To create jobs, we should start by firing the current bank regulators!

Sir, Sebastian Mallaby in “The US labour market does not work” August 22, reduces the discussion about the increasing unemployment to an issue about the government incentives for the workers to work, which is important, but leaves out completely the much more important angle of creating the new generation of jobs that will provide its own incentives to work. 

Let me just hint at one possibility. If the capital requirements for our banks were partially based on the potential of job creating ratings, instead of as now on the perceived risks of default of which have already been considered by the bankers, our small businesses and entrepreneurs might stand a chance to deliver us the new jobs we need and want. 

Frankly, one of the best ways of getting jobs is putting the current generation of bank regulators who do not understand one iota about the need for risk-taking, out of a job.

Risk-adverseness is also the subject of fashion.

Sir, John Kay asked “Why do we need to pay billions of pounds for big projects” August 21 and I suddenly remembered an anecdote, from some decades ago, which might illustrate one of the causes. 

In Venezuela, after a devaluation of its currency, the Bolivar, I witnessed amazed a CFO of a big multinational covering his company’s Bolivar positions by buying a swap at an absolutely absurd high price, and which de facto guaranteed a much larger loss that anything that could happen leaving that position un-hedged. I asked him why, and this is what he answered: 

“Per I know this is utterly silly, but you have to understand me, if I spend millions of dollars covering this exposure, and that would result in a huge waste of resources, nothing will happen to me, but, if I lose one single dollar, because of a non-hedged FX position, I am out!” 

In a similar way, if a bureaucrat spends millions of dollars more in order to have a reputable name carry out the works nothing happens, but one dollar of loss suffered in the hands of an unknown, that can bring him down… and the “reputable” make it of course their business for this to be well known. 

So you see, not all same risks are equal, even when measured in dollars, or pounds. Risk-adverseness is also the subject of fashion. 

Look at bank regulators, if banks go down, they feel responsible, but, if the economy tanks because of how they try to avoid bank failures, that doesn’t seem to bother them.

Distorting bank regulations makes a mockery out of rational capital allocation.

Sir, John Authers quotes Andrew Smithers in that contemporary bonus culture has introduced a short-termism that is threatening the economy misallocating capital on the back of distorted profit statements, “Distorted profits make mockery of call for UStax cuts” August 20. 

Indeed that is serious, but how it really impacts a market that looks a lot to the growth potential of future earnings is hard to tell. That said, what is really misallocating capital in our economy are bank regulations which so much favor what is officially perceived as not-risky, prominently the “infallible” sovereigns and discriminates against what is officially perceived as “risky”, like the small businesses and entrepreneurs. 

Unfortunately from its refusal to address it, FT seemingly does not care about this issue.

America (and Europe) by discriminating small businesses and entrepreneurs is becoming the “Home of the risk avoiders”

Sir, in “The US state will expand no matter the election result”, August 20, Lawrence Summers displays a serious lack of understanding of current bank regulations. 

Summers writes “the complexity and hence the cost of everything [like] regulating banks rises faster than overall inflation… imply… that government spending as a share of the economy has to rise”. 

Absolutely not! It is not the cost of bank regulations that is expanding the role of the state, but the regulations itself. Capital requirements for banks based on perceived risks create an extremely preferential access to bank credit for those officially perceived as not-risky, and that can only expand the role of the most prominent officially not-risky, namely the “infallible” sovereign. 

In the “Home of the bBrave” small businesses and entrepreneurs are being discriminated against. Not only is this expanding the US state, but more worrying it is changing its nature… the “home of the risk avoiders”.

Lawrence Summers defends convincingly voucher programs in health and education

Sir, in “The US state will expand no matter the election result”, August 20, Lawrence Summers writes: 

“Increases in the price of what the federal government buys relative to what the private sector buys will inevitably increase the cost of state involvement in the economy. Since the early 1980s the price of hospital care and higher education has risen fivefold relative to the price of cars and clothing and more than 100-fold relative to the price of televisions.” 

Even when netting out of the technological advance’s impact on costs, it would seem that the above constitutes an extremely spirited defense of vouchers programs.

America and Europe are practicing bungee jumping... without a rope!

Sir, when by means of capital requirements for banks based on perceived risks, regulators gave such a preferential access to bank credit to those officially perceived as not-risky, then they basically excluded the officially perceived as "risky", like the small businesses and entrepreneurs, from helping out in the economy. 

And that is immensely more dangerous than what Gillian Tett refers to in “Fiscal bungee jumping is the real threat to America” August 20, because it goes to the very heart of the economy. 

In fact considering the medium term implications of such unwise regulations I would say that America, and Europe too for that matter, are practicing bungee jumping without a rope. (And from its refusal to address this issue FT seemingly does not even care)

Oops! Is this why Martin Wolf launches a visceral attack on Paul Ryan?

So now Martin Wolf has entered the American political debate, by basically calling Paul Ryan an impostor lacking of integrity, “Paul Ryan does not offer a credible plan for America” August 18. 

Why Wolf does it this way, I sincerely do not know nor understand. What purpose does it serve? Could it be because Wolf believes Ryan’s opponents are offering a more credible plan? If so, it would be really interesting to see him following up with an article on that. 

Personally, I feel that neither democrats nor republicans got it right, or even have a chance to get it right, before some fundamental changes in bank regulations occur. Currently the capital requirements for banks overly discriminate in favor of what is officially perceived as not-risky, prominently the State, the infallible sovereign, and against what is officially perceived as risky, prominently the citizens, like small businesses and entrepreneurs, and with that, there’s nothing to do… America, as a nation, as the “Home of the bBrave”, is going down! (Europe likewise) 

But those capital requirement with their discriminations based on officially perceived risks, managed by mean of risk-weights set by regulation bureaucrats, playing the risk-managers of the world, have never seem to bother Martin Wolf. He is perfectly comfortable with the fact that a Basel II, or a Basel III, allows the banks to give loans to “infallible sovereigns” against almost no capital at all. The only explanation for that must be Wolf fundamentally believes in the superior capability of government bureaucrats to wisely spend any funds advanced by future tax-payers. Oops! perhaps that is why he hits at Ryan?

PS. In reference to this comment someone wrote me: 

“Nobody who is serious about cutting huge deficits starts by slashing taxes on the wealthiest, very partially offset by slashing spending on health for the poorest. It is a fraud AND a reverse Robin Hood tax, on a spectacular scale.” 

And I answered: 

When if phrased that way, yes! But then someone, who by means of risk-weights which determine the capital requirements for banks, favors the officially not risky, most likely the rich, and thereby discriminates against the officially "risky", most likely the poor…should also qualify as most definitely a fraud and a reverse Robin Hood, on a quite spectacular scale.

Current bank regulations cause less new growth and more inequality

Sir, John Plender in “Corporate cash power is holding the state hostage”, August 17, discusses the excessive savings of corporation produced “by investing less than the sum of its retained profits… well into an upturn”… and which forces governments “to accommodate these surpluses by running large fiscal deficits”. 

As a possible explanation Plender cites Andrew Smithers of Smithers & Co., who advances that this “has been driven by the dramatic growth of the bonus culture” which creates a bias in favor of short term profits and which are maximized by refraining from investing. 

That plays a role but it is small when compared to that that utter nonsense of allowing, like it is done now, bank regulation bureaucrats to decide what should be considered “not-risky” and be favored, and what should be considered “risky” and be discriminated against, and all that without any consideration given to the purpose of banks. 

The perceived as “not-risky” are normally related to past successes and current wealth, and the “risky”, like small businesses and entrepreneurs, harbor more often the possible future successes and those in need of bank credit. Favor the “not-risky” and discriminate the “risky” and you will get less new economic growth and more inequality. It is as simple as that! 

Regulators have no problems when bankers and market understands... their role is not so much understanding what is happening but preparing for when no one understands. A regulator that accepts being dumb, is immensely better than a regulator who believes himself to be smart.

Bank regulators, allow America to be the Home of the Brave

Sir, Jeffrey Sachs in “The US has already lost the battle over government” August 16, writes “ Mr. Ryan’s budget is nothing short of heartless in the face of the dire crisis facing America’s poor”. 

Hold it there Professor Sachs! I get too nervous about the poor, when someone recurs to arguing considerations based on the heart in order to service their needs. What was much worse for them than any heartlessness was the senselessness of bank regulators, that which caused the current crisis. 

By allowing banks to hold minimal capital when lending or investing in what was officially perceived as not-risky, regulators effectively discriminated against those perceived as “risky”, like small businesses and entrepreneurs, and doomed the banks to useless and obese exposures to what was or is still officially perceived as not risky. 

If there is anything that Republicans and Democrats should offer, as Americans, that is to wipe away the regulatory discrimination against what is perceived as risky and allow the US to fully be “the Home of the Brave” again… and that by the way would also do Europe a lot of good. 

And, if your bank regulator absolutely must mess around with market signals, so that they feel they have earned their salary, then why do you not ask them to base their capital requirements for banks on job creation and environmental sustainability ratings instead? That way they would at least serve a purpose.

Greece should state it will use the euro whether the eurozone likes it or not

Sir, George Pagoulatos writes: “Of all Greece’s many problems, including austerity, the threat of leaving the eurozone is the most damaging”, “Greece should not be sacrificed for the euro” August 16. But, when asking “Would the eurozone be justified in ejecting Greece?” professor Pagoulatos seems to imply that staying with the euro is not in Greece’s hands, and that is wrong. 

The best thing that Greece could do is to announce that, if by any reason expelled from the eurozone, for instance because it has not been able to service its debt, that which was recently considered risk-free by European bank regulators, it will stick to the euro, and NOT pull a dirty quickie new drachma on anyone... something which by the way would cost Greece useless fortunes, because of its unfortunate current lack of sufficient credibility. If Montenegro can use the euro why can’t Greece?

Could bank regulators and FT´s finance sector journalists be suffering from damage in the ventromedial prefrontal cortex?

All major bank crises originate not from too much lending to what is perceived as risky, that never happens, but from too much lending to something perceived as absolutely not risky but that later becomes very risky, and this often because too much has been lent to it. This is a fact, and regulators, financial journalists and other experts know it. 

And yet, bank regulators set up capital requirements for banks that were much higher when the perceived risk were higher than when the perceived risk were lower, and thereby generated the incentives for too much lending to the latter… as a result of that since banks were allowed to leverage their equity more when doing so, banks could obtain a higher return on their equity when lending to what was officially deemed as absolutely not risky. 

And that not only caused the current crisis but it also keeps us from digging ourselves out of it, as it discriminates against all the “risky” small businesses and entrepreneurs we need to help us. 

And no matter how much I have written about it, the regulatory nannies don’t seem to get it, and keep on digging us, deeper and deeper, into what I have called “L’economia castrata”, that which so dangerously discriminates against what seems as “risky”. And one reason for it is that financial journalists, like those in FT, neither seem to get it. Why is this so? 

Well Malcolm Gladwell, in his book “Blink”, 2005, wrote that those who suffer from damage in the ventromedial prefrontal cortex, “can be highly intelligent and functional, but they lack judgment”, and that “causes a disconnect between what you know and what you do”. Could that be it?

“Radical uncertainty” indicates regulators should stay away from “Bayesian subjective probabilities”

Sir, John Kay in “The other multiplier effect, or Keynes’s view of probability”, August 15, writes that “the largest and most famous Dutch book… a set of choices such that a seemingly attractive selection from it is certain to lose money for the person who makes the selection… would be the collection of ingenious structures products RBS acquired when it bought ABN Amro”. 

Forget it! That book, as a Dutch book, does not even come close to Basel II regulations. Those regulations, which offered a world without bank crises, set the bank capital requirements lower when the perceived risk were lower, and thereby doomed the banks to overdose on perceived risks, and create extremely dangerous and obese exposures to what was, and is, officially deemed as “absolutely not risky”. 

Kay mentions the possibility that one has to use “Bayesian subjective probabilities… because if they did not, people would devise schemes that made money at their expense”. That might or might not be true, but, at least, when it comes to bank regulators, the best is for them not even to engage in any sort of risk arbitration. One single capital requirement for any bank asset is the only rational response to any “radical uncertainty”.

Should regulators be in charge of the wrist-slapping of regulators?

Sir, Tom Braithwaite makes a courageous point in “Thin-skinned London should let the sunshine in”, August 14, by holding that even though the head of New York state´s Department of Financial Services is “a publicity-seeking, showboating, impertinent arriviste, who should get back in his box and leave the wrist-slapping of bankers to the professionals… that doesn´t make him wrong”. 

I certainly hope that someone in FT would have the same courage of defending “a publicity-seeking, showboating, impertinent arriviste” like me, who refuses to get back in his box and leave the wrist-slapping of” regulators in the hands of the same professional regulators. 

Ps. It’s the stupid bank regulations stupid!

Regulators must stop feeding banks bad cholesterols, and making these communist agents.

Sir, in “Waiting for growth” August 13, you write: “The sclerosis in UK’s balance sheets is clogging up the financial arteries through which central bank cash multiplies” yet again you refuse to even hint at the possibility that those truly dumb capital requirements for banks based on perceived risk, ex ante of course, represents the heavy doses of bad of cholesterol that regulators have been feeding the banking systems for quite some time now, UK’s included. To even discuss “direct monetisation of spending”, without cleaning up bank arteries , is just irresponsible. 

And just a few weeks ago, in “More bad news for banks and clients”, July 13, you also wrote “The industry must take its utility function seriously”, and also blithely ignored top mention the fact that the regulators have not defined the purpose of the banks, and are therefore actually with their regulations interfering with their utility function, as we believe that to be. At this moment no matter how lost banks might seem, they know more what they are there for than regulators do. If in doubt, just consider the extremely lenient capital requirements for banks when lending to “infallible sovereigns”. That cannot satisfy any reasonable capital allocation purposes, unless of course you are a communist state and you want your banks to be your agents.

To escape the no-growth trap, regulators must allow the “risky” to compete freely for access to bank credit

Sir, James Mackintosh, in “The world is halfway through a lost decade” August 11, writes: “The pressure is on for western governments to ease austerity plans, while the entire world seems ready for more aggressive monetary intervention. It is hard to see how this could lead to more than tepid growth, and there is an ever-present risk of a Spanish-style bond crisis.” 

I agree, the only way to escape the low-or no-growth trap is by eliminating the regulatory preferences for lending to the “not-risky” and thereby allow the “risky”, the small businesses and entrepreneurs, to compete freely for access to bank credit

What a great letter!

Sir, I am not at all sure I grasped the whole meaning of Simon Schama’s “A letter from America to beatific Olympic Britain”, August 11, but, intuitively, I know that I love it… and that is not only because I find the concept of “democracy has become the catspaw of plutocrats” to be so right on the dot.

Another very dark side of the technological revolution.

Sir, Gillian Tett in “Mobiles are ringing the global changes” August 11, refers to “dark side of this technological revolution”. 

Indeed, when I was a young boy, in a boarding school in Sweden I sent my parents, living in Venezuela, about one letter every six months. When receiving the letter, about one month later, they’ve read it, and concluded “Per is ok”, and then they were calm for the next six months, or more. Nowadays, if any of our three daughters do not message us within sort of hourly intervals, from around the corner, my wife and I go into a frenzy. And I truly fret the moment my 11 months grandchild gets her mobile device… what a stress!

If global bank regulations are as bad as the current, then a fragmented system is better.

Sir, John Plender concludes his “StanChart is a reminder of banking’s insatiable greed”, August 10, with “competition between financial centres is a trivial issue when compared with the wider global threat to jobs and growth. The stakes in this unfolding saga are uncomfortably high.” And he is absolutely right. 

But Plender also refers to the “growing risk that the regulatory response to scandals could, as a byproduct, lead to the fragmentation of the global financial system”, and there I must remind him that a global financial system subject to the wrong global financial regulations is worse than a fragmented system, where at least perhaps some places could do it better. 

For instance a system where a German bank was required to hold 8 percent in capital when lending to a German small business or entrepreneur, only on account of that being perceived as “risky”, while at the same time being able to lend to Greece holding only 1.6 percent in capital because Greece was officially perceived as “not risky”, are not the kind of regulations I would like to see applied globally.

FT, without fear and favoring, do not exclude bank regulators from being shamed

Sir, in “The limits of shame” august 10 you state “Shaming banks and bankers should only occur when evidence of wrongdoing has been found. Bankers have been guilty of excess but they should not be condemned as a class.” 

Absolutely! But why do you exclude in that same line bank regulators? They are the guiltiest of generating excesses in terms of the obese bank exposures to what was erroneously perceives as not risky. 

For many years now I have held they should all parade down 5th Avenue wearing cones of shame or whatever similar procedure is more familiar to you in Britain. 

Bank regulators, stop protecting the vested interest of the “not-risky”, which discriminates against the “risky”.

Sir, James Wilson and Giulia Segreti reports that “ECB calls for ‘courageous’ action to tackle‘vested interests’” and of “the need to bring down labour costs, boost productivity and improve the business climate”, August 10. 

Absolutely! But why does not ECB ask regulators to stop protecting the vested interest of those perceived as “not-risky” with their capital requirements for banks based on perceived risk. These regulations are precisely the main cause for why the report also states that “Coldiretti, the Italian agricultural association, estimates that 60 per cent of companies in the sector risk being starved of credit as they face interest rates that are 30 per cent higher than the average of other sectors” 

Really, bank regulators who allow banks to lend without any capital to supposedly infallible sovereigns and very little capital to what private is AAA rated while at the same time requires the banks to hold much more capital when lending to the “risky”, like small businesses and entrepreneurs, should be ashamed of themselves. They have no idea of what banking is all about. They are guilty of causing “L’economia castrata” and which threatens to bring theWestern world to its knees. 

If little I was president of the ECB

Sir, Jerome Booth in “Europe must seize the day now that Draghi has acted” writes that “However far away, if financial markets see light at the end of the tunnel in the form of a credible plan, hope can return.” Absolutely!

And that is why I fight so much for the real truth of this crisis to come out, so that market understands the why of it and sees it corrected… currently all stimulus efforts are being poured on basically the same economy as before, and that does not help the credibility of these. 

If I was the president of the ECB I would come out and explain how this crisis was caused, by excessive regulatory reliance on our capacity to measure risks, and consequently excessive incentives given to banks when engaging with what was officially perceived as not-risky, and consequently the discrimination that signified against the officially “risky” like small businesses and entrepreneurs. And then, I would immediately present a plan of how to correct the banking system for that monumental regulatory mistake. 

And I am sure markets would begin to understand how they were distorted and therefore begin to see that light which allows it, in the middle of all rubble and destruction, to sing that hopeful “Oh, what a wonderful morning!” 

But I am not the president of ECB, Mario Draghi is, one of the failed regulators.

What kind of parents are you?

Sir, Frank Partnoy more than suggests that lawyers might have been more of enablers and emboldeners of bank shenanigans and concludes: One lesson from recent scandals is that banks need reliably independent in-house counsel, with a strong moral backbone”, “Who are the true villains of the StanChart tragedy?” August 9. Does that not go for regulators too? 

I mean if your children’s nanny had allowed, even pushed, one of them to go bungee-jumping, on account of the child begging, and some safety rating agency deeming that safe, and then a fatal accident happened… what would you do with the nanny? Would you still retain her services? If so, what kind of parent would that make of you? 

Currently those same nannies who with Basel II authorized banks to lend to Greece holding only 1.6 percent in capital, only because credit rating agencies deemed it safe, and which signifies a mindboggling authorized 62.5 to 1 leverage, have been retained and put in charge of coming up with Basel III, if not, like Mario Draghi, kept busy as president of the European Central Bank. What kind of parents does that make you?

The Western world is being brought to its knees by mad bank regulators.

The Western world is the result of risk-taking in all shapes and forms… “God make us daring!”, ends one of the psalms sung in its churches. 

And so when regulators, with their capital requirements, decided to give the banks additional incentives to embrace what was perceived as “not-risky” and further avoid the “risky”, like small business and entrepreneurs, only so that banks would not fail, they stuck a dagger in the very soul of the Western world. 

And besides, they used a lousy dagger that could not stop banks from failing, because it is precisely when banks embrace too much something that is perceived as absolutely not risky, when they fail, en masse. 

And Mario Draghi is one of those Western-world-slayers regulators who do not yet even understand he is very much responsible for “L’economia castrata”. Therefore, Sebastian Mallaby’s heading “This will not be enough, Mr. Draghi”, August 8, would have been more precise stating “Nothing Mr. Draghi does, will be enough” 

Survival of Europe has to begin by rescuing the possibilities of its risk-takers to take risks, and that begins by firing the nannies in the Basel Committee and in the Financial Stability Board, and renaming the latter immediately the Financial Functionability Board.

The happiest bank story ever doomed the banks to the unhappiest ending ever.

Sir, I refer to John Kay’s, “When storytelling leads to an unhappy ending”, August 8. 

“The higher perceived risks, the more bank capital, the lower the perceived risk, the less capital.” 

With that so believable regulatory paradigm, bank regulators thought they had saved the world forever from bank crises, not realizing that with it they doomed the banks to the biggest crisis ever. 

That regulation only fed the monster, as risky assets have nothing to do with bank crisis, these all result from safe assets ending up as risky. 

If only bank regulators had drawn up their small including-excluding events probability circles, that could perhaps have stopped them from discriminating in favor of the “not-risky” and against the “risky”. But no! Even 5 years after the explosion, regulators still refuse to do so. 

John Kay, almost all believed in the regulator’s initial narrative, because that is what you do with experts, but please try to explain why do they now still allow utterly failed regulators to keep on regulating, using the same utterly failed narrative? 

And there is a lot of urgency in spreading the narrative about their failure, since that regulation is also castrating the economy at large, as it pushes bank credit toward the currently “safe” and away from the risky-risk-takers who the Western world needs in order to move forward and not stall.

Does Mario Draghi really have what it takes?

Sir, you hold that “risk managers of banks… failed to foresee the unsustainability of the US mortgage market – the cause of the crisis”, “The Euro still has a mountain to climb” August 7. Yes, they should have, but that is mainly because they should have distrusted their regulators. 

Bank regulators, among them FT´s hero, Mario Draghi, should have understood that you just do not allow banks to leverage their equity 62.5 times, when for instance investing in securities backed by mortgages to the subprime sector only because these were triple-A rated, or when lending to Greece. 

In fact, when bank regulators imposed on the banks their capital requirements, they basically told the banks that analyzing the mortgage market was none of their business, because for that purpose, they had appointed their official risk managers, namely the credit rating agencies. 

Does FT really think that European banks should have sent expensive and qualified analysts to the US to check up on the mortgage market, when even most US banks were not doing that? I really wonder when is FT going to behave “without fear and without favor” when it comes to sharing out the blame for this crisis among banks and regulators? 

As I see it, someone who has not yet understood the distortive implications of current capital requirements for banks and which caused “L’economia castrata”, does not have the qualifications to run an ECB in these very critical days.

Again, can we please have a Financial Functionability Board?

Sir, Gillian Tett writes, “After all a financial system in which transactions are secured on assets is likely to be a healthier system than one which is largely – or patchily – unsecured”, “Cyber finance takes its collateral thinking test”, August 6. Why is that so, how on earth does Ms. Tett know that? 

Ms. Tett, like most, is stuck in a Financial Stability Board mentality of let us castrate the banks so that they do no harm. She, like most, is seemingly incapable of understanding that giving the banks incentives to go for the officially not risky and avoid the risky, was a primary cause for this crisis. 

The healthiest banking system will always be the one helping to produce the healthiest economy. In this respect we urgently need a Financial Functionability Board, able and willing to understand also the risks of risk-avoidance, so as to stop the regulators from digging us further in this hole of “L’economia castrata” where we find ourselves.

The consequences of all banks managing their own risks and some few regulators managing the risks of all banks, are not the same.

Sir, Gillian Tett correctly holds that risk management is no exact science “Anthropologists join actuaries to teach us all about risk”, August 3. You would then assume she should object when regulators try to manage the risks of banking by setting the risk-weights which determine the capital requirements of banks… but it would seem she has no major problem with that. 

What she and so many other experts fail to understand is the world of difference that exists between the consequences of millions of market participants each one trying to manage their own risk and some few regulators trying to manage the risks for all, and this even if anthropologists and actuaries are in regulatory team. This crisis is the result of the latter, something which can be empirically confirmed, by running a regression between all current bank problem assets and the fact that when banks incorporated those assets on their books they needed to hold very little capital, only because those assets were officially deemed as safe.

How can you get growth when regulators order banks to dump small business and entrepreneurs?

Sir, David Rosenberg tries to get a grip on why the US economy, which given the extent of how the spending spigots have been turned on, should have delivered 8 percent grow, is barely coming up with more than 2 percent. “Credit bust scars will take years to heal in aftershock era”, August 2. 

Like most experts Rosenberg ignores as one of the explanations the fact that current capital requirements discriminate based on perceived risk. That leads not only to holding back natural risk-takers like small businesses and entrepreneurs, those whose actions are so necessary for growth, but, worse yet, that even forces the banks to dump more the “risky” than the “not risky”, as doing business with the first requires so much more of that everyday scarcer bank capital.

Sometimes, when the sunrays are dangerous, finance might be better off in the shadows.

Sir, Sebastian Mallaby in “Finance must escape the shadows” August 1, writes “the explosion in securitization was partly a response to a global craving for safe assets”. The question he needs to respond to though, before drawing any sort of conclusion, is how much of that was natural market craving, and how much the result of artificially induced appetite stimulation, such as allowing banks to hold these securities, if highly rated, against very little capital. 

With regulators who allowed banks to leverage their equity more than 60 to 1 when holding AAA securities or lending to Greece, we might all have been better off if all our banks had remained in the shadows, instead of exposing themselves to that kind of dangerous type of sunrays. The shadows, if not just fraudulent, would never ever have permitted such leverages. In fact Sebastian Mallaby’s own “More Money Than God” offers, in the case of the hedge funds, a great defense for finance to sometimes remain in the shadows. 

Now when Mallaby writes “Wherever you come down on these questions what is really striking is their absence from the public square”, there I cannot but agree wholeheartedly and express the same concern. Indeed you just need to see how FT have ignored or minimized this problem… and that cannot just be because it was little censored me who alerted FT about this in hundreds of letters.

The buck is being broken everywhere and investors know it.

Sir, Gillian Tett discusses the money market funds’ issue of “break the buck”, the return of less than 100 percent of investors’ cash, “The Achilles heel of America’s financial system”, July 31. 

The truth though is that the buck is being broken everywhere, especially if it is a real term buck, and investors have no other choice but to accept it … just look at Treasuries. 

And so clearly, the faster all explicit or implicit artificial guarantees are dismantled, the lesser distortions are produced, and the faster we might be able to return to some market sanity. 

But that would of course also requires the removal of all the regulatory distortions introduced in bank lending based on perceived risk, and which was and is the real cause of so much buck breaking going on.

FT, why do you go so much softer on regulators than on bankers?

JP Morgan Chase’s recent losses, Barclays’ manipulation of Libor, RBS’s IT failures and the money laundering assistance provided by HSBC, though all absolutely unpardonable, some most probably criminal, amount, in terms of real damages to the economy, to not more than some pick-pocketing, when compared to the harm that the bank regulations did, with their capital requirements for banks based on perceived risks already cleared for. 

All of which makes me wonder again, for the umpteenth time, why the Financial Times treats the bureaucrats of financial regulations with kid gloves when compared to how they treat the bad bad bankers, as for instance in Patrick Jenkins’ and Brooke Master’s “London’s precarious position” July 30, 2012.

The barrels of the economy must be cleaned before ECB fires its 357 Magnum

Mario Draghi belongs to that wimpy generation of regulators which so concerned with banks taking excessive risks created, by means of capital requirement based on perceived risks, the mother of incentives for the banks to dedicate themselves almost entirely to doing business with the “not-risky”. And, consequently, we are suffering this huge crisis of obscene obese bank exposures to what being officially perceived ex ante as absolutely not-risky turned out, ex post, to be very risky. 

In “The ECB talks tough on the euro” July 28, you now cast Draghi as Dirty Harry and mention that “relaunching ECB bond purchases or granting a banking license to the European Stability Mechanism”, can be “game changers”. Forget it! 

If the barrels of the economy are not clean of those regulatory obstacles which impede the “risky” small businesses and entrepreneurs to help out, Draghi’s 357 Magnum will backfire.

A bank regulator should not act like a banker, but think about how bankers act.

Sir, Sushil Wadhani and Michael Dicks remind us of Keynes´ teachings in that when picking winners of a beauty contest “rather than pick whom one believes to be the most beautiful person, it is best to pick those whom others might judge so”, “Investors must gauge perceived – ‘not true’ – chances of disasters” July 27. 

We sure wish bank regulators had headed that advice. Their capital requirements for banks were set based on ex-ante perceived risk, like credit ratings, and thinking of it almost as true risk. Basel II required for instance 1.6 percent when lending to a triple-A rated client and 8 percent, five times more, when lending to a small unrated business. 

Had the regulators instead set these requirements based on how the bankers would judge and act on the perceptions of risk, and had they also read about Mark Twain’s banker, he who lends you the umbrella when the sun shines and takes it away when it looks like it is going to rain, then they would have set the capital requirements for lending to the AAAs higher than when lending to a small unrated business, and this crisis would not have happened.

It was the firemen who, unwittingly, planted and incendiary AAA-bomb in our banks

Sir, John Gapper in “The banking firemen won´t prevent fires breaking out” July 26, mentions the need for bank supervisors to prevent banks from taking excessive risks…” 

Again I must remind him that this was not a crisis because of “excessive risks”, but a crisis that resulted from an excessive trust by regulators in the perceptions of risks, and of an excessive importance given also by regulators to these perceptions in the capital requirements for banks, when they ignored that these risk perceptions were already cleared for in so many other ways. 

Gapper refers to “Most supervisors admit they were too lax in the past… their job was to identify risks, and bring them to the attention of bank executives, but not tell them what to do.” Precisely, the problem though, is that these regulators have not yet understood that with their risk-weights that define the capital requirements they are, de-facto, telling a banker what to do. 

And so, in this case it was the firemen who, unwittingly, planted and incendiary AAA-bomb in our banks… and the firemen are still out there stoking the fire with their revised risk-weights.

FT, you´ve forgotten that unencumbered risk taking brought you the banks (and your Britain) to be proud of.

Sir, in “Reforming British banking after Libor” July 25, you, like seemingly Lord Turner and Sir Mervyn King too, show yourself unable to understand that you would never ever have had any British banks to be proud about, or even perhaps a Britain to be proud of either for that matter, if your banks had had to operate with regulatory bank capital requirements based on perceived risks, based on risk-adverseness. 

All banks that have grown to be important have always been allowed to manage their risks unencumbered, without some silly meddling nanny regulator assigning risk-weights for them.

"Disaster economics" is also a consequence of regulations that push the banks into what is officially deemed “infallible”.

Sir, Gillian Tett writes “We have entered the world of disaster economies” July 24, in which she analyses investor behavior, safe assets and sovereign bonds, and finds that in the case of for instance US and Germany, even though credit default spreads might be increasing, bond yields can fall. 

Amazingly, nowhere in her analysis, does Ms. Tett take into account the fact that one of the major financial actors, the banking system, has to operate under a regime of capital requirements based on risk, and therefore, lacking capital, has no choice but to park their liquidity where the least capital is required, like in US and German bonds.

John Kay, we all wish regulators had regulated based on bankers’ behavior

Sir, John Kay in “Finance needs trusted stewards, not toll collectors” July 23, writes of a new regulatory approach introduced in the 1970s and 1980s “based on behavioral regulation”. 

Not so, though we sure wish they had done just that. If so, regulators would have set the capital requirements for banks based on how bankers behave with respect to perceived risk, instead of as they did, based on the perceived risks.. and as if no one was perceiving these. 

And if regulators knew bankers as well as Mark Twain did, “those who lend you the umbrella when the sun shines and want it back when it looks like it is going to rain” then they could have set the capital requirements slightly higher for what is perceives as absolutely not risky, instead of the immensely lower, and then the world would not have fallen into this “safety” trap crisis.

There is a massive state stealth intervention of the financial markets

Sir, Francis Fukuyama writes that “Conservatives must fall back in love with the state” July 21, and I do indeed agree on the need for a complete organizational overhaul of a state that has become an amorphous monster, in order to turn it into a lean and efficiently mean governing machine, though, perhaps, “Conservatives must help the state to become more lovable”, would be a better phrasing. 

The problem is how do we get from here to there? Especially since the here is so much worse than what conservatives (and the left) can imagine. 

The here includes the most massive state stealth financial intervention ever. By means of that concoction known as capital requirements for banks based on perceived risk, the banks need to hold immensely more capital when lending to a “risky” citizen than when lending to an “infallible” sovereign… and that as you could understand translates into an immense subsidy for government borrowings and allow the governments to exercise their financial repression so much easier. 

Look at the current treasury yields and ask yourself if these would be the same without the help of bank regulators. No way Francis, it is one of the least transparent but largest taxes ever. How much tax is a purchaser of 30 years US bond yielding 2.55 percent paying? Not so lovable eh!

And what about FSA´s rate rigging?

Sir, Patrick Jenkins and Caroline Binham report “FSA steps up probe into bank rate rigging”, July 20. I just wonder when someone will initiate a probe into FSA´s very own rate rigging.

The FSA must have known that by using capital requirements for banks based on perceived risk, they were effectively rigging the interest rates charged by banks in favor of those perceived as not risky and against those perceived as risky. And the net effect of this rigging is of course immensely larger and damaging than any Libor rigging. 

And if the FSA did not know that, then the really urgent probe should be about the selection process of bank regulators.

Any country declines if it starts taxing risk-taking

Sir, congressman Paul Ryan writes many truths in “Republicans must return to free-market principles” July 20, the truest in my opinion being that of “the defeatism of those seeking to manage the west’s decline. 

But if the congressman would just pick up his phone and call a banker in his constituency, to ask him how much capital the bank needed to hold in order to lend to an unrated a more fuller understanding about the urgency of returning to free-market principles. 

With immense hubris bank regulators, thinking themselves to be the risk-managers of the world, started to allot risk-weights which determines how much capital a bank needs for any specific asset. And, that translates into extraordinary interest rate subsidies to what is officially perceived as not-risky and extraordinary interest rate taxes on what is officially perceived as risky. 

What drives a country forward is its willingness to take risk. If bank regulators skew the access to bank credit in favor of the not-risky, those already favored by risk-adverse bankers, then the country will stall, decline, and finally fall drowning in obese bank exposures to what is officially deemed as absolutely not risky.

The pro-cyclical tsunami machinery

Sir, Sir Samuel Brittan starts his “An ancient Greek approach to modern economics” July 20, taking about cycles and ends it with the need for “removing distortions at the micro level”. He might be interested in the following macro micro distortion that is taking economic cyclicality to unimaginable levels. 

A European bank was authorized to lend to Greece holding only 1.6 percent in capital, which meant being able to leverage Greece’s risk-adjusted margins 62.5 times, and so it did, but, unfortunately, so did too many other banks, and Greece went bust. 

And now, when the bank has lost all its capital, it is required to hold many times more capital if lending to Greece, and so the European bank has no other choice but to lend to Germany, as so must all other banks do, something which does not require it to hold any capital. In fact, if lending only to the infallibles, then the bank would not even need shareholders, and could retain all bank profits for bankers’ bonuses. 

If this bank regulation is not a machine for creating a tsunami of pro-cyclicality, what is?

We all need to get rid of a despicable incestuous crony state capitalism

Sir, when a bank needs no equity, which means it needs no shareholder, in order to make a loan to its government, because its government is declared “absolutely risk-free”, and therefore the government has much easier access to bank credit than does a normal citizen, like a small business or entrepreneur, that classifies as a serious case of a despicable incestuous crony state capitalism. 

In this respect, John Huntsman, writing “True conservatives despise America´s crony capitalism” July 19, would be well served by looking at how bank regulators have been able to introduce, in his USA, odious discriminations in favor of what is officially perceived as “not risky” and against what is perceived as “risky”, something which must be completely anathema in a “Home of the Brave”. 

Huntsman writes about “the need [of] financial reform so that innovators and entrepreneurs have access to capital without turning our banking system into a public utility”. For that, at this moment, nothing is as important as throwing out the regulatory paradigm of capital requirements for banks based on perceived risk of default… besides, he should know, that in banking, what is perceived as risky, does never ever pose a major systemic risk.

Was the USA, the Home of the Brave, built based on risk-avoidance?

Sir, Professor Glenn Hubbard presents “A conservative growth agenda for the US economy” July 18. It includes primarily “getting or fiscal house in order and reforming the tax code” the latter because it “discourages work and entrepreneurship… and distorts the allocation of capital.” 

I have no problem with that, but how come no conservative (nor progressive) growth agenda includes getting rid, immediately, of those capital requirements for banks based on perceived risk and which discriminate so odiously discriminate in favor of what is perceived as absolutely not risky (which includes government) and against those perceived as risky, like the small businesses and the entrepreneurs? If anything is distorting bank credit allocation that´s it. Frankly, Professor Hubbard, was the US, “the land of the brave” built based on risk-avoidance? I do not think so! 

In fact these bank regulations are as close to a virus that instills cowardness as can be… and, if I was part of a Homeland Security, I would definitely look into it… as it is an issue of national security.

What I would look for, as a bank investor.

Sir, Sebastian Mallaby writes “Breaking up thebanks will win investor’s approval” July 18, and this is absolutely correct, provided we do not consider the costs and the dilutions that must result for those breakups to be successful… there might be a lot of alimony to be paid. 

But, as it could be of interest to some of your readers, let me expose what I would be looking for, as a bank investor. 

The first thing I would want from the bank is that it dedicates itself exclusively to lending to what is officially considered as “risky”, like small business and entrepreneurs, and for which the bank is required to have capital... which of course means that I as a shareholder will count. 

In other words, I would abhor my bank to lend to anything that is officially considered as “absolutely safe”, for 4 reasons: a.- it will probably mean they will be less careful, b.- they can do so with much less bank capital and so therefore as a shareholder I become less important, c.- it is only in what is considered as not risky that the banks can build up that type of exposures that can lead me to lose it all, and d.- if I want to invest in something perceived as “absolutely not risky”, I certainly do not need a bank for that… we can all read the credit ratings.

By the way, I suppose you know about "risk-adjusted rates of returns"

What if “swift execution” had been the pillar of Basel II?

Sir, in May 2003, as an Executive Director of the World Bank, during a workshop on Basel II, I told some hundred regulators: 

“There is a thesis that holds that the old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, was much wiser than today’s no burning at all, that only allows for the buildup of more incendiary materials, thereby guaranteeing disaster and scorched earth, when fire finally breaks out, as it does, sooner or later.

Therefore a regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.” 

When we now read Gillian Tett´s “America´s timely lessons in killing off toxic banks” July 17, we should think about what would have happened if “swift execution” had been the pillar of Basel II, instead of those mindless capital requirements based on perceived risks which could only guarantee increased toxicity and the too-big-to-fail banks?

Want more opportunities and less inequality? Then scrap capital requirements for banks based on perceived risks.

Sir, Lawrence Summers, proposes university to promote economic diversity in “How the land of opportunity can combat inequality” July 16. 

Let me proposes a more immediate way, scrapping capital requirements for banks based on perceived risk. These drive in a further inequality wedge between those perceived as risky, most often the have-nots, and those perceived as safe, most often the haves, at the same time it makes it more difficult and expensive for small businesses and entrepreneurs to get an opportunity. 

What good would it make for universities to introduce opportunity slots for the poor if then, when the poor graduates, his jobs will much depend on legacy networks? 

“Ah but then our banks can become unsafe!” Don’t be silly, when have you ever heard about a bank crisis caused by too much lending to what was considered risky? 

Ps. I have recently introduced a complaint before the Consumer Financial Protection Bureau arguing that these capital requirements go against the Equal Credit Opportunity Act (Regulation B)

Why does not Professor Stiglitz get it?

Sir, I refer to Samuel Brittan´s “Unequal measures” and where he reviews Joseph Stiglitz latest book, July 14. As a former Executive Director of the World Bank I have over the years had several opportunities to interact with Professor Stiglitz, although that of course does not mean he should have the faintest idea of who I am.

Nonetheless, in doing so, it has been an immense source of frustration to me not being able to get him to understand that if your bank regulations have, as its principal pillar, that lending to those who are perceived as risky require the banks to hold more capital than when lending to those perceived as not risky, you are effectively, and aggressively, impairing the rights of the "risky" to an equal opportunity to access to bank credit… and that this signifies one of the most important drivers of the increased inequality. 

And Professor Stiglitz, like so many other experts, stubbornly keeps on mentioning excessive financial risk-taking as the cause of this crisis, not wanting to listen to the argument that it was because of excessive trust in things not being risky, cést pas la même chose, only because that does not perhaps fit his agenda. But then perhaps it is also so that when you get a Nobel Prize, it is only human to stop listening to anyone else but yourself. If so let that serve as a consolation, and warning, to all of us non Nobel Prize winners.

And again, failed regulators, want to show off as puritans!

Sir, the first article I published in my life, in June 1997, was titled “Puritanism in Banking”. In it I expressed serious concerns about how bank regulators, after a crisis, were overdoing it, in order to either show off or to have their previous lax oversight forgiven. It all gave way to a sort of “I am a stricter regulator than you are… no you aren’t… yes I am… no you aren’t… Yes I am, yes I am, yes I am.” 

The article ended with “If we insist in maintaining a firm defeatist attitude which definitely does not represent a vision of growth for the future, we will most likely end up with the most reserved and solid banking sector in the world, adequately dressed in very conservative business suits, presiding over the funeral of the economy. I would much prefer their putting on some blue jeans and trying to get the economy moving.” 

Today, fifteen years later, I get the same sinking feeling when I read about a request for “all banks everywhere to raise their tangible equity capital to 20 percent of assets”, Chris Giles’ “The bank that roared”, July 14. 

Do they not calculate how much bank capital would need to be raised in order to do that? Or are they contemplating keeping the risk-weights, which in such a case would mean causing even higher distortions? 

I believe that the basic 8 percent of capital requirements of Basel is sufficient as long as it is not diluted by risk-weighting. Already to achieve that 8 percent, for all assets, constitutes a major challenge, considering that some current capital requirements for banks are basically zero, like for instance when lending to the “infallible sovereigns”.

There’s also a need for a profound change in the culture of regulations

Sir, Sir Mervyn King, the Bank of England Governor lashes out with “From excessive compensation to deceitful manipulation of one of the most important rates, we can see we need a change in the culture of the industry”. Sorry, as a regulator he is not really one to speak about the need for a culture change.

Only because of the capital requirements based on perceived risks, the regulators caused the banks to charge hundred and so basic points in higher interest to those perceived as “risky”, like small businesses and entrepreneurs, and hundred and so basic points in lower interest to those perceived as not risky, like infallible sovereigns. If that is not manipulation of the most important rates, I do not know what that is.

And besides, most of the excessive compensations to bankers arose from the fact that regulators freed the bankers from having to compensate shareholders by requiring so little bank equity. By the way, on that issue, it might be better for Sir Mervyn King to lie low, because there could be calls for claw-backs on all types of compensation.

What was “not-risky” turned into risky because it was allowed to earn too high returns on bank equity.

Sir, I much appreciate Martin Wolf mentioning that I have reminded him regularly that “crises occur when what was thought to be low risk turns out to be very high risk”, arguing that “For this reason, unweighted leverage matters”, “Seven ways to clean up our banking ‘cesspit’” July 13. 

This is true, but what I have mostly tried to remind and explain to everyone, with less success, is about the dangerous distortion regulatory risk-weighting produces. 

For instance, Robert Jenkins, Member of the Financial Policy Committee, Bank of England, in a recent speech said: “The successful investor is not interested in promises of short-term return on equity; he is interested in achieving attractive risk-adjusted returns. The higher the perceived risk, the higher the return required. The lower the perceived risk, the lower the return expected. Capital will flow with either combination but its price will be different” 

What Mr. Jenkins, has not fully realized yet is that when regulators decide to allow banks to leverage their equity much more when something is perceived as risky than when something is perceived as not risky, they completely distort the system, producing the opposite; the higher the perceived risk the lower return on equity and the lower risk the higher the return. 

And this distortion is sheer lunacy, as it assassinates the risk-taking a society needs in order to move forward; and also dooms our banks to end up gasping for profits and capital on some beach that was perceived as very safe, but was not, when it became overcrowded

It's what's safe that's risky!

When "setting bank equity requirements, it is essential to recognise that so-called “risk-weighted” assets can and will be gamed by both banks and regulators. As Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk." Martin Wolf

https://www.ft.com/content/7a95df3e-cb50-11e1-b896-00144feabdc0

Wolf ends with:“We cannot hope for miracles. But we can make bankers more useful and less dangerous. Focus on that.”

Indeed, let's all focus on that.

Please free us from imprudent risk aversion and give us some prudent risk-taking

My 2019 letter to the Financial Stability Board: Acknowledged and Ignored.

PS. Read what #AI ChatGPT OpenAI opines on this.

Here a 2010 homemade YouTube in which I tried to explain the Global Financial Crisis with a 2x2 matrix.

“The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages.” Paul Volcker

PS. 2023 tweets

A tweet: "Incentives matter: The escape valves of risk weighted bank capital (equity) requirements, cause banks’ risk models to be more about equity-minimizing/leverage-maximizing, than about analyzing bank assets’ true risks. That’s life!"

Another tweet: "The world has been duped/lulled into a false sense of security by the use of risk weighted assets (RWA) as a real and valid measure of banks' risk exposure. E.g., the duration risk of #SVB long-term government bonds is not included in the weighted risks."

Another tweet: “SVB regulators were ‘asleep at the wheel’” What’s a supervisor to do? Inform his boss Treasury bonds' 0% risk weight must be increased?  It is difficult to get a man to understand something, when his salary depends on his not understanding it” Upton Sinclair

Another tweet: "The most dangerous risk banks take, #unwittingly, is the buildup of huge exposures with assets perceived as safe, those which caused all major bank crisis. Regulators’ risk weighted bank capital/equity requirements, unwittingly, puts that risk on steroids."

Another tweet: "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 [risk weighted bank capital/equity requirements] may calcify its structure and break with any small wind."

Another tweet: "Bank capital/equity requirements mostly based on perceived credit risks, not misperceived risks or unexpected events, e.g., covid, inflation, war, interest rate rise, doom banks to stand naked, when needed the most, when hardest to raise equity"

Another tweet: “A regulation that regulates less, but is more trigger-happy & treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might lead us to… the mother of all bank crises”

Another tweet: "Risk weighted bank capital/equity with decreed weights: 0% government – 100% citizens, as if bureaucrats know better what to do with credit than e.g., small businesses and entrepreneurs, is that communism, fascism or just plain vanilla Banana Republic?"

Another tweet: "#SVB have all besserwissers Monday morning quarterbacks explaining us duration risk; why holding long-term government bonds was dangerous. Not a word about why regulators require so little capital/equity/skin-in-the game against these assets.

Another tweet: "The stress test that shall not be dared. What if that what’s perceived as safe is more dangerous to bank systems than what’s perceive risky, and therefore the risk weighted bank capital/equity requirements do not reflect real bank risks?"

Another tweet: "When concocting the risk weighted bank equity requirements, evidently no regulator asked: What would Mark Twain opine about with what assets banks might create dangerously large exposures, with some perceived as risky or with some perceived as safe?

On bank regulations, I’m not a newcomer nor a Monday morning quarterback.