Thursday, May 16, 2019

Many experts read, agree and rightfully praise Hans Rosling, yet don’t understand him at all.

I quote from “Factfulness”, 2018 by Hans Rosling, Ola Rosling and Anna Rosling Rönnlund. 

Fear vs. Danger. Being afraid of the Right Things:

Fear can be useful but only if it is directed at the right things. The fear instinct is a terrible guide for understanding the world. It make us give our attention to the unlikely dangers that we are most afraid of, and neglect what is actually most risky…

‘Frightening’ and ‘Dangerous’ are different things. Something frightening poses a perceived risk. Something dangerous poses a real risk. Paying too much attention to what is frightening rather than to what is dangerous--that is, paying too much attention to fear--creates a tragic drainage of energy in the wrong directions.

But here we are, with expert bank regulators who, with their credit risk weighted capital requirements, decided that what is frightening to them, namely what is perceived risky, is more dangerous to our bank system than what is really dangerous to it, namely what is perceived as safe.

And so by imposing their fear on our banks we have:

A banking system that is doomed to especially large crises, as a result of building up especially large exposures to what is especially perceived as safe, against especially little capital.

A banking system that finances way too much the safer present and way too little the riskier future, dooming our economy to a lack of the oxygen it most needs, namely that of risk taking.

Where would we be had they introduced their fright of what they perceive as risky a couple of hundred years before their 1988 Basel Accord?

To top it up they decreed a risk weight of 0% to the sovereign and 100% to the citizen, and with that, they guaranteed way too high exposures to what I am most scared of, namely a great overhang of public debt that will cloud the future of my grandchildren.

Saturday, April 6, 2019

A tweet thread on rational and irrational expectations

Rational expectations of something being risky, simply makes most stay away from it.
Irrational expectations of something being risky, though certainly not presenting a danger to our bank systems, might sadly means lost opportunities to grow the real economy.

Rational expectations of something being safe, does of course not hurt the economy nor the banking system.
Irrational expectations of something being safe can easily bring down our bank system, and our real economy with it.

But with their risk weighted capital bank requirements, much lower for what was perceived ex ante as safe, than for what was perceived as risky, the Basel Committee bank regulators, de facto, irrationally based it all on rational expectations.

Tuesday, March 26, 2019

My letter to the Financial Stability Board was received.

From: Per Kurowski
Sent: 18 March 2019 19:16
To: Financial Stability Board (FSB)

I have not found sufficient strength to sit down and formally write up my comments, because I feel I would just be like a heliocentric Galileo writing to a geocentric Inquisition.

The Basel Committee’s standardized risk weights are based on the presumption that what is ex ante perceived as risky is more dangerous to our bank system.

And I hold a totally contrarian opinion. I believe that what is perceived a safe when placed on banks balance sheets to be much more dangerous to our bank system ex post than what is perceived ex ante as risky; and this especially so if those “safe” assets go hand in hand with lower capital requirements, meaning higher leverages, meaning higher risk adjusted returns on equity for what is perceived safe than for what is perceived as risky.

The following Basel II risk weights are signs of total lunacy or an absolute lack of understanding of the concept of conditional probabilities.

AAA to AA rated = 20%; allowed leverage 62.5 times to 1. Below BB- rated = 150%; allowed leverage 8.3 times to 1

The distortion the risk weighting creates in the allocation of credit to the real economy is mindboggling. Just consider the following tail risks.

The best, that which perceived as very risky turning out to be very safe. The worst, that which perceived as very safe turning out to be very risky.

And so the risk weighted capital requirements kills the best and puts the worst on steroids... dooming us to suffer an weakened economy as well as an especially severe bank crisis, resulting from especially large exposures, to what was especially perceived as safe, against especially little capital.

In relative terms all that results in much more and less (see note) expensive credit to for instance sovereigns and the purchase of houses, and less and more expensive credit to SMEs

I am neither a banker nor a regulator but I do believe that the following post helps to give some credibility to my opinions on the issue. And, as a grandfather, I am certainly a stakeholder.

And here is a more detailed list of my objections to the risk weighting

Now if by any chance you would dare open your eyes to the mistakes of your risk weighted bank capital requirements and want more details from me, you know where to find me.


Per Kurowski
A former Executive Director of the World Bank (2002-2004) 

Note: In the original letter I erroneously wrote more and more expensive credit, but which should be easily understood as a mistake. 

Tuesday, March 5, 2019

Reading, little by little, Adam Tooze’s “Crashed: How a Decade of Financial Crises Changed the World” 2018

Chapter 14 “Greece 2010: Extend and pretend”

I read: “As recently as 2007 Greece’s bonds had traded at virtually the same yield as Gemany’s”

The credit rating of Greece in 2007 was A, and that of Germany AAA. According to Basel II’s risk weighted capital requirements Greece should have a risk weight of 20% while Germany 0%.

But, European authorities extended Sovereign Debt Privileges to all Eurozone nations, and assigned Greece also risk weight of 0%. All this even though these nations are all taking on debt in a currency that de facto is not their own printable one. 

When Greece’s crisis breaks lose Greece has still a risk weight of 0%... meaning European banks could lend to Greece against no capital at all... and it is still 0% risk weighted. 

How is Greece going to extract itself from that corner into which it has been painted is anybody's guess. And extract itself it must, as  must all nations. A 0% risk weight for the sovereign and 100% for the citizens is an unsustainable statist proposition.

It all makes me wonder how Tooze would have written this chapter had he considered this. Perhaps he could have been closer to opine this?

Wednesday, February 20, 2019

The “experts” in the independent agencies, those most likely to introduce systemic risks, must be continuously questioned and supervised.

Paul Tucker for more than 30 years a central banker and a regulator at the Bank of England writes in his "Unelected Power" 2018

“Unlike price stability, the authorities cannot ‘produce’ financial stability by their own efforts but must stop or deter private intermediaries from eroding the system’s resilience.

That cannot be delivered by looking at intermediaries one by one because the financial system is just that - a system, with components parts connected within sectors and markets, via interactions with the real economy, and across countries. 

As the first chairman of the Basel Supervision Committee, George Blunden said in the mid-1980s: It is part of the [supervisors] job to take a wider systemic view and sometimes to curb practices which even prudent banks might, if left to themselves, regard as safe.”

And yet with Basel I in 1988, Basel II in 2004 and current Basel III the regulators in the Basel Committee, ignoring the system, ignoring the distortions it causes in the allocation of credit to the real economy and ignoring that no major bank crisis have resulted from excessive exposures to what ex ante was perceive as risky, went ahead and introduced that mother of all systemic risk and procyclical regulation, which is the risk weighted capital requirements for banks.

“Curb practices which even prudent banks might, if left to themselves, regard as safe”? No way, it only guarantees especially large exposures, to what is especially perceived as safe, against especially little capital, laying the ground for especially large crisis.

I did note that in the 568 pages of “Unelected Power” I found no explicit reference to the risk weighted capital requirements for banks.

At the end of his book Paul Tucker suggests “The principles for delegating to independent agencies insulated from day to day politics”. I agree with these. Had they been in place Basel I II or III would not have existed. Just for a starter, in all of Basel’s bank regulations there is not one single word about the purpose of the banking system, one that must surely contain the need to allocate credit efficiently to the real economy.

There is one aspect though that is not sufficiently laid out in Tucker’s principles and that is the absolute must for the independent agency to contain sufficient diversity, not only to foster better discussion but also in order to hinder, as much as possible, these turning into closed mutual admiration clubs.

PS. In the 568 pages of “Unelected Power” I found no explicit reference to the risk weighted capital requirements for banks, those which for a start caused the 2008 crisis

Here is a current summary of why I know the risk weighted capital requirements for banks, is utter and dangerous nonsense.

Tuesday, February 12, 2019

A tweet on tail risks

2 tail risks:

The best, that which perceived as very risky turns out to be very safe

The worst, that which perceived as very safe turns out to be very risky

The risk weighted capital requirements for banks, kills the best, and puts the worst one on steroids

Saturday, January 12, 2019

What I as a former Executive Director of the World Bank pray that any new President of it understands

I was an Executive Director at the World Bank from November 2002 until October 2004. During that time the Basel Committee's Basel II bank regulations were being discussed. It was approved in June 2004. 

I was against the basic principles of those regulations that had begun with the Basel Accord of 1988, Basel I. That should be clear from Op-Eds I had published earlier, transcripts of my statements at the WB Board, and in the letters that I wrote and FT published during that time. Here is a brief summary of all that 

Since then I haven't changed my mind... the risk weighted capital requirements for banks, which are a pillar of those bank regulations, is almost unimaginable bad.

I pray the next president of the world’s premier development bank, whoever he is, and wherever he comes from, at least, as a minimum minimorum, understands:

First, that risk-taking is the oxygen of any development, and therefore the regulators’ risk adverse risk weighted capital requirements, will distort against banks taking the risks that help to push our economies forward. “A ship in harbor is safe, but that is not what ships are for.”, John A Shedd.

Second, that what’s perceived as risky is much less dangerous to our bank systems than what’s perceived as safe, and so that these regulations doom us to especially large bank crises, because of especially large exposures to what is especially perceived (or decreed) as safe, against especially little capital.

Do you not agree that mine is a quite reasonable wish?


Sunday, December 30, 2018

Affordable homes or investment assets?

Should houses be affordable homes, or should they be investment assets? They can’t be both.

In 2004, under the Basel II business standards, if securities obtained a AAA rating, European banks and U.S. investment banks regulated by the Securities and Exchange Commission needed to hold only 1.6 percent in capital against them. That created an enormous demand for highly rated securities. The truth of securitization is that, as when making sausages, the worse the ingredients the larger the profits.

And the highly rated securities backed by mortgages to the subprime sector became the primary cause for the 2008 crisis.

After the crisis, ultra-low interest rates and huge liquidity injections fed the price of houses. In the process, houses morphed from being homes into investment assets.

That aspect of the housing market is what I most missed in the Dec. 26 front-page article “Quick to evict, properties in disrepair.”

If you want easy financing to help someone afford a house, then house demand and house prices go up, and you need to give even more help to the next person who wants to afford a house.

Do we want affordable homes or houses as investment assets? There’s no easy answer, because going back to just homes would also cause immense suffering for all those believing they have, with their houses, built up a safety net.

Per Kurowski, Rockville 

Here other of my letters in the Washington Post on this issue:
September 6, 2007: Factors in the Financial Storm
June 20, 2008: An Aspect of the Bubble
December 27, 2009: Another 'worst': Faulty bank regulation
January 6, 2012: Handcuffed by a triple-A rating
May 1, 2013: An American approach to banking
December 23, 2014: Let the market rule on risky trades
November 11, 2015: Reverse-mortgaging the future
August 9, 2016: Banks, regulators and risk
April 16, 2017: When banks play it too safe
July 11, 2018: There is another tariff war that is being dangerously ignored.

Sunday, December 9, 2018

What goes up too much must come down too much. The best countercyclical policy there is is the elimination of the procyclical ones.

Governor Lael Brainard on December 07, 2018, in “Assessing Financial Stability over the Cycle” a speech delivered at the Peterson Institute for International Economics, Washington, D.C., said:

“In an economic downturn, widespread downgrades of these low-rated investment-grade bonds to speculative-grade ratings could induce some investors to sell them rapidly--for instance, because lower-rated bonds have higher regulatory capital requirements or because bond funds have limits on the share of non-investment-grade bonds they hold.”

And Brainard then proceeds to extensively describe the advantages of countercyclical capital requirements (CCyB) for building additional resilience in the financial system.

BUT, the other side of the mirror is: In an economic upturn, higher credit ratings of bonds could induce some investors to buy them rapidly--for instance, because higher-rated bonds have lower regulatory capital requirements, or because bond funds have lesser or no limits on investment-grade bonds they hold.

So if that is not procyclical what is?

Therefore, before thinking of using countercyclical capital requirements, which by themselves might be introducing distorting signals, which might make the use of these at the right moment when they are really needed harder, let’s get rid, altogether, of the risk weighted capital requirements for banks. Those, which, by the way, even when the economic cycles are correctly identified, still distort the allocation of bank credit to the real economy.

And since credit ratings were mentioned in April 2003, at the World Bank I opined:

"Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as credit rating agencies. This will introduce systemic risks in the market"

Friday, December 7, 2018

September 2, 1986 was the tragic night when Paul A. Volcker, in London, gave in to (insane) European bank regulators.

Paul A. Volcker in “Keeping at it” penned together with Christine Harper writes on bank regulations and capital requirements the following:

"The travails of First Pennsylvania and Continental Illinois, the massive threat posed by the Latin American crisis, and the obvious strain on the capital of thrift institutions had an impact on thinking over time, but strong action was competitively (and politically) stalled by the absence of an international consensus.

An approach toward dealing with that problem was taken by the G-10 central banking group meeting under the auspices of the Bank for International Settlements (BIS) headquartered in Basel, Switzerland. A new Basel Committee would assess existing standards and practices in a search for an analytic understanding.

Progress was slow… 

The US practice had been to asses capital adequacy by using a simple “leverage ratio”-in other words, the bank’s total assets based compared with the margin of capital available to absorb any losses on those assets. (Historically, before, the 1931 banking collapse, a ten percent ratio was considered normal)

The Europeans, as a group, firmly insisted upon a “risk-based” approach, seemingly more sophisticated because it calculated assets based on how risky they seemed to be. They felt it was common sense that certain kind of assets –certainly including domestic government bonds but also home mortgages and other sovereign debt- shouldn’t require much if any capital. Commercial loans, by contrast, would have strict and high capital requirements, whatever the credit rating might be.

Both approaches could claim to have strengths. Each had weaknesses. How to solve the impasse?

At the end of a European tour in September in 1986, I planned to stop in London for an informal dinner with the Bank of England’s then governor Robin Leigh-Pemberton. In that comfortable setting without a lot of forethought, I suggested to him that if it was necessary to reach agreement, I’d try to sell the risk-based approach to my US colleagues.

Over time, the inherent problems with the risk-based approach became apparent. 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. Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011."

“Insane”? Yes! 

How can one believe that what bankers perceive as risky is more dangerous to bank systems than what bankers perceive as safe? 

Should it not be clear that dooms our bank system to especially severe crises, resulting from excessive exposures the what ex ante is perceived as especially safe, but that  ex post might not be, against especially little capital?

These self-nominated besserwisser experts had (have) just not the faintest understanding of conditional probabilities.

September 2? From here

Friday, October 12, 2018

If only I could tweet like Stephen Colbert perhaps I could be more effective warning about dangerously faulty bank regulations.

I saw a tweet from Stephen Colbert @StephenatHome where there was a photo of Melania Trump that I thought was caressing a baby elephant. (Later I found out the baby elephant had given her a push) 

The photo included the comment “I can’t wait for my stepsons to murder you”. 

I might be somewhat old fashioned and I did not like it. It was also obviously a comment that expressed much more Colbert's concern with the White House than his concerns about the destiny of the elephants… and those who follow me know how much I abhor any polarization profiteering.

I tweeted. “That comment reflects worse on you Colbert as it shows a lot of lack of taste.”

I am glad I went to bed shortly thereafter, as otherwise I would have been kept out all night, weathering a storm of hundred of tweets, about 2/3 of these angry at me.

Oh, if only I could receive a fraction of that attention to the following tweet.

“The current credit risk weighted capital requirements guarantee especially large exposures, to what’s perceived as especially safe, against especially little capital, which dooms our bank systems to especially severe crises.”

Perhaps I should ask Colbert to pardon my comment, and help me produce an attention grabbing tweet… something in line with “I cant’ wait for those in the Basel Committee turning our bank system into cosmic dust."

But then again who is the Basel Committee for Banking Supervision, that unelected committee that so dangerously distorts the allocation of bank credit around the world. Their members have so much less name recognition than any of Mrs. Trump’s stepsons.

Do you have any other tweet  suggestion for me?

Thursday, September 27, 2018

Mario Draghi, President of the ECB and Chair of the European Systemic Risk Board shows, again, he has dangerous little understanding about the true nature of systemic risks.

Systemic risk refers to the risk of a breakdown of an entire system rather than simply the failure of individual parts. In a financial context, it captures the risk of a cascading failure in the financial sector, caused by interlinkages within the financial system, resulting in a severe economic downturn.”

1. “The need for high-quality data: Policymakers’ ability to act hinges crucially on the availability of high-quality data. Data allow policymakers to identify, analyse and quantify emerging risks. Data also provide policymakers with the necessary knowledge to be able to target and calibrate their tools and to be aware of possible spillovers, or attempts to circumvent regulations”

a. The more you believe you are in possession of “high-quality data” the more you set yourself up for a systemic risk, like when banks were led by their regulators to believe that risk of assets rated AAA were minimal.

b. The more regulators might be tempted to “target and calibrate their tools” without considering how the markets might already have calibrated and targeted that “high-quality data”, the more they might generate the systemic risk of giving that “high-quality data” excessive consideration. Like when bank regulators based their risk weighted capital requirements basically on the same credit risk bankers were already perceiving and clearing for.

2. “Reflecting the targeted nature with which macroprudential policy can be applied, some countries have considered varying implementation by geographical area, to strengthen the impact on local hotspots. These policy actions have helped mitigate movements in real estate prices.”

But trying to contain “hotspots” and not allowing the market to determine the movements of real estate prices contains the clear and present systemic risk of pushing credit into “weak-spots” and not where it could be mots useful for the economy. Like when bank regulators by giving preferential risk weights to the “safe” sovereign and “safe” houses, negates credit to the “risky” entrepreneurs.

3. “Non-bank finance is playing an increasingly important role in financing the economy. Policymakers need a comprehensive macroprudential toolkit to act in case existing risks migrate outside the banking sector or new risks emerge.And that means widening the toolkit so that policymakers are able to effectively confront risks emerging beyond the banking sector.”

No, regulators who have not been able to regulate banks, and caused the 2008 crisis, and caused the tragedy of Greece, have not earned the right to expand their regulatory franchise anywhere.

4. “Conclusion: Policymakers across Europe have proven willing to use macroprudential policy to address risks and vulnerabilities. These measures have helped counter the build-up of risks”

NO! Regulators who still use risk weighted capital requirements based on that what is perceived as risky is more dangerous to our bank system than what is perceived as safe, have no idea about basic macroprudential policies.

NO! Regulators who still believe that with their risk weighted capital requirements for banks they can distort the allocation of credit without weakening the real economy, have no idea about basic macroprudential policies.

Sunday, September 2, 2018

Had there been a Basel Committee on Tennis Supervision, Roger Federer would be history by now.

The Basel Committee for Banking Supervision (BCBS) in order to make bank systems safer imposed risk weighted bank capital requirements. The lower the perceived risk the lower the capital the higher the leverage allowed. The higher the perceived risk the more capital the lower leverage allowed. 

For example, in Basel II of June 2004 they held that against any private sector asset that was rated AAA to AA banks needed to hold 1.6% in capital, meaning they were allowed to leverage 62.5 times. Against any private sector asset that was rated below BB- banks needed to hold 12% in capital, meaning they were allowed to leverage 8.3 times. 

In terms of tennis that would mean that those players ranked the highest would be able to play with the best rackets, and be allowed many more serves than those player ranked lower. Someone not only unranked but also lousy player like me would be happy to have one serve and at least be allowed a to uses a ping-pong racket if playing against Roger Federer. 

But what would have happened if there had been a Basel Committee on Tennis Supervision that implemented these regulations?

To make a long story short, the best tennis players would have it easier and easier to win, and would have less and less need to practice. Those betting on them would bet ever-larger amounts at ever-lower odds… until “Boom!” (2008 Crisis) suddenly the best player was discovered to completely have lost his ability to play and lost in three blank sets to a newcomer.

Tuesday, August 28, 2018

Anat Admati explains the financial crisis better than most, but does still not get to the real heart of it.

I refer to and where Stanford professor Anat Admati discusses her paper“It Takes a Village of Media, Business, Policy, and Academic Experts to Maintain a Dangerous Financial System” May 2016.

In it she explains how a mix of distorted incentives, ignorance, confusion, and lack of accountability contributes to the persistence of a dangerous and poorly regulated financial system.

Here some quotes and comments:

1. “Admati draws a contrast with aviation. Although tens of thousands of airplanes take off and land, often in crowded skies, busy airports, and within short time spans, crashes are remarkably rare. Everyone involved in aviation collaborates to maintain high safety standards”

PK. The main explanation for that is that everything in aviation is considered risky… and there are no aviation regulators giving anyone the excuse of “at this point you can relax”.

2. “When they seek profits banks effectively compete to endanger their depositors and the public. An analogy would be subsidizing trucks to drive at reckless speed even as slower driving would cause fewer accidents.”

PK. Of course allowing reckless speeds, like no limit at all when lending to Greece, and 62.5 times when AAA to AA ratings are present, must cause serious crashes.

But, the worst part of it all is that banks are not allowed to drive all assets at the same speed. As a consequence, being paid on delivery, banks will not go to where they must go slower, like the leverage speed limits that apply when lending to entrepreneurs, and will therefore not perform their vital function of allocating credit efficiently to the economy. The words “the purpose of banks is” are sadly nowhere to be seen in bank regulations.

3. “Politicians, find implicit guarantees attractive because they are an ‘invisible form of subsidy’ that appear free because they do not show up on budgets, as the costs associated are ultimately paid for by the citizenry.”

PK. At this moment the statist regulators and politicians find those “implicit guarantees” especially attractive because of its quid-pro-quo component. “We scratch your back with implicit guarantees and you scratch ours something for which we in 1988, with the Basel Accord assigned to the sovereign a 0% risk weight, and one of 100% to the citizen” And ever since the “good and friendly” sovereigns have had access to subsidized credit… and the regulators have now painted themselves into a corner. 

4. “Credit rating agencies, “private watchdogs,” have conflicted interests because they derive revenues from regulated companies as well as sometimes from regulators.”

PK. Yes but notwithstanding that, even if the credit rating agencies have behaved totally independent, there can be little doubt that assigning so much decision power to some few human fallible credit rating agencies would introduce the mother of all systemic risks.

And besides, since bankers already consider risks perceived when deciding on size of exposures and risk premiums to charge, to have perceived risks also reflected in the capital requirements, violates the “Kurowski dixit” rule: “Risks, even when perfectly perceived, leads to the wrong actions, if excessively considered.” 

5. “I had expected academics and policy makers to engage and care about whether what they were saying and doing was appropriate, particularly since they often know more than the public about the issues and are entrusted to protect the public”

PK. So had I. They, Anat Admati included, are still not able to explain to regulators about conditional probabilities. And so regulators keep on regulating based on the perceived risk of assets and not based on the risk of assets based on how these are perceived.

In terms of airplanes they regulate based on how the pilots perceive the risks and not based on that the pilots could perceive the wrong risks or act incorrectly when facing the correct risks.

6. “Lawmakers are rarely held accountable for the harmful effect of implicit guarantees combined with poor regulations.”

PK. Yes not one single regulators have been forced to parade down 5thAvenue wearing a dunce cap. On the contrary many of them have been promoted and are still regulating without even considering the possibility they have been mistaken all the time.

PS. Even though Daniel Moynihan is supposed to have opined: “There are some mistakes it takes a Ph.D. to make”, the challenges still remain for the PhDs about what to do with the opinions of the lowlier graduates, like with just an MBA. Do we dare to quote him?

And here my soon 2.800 letters to the Financial Times on this. Am I obsessed? Sure, but so are they ignoring my arguments.

And finally here a humble home-made youtube

Thursday, August 16, 2018

Risk weighted capital requirements for banks should consider the conditional probabilities

What are the conditional probabilities of assets being dangerous to bank systems when conditioned to that bankers have perceived these assets as risky?

Assets perceived by bankers as risky become safer, not riskier.

What are the conditional probabilities of assets being dangerous to bank systems when conditioned to that bankers have perceived these assets as safe?
Assets perceived by bankers as safe become riskier, not safer.

So regulators who base their capital requirements for banks on that what’s perceived as risky is more dangerous to the bank systems than what’s perceived as safe, is that because they have never heard about conditional probabilities?

The risk-weighted capital requirements for banks guarantee especially large exposures, against especially little capital, to what is ex-ante perceived, decreed or concocted as especially safe, dooming our bank systems ex-post to especially large crisis... like that one in 2008.

Here is an aide-mémoire on some of the many mistakes with the risk weighted capital requirements for banks.

And here are some of my early opinions on these regulations, some of them while being an Executive Director at the World Bank, 2002-04

Universities, like Harvard Business School, do have “Conditional Probabilities and Bayes’ rule” on the curriculum. Could it be that professors are kept too busy preparing these courses so to have time to look out at what’s happening in the world? Or could it be that their students never understood them?

And here is a very humble home-made youtube comment on it, from 2010

Wednesday, July 11, 2018

Trade wars will mean new tariffs

There is another tariff war that is being dangerously ignored. 

The July 6 editorial "A splendid little tariff war?" rightly held that "tariffs create all sort of inefficiencies, unintended consequences and uncertainty."

The risk-weighted capital requirements for banks also translate de facto into subsidies and tariffs, which have resulted in a too much-ignored allocation of bank credit war. 

One consequence is that those perceived as risky, such as entrepreneurs, have their access to bank credit made more difficult than usual, and our economy suffers. Another is that by promoting excessive exposures to what is especially dangerous, because it is perceived as safe, against especially little capital, guarantees that when a bank crisis results, it will be especially bad. 

In terms of Mark Twain's supposed saying, these regulations have bankers lending out the umbrella faster than usual when the sun shines and wanting it back faster than usual when it looks like it is going to rain.

Letter published in the Washington Post

Tuesday, June 19, 2018

Should we not expect the Fed to do something if they hear they are distorting the allocation of bank credit?

I refer to the letter from Managed Funds Association to the Board of Governors of the Federal Reserve System titled “Supplemental Comments in Response to Federal Reserve Staff Questions on Managed Funds Association Regulatory Priorities

In it, discussing “the flow-through impacts of the supplementary leverage ratio (SLR) on the buy- side’s use of centrally cleared derivatives” MFA comments: 

“At present the SLR is having a more direct impact on banks… [there are] cases in which certain banks have exited the clearing business altogether,or have reduced client clearing services.

Of course, banking organizations allocate capital to business lines based on expected returns. As such, an organization will use its balance sheet to fund businesses that can meet return-on-equity (“ROE”) targets given the amount of capital required to be held against the activities of each business.”

That is a crystal clear explanation (or confession) that bank’s business lines ROE targets are adjusted by “the amount of capital required to be held against the activities of each business.”

So therefore it should be crystal clear that whatever is ex ante perceived, decreed or can be concocted as safe, currently, because of the risk weighted capital requirements for banks, can easier meet the ROE targets of banks than what is perceived as risky.

So therefore it should be crystal clear the “safe” financing of house purchases, sovereigns and AAA rated securities, will stand too much better chances to meet the ROE targets of banks than the financing of “risky” entrepreneurs or SMEs.

So therefore it should be crystal clear that house purchases, sovereigns and AAA rated securities will obtain much easier credit, and that entrepreneurs or SMEs will see their difficulties to access credit only be increased.

Damn that distortion!

By giving banks the incentives to further increase, against especially little capital, the exposures to what being perceived as “safe” always represent the detonators, they set bank crisis on steroids.

By giving banks the incentives to further reduce the exposures to what’s “risky”, that dooms the economies to stagnation.

And as usual, most probably the Board of Governors of the Federal Reserve System won’t care one iota about that, as they until now see as their only bank regulatory role, that of keeping the banks as safe mattresses into which to stash away cash… and never concern themselves whether these mattresses might be infested by the lice of dangerous uselessness.

Tuesday, May 22, 2018

The Bank of England’s Museum’ explanation of “credit risk” keeps mum on how BoE, as a regulator, helped to mess it all up

Yesterday I visited the Bank of England’s Museum, and there I read the following:

“Banks have ways of reducing credit risk. When you apply for a loan, the lender will look at what’s known as the five C’s: credit history, capacity, collateral, capital and conditions.

Credit history, also known as character, is basically your track record for repaying debts.

Capacity refers to your ability to repay a loan by looking at your job stability and your debt compared to your income, known as the debt-to-income ratio.

If you can’t pay back your secured loan, the lender will seize an asset such as your house or car as collateral.

Would you still be able to pay your loan if you lost your job? To know, the lender looks at any savings, investments and other assets you might own to determine how much capital you have.

Finally, the purpose – or conditions – of the loan can affect whether someone wants to lend you money or not.

The bank’s assessment determines how much interest they’ll charge you. If you are seen as a risky customer, for example by having a bad credit history, your loan will be more expensive.”

Now that is how it used to be, before 1988, before overly creative and full of hubris regulators ,with Basel I, imposed risk weighted capital requirements on banks.

After that, and especially after 2004 Basel II, the banks must also consider how much capital (equity) the regulators require it to have against that loan... as that will determine their final risk adjusted expected return on equity.

I did not find a single word in the BoE museum about how these risk weighted capital requirements for banks distort the allocation of bank credit to the real economy.

I did not find a single word in the BoE museum about the fact that absolutely all assets that caused the 2007/08 crisis, had one single thing in common, namely very low capital requirements, that because these assets were perceived (residential mortgages), decreed (sovereigns) or concocted (AAA rated securities) as very safe. 

I can only conclude that the Bank of England is engaging in covering up their own fatal mistakes. Let us pray that at least internally they admit and learn from these.

I saw there that Bank of England is also presenting itself as the “Knowledge Bank”. When in 2002-04, as an Executive Director of the World Bank, I heard the same promo I begged WB to try being a “Wisdom Bank” instead, or at least a “Common Sense” bank.

“Banks need to manage risks, and they monitor their lending carefully, spreading the risk among many loans to different sectors.”

Yes, that is how a portfolio is managed… but the risk weighted capital requirements for banks were explicitly made “portfolio invariant” because to have these being “portfolio variant” presented too many complications for the regulator.

“Banks need enough capital to provide a strong basis for their lending in case things go wrong.” 

Indeed but the question remains when does a bank need the most of capital, when something perceived as risky turns up even more risky; or when something perceived safe turns up risky?

Sunday, May 20, 2018

If the Basel Committee had only been asked these four simple questions about its risk weighted capital requirements for banks?

1. What? Do you really know what the real risks for banks are? If you do, why are you not bankers?

2. What? Don’t you see that allowing banks to leverage differently with different assets will lead to a new not market set of risk adjusted returns on equity. Are you not at all concerned this could dangerously distort the allocation of credit to the real economy?

3. What? Do you think that what’s perceived risky by bankers that which they adjust by means of lower exposures and higher risk premiums, is more dangerous to the bank system than what they perceive as safe?

4. What? A 0% risk weight of sovereigns? That could only be explained by their capacity to print currency in order to get out of debt. But is that not also one of their worst possible misbehaviors?

How much sufferings and how many unrealized dreams would not have been avoided?

And now, 30 years after that faulty regulation was introduced with the Basel Accord in 1988, these questions are still waiting for an answer.

PS. Here a list of some of the horrendous mistakes of the risk weighted capital requirements