Thursday, May 1, 2014
I arrived to Washington in November 2002 to take up a two year position, until October 2004, as one of 24 Executive Directors at the World Bank.
I was then already warning about the distortions that capital requirements for banks based on perceived risks would cause in the allocation of credit to the real economy… and already predicting that it all had to end with a big AAA-Bang.
As an example in November 2004, in a letter published by the Financial Times I wrote: “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector (sovereigns)? In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits."
But over the years in hundred of conferences, I never got anyone reasonably high up to explain the why they did it… that is, until May 1 2014, at Brookings Institute, during a presentation of Jean Pisani-Ferry’s book “The Euro crisis and its aftermath”, Jörg Decressin, a deputy director in the IMF’s European Department, a former deputy director of IMF's Research Department gave me a very straightforward answer… bless him.
I could not believe what I heard… and neither will you.
My question: (audio 58.30-59.30)
"I am Per Kurowski, a Polish citizen, A European, at least since last Monday, since I suffered a little intermezzo due to a minor problem with the translation of my birth certificate (from Venezuela).
In Sweden we heard in churches psalms that prayed for “God make us daring!” And risk-taking is definitive something that has made and created Europe.
But in June 2002 the Basel Committee introduced capital requirements which really subsidized risk aversion, and taxed risk-taking. For instance a German bank when lending to a German business man need to hold 8 percent in capital but if they lent to Greece they needed zero.
And those capital requirements distorted the allocation of bank credit in the whole Europe. That is not mentioned in the book. Would you care to comment?"
Decressin’s answer: (audio 1.03.50 – 1.05.37)
"The capital requirements taxing entrepreneurs… 8% on entrepreneurs, 0% on governments
You raise a very good question and an answer to this revolves around:
Do you believe that governments have a stabilizing function in the economy? Do you believe that government is fundamentally something good to have around?
If that is what you believe then it does not make sense necessarily to ask for capital requirements on purchases of government debt, because you believe that the government in the end has to have the ability to act as a stabilizer, when the private sector is taking flight from risk, that is when the government has to be able to step in and the last thing we want is then for people also to dump government debt and basically I do not know what they would do, basically buy gold.
If on the other hand your view is that the government is the problem then you would want a capital requirement, so it depends on where you stand
I think the issue of the governments being the problem was very much a story of the 1970s and to some extent the 1980s. The problems we are dealing with now are more problems in the private sector, we are dealing with excesses in private lending and borrowing and it proves very hard for us to get a handle on this. We have hopes for macro prudential instruments but they are untested, and only the future will show how we deal with them when new credit booms evolve.”
Jean Pisani-Ferry… agreed and left it at that.
Holy Moly! I always suspected it, but I never believed I would be able to extract a confession from regulators that they really are regulating from an ideological position!!!
And sadly I had no chance to ask back: Are you Mr. Decressin arguing that we must help government borrowings ex ante, so that government can better help us ex post? As I see it then, when we might really need the government, it will not be able to help us out because by then it would itself already have too much debt… like Greece.
In short, the structural reform most needed to make Europe grow, is to throw out the bank regulators and their risk aversion, and their pro-government and anti-citizens ideology!
Who authorized the regulators to apply their ideology when regulating banks?
How does this square with the frequent accusations of IMF representing the extreme neo-liberalism?
Am I new to the problems of the euro and the eurozone? Judge yourself!
PS. Jean Pisany-Ferry's completely ignored this problem in his book. The approval in June of 2004 of Basel II, is not even listed among the 119 dates and events presented in the “Euro crisis timeline”. A timeline which begins in February 1992 with the signing of the Maastricht Treaty and ends on December 18, 2014, with the European Council reaching an agreement on the Single Resolution Mechanism.