July 22, 2015

FT, if regulators tell banks: “Blow the ‘safe’ balloons, not the risky”, which balloons are more likely to explode?

Sir, John Plender writes about “the bubble in (so-called) risk-free assets. In March, a third of eurozone government bonds had negative nominal yields. This was unprecedented. It reflected an acute shortage of sovereign debt for use as collateral after the European Central Bank’s resort to quantitative easing, which involves buying government bonds…official intervention created a distortion that drove a wedge between prices and fundamental reality. “Detecting a bubble in advance is not so hard — when you try” July 22.

That is indeed correct, but it obliges the questions of:

Why is it so hard for John Plender, FT, and most other to understand that credit-risk weighted capital requirements for banks, like QEs, represent an official intervention that distorts the allocation of bank credit?

Why do John Plender, FT, and most other, seemingly want to ignore that those capital requirements guarantee “safe” havens to become overpopulated and “risky” bays underexplored?

When banks have thousand of balloons they could blow credit into and regulator tell them in which they can blow easier, it should be easy to predict which balloons might grow too large and explode.