Professor Summers, fixing potholes using 0% public debt will not fix America. Don’t put the cart before the horse.

Professor Larry Summers, and many others with him, promote the idea that the government in America (and other governments too) should take advantage of the extraordinarily low interest rates on public debt, in order to finance new infrastructure and the maintenance of old.

Briefly their calculation is as follows: If government takes on debt at 0% and invest it in infrastructure projects that renders a 5% economic return, then the government, with a 30% tax on that, will have earned a net 1.5%... and we can all live happily ever-after.

NO! First, even if the government nominally pays 0% on its debt, that does not mean that debt has a zero cost. To begin with we should have to add the cost of all those giving up (cheated out of) some long term decent earnings on their saving, in order to finance the government for free. But, even more importantly, those zero or low rates are not free and clear market rates, but rates that are non-transparently subsidized by regulations.

In 1988, with the Basel Accord, Basel I; for the purpose of calculating the risk weighted capital requirements for banks, the regulators decided that the risk-weight for the sovereign was 0%, while that of We the People was 100%. And those risk-weights are still in full force.

I cannot say how much of the low interest rates on public debts are explained by this regulatory distortion, but it sure has to be quite a lot.

I have lately seen Professor Summers, and Lord Adair Turner, showing these rates trending down for the last 30 years. Unfortunately for reasons that are beyond my grasp, they have not been able to see a connection between this and 1988’s bank regulations.

But I do know that piece of egregious regulation, introduced such distortions in the allocation of bank credit that, worldwide, millions of SMEs and entrepreneurs have been negated the opportunities   provided by access to bank credit. That is a real huge cost that should be added to the nominal 0% rate. In other words the rates on public debt are the nominal rates, plus the economic and human costs of the distortions.

Since because of this regulatory risk aversion (even in the Home of the Brave) the economies are stalling and falling. So in this respect one could argue that in reality, never ever before have the interest rates on public debt been as high.

Which also leads me to my second objection, that of “infrastructure projects rendering a 5% economic return”. The final real return of any infrastructure project is a function of how it meets the needs of the economy, and of the state of the economy. If regulatory distortions impede the growth of the economy, those infrastructure projects, even if perfectly carried out, even if financed at 0%, might really turn out to provide a negative return.

Professor Summer, let us, very carefully, get rid of those regulatory distortions so that the banks of America, and those of the world, can return to the normality that was so rudely interrupted by regulatory hubris and statism in 1988. That would allow infrastructure to be financed by governments out of real economic growth, something that would then certainly even justify having to pay much higher nominal interest rates than now.

Please don’t put the cart before the horse! Don’t refuse “the risky” the opportunities to access bank credit only because they are risky. Our economies were all built on risk-taking, even when some of it was not adequately reasoned.

To lay on regulatory risk aversion on top of bankers natural risk-aversion, is an insult to intelligence and human wisdom.

God make us daring!

Since bank regulators in 1988 decreed sovereign debt to be risk free, the market has not set the risk-free rates

In the discussion by Lawrence Summers and Adair Turner on secular stagnation in the Institute of New Economic Thinking INET, on October 28, I extract the following:

15:25 Lord Adair Turner

“The longer we have the slow growth and sub-target inflation, the more you have to think that there is something secular is at work. And the thing that makes me pretty sure that Larry is right in his hypothesis that something secular is at work, is to look at the 30, not the 10 year trend, but the 30 year trend, in real risk-free interest rates. 

Take UK’s 10 year yields on real index linked gilts. 

Take an average for each five year period, from 86-90, 91 to 95 and so six of those 5 year periods until the last

And the sequence is 3.8%; 3.6; 2.5%; 1.9%; 1.2%; minus 0.6%, and the value is now minus 1.5%. 

When you see a trend like that you begin to think that there may be something secular, petty strong, about that; with a dramatic fall even before the 2008 crisis, so you can’t put all this down to central bank intervention, quantitative easing.

So we seem to have entered a world where savings and investments only balance at very low or negative real interest rates. And of course those very low interests rates themselves, played a role in stimulating the excessive private credit growth which landed us with the debt overhang. 

But despite this those low interest we have low growth and below target inflation, and so it is vital we try work why is this… 

17:58 Well logically, the long term decline in real interest rates must mean that we have faced over the last 30 year either:

an increase in the ex ante desired aggregate global saving rate 

or a decline in the ex ante desired or intended global investment rate 

or a mix of both.”

Lord Adair Turner, the former chairman of the Financial Service Authority, FSA (2008-2013), and therefore supposedly a technocrat well versed in bank regulations, had not a word to say about: 

That extraordinary moment when, after about 600 years of “one for all and all for one” capital in banking, in 1988, with the Basel Accord, Basel I, regulators introduced risk weighted capital requirements for banks and, to that purpose, set the risk weight for the sovereign at 0%, while the risk weight for We the People was set at 100%.

That of course signified an extraordinary regulatory subsidy of sovereign debt, that had to set the UK’s 10 year yields on real index linked gilts, on a negative path.

From that moment on, since the regulators had decreed sovereign debt to be risk free, we can no longer really hold the market, using public debt as a proxy, can provide a reliable risk free rate estimate.

For now those artificially decreed risk-free rates can only go down and down and down… until BOOM!

The low “real” public debt interests might be the highest real rates ever, in that these regulations also make banks finance less the riskier, like SMEs and entrepreneurs, those who could provide us with our future incomes, and therefore governments with its future tax revenues.

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.

To obtain loans sovereigns don’t need to threaten lenders with dungeons anymore. They now have the Basel Committee.

In Yuval Noah Harari’s “Sapiens: A brief history of humankind” we read: “The king of Spain desperately needs more money to pay his army. He’s sure that your father has cash to spare. So he brings trumped-up treason charges against your brother. If he doesn’t come up with 20.000 gold coins forthwith, he’ll get cast into a dungeon and rot there until he dies”

Nowadays sovereigns are much more intelligent and much less transparent. They appoint their expert technocrats to the Basel Committee for Banking Supervision and who, for the purpose of setting the risk weighted capital requirements for banks, assign a 100 percent risk weight to the private sector and a zero percent risk weight to the sovereign.

Read more about the horrors of the Basel Accord of 1988, and which no one protested.

How come American citizens did not protest the Basel Accord’s 1988 in your face statism?

I refer to:

Confidential Memorandum:

Attack of American Free Enterprise System

Date: August 23, 1971

To: Mr. Eugene B. Sydnor, Jr., Chairman, Education Committee, U.S. Chamber of Commerce

From: Lewis F. Powell, Jr.

It mentions "The Ideological War Against Western Society"

But I sure have a question for you all

In 1988, by means of the Basel Accord, Basel I, for the purpose of setting the risk weights applicable to the credit risk weighted capital requirements for banks, the regulators defined a zero percent risk weight for the OECD sovereigns (governments) and a 100 percent risk weight for the citizen (the private sector)

That meant that governments would have more favorable access to bank credit than the citizens; which de facto implied that government bureaucrats use bank credit more efficiently than citizens.

There were protests from other sovereigns who also wanted to be awarded a zero percent risk weight… but how come no American citizens protested this in your face statist regulation?

Is not the strength of a sovereign solely the reflection of the strength of its citizens?

That distortion subsidizes government debt; with the subsidy paid for all those in the private sector who as a consequence will, in relative terms, have less and more expensive access to bank credit?

Is this of no interest to America?

If so then America is not what I had learned to believe and admire.

How could a crisis resulting from statist interventions, morph into a backlash against banks, capitalism and markets?

1988 with the Basel Accord, Basel I, the regulators, for the purpose of determining the capital requirements for banks, set the risk weight of the Sovereign (the government) to be zero percent while that of the private sector was set at 100 percent. Have you ever seen something more statist than that?

And in 2004, with Basel II, regulators within the private sector, assigned risk weights that ranged from 20 to 150 percent.

Those risk weights translated into banks needing to hold much less capital (mostly equity) against the Sovereign and the Safe Privates (the AAArisktocracy and houses) than against the Risky Privates (SMEs and entrepreneurs).

That meant banks could leverage their equity much more with Sovereign and Safe Privates, than with Risky Privates.

And that meant banks could obtain much higher risk-adjusted returns on equity with Sovereign and Safe Privates, than with Risky Privates… have you ever heard of something that distorts the allocation of bank credit more than that?

And of course the world ended up with a typical bank crisis, one of those that always result from excessive exposures to something ex ante perceived (or deemed) as safe (AAA-rated securities – Greece), but in this case made so much worse by the banks having been allowed to hold especially little capital against “The Infallible”.

But yet this utterly faulty regulation has been framed in terms of “de-regulation”, which has placed the full blame for the crisis on banks, free markets and capitalism.

How did that happened… who are the responsible for that?

A question: Basel II required banks to hold 1.6 percent in capital against what is AAA rated and 12 percent against the below BB- rated. What do you think poses greater danger to the stability of the banking sector: what’s AAA or what’s below BB-?

Facts:

Bank capital is to help cover for unexpected losses.

The safer something is perceived the greater the potential of unexpected losses.

No bank crisis ever has resulted from excessive exposures to something ex ante perceived as risky.

Current capital requirements for banks are much lower for what is perceived as risky than for what is perceived as safe.

So the current capital requirements for banks seem to be 180 degrees wrong... could that be?

If earth suffers an immediate threat to its existence, let us pray bank regulators are not part of our first response team.

In 1988 the Basel Accord (Basel I), for the purpose of determining the capital requirements of banks, introduced the ludicrous out of this world concept of a zero percent weight for the sovereigns and a 100 percent weight for the private sector.

That could only have the effect of banks lending more and in better terms to the sovereign than to that private sector that usually is from which the sovereign gets its strength; and which implied bank regulators thought that government bureaucrats could use bank credit more efficiently than for instance SMEs and entrepreneurs. Unless one is a full-fledged statist or a communist, such a concept should have been totally unacceptable.

Myself, coming from being a corporate financial consultant primarily in Venezuela, had very little to do with bank regulations but, in 2004, when I was just awakening to what the Basel regulations contained, in a letter that was published in the Financial Times I wrote: “We wonder how many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

But now soon 30 years after that initial Basel Accord correcting that zero risk weighting flaw seems finally to have come up on a decision agenda.

In March 2011 the issue appeared at a roundtable of the IMF which concluded with José Viñals, IMF Financial Counselor and Director of Monetary and Capital Markets Department, stating: “The emphasis put by the panelists on issues such as the interconnectedness between sovereigns and banks, regulation and its impact on financial risk, the need for joint and credible sovereign-bank stress testing, debt issuance strategies, and the role of the central banks in mitigating liquidity versus credit risk have clearly demonstrated the need for us to look at sovereign risk in a much broader context of issues and vulnerabilities than we have done so far.” 

And then it pops up in October 2011, in a speech by Hervé Hannoun the Deputy General Manager Bank for International Settlements titled “Sovereign risk in bank regulation and supervision: Where do we stand?” Hannoun, first things first, clears regulators from any responsibility: “market participants’ complacent pricing and accumulation of sovereign risk in the decade up to 2009 was a market led phenomenon that cannot be attributed to the Basel standards.” But then he anyhow opines: “However it becomes crucial for regulators and supervisors of large banks to clarify that although sovereign assets are still a relatively low risk asset class, they should no longer be assigned a zero risk weight and must be subject to a regulatory capital charge differentiated according to their respective credit quality." That said he finally returns to the original sin stating:"A key objective for governments in advanced economies is to earn back the quasi-risk-free status of their debt"

Also the then General Secretary of the Prudential Supervisory Authority of Banque de France, Danièle Nouy in April 2012 wrote: “it appears that current regulatory framework does not require from financial institutions to hold significant regulatory capital against sovereign risk, inadequately assuming sovereign debt as a low-risk and even a risk-free asset class. Furthermore, some regulatory initiatives, while globally enhancing standards, could create further incentives to encourage financial institutions to hold sovereign debt. In addition to considering better reflection of sovereign risk in financial regulation, supervisory practices also appear as a crucial tool to address the issue of heightened sovereign risk and its potential impact on financial stability.” 

And in a speech delivered on May 5, 2015 Stefan Ingves, the current chair of the Basel Committee wrote: “A discussion of the risk-weighted capital framework would not be complete without a discussion of the Committee's work on sovereign risk… the Basel Committee's oversight body - agreed to initiate a review of the existing regulatory treatment of sovereign risk, including potential policy options... I think we can all agree that there is no such thing as a risk-free asset. When we talk about this issue we talk about ‘sovereign-risk’ - not about ‘sovereign risk-free’”

And Jens Weidmann, the President of the Deutsche Bundesbank in a speech on December 10, 2015 titled “A central banker’s take on improving the euro area’s stability” “While bail- outs and monetary financing are prohibited under the Maastricht treaty, sovereign debt is nonetheless treated as risk-free in the capital regime for banks. Danièle Nouy, the chairwoman of the European banking supervision, said: ‘Sovereigns are not risk-free assets. That has been demonstrated, so now we have to react.’ I totally agree with her. Sovereign debt in banks’ balance sheets needs to be backed by capital, just as is the case for any private debtor. But perhaps it is even more important to put a lid on banks’ exposures to a single sovereign.” 

Oh boy, this all sure is in slow motion... in the getting it and in the reacting to it, I can only conclude in that if earth suffered an immediate threat to its existence I sure wish bank regulators are not part of our humans’ first response team.

Of course I wish for the statist/communist favoring of the bank borrowings of the sovereign to disappear but, because of the temporary huge bank capital scarcity that could produce, I must pray it is carried out in such a way that it does not further increase the squeeze on the access to bank credit of those in the private sector perceived as “risky”. They have it hard enough as it is.

And sadly, the current bunch of bank regulators have given us enough evidence they do not understand what banks are for. In fact they have never even defined the purpose of banks before regulating these... and how stupid is not that?

PS. November 2018: In Europe by means of the European Commission’s “Sovereign Debt Privilege”, the risk weight assigned to all Eurozone sovereign debtors is still 0%, this even when that debt is de facto not expressed in a domestic (printable) currency. Oh boy, this all sure is no motion at all.

PS. How would government finances look if house prices had not gone up the last decades?

This is the farmer sowing his corn,
 That kept the cock that crowed in the morn, 
That waked the priest all shaven and shorn,
 That married the man all tattered and torn,
 That kissed the maiden all forlorn, That milked the cow with the crumpled horn,
 That tossed the dog,
 That worried the cat,
 That killed the rat,
 That ate the malt
 That lay in the house that Jack built...That was taxed by the taxman

'

PS. My letter to the Financial Stability Board dated March 2019

Excuse me Stefan Ingves. Are you a raving statist? Are you a raving communist?

In 1988, with the Basel Accord, Basel I, the bank regulators of the all important G10 decided that, for the purpose of defining the capital requirements of banks, the risk weight for the sovereign, meaning the government, was to be zero percent, while the risk weight for the private sector, meaning the citizens, was set at 100 percent. What a lunacy!

Mr Stefan Ingves, Chairman of the Basel Committee on Banking Supervision and Governor of the Sveriges Riksbank, in remarks made on May 5, 2015 to the 8th Meeting of the Regional Consultative Group for Europe, had this to say about “Sovereign risk”

“A discussion of the risk-weighted capital framework would not be complete without a discussion of the Committee's work on sovereign risk - a topic which is clearly of relevance to Europe. At its meeting earlier this year, the Group of Central Bank Governors and Heads of Supervision - the Basel Committee's oversight body - agreed to initiate a review of the existing regulatory treatment of sovereign risk, including potential policy options.

In many cases sovereign exposures are in fact relatively low credit risk assets and also highly liquid. 

Yes, they do receive a lower capital charge than other asset classes, but this is generally warranted. But - and this is an important but - I think we can all agree that there is no such thing as a risk-free asset. When we talk about this issue we talk about "sovereign-risk" - not about "sovereign risk-free"

For this reason the Committee will consider potential policy options related to the existing treatment of sovereign risk. It is important to note that this review will be conducted in a careful, holistic and gradual manner.”

Let me here concentrate on “Yes, sovereigns exposures do receive a lower capital charge than other asset classes, but this is generally warranted.”

Mr. Stefan Ingves, why is that generally warranted?

If sovereigns exposures receive a lower capital charge than other assets that means banks will be able to leverage more their equity and the support they receive from society when lending to the sovereign than when lending to the private sector, meaning to the citizens. 

And that of course means banks will be able to earn higher expected risk adjusted returns on equity when lending to sovereigns than when lending to the private sector, meaning to the citizens.

And that of course means banks will tend to favor lending to the sovereigns than to the private sector, meaning the citizens.

And the only possible rational explanations for that must be if you believe government bureaucrats more able than citizens to use bank credit.

Do you Stefan Ingves believe that? Are you a raving statist? Are you a raving communist?

Who has ever heard about a zero percent risk free sovereign? They even tell you in your face that they have an inflation target, so as to pay you off with money worth less and, if that does not suffice, that they will then increase your taxes to service their debt.

Tenured finance professors, with their indifference, are some of the villains who let us down.

Karthik Ramanna, an associate professor at Harvard Business School writes : “Narrower interests that would otherwise find themselves straining to shape political outcomes often prevail unchallenged. Somewhat perversely, we may well be better off when politics is a bazaar of ideas and incentives.

Consider the technical regulations that govern capital markets — whether banks have as much capital as they say they do…We might think these regulations are somehow self-evident, derived from fundamental laws of economics. In reality, they are largely social constructs, reflecting expert opinions and political necessities…. I call these regulatory processes thin political markets because they seldom attract wide public participation. On any specific rule-making issue, there are usually a handful of business executives … who are truly experts on the subject. They also have the greatest stakes in the outcome. They meet with regulators in genteel isolation, obligingly offering direction for regulation. The rules of the game that emerge reflect their interests.

But there are no manifest villains here. Executives get involved when they understand an issue, and it matters to them. When they participate, they rarely face serious opposition. Those who might oppose them are sometimes not even aware of the regulatory proceedings. What arises in aggregate is a system of rules that looks as if it was produced by a quilt of special interests. Society as a whole bears the costs of this subtle”  "Ruling From the Shadows" New York Times,  November 21, 2015.

No, that is unacceptable! What the heck do we have tenured academicians for, if not to question what is going on in the real world?

In 1988 the Basel Accord introduced risk weighted capital requirements for banks and decided, amazingly, that the risk weights for sovereigns (meaning governments) was to be zero percent, while that of the private sector (meaning citizens) was to be 100 percent.

And in 2004, with Basel II, they also divided the private sector into groups carrying risk weights of 20, 50 100 and 150 percent.

And of course that utterly distorted the allocation of bank credit to the real economy.

And where were the tenured finance professors to question this? As far as I know they were nowhere to be seen. In fact they are still mostly nowhere to be seen.

“There are no manifest villains here”? I could easily make a case for most academicians in finance being the indifferent villains. They truly are letting the society down.

Revoke their tenures!

https://teawithft.blogspot.com/2009/04/regulators-changed-odds-at-casino.html

The world’s banking system has been instructed by its regulator to give perceived credit risk a 200% weighting.

With bankers using perceived credit risk to set their interest rates and amount of exposures; and regulators using the same perceived credit risk to set their capital requirements for banks; it is clear that perceived credit risks get a 200% weighting. 

Any banking system that becomes 200% sensitive to perceived credit risks, dooms itself to lend dangerously much to The Safe, the Infallible Sovereigns and the AAArisktocracy; and way too little to The Risky, like to SMEs and entrepreneurs; which is of course fatal for the real economy and therefore also to the banks.

What would have happened if Winston Churchill, when confronted with the dangers had said: "In order to avoid our houses being bombed, we need to become 200% sensitive to risk."

This whole blog is dedicated to explaining how fatally flawed current Basel Committee originated bank regulations are. Here is a recent public letter to its current chair Mr. Stefan Ingves.

The Basel Committee is a pitiful bunch of bank regulators incapable of expressing even the smallest “We’re sorry Greece”

There is no doubt whatsoever that had regulators not allowed to leverage their equity over 60 times to 1 when lending to Greece, Greece not matter what accounting shenanigans it could come up with, would not have been able to borrow as much as it did. 

And now, as a consequence, we read about Greece having to hand over 16 of its airports to those who  in order for the creditors to be paid, have paid for the right of charging a toll on much of the future tourism to Greece.

And yet not even the slightest hint of the Basel Committee telling Greece, and its creditors, they're sorry. What a sad bunch of technocrats.

Who did the Eurozone in?

Pension funds, widows and orphans have been told to keep out of what’s perceived safe, that’s now the banks’ domain

Bank regulators, with their credit-risk-weighted capital requirements, allow banks to leverage their equity and the support received by deposit guarantees and similar, immensely, as long as they stick to lending to “The Safe”... in their mind the infallible sovereigns, the AAArisktocracy and housing.

Consequentially the more regulators favor and therefore subsidize bank lending to “The Safe”, the lower will be the interest rates paid by “The Safe”... sometimes even down to zero interests, and, of course, in relative terms the higher the rates “The Risky” need to pay. 

Ergo… non-banks who have to evaluate the increased spreads between The Safe and The Risky, without counting with the regulatory bank-subsidies, are more tempted by, or are in more need of the higher rates paid by The Risky.

Pension funds, widows and orphans who were the one investing in “The Safe”, have now been told to get out of there… “That’s for the banks!”

"The Risky", like the SMEs and the entrepreneurs they used to have access to the banks… now they are left out in the cold… desperately looking for some crowd-funding.

Suppose a dictator decided on bank regulations.

What if in a country there was a dictator who told banks: I will allow you to leverage much more your equity, so that you can earn much higher risk adjusted returns on your equity and on the implicit support our taxpayers give your banks, that is as long as you lend to the government, meaning to me, your infallible sovereign, to my friends and courtesans, the AAArisktocracy, and stay away from lending to those perceived as risky, like our quite vulgar SMEs and entrepreneurs.

Would you not be upset? Especially considering that it is precisely SMEs and entrepreneurs who most need to have fair access to bank credit in order to help the real economy to move forward and not to stall and fall.

Would you not be upset? Especially considering that de facto means the dictator believes the government, or the AAArisktocracy, can use bank credit more efficiently than what SMEs and entrepreneurs can?

Would you not be upset? Especially considering that never ever do major bank crises result from excessive bank lending to those perceived as risky, these always result from excessive lending to those who were erroneously perceived as safe.

For your information, the Basel Committee, and the Financial Stability Board, with their portfolio invariant credit risk weighted capital requirements for banks, dictated precisely that... for the whole world. And the world so submissively, says nothing about it.

Greece was taken down by loony statist technocrats or by hard line communists, acting as bank regulators.

More than six years ago, in jest, but also in all seriousness, I set up a blog named AAA-bomb. In it I recounted the actions of “Carlos Molotov Pavlov, a central planner who to avenge his loss of a cushy job in the Soviet entered the bank regulatory system in Basel and managed to create, seed and detonate an AAA-bomb in the heart of the capitalist Empire”

Already in 1999 in a Op-Ed I had written: “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”.

The AAA-Bomb, which had been invented in 1988 with the Basel Accord, Basel I, and that had been further refined in 2004, Basel II, was the credit-risk-weighted capital requirements for banks.

While these required banks to hold 8 percent in capital when lending to any unrated SME in Europe, these allowed banks, in accordance to how Greece was then rated, to lend to the government of Greece against only 1.6 percent in capital. So banks could leverage their equity, and the support they received from taxpayers, over 60 times lending to Greece, compared to only about 12 times to 1 when lending to, for instance, a German or a Greek SME.

Implicitly those capital requirements meant that regulators believed government bureaucrats were capable of using bank credit more efficiently than the private sector.

And of course that had to mean sovereigns were going to become over-indebted… and Greece was just one of the AAA-bomb's first casualties.

PS. Citizens beware of the Basel Committee's bureaucrats/technocrats bearing gifts to government bureaucrats/technocrats.

PS. Reality was even worse since European Commission felt that the Greece sovereign, even though it could not print euros on its own and independent of credit ratings, should also be 0% risk weighted, which meant European banks could lend to Greece holding no capital (equity) at all. And then they left Greece to pay for all of that mistake.

Current bank regulations present two absolute inexplicable lunacies, which can only be justified if you are a communist

Starting 1988, with the G10 Basel Accord of which the US is a signatory, bank regulators, in Basel I, for the purposes of establishing how much capital (equity) banks need to hold against assets, declared the following credit-risk-weights: Government Zero percent; citizens, or their SMEs, 100 percent.

Knowing that only the citizens are the real back up of any government, and that governments can be very creative dishonoring their debt, for instance by means of inflation… that is an absolute inexplicable lunacy... unless you’re a communist of course.

Worse yet. Those risk weights cause banks to lend more and at lower relative rates to the government than to the citizens and to their SMEs. And that would imply that government bureaucrats are more productive using bank credit than the citizens, or their SMEs.

In other words, the credit-risk-weights de facto simultaneously translates into bank-credit-productivity-weights of 100% for government bureaucrats and zero percent for citizens, or for their SMEs. 

And so the question lingers is the Basel Committee a tool for communists to infiltrate the financial system of the free world? It would certainly seem so.

Here: The confessions of an ideologue.

PS. Here my letter to the Financial Stability Board

An indebted unemployed student’s story:

An indebted unemployed student: "At last I thought I had a reasonably good paying job that would make me be able to repay my student debt, and earn me something on top of that, for all the time and efforts I had invested in my studies. But, that was not to be, because the owner of the SME who was offering me the job, had his credit application denied by the local bank that had the most intimate knowledge of his business and plans. Much saddened, even despaired, I asked the employer I had counted on… How come?”

SME owner: “The banker told me that if he gave me the loan then, because I was officially perceived as risky from a credit risk point of view, regulators required him to hold much more equity than if he lent that money to an AA rated corporation or invested it in treasury bills. And, unfortunately, he did not have that equity.”

Indebted unemployed student: “What? In the home of the brave, banks are required to hold more equity against loans to the supposedly risky than against loans to the supposedly safe?” 

SME owner: “Yes, ever since the US signed up on the principles of the Basel Accord back in 1988, and especially after the approval of Basel II in 2004, that is how it is. Sorry my dear unemployed student loan debtor, there’s nothing I can do about it! I am just as sad and hurt.”

Indebted unemployed student: “But why would the regulators do a thing like that?”

SME owner: “Beats me. As far as I know all real big bank crises have never ever resulted from excessive loans to “risky” SMEs and entrepreneurs like me, these have always resulted from excessive bank exposures to what banks, and regulators, believed to be absolutely safe, but turn out not to be.”

Indebted unemployed student: “But that’s plain crazy!”

SME owner: “Indeed, it is an odious discrimination, and by killing opportunities it promotes inequality.  But, no one dares to question the regulators, especially when it has become so fashionable to question bankers… or perhaps the regulators are all just statists and love the idea that banks should foremost lend money to government bureaucracy, as well as to their intimate friends of the AAArisktocracy they usually see in Davos.”

This fictitious but sadly too real story, is sent upon request to Rep Elijah Cummings and Senator Elizabeth Warren 

PS. I have always believed students should be given access to student debt as if they were AAA rated, because although they might not have an AAA credit rating, they sure have an AAA rated purpose. That said, much much more important than their debts, are their possibilities of future jobs.

Are these the bank regulators the world needs?

We central bank bureaucrats, we think government bureaucrats are much better at deciding whereto the savings of a society should be allocated, than what private bankers, SMEs and entrepreneurs are. 

And therefore we as bank regulators, government bureaucrats ourselves, have decided to launch the Basel Accord, that which allows banks to hold no equity when lending to the government but requires these to hold 8 percent in equity against any loan to the private sector.

This way we guarantee that whatever net margin our governments, our employers, pay our banks can be infinitely leveraged, so as to be able to produce the banks much higher risk adjusted returns on equity, than whatever returns banks can obtain when lending in fair terms to the private sector.

But of course, our only motivation, is to make banks safer :-)

Down with risky privates! Long live the infallible sovereigns! Government bureaucrats of the World unite!

July 1988: The Basel Capital Accord

PS. One of the benefits with this Accord is that all the subsidies our governments, our employers, are going to receive by having preferential access to bank credit, will not be identified as a tax. Another one is of course that markets will be seen perceiving us as much less risky than usual, which is good. Here among us, in our petit mutual admiration club, we often talk about “the subsidized risk-free rate”.

PS. Warning: We need though to be careful and not overdo it and suddenly have our governments pay negative interest rates on its debts; since then the citizens might begin to suspect not all smells right in the Kingdom.

World, beware of statist and communists dressed up as bank regulators

In July 1988 the Basel Accord (Basel I) approved that banks had to hold 8 percent in capital (equity) when lending to the private sector but that banks were allowed to lend to OECD’s central governments against no capital (equity) at all.

The introduction of such an amazing pro-government bias, I would even call it outright communism, distorted all common sense out of the allocation of bank credit to the real economy. 

And with Basel II, in June 2004, the Basel Committee made it even worse by allying themselves with the private AAArisktocracy, which of course left even more out in the cold, those we most need to have fair access to bank credit, our SMEs and entrepreneurs. 

And now with Basel III, the Basel Committee, with the blessing of the Financial Stability Board, and counting with the collegial silence of the IMF, is increasing regulatory complexity tenfold, and digging us even deeper into the hole.

PS. And, amazingly, Basel I happened while the attention was diverted discussing the supposed pro-private sector bias of the "Neo-Liberal" Washington Consensus.

PS. And even more amazingly... in its many hundred of pages... the Dodd-Frank Act does not even mention the Basel Accord of which US is a signatory or the Basel Committee

PS. Paul Mason just wrote "PostCapitalism". Since pure capitalism clearly ended with the Basel Accord, he must be referring to PostStateCapitalism.

The sad tale about the rookie instructors in the Basel Committee's bank driving school

More perceived credit risk more bank equity… less perceived credit risk less bank equity. Does that not sound logical? It does, and that is precisely why intuition manages to overtake understanding.

Let me try to explain it all with the help of the following image of a two driving wheel car sometimes used by driving schools.

Suppose the driving student is an expert driver, let’s call him a banker, and the driving instructors  is  a rookie who does not know even how to drive well on his own, let’s call him the regulator.

And let us also suppose that the car came with a manufacturing defect, namely the instructor's driving wheel not overriding the student's... and nobody at the driving school cared to check for that.

And now they are out on the street. The banker sees a credit risk danger, and averts it by turning his driving wheel, taking on small exposures and setting the risk premiums high so as to compensate for the added risk.. all as one should normally drive. 

But, seeing the same perceived credit risk, the scared rookie regulator also turns his driving wheel, that of equity requirements. The result will be a dangerous over-reaction to perceived credit risks… either too much steering the car into safety or too much steering it away from the risks that are natural when driving.

You might argue the regulator has accelerating and breaking pedals too he could use. Not so! In this case the regulators of the Basel Committee stated that, making the driving also depend on the speed, was much too complicated for them, and so the driving lessons were to be “portfolio invariant”.

And with bankers already hating velocity where risks seem high… they now do almost no lending at all to “risky” SMEs and entrepreneurs, to those who are those most in need of fair access to bank credit.

And with bankers loving to speed when it seems safe, they crash, where they usually crash, someplace seemingly “very safe”. Unfortunately, now the crashes causes much more tragedy because, when driving around in AAA rated securities, sovereigns like Greece, real estate in Spain and similar "safe"terrains, they are now allowed to drive with little use of safety belts, bank equity.

And here we are biting our nails, thinking about what still lies waiting for us around ultra-safe corners.

ECB, swap the European sovereign bonds you acquired with QEs, for fresh bank equity in European private banks.

My heart goes out to the so many who are unemployed in Europe, as a direct consequence of banks not lending to SMEs and entrepreneurs, this a direct consequence of being required to hold much more of very scarce bank equity when doing so, than when lending to the “infallible sovereigns” or to the AAArisktocracy.

My heart goes out to pension funds, widows and orphans, who do not find a “safe” place for their investment and savings because, as a direct consequence of those same bank equity requirements, they must now compete with banks eager to access debt issued by the “infallible sovereigns” or by the AAArisktocracy.

And growth in Europe is so dismal that even those classified as “infallible sovereigns”, are offering negative rates, which of course is a “haircut”.

I have no idea whether it would be politically viable but, if I was the ECB, and or a government in Europe, the following is the proposal I would put on the table for its urgent discussion:

Assign the same 100% risk weight to all bank assets, so as to allow banks to allocate credit efficiently to the European real economies. 

That would signify an 8 percent equity requirement for all bank assets, which would open up a very significant need for new bank equity.

Let the ECB temporarily fill that hole by subscribing bank equity, paying with the sovereign bonds it has acquired as a consequence of QEs.

In due time ECB would resell those bank shares to the markets. While these shares are in possession of ECB, it will refrain from exercising any voting rights.

Banks can do whatever they want with those bonds… but since holding sovereign bonds would now require them to have 8 percent in equity we can safely assume they would resell these as well as other sovereign bonds they had, to pension funds and widows and orphans.

Banks would as a consequence immediately be able to look again at credit request from the tough "risky" risk takers Europe needs in order to have a future. Enough with not financing the future and just refinancing history J

Bankers, having then to service the dividend aspirations of much more equity, could of course see their bonuses slightly constrained J

And I guess that adequately capitalizing banks, is of some interest not only of those sovereigns in the periphery J

What would happen to current market value of bank shares? We do not know, but perhaps their dramatically increased safety would more than compensate for their much lower allowed leverage, and prices could even go up. Who knows, perhaps even pension funds, widows and orphans could become buyers of European bank shares J

Western world... listen!

God make us daring!

Or do like Chile did!