Tuesday, December 29, 2015
Gillian Tett, she could almost be my daughter, in her book “The Silo Effect”, has a chapter titled “When gnomes go blind”. In it she describes the surprise of regulators when hearing that UBS “had secretly accumulated $50 billion worth of subprime mortgages on its balance sheet” which ended up in “taking the total hit to almost $19 billion”
And she writes “it was the banking gnomes at UBS had collectively fooled themselves; but then she quotes a report by Tobias Straumann stating “This [story]… fits perfectly into a pattern that has repeated itself again and again in the past. In reality, the biggest losers in a financial crisis are not those who have exposed themselves to major risks with their eyes open, but rather the ones who believed [they had] their affairs well under control”
And which means what? That what is truly dangerous is not what is perceived risky but what is erroneously perceived as safe.
And which means what? That the risk-weighted capital requirements for banks based on perceived credit risks makes absolutely no sense… precisely what I have been arguing for years, namely that what is perceived as risky, is not dangerous, precisely because it is perceived as risky.
And also any bank regulator who did not understand that allowing banks to leverage their capital 62 times to 1, if only an AAA to AA credit rating was present, created for even the most conservative bankers an irresistible temptation, was clearly blind, probably because of living in a mutual admiration club silo.
Since 2007, I have written more than a hundred letters commenting on articles penned by Gillian Tett about how risk weighted capital requirements for banks, assisted by credit ratings utterly distort the allocation of bank credit to the real economy. You can find the letters here: From her little silo she has ignored all of them.
Tett’s previous book “Fool’s gold” contained the same mistake… sometimes you really get caught up in your own personal little silo.
Do I also find myself in a silo? Of course I do! Only that mine is a nicer one J
Why on earth do regulators (and some reporters) refuse to discuss the issue of how current bank capital requirements distort the allocation of credit to the real economy? I can only refer to John Kenneth Galbraith: “If one is pretending to knowledge one does not have, one cannot ask for explanations to support possible objections.”