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.