Wednesday, August 3, 2016

Stiglitz doesn’t understand how regulators, when doubling down on credit risk perceptions, bully those perceived as “risky”

Joseph E. Stiglitz together with George A. Akerlof and A. Michael Spence won the 2001 Nobel Prize in Economics "for their analyses of markets with asymmetric information". The Nobel Prize website indicates that in the case of Professor Stiglitz his contribution was to show “that asymmetric information can provide the key to understanding many observed market phenomena, including unemployment and credit rationing.”

In a 1998 paper by Thomas Hellmann and Joseph Stiglitz titled “Credit and equity rationing in markets with adverse selection” we read: "The meaning of rationing: “Those entrepreneurs who are willing to accept the higher price are rationed in the sense that they cannot obtain funds at the same price as other observationally identical entrepreneurs. Those entrepreneurs who are not willing to accept the higher price fail to receive funding in this market. Some of them may seek funding in the other market. If there is rationing in the other market too, they may fail to obtain any funding. Even if there is no rationing some of them may not find any acceptable offer in the other market, and again they are left without funding. The point is that while an outside observer may look at this environment and argue that there are many opportunities for the entrepreneur to obtain funding, it may well be that the funding that is still available comes at unacceptable terms, and the funding that has acceptable terms is rationed." 

And in his most recent book “Re-writing the rules of the American Economy” 2016, in the “Fix the Financial Sector”, Stiglitz writes “it is regrettable that almost all of the discussions of reforming the financial sector have focused on simply preventing harm on the rest of society and not in developing a financial system that actually serves our society- for instance by helping to effectively finance small business, education and housing”.

Yet in his very long and somewhat questionable what-to-do list, Stiglitz does not include getting rid of the pillar of current bank regulations, the risk-weighted capital requirements for banks, those by which regulators bully those who are usually perceived as risky borrowers.

By allowing banks to leverage more with what is safe than with what is risky, banks now earn higher risk-adjusted returns on equity when lending to the safe than when lending to the risky… with all its logical consequences.

I have read Professor’s Stiglitz cv. (boy!) and in it I find absolutely nothing that indicates he has ever walked on main-street. So most probably he therefore knows nothing about the difficulties of SMEs and entrepreneurs have to access bank credit. These borrowers, perceived as risky, quite often have to cheat, lie, or at least withhold the whole truth, or even bribe someone, in order to get the opportunity they believe can transform their lives and that of their children. 

And all those difficulties were present even before regulators told the banks that, besides clearing for ex-ante perceived credit risks by means of risk premiums and amounts of exposure, they also had to clear for the same perceived risks in the capital. 

One should expect someone that has won a Nobel Prize researching “credit rationing” to know that any perceived risk, an information, even if perfectly perceived, leads to the wrong conclusions, if excessively considered. But apparently it is not so.

The current risk weight of an unrated SME or entrepreneur, “We the people”, is 100%. The corresponding risk-weights for the Sovereign is 0%, for the members of the AAArisktocracy 20% and for the financing of houses 35%.

For instance the 100% for SMEs and the 35% for houses will cause we end up in houses without the jobs to pay the mortgages and utilities.

For instance the 0% for the sovereign and the 100% for We the People means that regulators believe government bureaucrats can use bank credit better than citizens... an outrageous statism.

Stiglitz has also aspired to a lot of fame as a champion against inequality… but, though he won the “John Kenneth Galbraith Award, American Agricultural Economics Association, August 2004” perhaps he should have included in his academic library John Kenneth Galbraith’s “Money: “whence it came, where it went” (1975). There on job creation and fighting inequality we read:

“For the new parts of the country [USA’s West]… there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business...[jobs created] 

It was an arrangement which reputable bankers and merchants in the East viewed with extreme distaste… Men of economic wisdom, then as later expressing the views of the reputable business community, spoke of the anarchy of unstable banking… The men of wisdom missed the point. The anarchy served the frontier far better than a more orderly system that kept a tight hand on credit would have done…. what is called sound economics is very often what mirrors the needs of the respectfully affluent.

The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… Bad banks, unlike good, loaned to the poor risk, which is another name for the poor man.”


And, during the 2007 High-level Dialogue on Financing for Developing at the United Nations, from the perspective of the developing nations, I protested this regulatory risk aversion but no one really wanted to listen. 

And so when it all came down to the conclusions of the UN Conference Crisis & Development I suffered great disappointments.

I have said before and I repeat it again and again. Nobel Prizes should be recallable, especially if they are used for uttering opinions on matters the winners have no idea about… like bank regulations and Main Streets. Besserwissers from mutual-admiration-group-thinking-clubs monopolizing discussions, are just too costly for the future of our kids and grandchildren