Friday, July 29, 2016

Sovereign risk-weight = Zero percent, and We The People = 100%. In America?

I am not an American, and I am not well versed on its Constitution, and there is one issue which has for a long time been a mystery to me. 

How on earth could America, in 1988, as a signatory of the Basel Accord, accept that for the purposes of setting the capital requirements for banks, the risk-weight for the sovereign, meaning the government at zero percent, while the risk-weight for the citizen, meaning We The People was set at 100%; and all without a major discussion?

I know that “sovereigns” currently means the government but, when for instance reading Randy E. Barnett’s “Our Republican Constitution” one could have expected some debate about something that is akin to risk weighing the King with an "infallible" 0%, and his subservients with a "risky" 100%.

For instance Barnett's book states that Justice James Wilson, in the Chisholm v. Georgia case of 1793, opined that “To the Constitution of the United States the term Sovereign is totally unknown…and if the term sovereign is to be used at all, it should refer to the individual people”. And the book also frequently refers to the importance of the required consent of the people, which of course is also a thorny issue. 

And, since those risk-weights effectively permit banks to leverage their equity much more when lending to the sovereign than when lending to the citizen; banks will earn higher risk adjusted returns when lending to the sovereign than when lending to the citizens; and so banks will de facto, sooner or later lend too much to the sovereign and too little to the citizens… I can simply not fathom how citizens, be they individual or majority, could give their consent to something like that.

But worse it became. In 2004, in Basel II regulators also made a distinction between those who had great credit ratings, like AAA to AA, and who received a 20% risk-weight, and for instance those who had no ratings and who kept their 100% risk weight. And that to me creates a sort of AAArisktocracy that does not square well with the Constitution’s “No Title of Nobility shall be granted by the United States.

But even without entering into constitutional issues, there is even a current law that seem to prohibit this type of discrimination, but that is not applied to bank regulations. And I refer to the Equal Credit Opportunity Act: “Regulation B”.

So in the land in which its Declaration of Independence states: “We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.”, I just must ask: How could regulators dare to decree inequality?

And to top it up the current risk-weighted capital requirements for banks, more ex ante perceived risk more capital – less risk less capital, are arbitrary and irrational. And that is because no major bank crises ever result from the build up of excessive dangerous bank exposures to something perceived as risky, they always do with something, erroneously, perceived as very safe If you want to understand how really crazy these bank regulations are here is a brief memo.

And frankly what would a Governor answer to the question: Why can our banks leverage their equity lending more to a foreign sovereign or a foreigner with a high credit rating than when lending to a local SME or entrepreneur?

No! America would never have become what it is, had it had this type of risk averse discriminatory bank regulations before.

Oh and by the way, so surrealistically, the Dodd Frank Act, in all its 848 pages does not mention the Basel Committee nor the Basel Accord, not even once.

PS. In his book Professor Barnett defends Federalism from the perspective of making diversity more possible. That rhymes well with what I stated at the World Bank as an Executive Director 2002-04: "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”

Thursday, July 28, 2016

Would Bernardine of Siena have accused the Basel Committee for Banking Supervision of usury?

In Samuel Gregg’s “For God and Profit” 2016 I read “Bernardine of Siena (1380-1444)…a member of the famously ascetic Franciscan order [opined that] “Usury concentrates the money of the community in the hands of the few, just as if all the blood in a man’s body ran to his heart and left his other organ depleted”

And I wondered what would Bernardine of Siena have opined on the Basel Committee’s risk weighted capital requirements for banks? These, no doubt about it, concentrates bank credit in the few hands of those perceived, decreed and concocted ex ante as “safe”, like sovereigns and the AAArisktocracy; and leave the other vital organ of the real economy, like the SMEs and entrepreneurs lacking of it.


Wednesday, July 27, 2016

Should not a consultant group like McKinsey, if it sees-something dangerous for the society, have to say something?

During many years I have been wondering why consultants, like those in McKinsey, have not spoken out against the risk-weighted capital requirements for banks.

I do understand that McKinsey must have many bank clients who just love the idea of being able to earn higher-risk adjusted returns on equity with assets deemed as safe than with assets deemed as risky.

But any financial consultant should also be able to understand that, in the medium or long term, that will cause banks to dangerously overpopulate safe-havens; just as he must understand that the resulting under-exploration of the risky-bays, like SMEs and entrepreneurs, poses great dangers for the sustainability of the economy. 

Now I just read two new articles published by McKinsey. One “The future of bank risk management” by Philipp Härle, Andras Havas, and Hamid Samandari; and the other “Poorer than their parents? A new perspective on income inequality” by Richard Dobbs, Anu Madgavkar, James Manyika, Jonathan Woetzel, Jacques Bughin, Eric Labaye, and Pranav Kashyap.

None of these touch even remotely on the fact that current regulatory risk-aversion, distorts the allocation of bank credit to the real economy; and that the regulatory discrimination against those perceived as “risky”, cannot but increase inequality.

On its website McKinsey tells us: “Social Impact: We help address societal challenges” Again, why does it not address this super societal challenge? 

A ship in harbor is safe, but that is not what ships are for.” John A Shedd, 1850-1926 

Sunday, July 24, 2016

Nothing promotes secular stagnation as much as the regulatory promotion of risk aversion

J. Bradford DeLong, in “The Scary Debate Over Secular Stagnation: Hiccup ... or Endgame?” published October 19, 2015 in the Milken Institute Review, refers to that Martin Feldstein, at Harvard back in the 1980s, taught that "badly behaved investment demand and savings supply functions," could have six underlying causes:

1. Technological and demographic stagnation that lowers the return on investment and pushes desired investment spending down too far.

2. Limits on the demand for investment goods coupled with rapid declines in the prices of those goods, which together put too much downward pressure on the potential profitability of the investment-goods sector.

3. Technological inappropriateness, in which markets cannot figure out how to properly reward those who invest in new technologies even when the technologies have enormous social returns – which in turn lowers the private rate of return on investment and pushes desired investment spending down too far.

4. High income inequality, which boosts savings too much because the rich can't think of other things they'd rather do with their money.

5. Very low inflation, which means that even a zero safe nominal rate of interest is too high to balance desired investment and planned savings at full employment.

6. A broken financial sector that fails to mobilize the risk-bearing capacity of society and thus drives too large a wedge between the returns on risky investments and the returns on safe government debt.

J. Bradford DeLong points out that Kenneth Rogoff in his debt supercycle focuses on cause-six; Paul Krugman in “return of depression economics” focuses on five and six; and Lawrence Summers with “secular stagnation” has, at different moments, pointed to each of the six causes.

And then J. Bradford DeLong writes: “Rogoff has consistently viewed what Krugman sees as a long-term vulnerability to Depression economics as the temporary consequences of failures to properly regulate debt accumulation. Eventually, a large chunk of debt thought of as relatively safe is revealed to be risky, and financial markets choke on the lump. As the riskiness of the debt structure is revealed, interest rate spreads go up – which means that interest rates on assets already known to be risky go up, and interest rates on assets still believed to be safe go down."

And Rogoff is later quoted with "In a world where regulation has sharply curtailed access for many smaller and riskier borrowers, low sovereign bond yields do not necessarily capture the broader 'credit surface' the global economy faces,"

And here is when I just have to intervene: Of course, stupid credit risk weighted capital requirements for banks have impeded the mobilization of the so vital risk-taking willingness and capacity of the society, that which has traditionally been much exercised by its banking sector. That it did by driving a large wedge between the banks’ ROEs for risky investments, like loans to SMEs and entrepreneurs, and the returns on “safe” investments, like loans to governments, AAArisktocracy and the financing of houses.

And “stupid” it is: “Eventually, a large chunk of debt thought of as relatively safe is revealed to be risky, and financial markets choke on the lump”. The capital requirements, that are to guard against the unexpected, were based on the expected, the perceived credit risks.

Dare to read more here about the mind-blowing regulatory mistakes that have been ignored by the experts.

PS. Anyone who talks about low interest rates on public debt without considering the regulatory subsidy implied with: risk weight of sovereign = 0%, and risk weight of We The People = 100%, is either a full-fledged statist or has no idea of what he is talking about.

PS. #4 "the rich can't think of other things they'd rather do with their money" is one of the reasons I much favor the Universal Basic Income concept.

Sunday, July 17, 2016

Does Deutsche Bundesbank want research that now “discovers” bank regulation mistakes it should have known of before?

Arbitraging the Basel securitizationsframework: evidence from German ABS investment
Matthias Efing: (Swiss Finance Institute and University of Geneva)

"Non-technical summary Research Question: The 2007-2009 financial crisis has raised fundamental questions about the effectiveness of the Basel II Securitization Framework, which regulates bank investments into asset-backed securities (ABS). The Basel Committee on Banking Supervision (2014) has identified “mechanic reliance on external ratings” and “insufficient risk sensitivity” as two major weaknesses of the framework. Yet, the full extent to which banks actually exploit these shortcomings and evade regulatory capital requirements is not known. This paper analyzes the scope of risk weight arbitrage under the Basel II Securitization Framework. 

Contribution: A lack of data on the individual asset holdings of institutional investors has so far prevented the analysis of the demand-side of the ABS market. I overcome this obstacle using the Securities Holdings Statistics of the Deutsche Bundesbank, which records the on-balance sheet holdings of banks in Germany on a security-by-security basis. I analyze investments in ABS with an external credit rating to uncover risk weight arbitrage on the demand-side of the ABS market."

Results: The analysis delivers three main results.

“First, I provide security-level evidence that banks arbitrage Basel II risk weights for ABS. Banks tend to buy the securities with the highest yields and the worst collateral in a group of ABS with the same risk weight (and, therefore, the same capital charge). My findings corroborate the hypothesis that institutional invsstors bought risky ABS to some extent for motives of regulatory arbitrage.”

What does that mean? That banks, for the “same risk weight”, buy what offers them the highest expected risk adjusted return on equity. Is that not what they are supposed to do? Would we, or the regulators like banks to minimize their risk-adjusted returns on equity?

"Second, banks operating with low capital adequacy ratios close to the regulatory minimum requirement are found to arbitrage risk weights most aggressively. From a financial stability perspective this finding is troubling as it smplies that the presumably more fragile banks are also most pervasively optimizing the very capital regulation designed to constrain them." 

What does that mean? That banks that are more pressured by capital constraints might act more aggressively? Is that not to be expected? 

"Third, banks with tight regulatory constraints buy riskier ABS with lower capital requirements than other banks. The ABS bought by banks that arbitrage risk weights, promise an as much as four times higher return on required capital than the ABS bought by other banks."

What does “riskier ABS with lower capital requirements” mean? ABS perceived ex ante as safer have lower capital requirements. It looks like confusing ex post realities with ex ante perceptions. 

What does ”as much as four times higher return on required capital” mean? Simply that capital requirement minimization has become more important in delivering expected risk-adjusted returns on equity than the correct analysis of risk.

My conclusion:
This paper just evidences that the most important research needed is that which explains how on earth the regulators of our banks could have come up with something so stupid as the portfolio invariant ex ante perceived risk based capital requirements for banks.

And again how these regulations distort the allocation of bank credit to the real economy remains a non-issue.

Saturday, July 16, 2016

Brief Housing Bubble 2.0 explanation


Housing Bubble 1.0, created in part by Basel II risk-weights of only 20% to AAA rated securities backed with mortgages to the subprime sectors, exploded, and a lot of liquidity was then injected with Tarp, QEs and other means.

Much of that liquidity was channeled through banks with not much capital and which, because of lower capital requirements (risk-weights sovereign = 0% and residential housing = 35%), channeled that liquidity into financing the government (low interest rates) and housing. The SMEs and entrepreneurs, with a risk-weight of 100%, had no chance to access loans at correct risk premiums.

If there is no change we all end up in houses with mortgages, but no jobs to pay the utilities and service the mortgages with.

Monday, July 11, 2016

If a banker, I would ask: Is our bank being fooled by Basel regulators into dangerously overcrowding safe havens?

Gentlemen,

We are allowed to hold less capital against what is ex ante perceived (decreed or concocted to be safe than against what I perceived to be risky.

That, when compared to if we had to hold the same capital against any asset now permit us to expect higher risk adjusted returns on equity for what is perceived as safe than on what is perceived as risky.

To be able to earn more ROE on the safe than on the risky sounds wonderful, but it has its costs: 

First we might be willing to accept risk adjusted rates from “the safe” than might be lower than what would be the case in an undistorted market.

Second, to compensate for the above, we might be requiring “the risky”, like SMEs and entrepreneurs to pay us higher risk adjusted rates than what they would have to pay us in the case of an undistorted market, and that means we might lose out on some interesting business or otherwise make “the risky” riskier. 

If it was only our bank that had access to this regulatory distortion, then we might benefit without rocking the boat, but the fact is that the whole banking system is doing the same, and so the distortions in the allocation of bank credit to the real economy are huge.

So friends, it is clear that if we go on following the directives of our bank regulators, and basically only keep to refinancing the safer past, we are doomed to end up, sooner or later, gasping for oxygen in an overpopulated safe haven. 

And by abandoning the financing of the riskier future, we are also neglecting our duties to the real economy, and our children and grandchildren might, should, hold us accountable for that.

So what are we to do? What can we do? 

May I suggest we look into the possibility of ignoring the different capital requirements and, based of course on a sound bank diversification and portfolio management, begin, without discrimination, to look at the risk premiums offered by all, risky and safe, on an equal dollar to dollar basis.

Or, as our famous colleague Mr. George Banks once suggested, we could all go and fly a kite!


Thursday, June 30, 2016

When will bank regulators stop making bankers’ wet dreams come true and do more for the beautiful dreams of our young?

What is a banker’s wet dream? Presumably to earn a lot of return on equity while not having to take risks. And the regulators granted that dream by allowing banks to have especially little capital against assets perceived as safe. Little capital means high leverage, and which means high-expected risk adjusted returns on equity. So banks just refinance the "safer" past.

What could our young ones dream of? To find decent jobs that allows them to form families and earn sufficiently to maintain these well. And that we know requires a lot of SMEs and entrepreneurs to open up new roads and ways to jobs in the real economy. But these dreams are denied by the regulators when requiring banks to hold more capital when lending to the “risky” than when lending to the safe. More capital means lower leverage, and which means lower expected risk adjusted returns on equity. So banks do not finance the "riskier" future.

And the current nightmare is that regulators are not even aware of what their credit risk aversion is doing. “A ship in harbor is safe, but that is not what ships are for.” John A Shedd

And the current nightmare is that regulators are not even aware that for the banking system, what’s perceived as safe, is the only that can generate those dangerous excessive exposures that bring on crises.  “May God defend me from my friends [what’s safe]: I can defend myself from my enemies [what’s risky]” Voltaire

Here is an aide-mémoire that explains some incredible mistakes in the risk weighted capital requirements for banks, the pillar of current regulations.

Wednesday, June 29, 2016

Basel Committee, dare subject your risk weighted capital requirements for banks to a referendum… or at least dare answer my objections.

You hold: More ex ante perceived credit risk more capital, less ex ante perceived credit risk less capital.

I hold: It is not the ex ante perceptions of risk that matter, it is only the ex-post realities that do. And in this respect, what is perceived as risky is in fact usually safer than what is perceived as safe.

I hold: Bank capital should be there against unexpected losses not against expected credit risk losses.

I hold you never analyzed what causes bank crises you just analyzed what problems bank borrowers could face, and that far from being the same. 

I hold: To allow banks to leverage differently their equity and the support society and taxpayers give these differently, based on ex ante perceived credit risks; which allows banks to earn higher risk adjusted returns on equity on what is perceived as safe than on what is perceived as risky, distorts dramatically the allocation of bank credit to the real economy.

I hold like John A Shedd: “A ship in harbor is safe, but that is not what ships are for.” 

I hold like Voltaire: “May God defend me from my friends [AAA rated]: I can defend myself from my enemies [BB- rated]”

I hold that because of the dumb risk aversion in your regulations, banks no longer finance the riskier future our children needs to be financed, they only refinance the, for the short-time being, safer past.

I hold that when you set the risk weights of sovereigns at zero percent, but that of the citizens at 100 percent, you introduced statism through the back door. In fact Sovereign = 0% and We The People = 100% sounds sort of like a regulatory Ponzi scheme.

To sum up, Basel Committee, I hold you have clearly evidenced you have no idea of what you are doing.

When it comes to discrimination, EU cares more about the access to a monastery than about the access to bank credit

If I had the right to vote I would have voted for Britain to stay in EU. But I would have hoped for that this option had won by just one vote, so that there was huge pressure on EU to clean up its act. It sorely needs it.

For instance, the European Commissioner for Internal Market and Services is in charge of promoting free movement of capital and therefore has a lot do to with the extremely important area of regulating the financial services. 

It is a topic of much interest for me since, for more than a decade, I have argued that the Basel Committee’s risk weighted capital requirements for banks, is impeding the free movement of capital with disastrous consequences for the real economy.

But in 2012, during a conference in Washington by the then Commissioner Michel Barnier, I was handed a brochure that presented, as a success story of his office, the following: 

“A French citizen complained about discriminatory entry fees for tourists to Romanian monasteries. The ticket price for non-Romanians was twice as high as that for Romanian citizens. As this policy was contrary to EU principles, the Romanian SOLVIT centre persuaded the church authorities to establish non-discriminatory entry fees for the monasteries. Solved within 9 weeks.” 

And then I knew for sure something smelled very rotten in the EU, with its full of hubris besserwisser not accountable to anyone technocrats.

How can they waste time on such small time discrimination when those borrowers ex ante perceived as risky, and who therefore already got less bank credit and at higher interest rates, now suffer additional discrimination caused by regulators requiring banks sot hold more capital when lending to them that when lending to those ex ante perceived as safe? And on top of it all, for absolutely no reason, since dangerous excessive bank exposures, are always built up with assets perceived as safe.

Barnier, as Frenchman should know Voltaire’s “May God defend me from my friends: I can defend myself from my enemies.” But now bank regulators tell banks “trust much more your friends”, the AAA rated, and to which in Basel II they assigned a risk weight of 20%; and “beware even more of your enemies”, the below BB- rated, and which were given a risk weight of 150%.

As a result banks can leverage more their equity with “safe” assets than with “risky” assets, and so they now earn higher risk adjusted returns on equity when lending to sovereigns, members of the AAArisktocracy or financing houses, than when lending to SMEs and entrepreneurs.

And as a direct consequence of this regulatory risk aversion, banks do not any longer finance the riskier future, they only refinance the for the short time being safer past.

So there is no wonder EU is not doing well. And if Brexit helps to push for the reform that are needed, then Britain should be given an open invitation to return to it at its leisure.

PS. During the Washington conference I just could not refrain from asking what the French citizen did for 9 weeks while waiting for SOLVIT to come to his rescue.

PS. Lubomir Zaoralek the minister of foreign affairs of the Czech Republic in FT “Europe’s institutions must share the blame forBrexit” July 1. Hear hear!

Monday, May 30, 2016

Evidence that demonstrates, without any reasonable doubt, we have landed us some very feeble-minded bank regulators

What are the chances banks build up huge exposures to those rated prime, AAA to AA, and which could be dangerous to the bank system, if these, ex post, turn out to have been worthy of a much lower rating? Big!

What are the chances banks build up dangerously large exposures to those rated “highly speculative “ and worse below BB-? None! 

And yet the regulators, for the purposes of determining the capital requirements for banks, in Basel II, assigned to the AAA to AA rated, a risk weight of 20%, and to the below BB- rated, a risk weight of 150%.


Do we really need more evidence that the Basel Committee regulators and those affiliated to it are cuckoo?

They behave like nannies telling the children “Stay away from the ugly and foul smelling, and embrace the nice gents bringing you candy”, and so dangerously distort the allocation of bank credit to the real economy.

Voltaire to the Basel Committee: “May God defend me from my friends [AAA rated]: I can defend myself from my enemies [BB- rated]”

Here is a brief memo that further explains their idiocy.


Friday, May 27, 2016

Mervyn King’s book “The end of alchemy” is dangerously incomplete and excessively praised

Mervin King, former governor of the Bank of England begins his book “The end of alchemy” by citing from “The Rock” by TS Elliot, 1934. 
The endless cycle of idea and action,
Endless invention, endless experiment,
Brings knowledge of motion, but not of stillness; 
Knowledge of speech, but not of silence; 
Where is the wisdom we have lost in knowledge? 
Where is the knowledge we have lost in information? 

From a formal statement, delivered in March 2003, as an Executive Director of the World Bank, let me extract the following: 

“In this otherwise very complete Global Development Finance 2003, there is no mention about the issue of the growing role of the Independent Credit Rating Agencies, and the systemic risks that might so be induced, when they are called to intervene and direct more and more the world’s capital flows.

With respect to Basel, we would also like to point out that the document does not analyze at all a very fundamental risk for the whole issue of Development Finance, being it that the whole regulatory framework coming out of the BCBS might possibly put a lid on development finance, as a result of being more biased in favor of safety of deposits as compared to the need for growth.

As the financial sector grows ever more sophisticated, making it less and less transparent and more difficult to understand for ordinary human beings, like us EDs, it is of extreme importance that the World Bank remains prudently skeptical and vigilant, and not be carried away by the glamour of sophistication. In this particular sense, we truly believe that the World Bank has a role to play that is much more important than providing knowledge per-se and that is the role of looking on how to supply the wisdom-of-last-resort.

And some weeks later in another formal statement I insisted in my arguments and added:

“We truly have to find a way of helping the Knowledge Bank to try to evolve into something more of a Wisdom Bank, or, to put it more humbly, at least a Common Sense Bank.

Basel is getting to be a big rulebook (this was said by the Bank). And, to tell you the truth, the sole chance the world has of avoiding the risk that Bank Regulators in Basel, accounting standard boards, and credit-rating agencies will introduce serious and fatal systemic risks into the world, is by having an entity like the World Bank stand up to them—instead of rather fatalistically accepting their dictates and duly harmonizing with the International Monetary Fund”

Unfortunately though I expressed my reasoned concerns, timely, in a globally important and relevant institution, these fell on deaf ears and were unable to stop crazy Basel II from being approved in June 2004.

And that is the reason why I believe I have earned all the right to openly consider “The End of Alchemy” a very dangerously incomplete book that, equally dangerous, is being excessively praised. 

Mervyn King dedicates his book to his “four grandchildren because it is their generation who will have to develop new ways of thinking about macroeconomics and to redesign our system of money and banking if another global financial crisis is to be prevented."

While I equally dedicate, to my for the time being only two grandchildren, the fight against bank regulators who, fixated on turning the banks into safe mattresses where to stash away savings, did and do not give any consideration to the importance of banks allocating credit efficiently to the real economy, so that the economy can move forward and not stall and fall over us all.

Kings book, in 370 pages, except perhaps when discussing the “Chicago Plan” of banks’ holding 100 percent liquid reserves against deposits, and the configuration of “wide banks” financed with equity and long term debt, does not really discuss the allocation of bank credit to the real economy. That function which to me, represents the fundamental social purpose of banks. That allocation which has now been impeded by mindboggling stupid risk-weighted requirements, those which dangerously favor credit for what is perceived, decreed or concocted as safe, sovereigns, the AAArisktocracy and residential house financing over credit to those perceived as risky, like SMEs and entrepreneurs.

King's book, in 370 pages, does not mention the fact that allowing banks to hold less capital against assets perceived, decreed or concocted as safe, allows banks to earn higher expected risk adjusted returns on equity on these assets than on those perceived as risky.

But King writes “The people who designed those risk weights did so after careful thought and an evaluation of past experience”. Nonsense, they analyzed the perceived risks of bank assets, not the risk of those assets that have created bank crises.

And King follows that with “They simply did not imagine how risky mortgage lending and the sovereign debt of countries such as Greece would become during the crisis”. That clearly evidences that King does not yet understand the role the assignment of low risk weights as zero percent to sovereigns, 35 % to residential mortgages and 20% to AAA rated securities, played in helping create the dangerous excessive bank exposures to these categories.

And King follows that with: “Rather than lambast the regulators for not anticipating those events, it is more sensible to recognize that the pretense that it is possible to calibrate risk weights is an illusion” And I just have to ask, should we not lambast regulators more with the latter, as it proves their excessive hubris?

And King follows that with: “The need for banks to use equity to absorb losses is most important in precisely those circumstances where something wholly unexpected occurs” Right, that is precisely why setting capital requirement that are to cover of the unexpected based on expected credit risks, the risk most cleared for by the banks is so loony.

But at least King there concludes in that “A simple leverage ratio is a more robust measure for regulatory purposes. Good for him! Though clearly he does that only from the perspective of making banks safer, without any thought about the need for less distortions produced in the credit allocation.

In terms of TS Eliot, when it comes to making the bank system safer: 

Knowledge could, as it did, set the risk weights, based the ex ante perceptions of it. 
Wisdom would only set these based on their ex post possibilities of creating havoc. 
Knowledge can get you get started immediately on the avoidance of risks. 
Wisdom would first have you to identify, which risks you cannot afford not to take.

Where King is absolutely right is when he opines, “Regulation has become extraordinarily complex, and in ways that do not go the heart of the problem of alchemy… By encouraging a culture in which compliance with detailed regulations is a defense against a charge of wrong doing, bankers and regulators have colluded in a self-defeating spiral of complexity”

But then a much better title of the book would have been “How do we stop bank regulators from doubling down on alchemy”.

Current regulations only make banks refinance the safer past. For King’s grandchildren, and for mine, let us pray they can soon take on again their vital role in financing the riskier future.

The major mistake with current bank regulations, one that has not been rectified yet, is that the regulators never defined the purpose of banks before regulating these. In this respect, let me stop, for now, by quoting John A Shedd “A ship in harbor is safe, but that is not what ships are for.”

Saturday, May 21, 2016

“Futures Unbound” A Cato summit on bank regulations “Finance is about the future” Will the real questions be asked?

Current bank regulations require banks to hold more capital when financing what is perceived as risky than what is perceived as safe.

That means banks will be able to leverage more their equity, and the support they receive from the society, when financing what is perceived as risky than when financing what is perceived as safe.

That means banks will be able to earn higher risk adjusted returns on equity, when financing what is perceived as risky than when financing what is perceived as safe.

That means banks will no longer finance sufficiently the riskier future, they will mostly refinance the safer past.

And that silly credit risk aversion has been introduced in the Home of the Brave

To top it up, regulators have assigned a risk weight of zero percent to the sovereign and one of 100 percent to the citizens who give the sovereign its strength.

And all for nothing, since never ever has a major bank crises erupted because of excessive exposures to something ex ante perceived as risky, these have always resulted from excessive exposures to something ex ante perceived as safe.

I wonder if Cato is going to bring up the issue of how unelected technocrats, who have clearly never walked on Main Street, have thought it their right to distort the allocation of bank credit to the real economy.

Thursday, May 12, 2016

Dare answer this question, and then dare reflect on current bank regulations, and then dare doing something about it.

An AAA rating signifies a “prime” asset and assets rated below BB- signify, at their best as “highly speculative”

So here is the question: 

What might be more dangerous to the banking system, too much exposure to AAA rated assets, or too much exposure to below BB- rated assets?

Which is your answer? If you reply as I do, that of course banks will never-ever build up excessive and dangerous to something rated below BB-, and that this is much more likely to happen with AAA rated assets, then I dare you to reflect on the following:

Your regulators, for the purpose of deciding the capital requirements for banks, assigned a risk-weight of 150% for assets rated below BB-, and a risk-weight of only 20% to AAA rated assets.

Does that sound like the regulators know what they are doing?

If you answer “Yes!” go back to sleep, but if by any chance you answer “No!, then you must know you have a very important assignment in front of you, that is, if you care about the future economic perspectives of your children and grandchildren.


PS. What legal consequences should a bank regulator face if, informed of a serious mistake, he does nothing to correct it?