The Western World is in a freefall, and no one is discussing the reason why

Simplified, if the cost of funds for a German bank was 2 percent; if it wanted to earn a 1.5 percent margin; if the cost of analyzing the credit worthiness of a German small business was 1 percent; and if the risk that the borrower would default was perceived as 3 percent, then the German bank would charge the German small business an interest of 7.5 percent. 

And if the cost of funds for a German bank was the same 2 percent; if it wanted to earn the same 1.5 percent margin; if the cost of analyzing the credit worthiness of Greece was zero, because that is paid by Greece to the credit rating agencies to do; and if the risk that Greece would default was perceived as 1 percent, then the German bank would charge Greece an interest of 4.5 percent. 

If the German bank was required to have about 8 percent in capital against any loan, and could therefore leverage its capital about 12 times, the bank could expect to earn 18 percent on its capital when lending to a German small business or when lending to Greece. 

But that was before the bank regulators of the Basel Committee intervened and messed it all up. 

These regulators, ignoring the empirical evidence that bank crisis never occur because of excessive exposures to what was considered risky but only because of excessive exposures to what was considered as absolutely not risky, with their Basel II, told the banks “You German bank, if you lend to a “risky” German small business you need 8 percent in capital, but if you lend to an infallible Greece you only need to have 1.6 percent in capital”. 

And because that 1.6 percent allowed for a leverage of more than 60 times when lending to Greece, the German bank, though it still could earn a decent 18 percent on its capital when lending to a German small business, suddenly could expect to earn 90 percent on its capital when lending to Greece. Hell, the German Bank could even afford to lower the interest rate it charged Greece and still earn more when lending to Greece than when lending to a German small business. 

And of course the German bank, as did all banks in the Western world, started running to the officially perceived safe-havens of Greece, Italy, Spain, triple-A rated securities and others, where they could earn much more; and of course the governments of the safe havens could not resist the temptations of cheap and abundant loans, and all these safe-havens became dangerously overcrowded… while the small German business found it harder and much more expensive to access any bank credit… and while the too big to fail banks grew even bigger.

And, many years into a crisis that has the Western World in a freefall, this issue is not even discussed, and the same failed bank regulators are allowed to work on Basel III, using the same failed loony and distorting ex-ante perceived risk of default based capital requirement discrimination principle.

Hell, even the Financial Times has decided to ignore the hundreds of letter I sent them about it, and this even when they know they published two letters of mine that clearly warned about what was going to happen. In January 2003, “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds” and, in October 2004, “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector (sovereigns)? 

Occupy Wall Street? No! Occupy Basel! (Perhaps occupy the Financial Times too!)

PS. This post was made before I realized that the reality was even so much worse because, instead of applying to Greece the 20% risk weights Basel II would have ordered EU authorities assigned Greece a 0% risk weights and so European banks, when lending to Greece did not have to hold any capital. How crazy is that?

PS. At the end of the day the EU authorities kept total silence about their mistake and blamed Greece for it all. No solidarity. What a Banana European Union.