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.

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?

Sunday, May 8, 2016

Crony bank regulations got us into serious problems

For the purpose of setting the capital requirements for banks…

To our bosses, the infallible sovereigns, the governments, let’s give them a zero percent risk weight,

To that house financing politicians want to favor, let’s give them a 35 percent risk weight.

To that AAArisktocracy that we meet in Davos, let’s give them a 20 percent risk weight.

But to the SMEs, entrepreneurs and citizens, so that we seem prudent and conservative, let’s give them a 100 percent risk weight.

And for better measure, to the below BB- rated, let us assign them a 150 percent risk weight

And so banks earned higher risk adjusted returns on what was perceived, decreed or concocted safe, than on what was perceived as risky.

And so banks held too much AAA rated securities, loans to Greece and residential housing finance… and we got us the 2007-08 crash.

And so banks hold too little loans to “risky” SMEs and entrepreneurs… and so we can’t get ourselves out of the doldrums.

Anyhow let us pray Per Kurowski does not insist in explaining to others that, with respect to the real risk assets can pose to the banking system, these risk weights could be just 180 degrees the opposite.

Don’t put the blame on politics, when clearly technocratic stupidity is at fault

Below the abstract from a recent paper by Jihad C. Dagher from the International Monetary Fund titled "Regulatory Cycles: Revisiting the Political Economy of Financial Crises"

“Financial crises are usually perceived and analyzed as purely economic phenomena. The political economy of financial booms and busts, while far from ignored, remains under-emphasized and has often been analyzed in isolated episodes. 

The recent wave of financial crises has brought unprecedented attention to financial regulatory policy; yet the policy discussions and economic literature, which are usually cast in technical terms, tend to overlook political forces that shape regulations and impact their effectiveness over time. 

This paper examines the political economy of financial policy during some of the most infamous financial booms and busts and finds consistent evidence of pro-cyclical policies. 

Financial booms, and risk-taking during these episodes, were often amplified, if not ignited, by a political regulatory stimulus and interventions. The bust has always resulted in an overhaul of the regulatory and supervisory framework and a political turnover. The interplay between politics and financial policy over these cycles, and their institutional underpinnings, deserve further attention. 

Politics can be the undoing of macro-prudential policy”

Basel II, of June 2004, for the purpose of determining the capital requirements for banks, set the risk weights for corporates rated AAA at 20% and that of those rated below BB- at 150%.

Sorry, frankly, those who believe that those below BB- rated pose a greater risk for the banking system, have no idea about what they are talking about, and have probably never ever left their desks to walk down on Main Street.

That has nothing to do with politics, that is sheer technocratic stupidity

Saturday, May 7, 2016

Why was the most important obstacle for small businesses accessing bank credit not even mentioned in 2012 JOBS Act?

Bank regulators consider small unrated businesses to be much more dangerous to the banking system and to financial stability, than well-rated corporations.

That is an extremely flimsy and wrong proposition, based on absolutely nothing! 

And that is why, with Basel II, for the purpose of defining the risk weighted capital requirements for banks, regulators assigned a risk weight of 100 percent for the small unrated businesses and one of only 20 for AAA to AA rated corporations.

And that translated into banks being allowed to hold much less capital against “the safe” assets than against “the risky assets; which meant banks could leverage more their equity lending to the safe than lending to the risky; which meant banks earn higher expected risk adjusted returns on equity when lending to the safe than when lending to the risky.

And that represents the most significant cause for small-unrated businesses not having fair access to bank credit.

And not a single word about that obstacle, and the need to remove it, was mentioned in the Jumpstart Our Business Startups (JOBS) Act of 2012

And amazingly, the issue of the distortions in the allocation of bank credit to the real economy that credit risk aversion causes in the Home of the Brave, is still not even being discussed.

Tuesday, April 26, 2016

America "The Home of the Brave" is going down, because of bank regulators' silly/sissy credit risk aversion.

Banks use to decide whom to lend to, based on who offered them the highest risk adjusted interest rates. 

Not any more. Now banks have to calculate what those risk adjusted interest rates signify in terms of risk-adjusted rates of return on their equity. That is because with their risk weighted capital requirements, regulators now allow banks to hold less capital, and therefore be able to leverage more their equity, when engaging with The Safe than with The Risky.

And those perceived, decreed or concocted as belonging to The Safe, include sovereigns (governments), members of the AAArisktocracy and the financing of houses.

And those belonging to The Risky are SMEs, entrepreneurs, the unrated or the not-so good rated, and citizens in general.

And that of course has introduced a regulatory risk aversion that distorts the allocation of credit to the real economy. By guaranteeing “The Risky” will now have too little access to credit, that dooms the economy and the banks to slowly fade away.

But the banks and the economy could also disappear with a Big Bang. That because by giving banks incentives to go too much for The Safe, sooner or later, some safe havens will be dangerously overpopulated, and we will all suddenly find ourselves there gasping for oxygen.

In essence, because of this regulation, banks no longer finance the riskier future; they just refinance the (for the time being) safer past.

How did this happen? There are many explanations but the most important one is that regulators never defined the purpose of the banks before regulating these.

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

PS. That also goes for the rest of the world. For instance the Eurozone was done in with it.

Saturday, April 23, 2016

There are risks and risks. Bank regulators promote the worst and avoid the best.

We now read “US federal regulators this week proposed new pay rules intended to limit excessive risk-taking”

And so its time again to understand there are different “excessive risk-taking”.

One “excessive risk-taking”, is that of creating dangerously large exposures to what is perceived, decreed or concocted as safe. Those exposures currently require very little bank capital. That was the “excessive risk taking” that caused the 2007-08 crisis; AAA rated securities, residential housing finance and sovereigns like Greece.

Another different “excessive risk-taking” is taking risks on the risky, like on SMEs and entrepreneurs. These risks, because they currently generate much higher capital requirements, are risks not sufficiently taken by the banks, and the economy suffers from that.

Do regulators really know what “excessive risk-taking” they want to limit? I seriously doubt it. The “more-risk less-pay” and the “less-risk more-pay” is just the typical kind of intervention that brings on unexpected consequences.

More-risk more-capital less-pay. Less-risk less-capital more-pay. Friends with these regulations we will soon all end up suffocating because of lack of oxygen in some over-populated safe haven!

And our children, they will be without jobs. Because with this regulatory silliness banks do not finance the riskier future any longer, they just refinance the for the short time being safer past.

In short, any senseless risk aversion, whether in bank regulations or elsewhere, condemn our economies and nations to fizzle out.

Friday, April 22, 2016

The Vasa and the Basel I, II and III disasters

Stefan Ingves, the chair of the Basel Committee, in a speech titled "From the Vasa to the Basel framework: The dangers of instability" last November, said the following:

“In 1625, King Gustav II Adolf of Sweden ordered the construction of…the mighty Vasa. 

It took three years and 300 men to build the Vasa. And 40 acres of timber were consumed. 

The final result was impressive. The Vasa had two gun decks, 64 bronze cannons, and its tallest mast soared to 57 metres. The ship was the result of a quest for perfection. 

This perfection was, alas, short-lived. Tragically, the Vasa sank on its maiden voyage, after sailing only 1,300 metres, on 10 August 1628. 

After so much planning, so many resources and so much time and effort, why did the Vasa sink? According to the King, it was the result of ‘foolishness and incompetence’ 

But historians generally agree that a key factor in the Vasa's fate was the lack of stability and the hull's excessive rigidity… the Vasa was well constructed but incorrectly proportioned” 

As I read it if the historians are right, then clearly so is the King.

And bank regulations designed by the Basel Committee, especially the risk weighing of the capital requirements, was absolutely “incorrectly proportioned”, and so to me the regulators have been foolish and utterly incompetent.

And with respect to Basel III Stefan Ingves said: “The framework has remained unchanged from Basel II across two broad dimensions: first, the way in which risk is measured - and in particular, the reliance on banks' own estimates of risk - has remained the same following the crisis; and second, the risk-weighted approaches are essentially the same as they were before the crisis"

But, in order to “address the fault lines that emerge from these two dimensions” Ingves now tells us that the regulators are working to fix that with "(i) enhancing the risk sensitivity and robustness of standardized approaches; (ii) reviewing the role of internal models in the capital framework; and (iii) finalizing the design and calibration of the leverage ratio and capital floors."

As I see it, in Vasa terms, the hull of Basel III still lacks stability, but the Basel Committee just keeps on loading more “bronze cannons” on its deck.

“Enhancing the risk sensitivity”? For God’s sake, they are still looking at the risk of the assets and not at the risk those assets pose to the banks… and so they still do not understand that the safer an asset might be perceived, the riskier it could be for the banking system.

And they still have not defined the purpose of the banks, and so they still do not care one iota about if their risk weighing distorts the allocation of credit to the real economy.

I ask, would, King Gustav II Adolf of Sweden have given the constructors of Vasa the resources to build another boat, like we allow the same regulators who designed Basel I and Basel II to now work on Basel III? I don’t think so!

And in wikipedia we read “An inquiry was organized by the Swedish Privy Council to find those responsible for the Vasa disaster, but in the end no one was punished for the fiasco.”

Lucky Stefan Ingves... in the case of the monumental failings of Basel II there has not even been an inquiry!

“A ship in harbor is safe, but that is not what ships are for.” said John Augustus Shedd, 1850-1926. Well, if built by something like the Basel Committee, it is not even safe in the harbor J


Thursday, April 21, 2016

Let us tell the story of the Basel Committee’s risk weighted capital requirements for banks this way:

This happened during a meeting in the Basel Committee for Banking Supervision

Q. Colleagues, how on earth can we stop banks from failing? 

A. Well they must avoid taking risks?

Q. Absolutely! But how do we stop them from taking risks?

A. Perhaps by giving them great incentives to make their profits where it is safe?

Q. Sounds great! Any idea how?

A. Well we could allow them to leverage much more when lending to what is safe than when lending to what is risky.

Q. How would that help?

A. Well then the banks could obtain higher risk adjusted rates of return on lending to what is safe than on lending to what is risky.

Q. But, could that not distort the allocation of credit to the real economy?

A. Oh that is not our problem. We are just here to make banks safe. 

Q. But, what if something perceived as safe turns out to be risky?

A. Don’t be so negative. We will deal with that later if it ever happens.

Q. But could not someone argue we are introducing a regulatory discrimination against The Risky?

A. Who cares? The sovereign will be more than happy if we give it a zero percent risk weighting. The banks, making their best profits on what is safe, will only have their wettest wet dreams realized. And the risky, the SMEs and entrepreneurs, they have no voice… hey they are not even invited to the World Economic Forum at Davos… there we only meet the AAArisktocracy.

Q. Dear colleague, you have convinced all of us… let us go for it. By the way, what is your name?

A. Chauncey Gardiner Sir