February 28, 2015

‪#Oxfordlitfest‪ ‬An opportunity to see if Martin Wolf has overcome his intuitions with respect to bank regulations

"More-perceived-risk-more-bank-equity and less-risk-less-equity", sounds so utterly logical, that perhaps intuition kills understanding… or, in Daniel Kahneman’s terms, that System 1, the fast intuitive and emotional one, is so convinced it has done its part, so as not to allow System 2, the slower more deliberative and more logical thinking process, to kick in.

For instance Martin Wolf, in July 2012 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.” 

Yet Wolf has not been able to take it from there and deduct that, if so, and as all empirical evidence supports, then those bank equity requirements should perhaps be 180 degrees the opposite.

Sir, what on earth has a regulator to do with the perceived risks of bank assets, when what he should be exclusively concerned with, is with how bankers perceive those risks and manage these?

Our banks currently are like in a car with two steering wheels; the first one controlled by bankers, and the second by regulators who are responding, simultaneously, to basically the same risks the banker sees. And so of course we must crash either because banks embrace excessively what seems safe, or because of an excessive aversion to what seems risky.

Perhaps ‪Oxfordlitfest‪ would provide an opportunity to see if Martin Wolf has finally managed to engage System 2, by asking him: 

Mr. Wolf: If bank crises usually result from excessive exposures to something which ex ante has seemed safe but that ex post turned out to be risky: Why are equity requirements for banks lower for what is perceived as risky than for what is perceived as safe?

Mr. Wolf: Give us one single bank crisis resulting from an excessive exposure to something that was perceived as risky, when banks put that asset on their balance sheet.