European banks that leveraged more than 40 (25) times were (are) not banks; only scary betting propositions.

Sir, Stephen Morris, summarizing the state of European banks writes, “Poor profitability, outdated business models, negative rates and little cause for optimism have driven investors away”“Europe’s banks languish in a climate of gloom”, December 28.

As I see it, something leveraged way over 40 times, as many European banks were before the 2008 crisis, should hardly be called bank. When regulators went along with some bankers’ plea to reduce the capital the banks needed to hold, perhaps for bankers to be able to pay themselves larger bonuses, they simply destroyed the bank system that was. 

If I was a regulator, and wanted my banks to grow stronger than their competitors, the last thing I would do, is to allow them to hold little capital.

The regulators, with Basel II in 2004, showed they believe banks could leverage 62.5 times with assets that have obtained an AAA to AA rating. The market initially believed their risk-weighing capacity and valued banks accordingly. The markets, after 2008, no longer believe such nonsense; “There is better risk-reward elsewhere,” one fund manager is here quoted to have said.

The European Commission assigned a sovereign debt privilege of a 0% risk weighting, meaning no bank capital requirement, to all those sovereigns within the Eurozone that take on debt denominated in a currency that de facto is not their domestic (printable) one. The market had blamed Greece for its excessive public debt and is only now beginning to wake up to that statist horror.

Morris writes: “One activist is trying to force it to exit large swaths of the business, arguing it absorbs too much capital for too little return”. That does not mean capital is unavailable for banks.

Do you want bank investors to return? Then offer them to invest in well-capitalized banks with well-diversified portfolios. To invest in banks that values the highest first class loan officers, not some bright equity minimizing financial engineers.

PS. Seeing “Mary Poppins return” reminded me of why good old George Banks went to fly a kite.

@PerKurowski

Why do financial regulatory authorities, while preaching the value of diversification, act in favor of concentration?

Sir I refer to Harriet Agnew’s “FT BIG READ. Professional Services: Accounting for change” August 28.

In November 1999, in an Op-Ed in Caracas Venezuela, this is what I had to say on what is discussed there:

“I recently heard that SEC was establishing higher capital requirements for stockbroker firms, arguing that . . . ‘the weak have to merge to remain. We have to get rid of the rotten apples so that we can renew the trust in the system.’ As I read it, it establishes a very dangerous relationship between weak and rotten. In fact, the financially weakest stockbroker in the system could be providing the most honest services while the big ones, just because of their size, can also bring down the whole world. It has always surprised me how the financial regulatory authorities, while preaching the value of diversification, act in favor of concentration.

The SEC should not substitute the need for capital in place of the need for ethics, nor should it allow that fraudulent behavior hides amid the anonymity of huge firms. In this respect, let us not forget that the risk of social sanctions should be one of the most fundamental tools in controlling financial activities.

Currently market forces favors the larger the entity is, be it banks, law firms, auditing firms, brokers, etc. Perhaps one of the things that the authorities could do, in order to diversify risks, is to create a tax on size.”

@PerKurowski

Here’s another reminder of how scary our current bank regulators really are.

Sir, the Lex Column writes about “Nigerian banks: wrong concentrations” March 27.

I just thought it would be a good opportunity to remind everyone that we have put our banks into the hands of regulators who, on their own, have decided to impose “portfolio invariant” equity requirements for banks. And that means the regulators do not consider the benefits of diversification, nor the dangers of concentration.

By their own admittance, to do otherwise, would be too hard work for them.

Scary eh?

@PerKurowski

Ms. Gillian Tett, if anything, banks are even more dangerous than in 2008

Sir, because the incentives provided by the (credit) risk weighted capital (equity) requirements for banks remain in place, these still guarantee that banks will grow dangerously large exposures, against little capital, to whatever is considered to be “absolutely safe”, and very little exposures to what could be considered as “risky”

Yet Gillian Tett writes: “though the banking system may be safer than it was before 2008, parts of the markets may have become more dangerous for unwary investors”, “Markets are parched for liquidity despite a flood of cash” October 17.

No! Ms. Tett, the banking system is not safer than it was before 2008, if anything, it is even more dangerous… even for wary investors.

Ms. Tett I know you are an anthropologist, and you therefore perhaps not know too much about finance, but, ask your financial advisor about the medium and long term safety of a portfolio that avoids taking any risks… ask him if for instance diversification is a good thing… and then extrapolate his answer to the banks, and to the chances of our young not becoming a lost generation.

Mr. Martin Wolf, would not having a climate fix ruin investors even more?

Sir, I do not understand Martin Wolf’s “A climate fix would ruin investors” June 18. If climate change warnings are for real, as Wolf says he believes … would not having a climate fix ruin investors even more?

And what about diversification? If, while fixing the climate, governments go wrong and mess it all up by for instance financing Solyndras and then go broke… would not a little coal mine left in the portfolio perhaps come in handy for those days we might have to mitigate the disaster?

The Turner report is not even close to being a watershed.

Sir I have tried to figure the why of Martin Wolf´s “Why the Turner report is a watershed for finance” March 20, but I can´t. A regulatory watershed implies some fundamental change in the basic paradigms used, and this is definitely not it.

As an example the Turner Review holds that “Credit ratings have played a valuable role since (i) good investment practice should seek diversification across a wide spread of investments; and (ii) it is impossible for all but the very largest investing institutions to perform independent analysis of a large number of issuing institutions” which only makes us ask: Have they not seen enough of that what matters is not the diversification within one institution but within the whole system? Have they not seen enough of the how expensive the too-big-to-fail are so as to insist in giving the larger institutions special rights?

But perhaps Martin Wolf illustrates best the shortcomings of the report when he writes “if everybody believes in the same (faulty) risk models, the system will become far more dangerous than any individual player appreciates”. Did you notice that “(faulty)”? Well that means that Martin Wolf, like the report, still believes that the risk models can be right and that if we all follow them we will find financial Nirvana.

Wolf also stands firm and refuses to understand that a credit rating is simply the result of a model that analyzes one type of risk, and that these simple one dimensional published result created more havoc than all the other sophisticated financial models put together and that without the AAAs would have remained stacked away as unsellable nerdy creations.

Long live the diversifications of views that can only be present in a free market!... though that does not mean of course that we not do have to get rid of the regulatory naiveté that actually reigns and that allows a bank to leverage itself 62.5 to 1 times, as long as it lends to corporations rated AAA or AA- by some very few eyes.

PS. “A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind."