Sunday, May 10, 2015
I have frequently commented on statements or writings of Anat Admati. I have done so mostly because I find reasons to think she understands better than many the problems with current bank regulations, and so therefore I am especially frustrated when I see her being somewhat imprecise.
Here I refer to Admati’s comments at the Finance and Society INET Conference May 6, 2015 “Making Financial Regulations Work for Society”
1. Admati writes: “What we are tricked into tolerating, even subsidizing, is the equivalent of allowing trucks full of dangerous chemicals to drive at 120 mph in residential neighborhoods (and having trouble actually measuring actual speed), which burns lots of fuel, harms the engine and risks explosions.”
That is indeed a good description of the risks of a blow-up of the banking system… but it needs clarifications in order not to create confusion… in order to correct the system.
Banks are currently allowed to drive at 120 mph or faster only if they are thought not to carry anything dangerous, like if they carry a cargo of loans to sovereigns or AAArisktocrats, if they carry a load that is perceived as risky, like loans to SMEs and entrepreneurs, then they must drive at much lower speeds. That is what the credit-risk-weighted equity requirements do.
The problem with that is twofold. First, since the drivers are paid based on how fast they complete the journey (returns on equity) they only carry “safe” cargo, which constitutes an odious discrimination against all those who need the transport of “risky” cargo. And second, that it does not make any traffic-safety-sense, because all major crashes have always occurred precisely when the drivers think they are carrying something safe and therefore speed too much.
2. Then Admati writes: “harm from finance is abstract and spread out. Connecting the harm to individual wrongdoing or recklessness is hard to establish. Courts might work for fraud, but you can't take someone to court for designing bad regulations.”
I believe you can. If somebody had designed regulations that discriminate based on race and gender they could be taken to court… at least so that those regulations were immediately suspended. Here the regulators are layering on artificial discrimination against the fair access to bank credit of those perceived as risky, precisely those who are already naturally discriminated against by bankers. There is an Equal Opportunity Act in the US, Regulation B, the problem is that no one is applying to what regulators concoct.
3. And Admati writes: “Goldman Sachs CEO was wrong when he said banking is ‘god's work.’ Creating and enforcing good financial regulation is god's work.” No way Jose! Neither Goldman Sachs CEO nor regulators can do God’s work. 1999 in a Op-Ed in I wrote: “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse of our banks”.
4. Admati also gives some ideas of how to proceed: “First, increasing the pay of regulators may reduce revolving door incentives. Second, effective regulators might be industry veterans who are not inclined to go back. Third, we must try to reduce the role of money in politics.”
Yes... but totally insufficient! In terms of fixing current bank regulations there are three things that I find to be much more important.
The first is to define a purpose for the banks that is agreeable to the society as a whole. In all thousand of pages of regulations, there is not a single word about what banks are supposed to do… and I ask: how on earth can you regulate what you do not know what it is to do?
The second to close up the mutual small admiration club bank regulators have turned themselves into. Sovereigns and AAArisktocrats might have access to regulators at the IMF or Davos… but risky borrowers are never invited.
The third is to fully understand the need of risk-taking. If nothing is done on that, rest assure, our grandchildren will damn the Basel Committee and the Financial Stability Board, for denying them the risk-taking of banks their economies need.