Showing posts with label asset bubble. Show all posts
Showing posts with label asset bubble. Show all posts

Thursday, March 24, 2016

Please, let us not favor financing our houses more than the jobs our kids and grandchildren need


Avinash Persaud correctly states: “This story is not just about mortgages but also about the overall allocation of liquid and illiquid assets across the financial system” March 2016

Yes, indeed it is. I have for soon two decades criticized that the Basel Committee's concept of risk-weighted capital requirements for banks, dangerously distorts the allocation of bank credit.

Persaud writes: “Under Basel I, in the calculation of the amount of risk-weighted assets a bank had to fund with capital, securitized mortgages had a risk weight of 20 percent while nonsecuritized mortgages had a risk weight of 50 percent.” And Persaud translates that into “This allowed banks to earn fees and net interest margins on holding 2.5 times more credit”

A more precise description is that Basel I assigned a 50% weight to loans fully secured by mortgage on residential property that is rented or is (or is intended to be) occupied by the borrower, and Basel II reduced that to 35 percent. And Basel II also introduced that security or any financial operation that could achieve an AAA to AA- rating, was assigned a 20 percent weight.

And I translate that as: With Basel I and II’s standard risk weight of 8 percent, anything that has a risk weight of 100%, like loans to unrated SMEs and entrepreneurs, means banks can leverage its defined capital 12.5 times to 1 (100/8). 

But if it has access to a 20 percent risk weight, the bank can leverage its defined capital 62.5 times to 1 (100/1.6)

And banks, naturally, operate to maximize risk-adjusted returns on equity (and bonuses to the bankers).

And so there can be no doubt banks will allocate much to much credit, in much to easy conditions to mortgages and AAA rated securities (and to sovereigns with a zero percent risk weight) and much too little credit, in much to harsh relative terms, to what is risk weighted more than that like, SMEs and entrepreneurs.

And so, while I fully share Persaud’s argument about preferring insurance companies to banks to finance mortgages, so as to minimize maturities mismatches, my concerns go much further than his.

I do not want to favor, in any way shape or form, the “safe” financing of mortgages, whether by banks or insurance companies, over the “risky” financing of the job creation our children and grandchildren need.

PS. What would houses be worth if there was no financing available for buying houses? I ask because mortgages might now be financing more the credit available for buying houses than the real intrinsic value of houses. Oops!


PS. A memo on the many mistakes of current risk weighted capital requirements for banks

Saturday, March 21, 2015

Our economies are bloated by QEs, low interests and other stimuli, and the lack of real risk-taking.

Tarps, fiscal deficits, QEs and minimal interest rates, in an economy where regulators have by means of risk-weighted equity requirements de facto prohibited banks to take real risks, like lending to SMEs and entrepreneurs, only to take on false risks, like leveraging too much on what is "safe", has created a bloated economy full of assets with inflated values... and helped finance the permanence of inefficiencies that should have been long gone.

The economy now needs to fart, urgently, but boy is it going to be embarrassing smelly… and painful!

That deflation is not curable with factory produced inflation but only with the type of sturdy growth that can justify the relative values of all assets. You do not live on existing assets alone.

You cannot grow muscles by staying in bed just eating fats and carbs... you need exercise and proteins... even if "risky" 

Way back I had a feeling this had to come sooner or later. 

PS. I now feel sort of like a Chance the gardener (Physician) :-)


But who knows, Mario Draghi and his colleagues might all just be Chauncey Gardiners too :-( 


And what could lead to less inequality: to inflate the value of assets that are already owned or to try to create new assets?

Friday, June 20, 2008

A letter in Washington Post: An Aspect of the Bubble

An Aspect of the Bubble

The June 17 installment in the front-page series "The Bubble," though comprehensive, missed one vital piece of the subprime mortgage puzzle. The accompanying glossary defined a "credit rater" as "a company that Wall Street and investors rely upon" to provide analysis but did not tell us that a credit rater's credibility is foremost based on the rater's having been appointed by bank regulators. This arrangement sent the market the loud, clear and false message that risks could be precisely measured and that these entities were capable of carrying out this mission.

Nothing whetted the appetite for securities collateralized with plainly lousy mortgages as much as the combination of high returns and prime credit ratings. Using a regulatory system for banks that is based on following the credit rating agencies will, given that it is human to err, lead us into even greater danger.

Thursday, September 6, 2007

A letter in Washington Post: Factors in the Financial Storm

Factors in the Financial Storm

 David Ignatius, in his Sept. 2 op-ed, "The Real Causes of the Financial Storm," failed to mention the two lead actors in the financial mess we find ourselves in: the credit rating agencies, whose AAA ratings turned what should have remained a local problem involving some subprime lenders into a global financial storm; and, of course, the bank regulators who against all wisdom enabled the credit rating agencies to foist what they consider to be only their First Amendment-enabled opinions upon the markets.

In May 2003, as one of the 24 executive directors of the World Bank, and probably only because of that, I was invited to make some comments during a workshop arranged by the World Bank for bank regulators on assessing, managing and supervising financial risk. Along with offering some suggestions, I told the regulators, "I simply cannot understand how a world that preaches the value of the invisible hand of millions of market agents can then go out and delegate so much regulatory power to a limited number of human and very fallible credit rating agencies. This sure must be setting us up for the mother of all systemic errors."

I never got invited to comment again.

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