Bank systems’ “Fifth Risk”: When shit really hits the fan, banks will be holding especially little capital.

Sir, Brooke Masters reviews Michael Lewis’ “The Fifth Risk”, a book that got its titled when John MacWilliams, a former Goldman Sachs investment banker told the author about the “fifth risk”, referring to ‘project management’, the risk society runs when it falls into the habit of responding to long-term risks with short-term solutions.” “Why boring government matters”, November 3.

Well-intentioned bank regulators, wanting to make our bank system safer, and came up with risk weighted capital requirements based on the perceived credit risks. If the perceived credit risks (those that bankers saw and used to adjust to with size of exposure and risk premiums) do not represent the most immediate short-term outlook on risk for banks what does? 

The real long-term risk is obviously that something that was ex ante perceived as safe, and with which banks could therefore build up large exposures, suddenly, ex post turned out very risky. The regulators with their short-term solutions only guaranteed that when shit really hit the fan, banks would stand naked with especially little capital.

Brooke Masters quotes Ronald Reagan with “the nine most terrifying words in the English language are ‘I’m from the government, and I’m here to help’ ”.

Indeed! Just like when regulators told us “we credit rating agencies know all about risks so, with our regulations, we will make your bank systems safer”. As a result they gave us the 2008 crisis, way too much credit for house purchases, and mountains of 0% risk weighted sovereign debt around the world. If only they had stayed home.

Sir, “good boring government” is indeed needed, but beware, few things as dangerous as bored bureaucrats… they’re truly frightening.

@PerKurowski