Sir FT, do you, or our dear The Undercover Economist Tim Harford, have an explanation for what is a monstrous regulatory mistake?

Sir, I refer to Tim Harford’s “The Changing Face of Economics” December 19.

As an economist, if I were to regulate or supervise banks, I would mostly be concerned with bankers not perceiving the credit risk correctly. Wouldn’t you?

That’s why I cannot understand why so many economist colleagues, when acting as bank regulators, can be so dumb so as to bet our banking systems on that bankers will be able to perceive what is safe correctly. 

Let me explain it having bankers answering the four possible outcomes.

If the ex ante risky, ex post turns out safe = “Great News we helped an entrepreneur to have success”

If the ex ante risky, ex post turns out safe = “You see, that is why we lend them little and charge them high risk adjusted interest rates.”

If the ex ante safe, ex post turns out safe = “Just as we expected”

If the ex ante safe, ex post turns out risky = “Holy moly what do we now do? We lend it way too much at way too low interest rates”

But the regulators in the Basel Committee, in their Basel II of 2004, assigned risk weights of only 20% for what is so dangerous to our bank systems as what human fallible credit rating agencies have rated AAA, and a whopping 150% for what has been made so innocous, by being rated below BB-?

Sir, so do you, or our dear The Undercover Economist Tim Harford, have an explanation for what is clearly a monstrous regulatory mistake? 

Or is it that you, and our dear The Undercover Economist Tim Harford, out of sheer collegiality solidarity, both agree with such dumb regulations?

If so, let me assure you that when I studied economics, it was to learn and understand economics, not to join an economists’ union/mutual admiration club.

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

PS Tweet: I can understand a child believing that what’s rated below BB- is more dangerous to our bank systems than what’s rated AAA, and therefore assigning a bank capital requirement of 12% to the BB- rated assets, and only 1.6% to those rated AAA. But mature professionals?

@PerKurowski

To explain the 2008 financial crisis a two pieces puzzle could suffice.

Sir, Tim Harford writes, “Raghuram Rajan, when he was chief economist of the IMF, came closest to predicting the 2008 financial crisis. He later observed that economists had written insightfully on all the key issues but had lacked someone capable of putting all the pieces together”, “How economics can raise its game” June 29.

According to 2004’s Basel II, a corporate rated AAA to AA, could offer banks to leverage their equity 62.5 times (100%/(8%*20%)) with its risk adjusted interest rate, while one rated BB+ to BB-, or not rated at all, could only offer banks to have their risk adjusted interest rate leveraged 12.5 times (100%/(8%*100%))

Sir, I am not arguing whether it is better to be a hard or a soft economist but, any economist looking at that proposition and not seeing it would cause serious misallocation of bank credit, should either go back to school, perhaps to take some classes on conditional probabilities, or go out on Main-street, and learn a bit of what real life is about.

62.5 times leverage? What banker could dare resists that temptation and stay out of competition thinking, what if that AAA to AA rating is true?

PS. That leverage applied for European banks and US investment banks supervised by SEC.

@PerKurowski

Tim Harford, why should the 2008 bank crisis have reminded even an "undercover" economist of that “banking matters”?

Sir, Tim Harford writes: “If 2008 was a sharp reminder that banking matters, then 2016 has reminded us that politics matters too” “Prediction in an age of uncertainty” October 29.

Obviously this has to be a statement made by a deskbound undercover economist, or by one of his current bank regulation technocrats colleagues, and not by a main-street economist. If there is little as important to an economy’s real day-today, always, that is the access to bank credit, especially in a Europe so dominated by banks.

Here Harford also writes about predictions in age on uncertainty, without seemingly having understood that the Basel Committee’s capital requirements for banks were predicated on believing in a 100% world of certainty.

Harford refers to Nicholas Bloom concluding in that “uncertainty also causes recessions because it makes consumers, employers and investors hesitate before spending money. And if we all hesitate, that is exactly what a recession looks like.”

Sir, but what is more hesitation than that what bank regulators showed, when they decided banks should not be able to leverage as much with what they perceived as risky than with what they perceived as safe… as if banks had ever done such thing.

@PerKurowski ©

Might economists have spent too much time at their desks and too little on Main-Street to understand risks?

Sir, Tim Harford discusses how economists could have presented their case against Brexit more effectively. In doing so Harford refers to Dan Kahan, a Yale law professor, when arguing that “Giving people evidence that threatens deep beliefs is often counterproductive, because we start with our emotions and trim the facts to fit them”, “Economists face up to Brexit fail” July 9.

Interesting because that is very similar to what I have been asking myself:

How can I get my fellows economist colleagues to understand that, in banking, what is ex-post more dangerous, is what has ex ante been perceived as safe, and which therefore signifies that bank regulators are basically 180 degrees off the charts with their current risks weighted capital requirements for banks?

And how can I get my fellows economist colleagues to understand that if you allow banks to earn higher expected risk adjusted returns on equity when lending to what is perceived as safe than when lending to what is perceived risky, the banks will dangerously overpopulate the safe havens and, equally dangerously, under-explore the risky bays our real economy needs to be explored in order to move forward, so as to not stall and fall?

What deep beliefs do economists hold that block them from understanding risks? Might it only be they have spent too much time at their desks and too little on main street?

@PerKurowski ©