Don’t keep adding bank regulations for what is ex ante perceived risky. It is what is ex ante perceived as very safe that should concern us the most.

Sir, I refer to Sheila Bair discussion of how much banks are to set aside in order to cover for loan losses. “Congress should stay out of new bank rules for loan losses” August 5.

Bair mentions, “that FASB wants to switch to a new rule, known by the name of “current expected credit losses” or “CECL.” That rule “says that banks should set aside enough to cover expected losses throughout the life of a loan, taking into account a wide variety of factors, including historic loss rates, market conditions, and the maturity of the economic cycle.”

Bair argues the new rule has two key benefits. “First, banks will start putting aside money on day one of each loan so when trouble hits — as it did in 2008 — they will not be trying to play catch-up with their reserves.” 

Really, what money would they have had to put aside for the AAA rated securities gone bad? What money would they have had to put aside for loans with a default guarantee issued by an AAA rated entity like AIG?

Then “Second, it should make bankers a little more cautious in their lending decisions, as they will have to account for likely losses when the loan is made, not kick the can down the road until the borrower is actually in arrears.”

That all has me concerned with that we might be adding a new layer of discrimination against the access to credit of the risky.

Those perceived ex ante as risky already get less credit and pay higher risk premiums. Those perceived ex ante as risky already cause banks to have to hold more equity against loans to them. 

If those perceived ex ante as risky must now also require banks to set aside reserves earlier than what is required for those perceived as safe, banks might stop altogether lending to the risky, like to entrepreneurs, and that will absolutely hurt the economy.

And Sir, it would all be for nothing, because major bank crises are never caused by excessive exposures to what was ex ante perceived as risky when placed on banks’ balance sheets. 

http://subprimeregulations.blogspot.com/2019/03/my-letter-to-financial-stability-board.html

@PerKurowski

We need student debt service data, for each university, so as to allow the market to help correct some education failures.

Sir, Dennis Gerson, in reference to a recent article by Sheila Bair on student debts writes: “What she fails to address is the repayment of the income share agreements by college graduates earning the minimum wage, service industry minimum wage plus tips, or those who fail to graduate from college. A substantial portion of student debt and defaulted debt falls into these categories.” “US universities need to fix cost problem they created”

For a starter if university students end up earning too little or do not graduate, then that could be as much or more the failure of the university than the student’s. By just putting out information of each university indicating the respective overall default rate of their students, the market would help to correct much of what is going on... not all.

PS. Higher education should be much more of a joint venture.

@PerKurowski

Yes, higher education must be much more of a joint venture, for all involved.

Sir, Sheila Bair is absolutely right that “proceeds from student debts go to colleges, while the risk of repayment falls on borrowers and, if they default, on taxpayers provides little incentive for schools to contain costs [which] provides little incentive for schools to contain costs.” As a solution she refers to “income share agreements” where universities provide some funding and students pay back a small share of their income over some years. “An investment model to put US students through college”, March 15. 

Since in a 2007 Op-Ed I asked whether higher education should not be more of a joint venture, I fully agree with the orientation of these proposals. 

That said I would not leave it solely as a student to college/university level. I believe that professors should also have skin in the game, and so perhaps their retirement plans should include a clear linkage to how their students did.

And why leave it at that? Why not think of securitizing those possible future participations in earnings so as to provide some upfront money to cover expenses? And what about insurance companies investing in these? And what about some students crowdfunding their tuition fees?

Where I do part though from Bair’s opinion, is on the concept that high earning students could/should subsidize the study costs of lower earning professions. That could cause some unexpected distortions, and it is much more a general societal responsibility, which the higher earning - higher tax paying already share.

PS. Sir, over the years I have written several letters to you on this subject... but 😒

@PerKurowski

Regulators, shareholders and clients, do not have a vested interest in banks holding little capital; only bankers do, because of their bonuses.

Sir, Sheila Bair discussing ongoing pressures in the US to reduce bank capital levels, especially for the big banks, correctly opines: “Tough capital rules are a competitive advantage, not weakness. Studies show that well-capitalised banks do a better job of lending than more leveraged rivals. Thick capital buffers keep the banking system functioning through economic cycles. Every dollar reduction in bank capital weakens the public’s protection against big failures.” “The US must hold firm on bank capital rules”, October 2.

That is the argument that should prevail and the more it is understood that those who mostly stand to win by low bank capital requirements, are just the bankers themselves, as the less equity there is a need to compensate, the higher can the bonuses be.

To that I would perhaps add what I wrote in an Op-Ed in 2001, “Today, when the world seems to be asking much for bank mergers or consolidations, I wonder if we on the contrary should be imposing on banks special reserves depending on their size. The bigger the bank is, the worse the fall, and the greater our need to avoid being hurt.”

In 2003, in a workshop for regulators at the World Bank I repeated, “Knowing that “the larger they are, the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size. “

But what is sadly almost completely left out in the debate is that, no matter how high or how low the capital requirements are, different requirements, especially when like the current risk weighted ones do are based on risks perceived and mostly already cleared for, dangerous distortions in the allocation of credit to the real economy could result.

Again, for the umpteenth time risks, even if perfectly perceived, cause the wrong actions if excessively, or insufficiently considered.

In that respect my first recommendation on any bank regulation reform would be to get rid of the risk weighted capital requirements for banks. They stand out as one of the worse piece of regulations ever.

What was the 2007-08 crisis (and Greece’s tragedy) made off? Exclusively, 100%, by assets ex ante perceived (or decreed) as safe, and against which banks needed to hold especially little capital.

@PerKurowski

Some are waking up to the colossal failings of Basel bank regulations... when will FT?

Sir, Shahien Nasiripour and Tom Braithwaite report “US regulators urged to outdo Basel III rules” October 5. In it they mention that “some like Jeremiah Norton, a director on the FDIC´s five man board, have voiced doubts about the proposed risk-weighting scheme, which links capital levels to assets risk”. Might he have tried to answer some of my wicked questions on bank regulations? Like: 

1st: When do banks most need capital, when the risky turn out risky, or when the “not-risky” turn out risky? 

2nd: If bankers do as Mark Twain says, namely “lend you the umbrella when the sun shines and wanting it back when it rains”; and all bank crisis ever have result from excessive lending to what was perceived as “not risky”; and the perceptions of risk have already been cleared for in the interest rates and the amounts of the loans, then what is the logic behind allowing banks to hold less capital requirements when they engage in what is perceived as “not risky”, as current bank regulations do? 

3rd: What economists can be so dumb not understanding that if you allow banks to leverage 60 times or more their bank equity for some assets and only 12 times for other, producing thereby vastly different returns on equity, you will drastically distort the economic efficient resource allocation that banks are supposed to perform? 

More sooner than later, everyone is going to wake up to the fact that our current bank regulations are built upon absolutely insane foundations. And then of course, the silence of the Financial Times on this issue is going to be a source of immense embarrassment for the paper and especially for those responsible of, notwithstanding its motto, ordering its silence on it, during so many years.

Sheila Blair... keep away from Basel.

Sir Sheila Blair opines that “The road to safer banks runs through Basel”, August 24. She is in her right to ask for safer banks but let me remind her that there are plentiful of people with no savings and no jobs who most want and need the banks to travel on the road of being more productive for the society, and that will not happen by going through the Basel Committee where not a word is spoken about the purpose of the banks.

But even in having the Basel Committee helping making the banks safer, Sheila Blair is wrong, because since that Committee has yet to understand what is wrong with their regulatory paradigm, it is not as she says “now moving to correct the problem”.

Blair correctly indentifies capital misallocation as the cause of the bust, but that was in itself caused by giving the banks, in real and relative terms, higher incentives to pursue what ex-ante is perceived as not risky, the AAA-ratings. We simply need to ask… where else but in excessive investments in what ex-ante is perceived as not being risky have all the bank crisis originated? The answer is nowhere!

The Basel Committee must be made to understand that they do not have the right to interfere in the markets by imposing on it, through the different capital requirements for banks, their own set of arbitrary and regressive discrimination of what is perceived as having higher risk.

Currently small businesses and entrepreneurs, those usually perceived as riskier, but who could perhaps most help us to generate the next generation of jobs, must pay around 2 percent more in interest rates, just in order to be competitive when accessing bank credits, just because of the discriminating capital requirements. The members of the mutual admiration club in Basel seem incapable to understand that… and unfortunately that seems to go for Sheila Blair too.

The restructured mortgages need to earn the prime status they should not before have been awarded.

Sir the chairman of the US Federal Deposit Insurance Corporation Sheila Bair opined on "How the state can stabilize the housing market", April 30.

She describes the pros of some current options but misses out on what is the most important rule of any restructuring namely that if you are going to pay for the costs of restructuring, this is normally only worthwhile to do, if you get it right once and for all; and that what is left in the pot is deemed as being of much better risk quality than what went in. In other words the resulting mortgages should have to earn the real prime status they should never before have been awarded.

In this respect when Bair states as a clear advantage that "it keeps the risk of re-default on mortgage investors", though it sounds about right, it should be irrelevant if the restructuring has been done correctly and the risk of re-default are negligible.