Monday, May 30, 2016

Evidence that demonstrates, without any reasonable doubt, we have landed us some very feeble-minded bank regulators

What are the chances banks build up huge exposures to those rated prime, AAA to AA, and which could be dangerous to the bank system, if these, ex post, turn out to have been worthy of a much lower rating? Big!

What are the chances banks build up dangerously large exposures to those rated “highly speculative “ and worse below BB-? None! 

And yet the regulators, for the purposes of determining the capital requirements for banks, in Basel II, assigned to the AAA to AA rated, a risk weight of 20%, and to the below BB- rated, a risk weight of 150%.

Do we really need more evidence that the Basel Committee regulators and those affiliated to it are cuckoo?

They behave like nannies telling the children “Stay away from the ugly and foul smelling, and embrace the nice gents bringing you candy”, and so dangerously distort the allocation of bank credit to the real economy.

Voltaire to the Basel Committee: “May God defend me from my friends [AAA rated]: I can defend myself from my enemies [BB- rated]”

Here is a brief memo that further explains their idiocy.

Friday, May 27, 2016

Mervyn King’s book “The end of alchemy” is dangerously incomplete and excessively praised

Mervin King, former governor of the Bank of England begins his book “The end of alchemy” by citing from “The Rock” by TS Elliot, 1934. 
The endless cycle of idea and action,
Endless invention, endless experiment,
Brings knowledge of motion, but not of stillness; 
Knowledge of speech, but not of silence; 
Where is the wisdom we have lost in knowledge? 
Where is the knowledge we have lost in information? 

From a formal statement, delivered in March 2003, as an Executive Director of the World Bank, let me extract the following: 

“In this otherwise very complete Global Development Finance 2003, there is no mention about the issue of the growing role of the Independent Credit Rating Agencies, and the systemic risks that might so be induced, when they are called to intervene and direct more and more the world’s capital flows.

With respect to Basel, we would also like to point out that the document does not analyze at all a very fundamental risk for the whole issue of Development Finance, being it that the whole regulatory framework coming out of the BCBS might possibly put a lid on development finance, as a result of being more biased in favor of safety of deposits as compared to the need for growth.

As the financial sector grows ever more sophisticated, making it less and less transparent and more difficult to understand for ordinary human beings, like us EDs, it is of extreme importance that the World Bank remains prudently skeptical and vigilant, and not be carried away by the glamour of sophistication. In this particular sense, we truly believe that the World Bank has a role to play that is much more important than providing knowledge per-se and that is the role of looking on how to supply the wisdom-of-last-resort.

And some weeks later in another formal statement I insisted in my arguments and added:

“We truly have to find a way of helping the Knowledge Bank to try to evolve into something more of a Wisdom Bank, or, to put it more humbly, at least a Common Sense Bank.

Basel is getting to be a big rulebook (this was said by the Bank). And, to tell you the truth, the sole chance the world has of avoiding the risk that Bank Regulators in Basel, accounting standard boards, and credit-rating agencies will introduce serious and fatal systemic risks into the world, is by having an entity like the World Bank stand up to them—instead of rather fatalistically accepting their dictates and duly harmonizing with the International Monetary Fund”

Unfortunately though I expressed my reasoned concerns, timely, in a globally important and relevant institution, these fell on deaf ears and were unable to stop crazy Basel II from being approved in June 2004.

And that is the reason why I believe I have earned all the right to openly consider “The End of Alchemy” a very dangerously incomplete book that, equally dangerous, is being excessively praised. 

Mervyn King dedicates his book to his “four grandchildren because it is their generation who will have to develop new ways of thinking about macroeconomics and to redesign our system of money and banking if another global financial crisis is to be prevented."

While I equally dedicate, to my for the time being only two grandchildren, the fight against bank regulators who, fixated on turning the banks into safe mattresses where to stash away savings, did and do not give any consideration to the importance of banks allocating credit efficiently to the real economy, so that the economy can move forward and not stall and fall over us all.

Kings book, in 370 pages, except perhaps when discussing the “Chicago Plan” of banks’ holding 100 percent liquid reserves against deposits, and the configuration of “wide banks” financed with equity and long term debt, does not really discuss the allocation of bank credit to the real economy. That function which to me, represents the fundamental social purpose of banks. That allocation which has now been impeded by mindboggling stupid risk-weighted requirements, those which dangerously favor credit for what is perceived, decreed or concocted as safe, sovereigns, the AAArisktocracy and residential house financing over credit to those perceived as risky, like SMEs and entrepreneurs.

King's book, in 370 pages, does not mention the fact that allowing banks to hold less capital against assets perceived, decreed or concocted as safe, allows banks to earn higher expected risk adjusted returns on equity on these assets than on those perceived as risky.

But King writes “The people who designed those risk weights did so after careful thought and an evaluation of past experience”. Nonsense, they analyzed the perceived risks of bank assets, not the risk of those assets that have created bank crises.

And King follows that with “They simply did not imagine how risky mortgage lending and the sovereign debt of countries such as Greece would become during the crisis”. That clearly evidences that King does not yet understand the role the assignment of low risk weights as zero percent to sovereigns, 35 % to residential mortgages and 20% to AAA rated securities, played in helping create the dangerous excessive bank exposures to these categories.

And King follows that with: “Rather than lambast the regulators for not anticipating those events, it is more sensible to recognize that the pretense that it is possible to calibrate risk weights is an illusion” And I just have to ask, should we not lambast regulators more with the latter, as it proves their excessive hubris?

And King follows that with: “The need for banks to use equity to absorb losses is most important in precisely those circumstances where something wholly unexpected occurs” Right, that is precisely why setting capital requirement that are to cover of the unexpected based on expected credit risks, the risk most cleared for by the banks is so loony.

But at least King there concludes in that “A simple leverage ratio is a more robust measure for regulatory purposes. Good for him! Though clearly he does that only from the perspective of making banks safer, without any thought about the need for less distortions produced in the credit allocation.

In terms of TS Eliot, when it comes to making the bank system safer: 

Knowledge could, as it did, set the risk weights, based the ex ante perceptions of it. 
Wisdom would only set these based on their ex post possibilities of creating havoc. 
Knowledge can get you get started immediately on the avoidance of risks. 
Wisdom would first have you to identify, which risks you cannot afford not to take.

Where King is absolutely right is when he opines, “Regulation has become extraordinarily complex, and in ways that do not go the heart of the problem of alchemy… By encouraging a culture in which compliance with detailed regulations is a defense against a charge of wrong doing, bankers and regulators have colluded in a self-defeating spiral of complexity”

But then a much better title of the book would have been “How do we stop bank regulators from doubling down on alchemy”.

Current regulations only make banks refinance the safer past. For King’s grandchildren, and for mine, let us pray they can soon take on again their vital role in financing the riskier future.

The major mistake with current bank regulations, one that has not been rectified yet, is that the regulators never defined the purpose of banks before regulating these. In this respect, let me stop, for now, by quoting John A Shedd “A ship in harbor is safe, but that is not what ships are for.”

Saturday, May 21, 2016

“Futures Unbound” A Cato summit on bank regulations “Finance is about the future” Will the real questions be asked?

Current bank regulations require banks to hold more capital when financing what is perceived as risky than what is perceived as safe.

That means banks will be able to leverage more their equity, and the support they receive from the society, when financing what is perceived as risky than when financing what is perceived as safe.

That means banks will be able to earn higher risk adjusted returns on equity, when financing what is perceived as risky than when financing what is perceived as safe.

That means banks will no longer finance sufficiently the riskier future, they will mostly refinance the safer past.

And that silly credit risk aversion has been introduced in the Home of the Brave

To top it up, regulators have assigned a risk weight of zero percent to the sovereign and one of 100 percent to the citizens who give the sovereign its strength.

And all for nothing, since never ever has a major bank crises erupted because of excessive exposures to something ex ante perceived as risky, these have always resulted from excessive exposures to something ex ante perceived as safe.

I wonder if Cato is going to bring up the issue of how unelected technocrats, who have clearly never walked on Main Street, have thought it their right to distort the allocation of bank credit to the real economy.

Thursday, May 12, 2016

Dare answer this question, and then dare reflect on current bank regulations, and then dare do something about it.

An AAA rating signifies a “prime” asset and assets rated below BB- signify, at their best as “highly speculative”

So here is the question: 

What might be more dangerous to the banking system, too much exposure to AAA rated assets, or too much exposure to below BB- rated assets?

Which is your answer? Here's a hint: “May God defend me from my friends, I can defend myself from my enemies” Voltaire

If you reply as I do, that of course banks would never-ever build up excessive and dangerous to something rated below BB-, and that this is much more likely to happen with AAA rated assets, then I dare you to reflect on the following:

Your regulators, for the purpose of deciding the capital requirements for banks, assigned a risk-weight of 150% for assets rated below BB-, and a risk-weight of only 20% to AAA rated assets.

Does that sound like the regulators know what they are doing?

If you answer “Yes!” go back to sleep, but if by any chance you answer “No!, then you must know you have a very important assignment in front of you, that is, if you care about the future economic perspectives of your children and grandchildren.

PS. What legal consequences should a bank regulator face if, informed of a serious mistake, he does nothing to correct it?

Sunday, May 8, 2016

Crony bank regulations got us into serious problems

For the purpose of setting the capital requirements for banks…

To our bosses, the infallible sovereigns, the governments, let’s give them a zero percent risk weight,

To that house financing politicians want to favor, let’s give them a 35 percent risk weight.

To that AAArisktocracy that we meet in Davos, let’s give them a 20 percent risk weight.

But to the SMEs, entrepreneurs and citizens, so that we seem prudent and conservative, let’s give them a 100 percent risk weight.

And for better measure, to the below BB- rated, let us assign them a 150 percent risk weight

And so banks earned higher risk adjusted returns on what was perceived, decreed or concocted safe, than on what was perceived as risky.

And so banks held too much AAA rated securities, loans to Greece and residential housing finance… and we got us the 2007-08 crash.

And so banks hold too little loans to “risky” SMEs and entrepreneurs… and so we can’t get ourselves out of the doldrums.

Anyhow let us pray Per Kurowski does not insist in explaining to others that, with respect to the real risk assets can pose to the banking system, these risk weights could be just 180 degrees the opposite.

Don’t put the blame on politics, when clearly technocratic stupidity is at fault

Below the abstract from a recent paper by Jihad C. Dagher from the International Monetary Fund titled "Regulatory Cycles: Revisiting the Political Economy of Financial Crises"

“Financial crises are usually perceived and analyzed as purely economic phenomena. The political economy of financial booms and busts, while far from ignored, remains under-emphasized and has often been analyzed in isolated episodes. 

The recent wave of financial crises has brought unprecedented attention to financial regulatory policy; yet the policy discussions and economic literature, which are usually cast in technical terms, tend to overlook political forces that shape regulations and impact their effectiveness over time. 

This paper examines the political economy of financial policy during some of the most infamous financial booms and busts and finds consistent evidence of pro-cyclical policies. 

Financial booms, and risk-taking during these episodes, were often amplified, if not ignited, by a political regulatory stimulus and interventions. The bust has always resulted in an overhaul of the regulatory and supervisory framework and a political turnover. The interplay between politics and financial policy over these cycles, and their institutional underpinnings, deserve further attention. 

Politics can be the undoing of macro-prudential policy”

Basel II, of June 2004, for the purpose of determining the capital requirements for banks, set the risk weights for corporates rated AAA at 20% and that of those rated below BB- at 150%.

Sorry, frankly, those who believe that those below BB- rated pose a greater risk for the banking system, have no idea about what they are talking about, and have probably never ever left their desks to walk down on Main Street.

That has nothing to do with politics, that is sheer technocratic stupidity

Saturday, May 7, 2016

Why was the most important obstacle for small businesses accessing bank credit not even mentioned in 2012 JOBS Act?

Bank regulators consider small unrated businesses to be much more dangerous to the banking system and to financial stability, than well-rated corporations.

That is an extremely flimsy and wrong proposition, based on absolutely nothing! 

And that is why, with Basel II, for the purpose of defining the risk weighted capital requirements for banks, regulators assigned a risk weight of 100 percent for the small unrated businesses and one of only 20 for AAA to AA rated corporations.

And that translated into banks being allowed to hold much less capital against “the safe” assets than against “the risky assets; which meant banks could leverage more their equity lending to the safe than lending to the risky; which meant banks earn higher expected risk adjusted returns on equity when lending to the safe than when lending to the risky.

And that represents the most significant cause for small-unrated businesses not having fair access to bank credit.

And not a single word about that obstacle, and the need to remove it, was mentioned in the Jumpstart Our Business Startups (JOBS) Act of 2012

And amazingly, the issue of the distortions in the allocation of bank credit to the real economy that credit risk aversion causes in the Home of the Brave, is still not even being discussed.