Friday, December 28, 2012

On June 26, 2004 our banks in Europe and America got castrated, and our real economies became doomed... to stall and fall

On the 26th of June 2004 the G10 approved Basel II. With that they declared as a regulatory principle that if banks lent to a corporation rated AAA to AA- “The Infallible”, it needed to hold only 1.6 percent in capital, signifying an authorized leverage of bank equity of 62.5 to 1, but, if it lent to someone rated BBB+ to BB-, or without a rating, “The Risky” then it had to hold 8 percent in capital, and thereby being authorized to only leverage 12.5 times to 1. 

That meant of course that from that day on banks would earn much higher risk-adjusted returns on their equity when lending to “The Infallible” than when lending to “The Risky” and that meant, of course, that from that day on banks would only lend to “The Infallible”, that is unless “The Risky” were willing to pay the banks much higher interest rates than those higher interest rates they were already paying to the banks, because they were perceived as more risky. 

And that meant that the risk-taking that had helped Europe and America become what they were was halted in its track… and no longer did it help that in church hymns praying “God make us daring” were sung, from that day on Europe, and America, or at least their banks, had been castrated and sang in falsetto. 

And it only took some few years for Europe and America to start stalling and falling, with their banks drowning in excessive exposures to “The Infallible”, such as triple-A rated securities backed with lousily awarded mortgages to the subprime sector in the US, or loans to sovereigns like Greece. 

And from that day, day by day, less bank financing was awarded, on reasonable terms, to “The Risky”, those small and medium companies, and entrepreneurs, best in position to deliver to our youth the next generation of jobs.

Damn Basel II and all those responsible for it, and damn all those helping to silence what the regulators did, on their own, with absolutely no authorization.

Put an end to the Basel Committee’s and the Financial Stability Board’s absolutely crazy capital controls.

Channeling economic resources efficiently signifies channeling the next dollar of available funds to what produces the highest risk-adjusted return on equity, and that is one of the prime functions of a banking system. 

But banks have been impeded from performing such resource allocation efficiently because regulators, by means of capital requirements based on perceived risks, allow banks to earn much higher risk-adjusted returns when lending or investing in “The Infallible” than when lending or investing in “The Risky”. 

Like in roulette, it is like telling the banks they can earn much more on “safe bets”, red or black, that on “risky bets”, any number, even though from the start the expected result of all roulette bets are identical. 

And these de-facto Basel capital controls are, ever faster, dangerously overpopulating the safe-havens and equally dangerously, ever faster, causing the under-exploration of the more risky but also perhaps more productive bays.

As things goes, the western economies, at least the formal ones, are doomed to end up like penguins over-crowding the last AAA rated rock, and where they will suffocate because of the lack of that oxygen that risk-taking signifies.

In other words, Europe and America, in order to stop stalling and falling, need regulators who know the reasons of why our ancestors went to church and prayed “God make us daring!


Saturday, December 22, 2012

The Basel II Roulette Manipulation

Because of what they perceive as reckless speculative risk-taking by banks, many refer to banking as a casino. So, let us think of the different loans and investments a bank can make, in other words of their allocation of bank credit to the economy, as their alternative bets on a roulette table.



On such table there are e.g., “Safe Bets”, black or red, with a payout of 1 plus the bet; “Intermediate bets”, columns, with a payout of 2 plus the bet; and “Risky Bets”, any single number, with a payout of 35 plus the bet. All bets have of course a similar expected value of return, the same risk-adjusted return. In the case of the roulette, a somewhat negative one, because the House always wins when the zero or double zero comes up, the House Edge. In banking, good credit and investment analysis, is expected to provide positive yields, even for the "zero" and "double zero".

Imagine then that a Basel Committee for Roulette Supervision suddenly got concerned with that some players were making too many risky plays; losing all their money, very fast, and that this was something for which they, as a regulatory authority, could be blamed for, and decided to do something about it.

And so, they decreed their Basel Roulette Regulations by which, in order to keep the players playing longer and not losing it all so fast, they allowed the payout for “Safe Bets” to be five times higher, 5 plus the bet; the payout for “Intermediate Bets” double the current, 4 plus the bet; while the payout for “Risky Bets” would remain the same, 35 plus the bet. 

What do you think would happen? Just what had to happen! Every player ran to make “Safe Bets”, and now and again, just for kicks, perhaps an “Intermediate Bet”, but they all stayed away from “Risky Bets”, since these just did not any longer make sense.

And the players got so excited with their profits, and bet more than ever, and so when suddenly the zero or double zero appeared, as had to happen, sooner or later, they lost fortunes and got wiped out, more than ever, often to such an extent that the casino even had to pay for their taxi ride home. Of course casinos, as we know them, could no longer exist.

Before current Basel bank regulations, all bank lending or investment alternatives produced basically the same expected risk and cost of transaction adjusted returns on equity; because that is what a free competitive market and banking mostly produces. This was precisely what The Basel Committee for Banking Supervision changed when, with Basel II, it imposed different risk-weights to determine the banks shareholder's capital/equity/skin-in-the-game requirements for different assets.

For instance, against any AAA to AA rated asset, “The Infallible”, banks had to hold only 1.6 percent in shareholders’ capital/equity/skin-in-the-game, and were therefore allowed to leverage their equity with the net risk adjusted interest rate 62.5 times to 1. Against “The Risky” assets, like loans to unrated small businesses and entrepreneurs, banks must hold 8 percent in capital meaning they then can “only” leverage their equity 12.5 times to 1. For “The Intermediate” assets, with a 4 percent capital requirement, in a similar way a 25 to 1 leverage is authorized.

The result? When compared to the allowed leverage on equity of the net risk adjusted interest rate, the payout/ROE for “The Risky”, translates into a FIVE times higher allowed payout/ROE for “The Infallible”, and TWO times higher for “The Intermediate”. 

This absolutely loony manipulation of the odds of banking; and which obviously not only guaranteed that when disaster struck the banks would be standing there naked without any capital; also made it impossible for the banks to perform with any sort of efficiency their vital role of allocating economic resources. 

And the craziest thing is that soon five years after the 2008 GFC disaster occurred, this manipulation of the odds of banking is not even being discussed. Not even against clear evidence that, as usual, as these always are, this crisis was the result of banks building up excessive exposures to what’s perceived or decreed as safe, in this case AAA to AA rated securities backed with mortgages to USA’s subprime sector.


Poor us! These banking regulations are castrating our banks, making them sing in falsetto accumulating more balance sheets exposure to the "safe-havens", which will become dangerously overpopulated; while avoiding like the plague exposures to the riskier but probably more productive bays where our young could find the next generation of jobs they so urgently need.

PS. The distortion had already begun in 1988 with Basel I: “The assets assigned the lowest risk, for which bank capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgagesPaul Volcker


PS. And it would be so comic, if not so tragic, that absolutely most experts, including Nobel Prize winners, keep on referring to the crisis as a result of excessive risk-taking by banks, and which is of little assistance when trying to explain that what all banks were doing, was betting excessively on boring safe bets, red or black, and this only because of bad regulations… rien ne va plus.


Sunday, December 16, 2012

What are historians going to say about the Basel Committee's capital requirements for banks based on perceived risk?

I am sure historians will be scratching their heads trying to figure out how the bank regulators of the Basel Committee for Banking Supervision, and of the Financial Stability Board, could have been so dumb so as to base their capital requirements for banks on perceived risks already cleared for by markets and banks through interest rates, amounts exposed and other contractual terms. 

And with it they doomed our banking system to overdose on perceived risks and create obese exposures to "The Infallible" and anorexic exposures to "The Risky". 

In other words the regulators castrated the banks of the Western World and made these sing in falsetto.

Most probably the historians will be explaining it in terms of the incestuous group think which can result when allowing “experts” to debate such matters in a mutual admiration club subject to absolutely no accountability at all.

Damn you dumb bank regulators!

Wednesday, December 12, 2012

Are “Those magnificent men in their flying machines” the explanation for the so failed bank regulations?

Was this what the current generation of bank regulators, like Lord Turner and Mario Draghi, watched as kids, and so that they could grow up arrogantly thinking that by deftly pulling at some risk-weights levers they could guarantee an ever bliss of adequate bank capital ratios? 

I mean there has to be some kind of explanation for the stupidity of higher capital requirements for banks when lending to “The Risky”, when it is always excessive exposures to “The Infallible” that has posed dangers to our banks.

What I do not understand then is why regulators were so lack in daring as clearly “the magnificent” were not. But that might be because there must be a tremendous difference between flying a plane in the air, and flying some banks while sitting at your desk, especially in safe Basel.


Those magnificent men in their flying machines,
they go up tiddly up up,
they go down tiddly down down.

They enchant all the ladies and steal all the scenes,
with their up tiddly up up
and their down tiddly down down.

Up, down, flying around,
looping the loop and defying the ground.

They're all frightfully keen,
those magnificent men in their flying machines.

They can fly upside with their feet in the air,
They don’t think of danger, they really don’t care.
Newton would think he had made a mistake,
To see those young men and the chances they take.

Those magnificent men in their flying machines,
they go up tiddly up up,
they go down tiddly down down.

They enchant all the ladies and steal all the scenes,
with their up tiddly up up
and their down tiddly down down.

Up, down, flying around,
looping the loop and defying the ground.

They're all frightfully keen,
those magnificent men in their flying machines.

Wednesday, December 5, 2012

Allowing for risk-taking is an absolute necessity for having a vibrant economy.

Senior government officials who have served Democratic and Republican administrations, and former leaders in Congress from both parties, the Coalition for Fiscal and National Security, urgently call out “Addressing Our Debt is a National Security Imperative”, as U.S. national security in the 21st Century depends on a vibrant economy, and it not being undermined by the accumulation of excessive debt.

Unfortunately their proposed “The Framework”, does not include correcting the one fatal regulatory mistake that has destroyed the economies of both the U.S. and Europe and is impeding these from becoming vibrant again.

And I refer specifically to that odious policy, especially so in “the land of the brave”, of allowing banks to hold less capital (equity) when lending to those who are perceived as safe, “The Infallible” than when lending to those perceived as “The Risky”.

That results in the banks being able to earn immensely higher risk-adjusted returns on their equity when lending to “The Infallible” than when lending to The Risky”, and which effectively locks out the latter from having a competitive access to bank credit.

And those regulations are the sad result of bank regulators not having defined the purpose of the banks to include the efficient economic resource allocation, and to being completely oblivious to the fact that in order to even have “The Infallible”, “The Risky” play a fundamental role.

That truly odious regulatory discrimination, in favor of those already favored by markets and banks on account of being perceived as “safe”, and against those already disfavored by markets and banks on account of being perceived as “risky”, is sapping the economies of the necessary risk-taking and entrepreneurial spirit to keep these vibrant.

And the truly sad part of this fatal regulations is that they do nothing to diminish the risks of major bank failures because these, with the exception of when fraudulent behavior has been present, have always resulted from excessive exposures to what was ex-ante perceived as absolutely safe, and never ever from excessive exposures to something that was perceived as risky when incorporated in the balance sheets of the banks.

I, among others while being an Executive Director at the World Bank, 2002-2004, warned about the consequences of this regulatory risk-adverseness, but I have mostly hit the wall of disbelief in that the regulatory experts could have been so dumb. Well friends, they were!

I am not a U.S. citizen but I know that much of the future well being of my family depends directly on the well being of U.S. and Europe, and so this is also for me a vital issue... a real National Security Imperative.

Thanks for the attention. If you need more explanations you will find me at your service.

Per Kurowski

PS. In my church they sing a psalm that prays for "God make us daring"

Monday, December 3, 2012

Democrats and Republicans… for the sake of America, agree at least on eliminating bank regulations which discriminate against "The Risky” and in favor of "The Infallible"

The access to bank credit has been rigged against those perceived as "risky", like small businesses and entrepreneurs, by means of requiring banks to hold much higher capital when lending to them compared with what the banks need to hold when lending to those perceived as “not risky”. 

This, in a country that became what it is, thanks to risk-taking, and which also likes to refer to itself proudly as “the land of the brave”, is a direct affront to the American courage and spirit of entrepreneurship.

This, is what most neutralizes the impact of fiscal and QEs stimulus, and which most stands in the way of job creation.

Why cannot Democrats and Republicans set aside their differences for one second, and agree on eliminating any bank regulations which discriminate against those perceived as “risky”? 

Would they do so, there would be no reason to concern themselves with a heightened risk in the financial sector, since never ever has a major bank crisis resulted from excessive exposure to those perceived as “risky” (consult your Mark Twain), these have always resulted from excessive exposures to what was ex ante erroneously considered as “absolutely-not-risky”.

Republicans could sell it to their side, correctly, as an elimination of regulatory distortions that impede the markets to efficiently allocate economic resources. 

Democrats could sell it to his side, also correctly, as an elimination of a discrimination against the “risky-not-haves” and in favor of the “not-risky-haves” which drives increased inequality.

Both parties need to understand that discriminating against "The Risky" and in favor of "The Infallible" is about as Un-American it gets... in fact it is outright immoral!

http://perkurowski.blogspot.com/2008/08/discrimination-based-on-financial.html

Sunday, December 2, 2012

Damn you the Basel Committee for Banking Supervision, and you the Financial Stability Board.

In the name of all those perceived as risky small businesses and entrepreneurs who always had to pay higher interest rates and manage with smaller loans, damn you bank regulators! Thanks to you allowing banks to leverage more their equity when lending to “The Infallible” than when lending to us, “The Risky”, we now have to pay even higher interest rates and need to manage with even smaller loans, if we can even get them. 

In the name of all those who are unemployed because there are not enough small businesses and entrepreneurs creating new jobs thank to your stupid kind of risk-adverseness, damn you bank regulators. 

In the name of all citizens of nations with too high public indebtedness only because you, statist bank regulators, allowed banks to lend to sovereigns holding much less capital than when lending to citizens, damn you bank regulators! 

In the name of all us taxpayers who will now be saddled with much higher tax payments for having to bail out so many banks, damn you bank regulators, for regulating without knowing what you are doing. Not only did you not define a purpose for our banks before regulating these, but you also failed to know that in banking, major crisis never ever occur, because of excessive bank exposure to “The Risky” but always because of excessive exposures to "The Infallible” 

Damn you bank regulators for not having the cojones to admit you were so wrong and for now, with Basel III, even doubling down on your huge mistakes of Basel II. Not only are you knighting the too-big-to fail banks as Systemic Important Financial Institutions, leaving all other banks as unimportant, but, on top of your nefarious capital requirements based on perceived risks, you also layer on liquidity requirements based on perceived risks. 

In the name of America and Europe, damn you, you “Great Castrators” who are taking our economies down and making our banks sing in falsetto. 

In our churches we prayed “God make us daring” and that is why we became great… and then you had to come along and spoil it all. Damn you! Don’t you know there can be no “The Infallible” without “The Risky” daring risking it all, and all of us risk adverse citizens being grateful to them for that?

One of the greatest myths is that if Greece had collected all taxes, Greece would not have been in trouble.

Greece is not in trouble because of the taxes it did not collect. Greece is in trouble because its government squandered away funds it borrowed. And because the Greek government was able to borrow so much, thanks to the loony bank regulations. 

For instance, if a German bank wanted to lend to a German entrepreneur, according to Basel II it needed to hold 8 percent in capital, which meant it could leverage its capital 12.5 to 1 times, but, if it lent to Greece, the way Greece was rated at the time, it only had to hold 1.6 percent in capital, which meant it could leverage its capital a mind-boggling 62.5 times to 1. No unregulated or shadow bank would ever manage to do that. 

And that meant, sort of, that if the bank could earn a risk and transaction cost adjusted margin of 1 percent when lending to a German small entrepreneur, it could expect to earn 12.5 percent on its capital, but, if it expected to earn the same margin lending to Greece, it could earn a whopping 62.5 percent on its equity per year. And that is of course a temptation that not even the most disciplined Prussian would be able to resist. And of course what Greek (and many not Greek) politician can resist the temptation of abundant and cheap loans? 

And so had all Greeks paid all their taxes that would have made no difference, in fact, since the Greek government could then have been able to show greater fiscal income, it could have justified keeping credit ratings great for a longer time, which meant having taken on even bigger debts.

Or did the Greek politicians think the loans Greece took on would be repaid by them being able to make of the Greeks exemplary tax–paying-citizens in just some few years? If they did, then they are more stupid than any ordinary politicians.

And now what? Yes Greeks, pay your taxes! But of course only after Greece creditors have accepted a reasonable deal based on a very substantial haircut, and only after you are sure your government will not keep squandering away your taxes.

It is of course very understandable that many Greeks are mad at those who have not paid their taxes but, let’s face it, on the other hand, the way things have turned out, those taxes that were not paid in earlier, might come in very handy now, and will, hopefully, we pray, be put to a much better use.

PS. This post was made before I realized that reality was much worse. Instead of applying to Greece the risk weights dependent on credit ratings that Basel II ordered, EU authorities assigned to all Eurozone sovereigns' debts, including Greece's a 0% risk weight, this even when none of theses nations can print the euro. So European banks, when lending to Greece, did/do not have to hold any capital at all. Now how crazy is that?

PS. At the end of the day the EU authorities kept total silence about their mistake and blamed Greece for it all. What a sad European Union L

Saturday, December 1, 2012

Mario Draghi. Do the structural reforms in bank regulations needed to allow job creators to do their job. Or shut up!

Pan Pylas, AP, reports that “Eurozone unemployment hits another record high”, December 1, 2012. 

And in this context that Mario Draghi, the president of the European Central Bank, the former chairman of the Financial Stability Board, and as such one of the most responsible for current bank regulations declared: “We expect, however, that progress in structural reforms, especially those that improve the functioning of labor markets, will help lower unemployment and facilitate new employment opportunities” 

Of course Draghi is partially right, but neither he nor any of his other bank regulating colleagues, has a right to preach anything to anyone about unemployment. 

He and the other overly risk-adverse nannies decided to allow banks to hold much less equity when lending to “The Infallible” than when lending to “The Risky”; which of course made the banks expect earn much higher risk-adjusted returns when lending to The Infallible” than when lending to “The Risky”. And that effectively locked out, from having a competitive access to bank credit, the “risky” job creating small businesses and entrepreneurs. 

What Draghi should do, now, besides stating his mea culpa, are to push for the structural changes to bank regulations that are needed for our job creators to have a chance to do their job… or just shut up and go home, wearing of course his cone of shame.