Friday, April 22, 2016

The Vasa and the Basel I, II and III disasters

Stefan Ingves, the chair of the Basel Committee, in a speech titled "From the Vasa to the Basel framework: The dangers of instability" last November, said the following:

“In 1625, King Gustav II Adolf of Sweden ordered the construction of…the mighty Vasa. 

It took three years and 300 men to build the Vasa. And 40 acres of timber were consumed. 

The final result was impressive. The Vasa had two gun decks, 64 bronze cannons, and its tallest mast soared to 57 metres. The ship was the result of a quest for perfection. 

This perfection was, alas, short-lived. Tragically, the Vasa sank on its maiden voyage, after sailing only 1,300 metres, on 10 August 1628. 

After so much planning, so many resources and so much time and effort, why did the Vasa sink? According to the King, it was the result of ‘foolishness and incompetence’ 

But historians generally agree that a key factor in the Vasa's fate was the lack of stability and the hull's excessive rigidity… the Vasa was well constructed but incorrectly proportioned” 

As I read it if the historians are right, then clearly so is the King.

And bank regulations designed by the Basel Committee, especially the risk weighing of the capital requirements, was absolutely “incorrectly proportioned”, and so to me the regulators have been foolish and utterly incompetent.

And with respect to Basel III Stefan Ingves said: “The framework has remained unchanged from Basel II across two broad dimensions: first, the way in which risk is measured - and in particular, the reliance on banks' own estimates of risk - has remained the same following the crisis; and second, the risk-weighted approaches are essentially the same as they were before the crisis"

But, in order to “address the fault lines that emerge from these two dimensions” Ingves now tells us that the regulators are working to fix that with "(i) enhancing the risk sensitivity and robustness of standardized approaches; (ii) reviewing the role of internal models in the capital framework; and (iii) finalizing the design and calibration of the leverage ratio and capital floors."

As I see it, in Vasa terms, the hull of Basel III still lacks stability, but the Basel Committee just keeps on loading more “bronze cannons” on its deck.

“Enhancing the risk sensitivity”? For God’s sake, they are still looking at the risk of the assets and not at the risk those assets pose to the banks… and so they still do not understand that the safer an asset might be perceived, the riskier it could be for the banking system.

And they still have not defined the purpose of the banks, and so they still do not care one iota about if their risk weighing distorts the allocation of credit to the real economy.

I ask, would, King Gustav II Adolf of Sweden have given the constructors of Vasa the resources to build another boat, like we allow the same regulators who designed Basel I and Basel II to now work on Basel III? I don’t think so!

And in wikipedia we read “An inquiry was organized by the Swedish Privy Council to find those responsible for the Vasa disaster, but in the end no one was punished for the fiasco.”

Lucky Stefan Ingves... in the case of the monumental failings of Basel II there has not even been an inquiry!

“A ship in harbor is safe, but that is not what ships are for.” said John Augustus Shedd, 1850-1926. Well, if built by something like the Basel Committee, it is not even safe in the harbor J

PS. Had the Vasa and the Titanic been perceived as "risky" would the outcomes have been the same? No! The outcomes were quite much partly conditioned on the ships being ex ante perceived as safe.