Carvalho, chief strategist of the 1974’s Carnation Revolution in Lisbon, told Sweden’s social democrat leader Olof Palme: “In Portugal we want to get rid of the rich”, Palme replied, “how curious, in Sweden we only aspire to get rid of the poor”

PS. And, as I have written to you soon 3.000 times, those “subprime banking regulations”, with their risk weighted capital requirements, impede that much of that money the wealthy are sloshing around, is efficiently allocated to the real economy. Now, whose fault is that?

@PerKurowski

The “Parable of talents” is currently quite inapplicable to any wealth tax.

Sir, I refer to “Why the toughest capitalists should root for a wealth tax” Martin Sandbu, FT, May 10.

Much of the current wealth is the direct result of huge liquidity injections, and which are distorted by risk weighted bank capital requirements that, among other, so much favors the debts of the government over debts to the citizens… all as if bureaucrats/politicians know better what to do with credit for which repayment they are not personally responsible for, than e.g., small businesses and entrepreneurs.

To favor such wealth tax, besides removing such distortions, I would also like to know what assets, and to whom, the wealthy should sell in order to raise the money to pay such taxes… and what would be the resulting overall productivity of such resource transfer. I believe a full review of the current productivity of all government spending is long overdue.

So, in this respect, taxing wealth with its revenues seemingly not being sufficiently productive, an understatement, sort of reminds me of a Harry Belafonte & Odetta song titled “A Hole in the Bucket”

Sandbu also writes that “a net wealth tax…is the tax version of the New Testament’s parable of the talents” I’m not at all sure that’s currently really so.

I extract the following from Matthew 25: 24-27: 24 “Master,’ 25 I was afraid and went out and hid your gold in the ground. 26 “His master replied, ‘You wicked, lazy servant! So, you knew that I harvest where I have not sown and gather where I have not scattered seed? 27 Well then, you should have put my money on deposit with the bankers, so that when I returned, I would have received it back with interest.”

First, we now have regulators who, with bank capital requirements, tell banks that when they scatter and sow, they should be risk averse, guarding it all in safe gold, e.g., loans to governments and residential mortgages; staying away from what’s risky, e.g., entrepreneurs and small businesses.

Second, to top that up, with QEs central banks are injecting money thereby keeping interest rates ultra-low.

So, are we allowing bankers to exploit their talents? No! 

Will that produce good interest rates for the depositors? No! 

And if inflation takes off, will they receive their real money back? No!

Sir, with respect to risk taking, and even though I am a protestant, let me finally quote Pope John Paul II: Our hearts ring out with the words of Jesus when one day, after speaking to the crowds from Simon's boat, he invited the Apostle to "put out into the deep" for a catch: "Duc in altum" (Lk 5:4). Peter and his first companions trusted Christ's words, and cast the nets. "When they had done this, they caught a great number of fish" (Lk 5:6).

Will this tweet be ignored by FT?

How much hubris is needed for regulators to impose risk weighted bank capital requirements, as if they know what the risks are?

How much wishful hoping is needed when even Nobel Prize winners in Economic Sciences believe that the regulators do know?

http://subprimeregulations.blogspot.com/2019/03/my-letter-to-financial-stability-board.html

About Italy, there are serious questions that FT, and others, should not silence.

Sir, I refer to “Draghi plots €221bn rebuilding of Italy’s recession ravaged economy” Miles Johnson and Sam Fleming, and to “Europe’s future hinges on Italy’s recovery fund reforms”, Andrea Lorenzo Capusella, FT April 22, and to so many other articles that touch upon the issue of Italy’s future, in order to ask some direct questions.

Do you think Italy’s chances of a bright future lies more in the hands of Italy’s government and its bureaucrats, than in hands of e.g., Italian small businesses and entrepreneurs?

I ask this because, with current risk weighted bank capital requirements, regulators, like Mario Draghi a former chairman of the Financial Stability Board, arguably arguing Italy’s government represents less credit risk, do de facto also state it is more worthy of credit. I firmly reject such a notion.

Yes, Italy clearly shows a stagnant productivity, but could that be improved by in any way increasing its government revenues?

Italy, before Covid-19, showed figures around 150% of public debt to GDP and government spending of close to 50% of GDP. I am among the last to condone tax evasion… but if Italian had paid all their taxes… would its government represent a lower share of GDP spending, and do you believe its debt to GDP would be lower?

One final question: Sir, given how Italy is governed, excluding from it any illegal activities such as drug trafficking, where do you think it would be without its shadow eeconomy, its economia sommersa? A lot better? Hmm!

PS. As you know (but seemingly turn a blind eye to), Italy’s debt, even though it cannot print euros on its own, has, independent of credit ratings, been assigned by EU regulators, a 0% risk weight.

No remittances without representation!

Sir, you write “Poor government plagues Central America”, “Central America needs a bold gesture from the US”, FT April 22.Those migrants who often see no choice in life than to depart, with their family remittances produced their efforts far away from home, too often only help to keep in power those who caused them to depart.

An ambitious process such as that one referred to by FT, requires time to acquire political feasibility, and moments of sharp internal divisions might not be the best moment to find it.

In this respect I argue that to help the migrants acquire much more political representation in their homelands, would be a better place to start.

And the migrants sure have economic ammunition they could use. For some of these countries the GDP they help generate in e.g., USA, is larger than the whole GDP registered in their respective homeland.

If our pied-à-terre falls into the hands of a Climate Stability Board, we’re toast.

Climate change dangers require:

Spending fighting it, trying to hinder it 

Spending adapting to it, to avoid its worst consequences

Saving, in order to be able to mitigate its worst effects

How should we budget for that to best avoid ending up toast?

Sir, let me begin with a very brief take on the last three decades of bank regulations.

“A ship in harbor is safe, but that is not what ships are for” John A. Shedd. 

And neither are the banks, but that was ignored.

Before Basel Committee’s risk weighted bank capital requirements, everyone, whether perceived as a risky or as a safe credit, paid risk adjusted interest rates. After these were introduced, bank credit is allocated based on risk adjusted returns on equity.

The “safe”, meaning e.g., governments (bureaucrats/politicians), assets with high credit ratings and residential mortgages, pay relatively lower rates, because banks can leverage their capital/equity many times more with the net margin they provide. The “risky”, meaning e.g., small businesses and entrepreneurs, must pay comparatively higher rates, in order to compensate for the fact that banks must leverage less capital/equity with their net margins.

That has caused banks to overpopulate the safe harbors of the past and present, and to explore the riskier oceans much less than the future of our children and grandchildren needed.

Of course, all for nothing, since those excessive exposures that can become dangerous to our bank systems, are always built up with assets perceived as safe, never ever with assets perceived as risky.

And since current bank capital requirements are mostly based on expected credit risks banks should clear on their own; not on misperceived credit risks, 2008’s AAA MBS, or the unexpected, COVID-19, banks now stand there naked, though few dares to call out the Emperor on that.

So, how did we end up with all this? There are many reasons but, if I must pick one, that would be, “mutual admiration clubs”.

Sir, in November 2004 you published a letter in which I wrote: “The Basel Committee is just a mutual admiration club of firefighters seeking to avoid bank crisis at any cost - even at the cost of growth. Unwittingly it controls the capital flows in the world, and I wonder when will it realize the damage they’re doing, by favoring so much bank lending to the public sector.”

In “A new dawn for globalization” FT, Life & Arts, March 20, Mark Carney is allowed to write: “As chairs of the Financial Stability Board, Mario Draghi and I were at the forefront of efforts to reform the global financial system. Our aim was a system that once again valued the future, financed innovation and was prepared to take action in the event of failure. As its performance during the Covid-19 crisis has demonstrated, although far from perfect, the financial system is now safer, simpler and fairer”

If that’s not spoken as a member of a club that will not call him out on anything, what is?

And now Carney wants “a set of networks that can turn the existential threat of climate change into the greatest commercial opportunity of our time… and the Institute of International Finance’s Taskforce on Scaling Voluntary Carbon Markets is developing a large-scale, high-integrity carbon offset market.”

A new powerful mutual admiration club, backed enthusiastically by all climate-change fight profiteers. Scary indeed!

PS. As I read it, Pope Francis, when nailing his “Encyclical Letter LAUDATO SI’” to the web, denounced carbon credits to be just like the indulgences Martin Luther protested, when he nailed his “95 Thesis” to the church door.

PS. Why do you not ask Mark Carney to comment on Chris Watling’s “Now is the time to devise a new monetary order”, FT, March 19.

@PerKurowski

A new monetary order requires the old regulatory order.

I refer to Chris Watling’s “Now is the time to devise a new monetary order” March 19.

Sir, it is hard for me to understand how Watling, correctly pointing out so many distortions in the allocation credit and liquidity, can do so without specifically referencing the role of the risk weighted bank capital requirements.

For “the world economy [to] move closer to a cleaner capitalist model where financial markets return to their primary role of price discovery and capital allocation is based on perceived fundamentals”, getting rid of Basel Committee’s regulations is a must.

For such thing to happen, discussing and understanding how distorted these are, is where it must start.

E.g., Paul Volcker, in his 2018 “Keeping at it” penned together with Christine Harper valiantly confessed: “The assets assigned the lowest risk, for which bank capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages”.

Sir, why is that opinion of Volcker rarely or perhaps even never quoted? Could it be because in a mutual admiration club it’s not comme-il-faut for a member to remark “We’re not wearing any clothes?

Volcker mentions “The US practice had been to assess capital adequacy by using a simple ‘leverage ratio’- capital available to absorb losses on the bank’s total assets”

Going back there, would return banks to loan officers; and send all those dangerously capital minimizing/leverage maximizing creative financial engineers packing.

My 2019 letter to the Financial Stability Board

My 2019 letter to the IMF

@PerKurowski

 

Has Thatcherism run its course, or has Thatcherism been run off its course?

Sir, Martin Wolf asks “once we accept that Thatcherism has run its course, what follows?” “Sunak takes an axe to Thatcher’s low-tax ideology” FT, March 8.

Sir, to keep it brief, let me just ask three questions:

What would Margaret Thatcher have said about risk weighted bank capital requirements that de facto imply Britain’s bureaucrats/politicians know better what to do with credit for which repayment they’re not personally responsible for, than e.g. Britain’s small businesses and entrepreneurs?

What would Margaret Thatcher have said about risk weighted bank capital requirements that de facto imply the financing of residential mortgages is more important to Britain’s economy than the financing of its small businesses and entrepreneurs?

What would Margaret Thatcher have said about risk weighted bank capital requirements that de facto imply that what’s correctly perceived as risky, is more dangerous to Britain’s bank systems than what’s perceived as safe?

Sir, can you dare your Mr. Wolf to answer those questions?

PS. My 2019 letter to the Financial Stability Board

@PerKurowski

Before aiming at any target, central banks must cure their shortsightedness

Sir, I refer to Martin Wolf’s “What central banks ought to target” FT, March 3.

With risk weighted bank capital requirements, the regulators are targeting what’s perceived as risky, thereby de facto fostering the creation of the excessive exposures to what’s perceived as safe, but that could end up being risky, which is precisely what all major bank crises are made off. In other words, they are putting future Minsky moments on steroids.

And if to the distortions in the allocation of credit to the economy that produces, you add the QEs, then you end up with such a mish-mash of monetary policy that no one, not even Mr. Wolf, should be able to make heads and tails out of it.

Wolf writes, “Central banking is art, not science… it must be coupled to deep awareness of uncertainty”. Sir, I ask, can you think of anything that evidences such lack of awareness of uncertainty than the risk weighted bank capital requirements?

So, before discussing what else to target, it is essential that central banks and regulators get their shortsightedness corrected.

Of course, “the central bank [should] set a rate that is consistent with a macroeconomic equilibrium” but, what would those rates be if banks needed to hold as much money when lending to the sovereign (the King) than when lending to citizens?

And when Wolf reports that “the New Zealand government has told its central bank to target house prices”, that makes me ask: Is anyone aware of the implications of having a central banks placed in the middle of that real, though not named, class war between those who have houses as investment assets and those who just want affordable homes?

Finally, as so many do, Wolf also signs up on that: “If people want less wealth inequality, they should argue for wealth and inheritance taxes”. But just as most do, he does so without explaining what assets, and to whom, the wealthy should sell, in order to reacquire that cash/purchase power needed to pay the tax that they handed over to the economy when they bought these. Not doing so, leaves one quite often a sort of populist aftertaste.

PS. Inflation? Just the same old confusion

@PerKurowski

Bank capital requirements or bank leverage allowances?

Martin Wolf referring to Windows of Opportunity by David Sainsbury writes that growth is “exploiting new opportunities that generate enduring advantages in high-productivity sectors and so high wages… developing something fundamentally new is often costly and risky” “Why once successful countries get left behind” February 22.

Indeed, but as Pope John Paul II, in his Apostolic Letter "Novo Millennio Ineunte" reminded us of the words of Jesus when one day, he invited the Apostles to "put out into the deep" for a catch: "Duc in altum" [and] "When they had done this, they caught a great number of fish".

Sir, “risk weighted bank capital requirements” reads like a very sophisticated tool that, when it comes to keeping our bank systems safe, is expected to assure great prudence. For instance, a 20% risk weight assigned to AAA rated asset and 100% to loans to unrated entrepreneurs and using Basel Committee’s basic 8% capital requirement, translates into 1.6% in capital for AAA rated assets and 8% for loans to unrated entrepreneurs. At first sight, that seems quite reasonable, because of course AAA rated could be five times riskier than what’s not rated.

But there is another side of that coin, that of a very costly risk-taking avoidance. It becomes much clearer if we label the former as “risk weighted bank leverage allowances”. 

Doing so we observe banks are allowed to leverage 62.5 times to one with assets rated AAA, but only 12.5 times with loans to unrated entrepreneurs. The question then is: if banks are allowed to leverage 50 times more their capital with AAA rated assets, why would any bank lend to unrated entrepreneurs, that is unless these pay much more in interest rates would in order to make up for that regulatory discrimination?

Sir, John A. Shedd wrote “A ship in harbor is safe, but that is not what ships are for” and I am sure FT agrees that applies to banks too. Unfortunately, current regulations have banks dangerously overpopulating “safe” harbors, e.g. residential mortgages, while leaving those deep waters that need to be explored in order for once successful countries not ending up left behind.

PS. Much as I already wrote 2009 in Martin Wolf's Economic Forum. 

Basel Committee’s risk weighted bank capital requirements is fodder for our wishful thinking hopes.

I refer to Tim Harford’s “From forgeries to Covid-denial" On how we fool ourselves: Whether believing implausible statistics or falling for frauds, humans are addicted to wishful thinking” FT, January 30, 2021.

Sir, I ask, the Basel Committee’s risk weighted bank capital requirements, could that just be a forgery made to satisfy our deep wishes of our banks always being safe?

Now why so little objections? Edward Dolnick explained it with: “Experts have little choice but to put enormous faith in their own opinions. Inevitably, that opens the way to error, sometimes to spectacular error.”

By the way. Where has Academia been on all the regulatory distortion of the allocation of bank credit?

Macroeconomic theory stands no chance while autocratic regulators distort the allocation of bank credit.

Sir, in reference to Martin Sandbu’s “The revolutions under way in macroeconomics”, January 28, I must ask: What macroeconomic theory stands a chance against the Basel Committee’s risk weighted bank capital requirements? 

Lower bank capital requirements when lending onto the government than when lending to citizens, de facto implies bureaucrats know better what to do with credit they’re not personally responsible for than e.g. entrepreneurs. 

Lower bank capital requirements for banks when financing the central government than when financing local governments, de facto implies federal bureaucrats know much better what to do with credit than local bureaucrats.

Lower bank capital requirements for banks when financing residential mortgages, de facto implies that those buying a house are more important for the economy than, e.g. small businesses and entrepreneurs.

Lower bank capital requirements for banks when financing the “safer” present than when financing the “riskier” future, de facto implies placing a reverse mortgage on the current economy and giving up on our grandchildren’s future.

https://subprimeregulations.blogspot.com/2019/07/risk-weights-are-to-access-to-credit.html

@PerKurowski

What America (and much of the rest of the world) needs is to free itself from the clutches of statist/communist bank regulators.

Sir, Martin Wolf, opines that “Joe Biden may be a last chance for US democracy” “Competency is Biden’s best strategy” January 27. 

Oh, if only all was that easy and in Biden’s hands. When compared to what some dark hands through bank regulations are doing to America (and to much of the world), both Donald Trump and Joe Biden are small fry.

Paul Volcker in his 2018 autography “Keeping at it” wrote: “The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages”. Volcker continued with “Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011”. That compared to all other that has been said about and quoted from Paul Volcker, has been totally ignored, or outright censored. 

But what does it really mean?

Lower bank capital requirements when lending to the government than when lending to citizens, de facto implies bureaucrats know better what to do with credit they’re not personally responsible for than e.g. entrepreneurs. 

Lower bank capital requirements for banks when financing the central government than when financing local governments, de facto implies federal bureaucrats know much better what to do with credit than local bureaucrats.

Lower bank capital requirements for banks when financing residential mortgages, de facto implies that those buying a house are more important for the economy than, e.g. small businesses and entrepreneurs.

Lower bank capital requirements for banks when financing the “safer” present than when financing the “riskier” future, de facto implies placing a reverse mortgage on the current economy and giving up on our grandchildren’s future.

Sir, I just ask, would America have even remotely become the great land it is, if that kind of risk adverse bank regulations had welcomed the immigrants when arriving at Ellis Island / Liberty Island... to the Home of the Brave?

Wolf also uses new-confirmed Treasury secretary, Janet Yellen, to endorse what he himself have argued so many times namely: “With interest rates at historic lows, the smartest thing we can do is act big” Again, where would those historic low rated be without the Fed’s QEs and without the regulatory favors mentioned? Really? Historic lows or historical communist subsidies?

PS. Not the first time (nor probably the last) I've written to Martin Wolf on this.

@PerKurowski