The missing (perhaps prohibited) regression!

Run a regression for all the different serious problem loans of banks around the world, like lousy securities disguised as splendid triple-A’s, loans to Icelandic banks, loans to the real estate sector in Spain, loans to a Greek government, and other similar… on the risk-weight of 20 percent or less established in Basel II, and which allowed the banks to finance what´s mentioned above holding only 1.6 percent or less in capital, which means an authorized leverage of bank capital 62.5 to 1 … and then draw your conclusions.

Turning the bank capital thumbscrews in Europe!

According to Basel II, until January 13, 2012 European banks could hold sovereign debt of Spain against zero capital and then, until May 13, they were required to hold a modest 1.6 percent in capital; currently, with Spain rated BBB+, they need to hold 4 percent, and, if Spain would be downgraded 3 notches more, to BB+, then they would be required to have 8 percent of capital. 

Of course, the more capital you must hold against any asset, the higher must the interest rate be in order to produce the same return on bank equity… which is one of the torture instruments of that so cruel economic torture chamber the Basel Committee bank regulators unwittingly designed. 

Of course, if and when banks are required to hold 8 percent in capital when lending to Spain, the same capital they are required to hold when lending to ordinary small businesses or entrepreneurs, then that would be a more real market rate… since all those lower earlier rates where in fact regulatory subsidized rates. 

And Europe still has the same set of regulators using the same paradigm writing up Basel III! Go figure that out.

The Paper... the most current version

Excessive Regulatory Risk Adverseness Caused the Crisis 5912

Greece… even if expelled from the Eurozone, is free to use the Euro

Though it would obviously not enjoy any seigniorage benefits, Greece, if expelled from the Eurozone can very well keep on using the Euro… so at least not having to waste money changing vending machines or feeding the fx-changers. 

Yes, obviously, it would have to earn the Euros it needs, and not survive on some Drachmas it can print, if it finds buyers for them, but, having to earn ones livelihood seems like a reasonable point where to start the reconstruction.

Europe…what if?

What if European bank regulators had imposed their 8 percent capital requirement for banks on all their assets (12.5 to 1 leverage) like they did for instance on loans to small businesses and entrepreneurs, instead of allowing the banks to hold some ex ante perceived as no risk assets against a meager 1.6 percent or less (62.5 to 1 leverage)?

Just for starters, European banks would not have invested in triple-A rated securities backed by lousily awarded mortgages to the subprime sector in the USA; would not have lent the outrageous amounts they did to Icelandic banks or Greece; and Spanish banks would not have overexposed themselves to the real-estate sector. Do you want me to continue?

Thank God for timely capital flight!

Because of the regulatory incentives of only having to hold 1.6 percent in equity when lending to Greece, which meant being allowed to leverage their bank equity a mind-boggling 62.5 to 1, German and other European banks lent to Greece like crazy and at crazy low rates. What would you have liked the Greeks to do?... the same nonsense?... so that even more money had been lost down the same drain? 

No thank God there was some intelligent and timely capital flight, and private Greeks placed at least some or their funds out of harm´s way. 

Now it is up to these private Greeks, to see how, with their diminished resources they can best help their homeland, in times when helping it might actually produce some good results. 

But, whatever it does, Europe first needs to put the sparkplugs back into its economic engine.

Those sparkplugs, the risk-takers, the “risky” small business and entrepreneurs, were forcedly removed by the regulators when they decided to base the capital requirements for banks on the perceived risks of default, as if those perceptions were not already discriminated for sufficiently by the banks. 

What these regulations delivered, as should have been expected, are dangerous obese bank exposures to what is officially perceived as not-risky, and, for us and economic growth, equally dangerous anorexic exposures to what is officially perceived as “risky”. 

But, unfortunately, what does Mario Draghi of ECB and his fellow failed regulators know about sparkplugs?

A Nobel Prize recall

Frankly, any Nobel Prize winning economist, like Joseph Stiglitz, who is capable of defining over and over again a crisis resulting from excessive and obese bank exposures to what was officially perceived as absolutely not risky, as a demonstration of excessive risk-taking by the banks, should be asked to return his Nobel Prize.

Risk taking provides the financial system with the Lebensraum it needs to grow sturdy

The better the credit ratings are, and the better our risk models are, the better will we stack our financial system, for a while, but then also the higher¸ in Nassim Taleb´s terms, its fragility, or its brittleness will be. 

If we want a flexible, a sturdy, or in Nassim Taleb´s terms an anti-fragile system, then our financial system need risk-taking, a lot of it, of many varied kinds. Risk-taking is not only the oxygen of economic growth it is also what allows our financial system the Lebensraum it needs.. 

Risk-taking is “anti-fragility”, which is why in our churches we can hear the prayer of “God make us daring!” Our current problem is that our nanny bank regulators in the Basel Committee completely forgot all about it… or perhaps they never knew.

PS. What I spoke and wrote about fragility