The insidious credit distorting risk weighted bank capital requirements’ tax, crosses the Laffer Curve at point zero

The Laffer Curve indicates at what rate, a tax will produce less tax revenues for the government.

For purposes of setting the capital requirements for banks in 1988 (Basel Accord) the regulators introduced the risk weighing of banks’ assets. And they decided that loans to the sovereign carried a 0% risk weight, while loans to the citizens (SMEs and entrepreneurs) 100%. 

That means banks need to hold less capital (meaning equity) against loans to the sovereign (meaning government) than against loans to citizens.

That means banks can leverage more their equity with the market risk adjusted interest rates for loans to the sovereign than with the market risk adjusted interest rates for loans to the citizens; which means sovereign will have more and cheaper access to bank loans, a regulatory subsidy, paid by lesser and more expensive access to bank credit for the private sector, a regulatory tax.

That de facto signifies that regulators believe government bureaucrats can make better use of bank credit than the private sector, something that is not true. 

As a consequence of this regulatory distortion, bank credit will not be allocated efficiently to the economy; and so the economy will grow less; and so the tax intake will be smaller; and so the Laffer curve has immediately been crossed. 

Of course, if the current generation does not care about falling tax revenues being compensated with higher debts to be repaid by grandchildren, then this is a moot issue.

PS. Of course all other favoring, like a 20% risk weight for the AAA-risktocracy and 35% for residential housing also to misallocate credit... and thereby cause less ordinary tax revenues. 

PS. Of course, sadly, nothing is gained in term of stability, as never ever do major bank crisis result from excessive exposures to something perceived risky. These results from excessive exposures to something perceived safe, like sovereigns like Greece, like AAA rated securities.

FSB’s Mark Carney is no one to lecture us on inequality, lack of opportunities and intergenerational divide

Mark Carney, the Governor of the Bank of England, in a speech titled “The Spectre of Monetarism” December 5, 2016 said: 

“For both income and wealth, some of the most significant shifts have happened across generations. A typical millennial earned £8,000 less during their twenties than their predecessors. Since 2007, those over 60 have seen their incomes rise at five times the rate of the population as a whole. Moreover, rising real house prices between the mid-1990s and the late 2000s have created a growing disparity between older homeowners and younger renters...  At the same time as these intergenerational divides are emerging, evidence suggests that equality of opportunity in the UK remains disturbingly low, potentially reinforcing cultural and economic divides.”

But Mark Carney is also the current Chairman of G20’s Financial Stability Board and, as such, one of the primarily responsible for current bank regulations… the pillar of which is the risk weighted capital requirements for banks.

That piece of regulation decrees inequality resulting from negating “the risky”, like SMEs and entrepreneurs fair access to bank credit. 

That piece of regulation favors the financing of “safe” basements where jobless kids can stay with their parents over “riskier” ventures that could provide the kids in the future the jobs, so that they had a chance to become responsible parents too.

That piece of regulations is a violation of that holy intergenerational bond Edmund Burke spoke about.

Carney also said: “Higher uncertainty has contributed to what psychologists call an affect heuristic amongst households, businesses and investors. Put simply, long after the original trigger becomes remote, perceptions endure, affecting risk perceptions and economic behaviour. Just like those who lived through the Great Depression, people appear more cautious about the future and more reluctant to take irreversible decisions. That means less willingness to put capital to work and, ultimately, lower growth.”

If any have suffered form “affect heuristic” that is the bank regulators. Mixing up ex ante perceptions with ex post possibilities, these decided on “more risk more capital – less risk less capital”, without: defining the purpose of banks “A ship in harbor is safe, but that is not what ships are for.” John A Shedd; or looking at what has caused bank crises in the past “May God defend me from my friends, I can defend myself from my enemies” Voltaire

Mark Carney also said “For two-and-a-half centuries, the prices of government bonds and the prices of equities tended to move together: the typical bull market entails rising equity prices and falling bond yields, with the reverse in bear markets. Since the mid-2000s, however, this pattern has reversed and bond yields have tended to fall along with equity prices”.

He is not able to connect that to the fact the risk weight given to sovereign debt is 0%, as compared to one of 100% for We the People… and that capital scarce banks therefore shed “riskier” assets in favor of public debt. As statist, Carney also ignores the fact that regulation has subsidized public borrowings, paid of course by negating credit opportunities to SMEs and entrepreneurs.

Must one go on a hunger strike in order to get some contestability from the Basel Committee or the Financial Stability Board?

Perhaps I did not understand all Professor Lawrence Summers answered me at IMF, but he might have understood less of what I asked/argued.

In the IMF’s Annual Research Conference at the end of Professor Lawrence Summers' Mundell Fleming Lecture I had a chance the pose a question (1:18:25)

Here is the short explanation for my question:

Suppose banks believe that a 10% return on equity to shareholder’s resulting from lending to the sovereign is, in terms of risk, equivalent to a 25% return derived from a diversified portfolio of loans to SMEs.

Then if banks held on average 10% in equity, meaning a leverage of 10 to 1, banks would have to earn about 1% in net margins on sovereigns and on average 2.5% to SMEs to produce those desired ROEs.

But, then suppose that banks were told by regulators that though they must hold the usual 10% of equity against SME loans, they were now allowed to lend to the sovereign holding only 5% in equity, meaning an authorized 20 to 1 leverage. Then banks could produce that 10% ROE on equity by obtaining only a .5% net margin on sovereign loans. That would clearly but downward pressure on the interest rates paid on public debt.

And in 1988, with the Basel Accord, the regulators decided that the risk weight for the sovereign was 0% and that of SMEs 100%... meaning banks were allowed to leverage equity immensely more with public debt than with loans to the private sector.

My question: Professor Summers, today you showed a graph that showed the risk free rate going down over the last 30 years, the risk free rate based on the proxy of public debt of course. And Lord Turner also recently showed that same trend. And it started around 1989/90. Can that not have anything to do with the very clear evidence that in 1988 the Basel Accord decided that for purposes of the risk weighted capital requirements for banks, the risk weight of the public sector, of the sovereign was 0%, and the risk weight for us, we the people, 100% 

Professor Summers' answer: Could it have anything to do with it? Yes it could have something to do with it. 

Notice that your explanation is in the category of Ricardo Caballero’s explanation. Its in the category of something has happened that has shifted the relative demand for government bonds versus other things.

And my argument is that, if that were true, what you would expect to see as the major counterpart to the decline in government rates is a major increase in risk premiums. And the fact is that I think is closer to right, a better first approximation I believe, to assume that risk premiums have been relative constant, or not long term trending, and that real rates have declined, than it is to believe that risk premiums have been long term trending.

And therefore I prefer the saving and investment based explanations, rather than the asset specific explanations of the kind that Ricardo adduces, or of the kind you suggest.

My afterthoughts: 

How is it possible to hold that such in favor of the public sector distorting bank regulations, would not have “shifted the relative demand for government bonds versus other things”?

How is it possible, like Professor Summer does, to use the “artificially low public sector debt rates”, as a justification of putting more financial resources in hands of government bureaucrats, to build infrastructure, than in the hands of the private sector’s SMEs and entrepreneurs?

PS. The day after, I got a much more straightforward answer from Mr. Olivier Blanchard.
PS. Here’s my recent, 2019, comments sent to the Financial Stability Board
PS. Here’s my recent, 2019, letter sent to the IMF

To lower the real real-interests in order to stimulate the real economy, take away the too costly subsidies of public debt.

Would any serious economist discuss gas prices at the pump ignoring taxes? No!

Would any serious economist discuss milk prices ignoring various subsidies? No!

Then why have almost all serious economists been discussing low real interest rates on public debt ignoring regulatory subsidies? I have no idea!

In 1988, the Basel Accord, Basel I, for the purpose of setting the capital requirements for banks, decided that the risk weight of the sovereign was 0% and that of We the People 100%. 

That would hence mean that banks would be able to leverage much more their equity, and the value of any explicit or implicit government guarantees they received, with loans to the public sector than with loans to the private sector. 

That would hence mean banks could obtain higher risk-adjusted returns on equity when lending to the public sector than when lending to the private sector.

That would hence mean that the interest rates of bank loans to the public sector included a regulatory subsidy.

That would hence mean that the subsidies for the access to bank credit by the public sector was to be paid by taxing the private sector with more restricted or more expensive access to bank credit.

And that should hence have meant that in order to know the real real-rate on public debt, to the nominal rates, we would have to add the cost of the regulatory taxes paid by the private sector.

That has not been done! All references to the interest rates of public debt have been limited to using the nominal rates. That has led experts like Lawrence Summers, Lord Adair Turner, Martin Wolf and many other, to argue that the public sector should take advantage of extraordinary low rates in order to finance public investments, like in infrastructure.

That is very wrong! If we include the economic cost of restricting the access to bank credit over the decade and around the world, for many millions of SMEs and entrepreneurs, the current real real-interests rates on public debt could in fact be the highest ever.

So, if the Fed, ECB, BoE or any other central bank, really wants to lower the interests in order to stimulate the real economy, then they should begin by asking bank regulators to take away those so very costly subsidies of public debt.

Central bankers might start doing this, in the name of equality, since making it harder than necessary for “the risky” to access bank credit, can only help to increase inequality. 

If bank regulators get too anxious and nervous about this, central bankers can (gently) remind them that there has never ever been a major bank crises caused by excessive exposures to what was ex ante perceived as risky. 

But what if the central banker also wears the hat of bank regulator? Then he has a problem he needs to solve… maybe with the help of some outside counseling assistance?

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!

Statist baby-boomers want us to extract all existent public borrowing capacity, leaving nothing for the future

An article by M. Barton Waring and Laurence B. Siegel titled "The Only Spending Rule Article You Will Ever Need" is introduced by Bob Dannhauser, CFA, the head of global private wealth management at CFA Institute with the following:

“Retirement portfolios can fail us in two ways: living cautiously might ‘leave too much on the table’ when our money outlasts us, but spending too much can mean running out of money before we run out of life.”

In the same way, those statist baby-boomers who scream for more debt financed government spending, taking advantage of current low borrowing rates, seem also to be doing their utmost to extract whatever public borrowing capacity they can from the current economy. You can call it placing a reverse mortgage on the economy if you want, so as to leave absolutely nothing on the table for the next generations. Our children and grandchildren will get the bill!

But, if the baby-boomers live long enough, and economic disasters result from too many bridges to nowhere being built, or just the markets catching up on the fact that even the safest haven can become dangerously over populated, then they could also end up in poverty.

Personally, since I am convinced that because of regulatory subsidies, and the use of monetary policies like quantitative easing, the current low interest rates on public debts are artificially low, I find calls for further indebtedness based on low rates to be highly irresponsible.

Moreover as statist bank regulators have decreed a 0% risk weight for the government and a 100% risk weight for We-the-risky-People, those who could really help to build future, like SMEs and entrepreneurs, are now not getting the credit our children and grandchildren need for them to get.

Paul Krugman

The way governments are cooking it perhaps we should all run to Panama, for our children and grandchildren’s sake.

Look at what government’s are doing.

The regulators set risk weights for public debt at zero percent, which means that the banks need to hold the least capital when lending to those who sort of appoint them, talk about a conflict of interest… talk about lobbying.

The central banks, with their QEs, buy mostly sovereign debt.

And the central banks with their negative interest rates benefit mostly governments, since who in his sane mind would lend to his neighbor at a negative rate?

So really, what do they need our taxes for?

But those who will surely have to pay for all this madness, will be our children and grandchildren, and so perhaps we, responsible fathers and grandfathers, should all be running to Panama and similar places to see what we can safeguard for them.

Here is the explanation for the genesis of the financial crisis of 2007-08 and of the secular stagnation since.

Getting the clue from Charles Goodhart’s “The Basel Committee on Banking Supervision: A History of the Early Years 1974-1997”, in Steven Solomon's “The Confidence Game” we read:

“On September 2, 1986, the fine cutlery was laid once again at the Bank of England governor’s official residence at New Change… The occasion was an impromptu visit from Paul Volcker… When the Fed chairman sat down with Governor Robin Leigh-Pemberton and three senior BoE officials, the topic he raised was bank capital…

Adequate capital – the bank’s buffer against bankrupting loss- was the keystone of a central banker’s mission to uphold financial system safety and soundness. It was the banks’ capital inadequacy that made LDC (Less Developed Countries) over-indebtedness so grave a threat; upgrading U.S. bank capital was Volcker’s strategy to extricate the world financial system from that crisis. 

At dinner the governor’s hopes had been modest: to find areas of sufficient convergence of goals and regulatory concepts to achieve separate but parallel upgrading moves… 

Yet the momentum it galvanized… produced an unanticipated breakthrough of a fully articulated, common bank capital adequacy regime for the United States and United Kingdom. This in turn catalyzed one of the 1980’s most remarkable achievements – the first worldwide protocol on the definitions, framework, and minimum standards for the capital adequacy of international active banks…

They literally wiped the blackboard clean, then explored designing a new risk-weighted capital adequacy for both countries… 

It included… a five-category framework of risk-weighted assets… It required banks to hold the full capital standard against the highest-risk loans, half the standard for the second riskiest category, a quarter for the middle category, and so on to zero capital for assets, such as government securities, without meaningful risk of credit default.”

But then in Alexis Rieffel’s “Restructuring Sovereign Debt”,‪ Brookings Institution Press, 2003 we also read:

“Countries don’t go bankrupt” seems to be the most frequently repeated sound bite associated with the broad subject of sovereign debt workouts. It is everywhere. Former Citibank chairman Walter Wriston is usually cited as the originator of the quip [An Op Ed in New York Times 1982]. This is almost certainly wrong. It was considered conventional wisdom in the international financial community at least a decade earlier”

And there you have it! The regulators completely confused ex ante perceived risks with ex-post realities. The LDC crisis did not result from banks taking large ex ante perceived risks.

And so what resulted? The pillar of current bank regulations, the risk weighted capital requirements for banks. More ex ante perceived risk more capital - less risk less capital.

Which allowed banks to leverage more with The Safe than with The Risky.

Which allowed banks to earn higher risk adjusted returns on equity with The Safe than with The Risky.

Which made banks lend more against less capital to The Safe… like AAA rated securities and sovereigns like Greece. Hence the Financial Crisis!

And which make banks lend less to The Risky, like SMEs and entreprenuers. Hence Secular Stagnation!

Which make banks finance more the basements in which kids can live with parents, than the jobs they need.

PS. Here is an aide memoire on the final monstrous mistakes of such risk weighted capital requirements.

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.

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?

Do we really want to bet our economies on government bureaucrats using bank credit better than SMEs and entrepreneurs?

Those who protest government austerity the loudest are frequently those who most want to force banks to increase their capital. Let us analyze the implications of that position:

If governments are not going to be austere and spend more, and consequentially run deficits, it is only natural governments will need to take on more debt.

If banks are forced to hold more capital then, while the banks find more capital and adjust their business models to those new realities, there is going to be quite a lot of austerity when it comes to the supply of bank credit to the economy.

Since current capital requirements for banks are lower when lending to the government than when lending to the private sector, that will generate a bank credit squeeze on the private sector, affecting most especially those against which loans banks needs to hold more equity, like the SMEs and the entrepreneurs.

The only way to bridge the contradiction between government austerity being something bad for the economy, and bank credit austerity something good for the economy, is of course by believing that government bureaucrats can use bank credit more efficiently than SMEs and entrepreneurs. And that friends, is a truly doubtful proposition on which to bet the future of our economies.

Citizens, it behooves us to unite much more than what government bureaucrats/technocrats unite.

Greece urgently needs lower capital requirements for banks when lending to SMEs than when lending to its government

Between June 2004 and November 2009 thanks to Basel II, banks were allowed to lend to the Government of Greece against only 1.6 percent in capital while requiring banks to hold 8 percent in capital when lending to the private sector.

That meant that banks could leverage their equity 62.5 times lending to the Government but only 12.5 times when lending to the private sector.

That meant, of course, that banks ended up lending much too much to the government and much too little to the private sector, like to Greek SMEs and entrepreneurs.

And here we are with Greece stuck in the doldrums and not finding its way out.

If I were its doctor, I would immediately recommend that banks should be allowed to hold less capital when lending to the private sector than when lending to the government. Since the private sector is the heart of the economy it is very urgent it gets out of it flat-line, by banks pumping the oxygen it needs.

Just before the Berlin Wall felt, communists, statists, dictators and those who benefit from crony statism, gave the liberal capitalistic free-market world the finger.

In 1988, just before the fall of the Berlin Wall in 1989, some communists/statists hacked into the free market capitalist world’s bank regulations. By means of Basel I, and for the purpose of determining the capital requirements for banks, they arranged so that the risk weight for lending to OECD sovereigns was zero percent, the risk weight for lending secured with houses 50 percent, while the risk weight for lending to the private sector was set at 100 percent.

Since the basic capital requirement was set at 8 percent that meant that banks could leverage their capital unlimited times when lending to sovereigns, 25 times (100/4) when financing the purchase of houses and 12.5 times to 1 (100/8) when lending to the private sector... citizens. 

That doomed bank to lend too much to the governments and too much to the housing sector, and basically to abandon the traditional role of banks, namely to provide credit for the private sector, like to SMEs and entrepreneurs. Of course those from the private sector that were exploiting crony statism, they just loved it. 

That de facto reflected the belief that government bureaucrats know better what to do with bank credit they are not personally liable for, than for instance entrepreneurs.

And that in turn doomed the liberal free-market and capitalistic economies of the western world.

That the world suffers under the thumb of neo-liberalism? That's a sad fake-news cover up the statists invented.

How much public debt would have been avoided, or at least priced correctly if banks, when lending to the sovereign, needed to hold that same 8% they were required to hold when lending to the citizen?

Please, for the good of our grandchildren, it might already be too late for our children, help me tear down that wall the Basel Committee built… urgently … Greece was just the tip of the iceberg!

PS. On that day, financial communism was decreed

PS. November 2019, there will be 30 years since the world went from “Tear Down that Wall” to the “Build Up that Wall” for 30 years.

PS. Here is an aide memoire on the mistakes in the risk weighted capital requirements for bank made so much worse with the introduction of Basel II in 2004.

A letter to the Financial Stability Board

A letter to the IMF titled: "The risk weights are to access to credit, what tariffs are to trade, only more pernicious."

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.

What I would be tempted to say to Mario Draghi of the ECB, if I were Yanis Varoufakis of Greece

Mr. Mario Draghi.

You were the chairman of the Financial Stability Board for some years. In this respect, and especially since we have never heard you say otherwise, you were in full agreement with current bank regulations.

These regulations allowed any European bank to leverage much more when lending to the Government of Greece, or to other sovereigns, than when doing any other type of lending in Europe. For instance, Basel II restricted banks to leverage their equity to not more than 12 to 1 when lending to any unrated small business or entrepreneur in Europe, while allowing a leverage of more than 60 to 1 when lending to our government.

And so bankers became too interested in tempting our government with credit; and sadly our government-officials/politicians were unable to resist the sirens, and got too much into debt; and those Greek small businesses or entrepreneurs, those who with their activities are to generate the fiscal income needed to pay for our government’s expenses, they have had their fair access to bank credit severely curtailed.

And so I hold that you, Mario Draghi, are directly co-responsible for Greece’s current tragic predicaments.

Therefore, please allow me to speak with somebody else in the ECB.

PS. What is not included in the Memorandum on Economic and Financial Policies.

PS. Mr. Yanis Varoufakis, ask your own Greek bank regulators the following:

"Why on earth should a bank, operating in Greece, be allowed to lend to well-rated corporations elsewhere, or to sovereign governments, holding less equity than when lending to Greek SMEs and entrepreneurs?

I mean that does not sound right. That sound like a regulatory tax on our “risky” borrowers and a regulatory subsidy to strange “safe” borrowers."

All our bankers (including Jamie Dimon) betrayed us citizens by selling out to sovereigns and the AAArisktocracy.

Bank regulators, and because these borrowers are perceived as absolutely safe, allow banks to have much less equity when lending to sovereigns and the AAArisktocracy, than when lending to “risky” small businesses and entrepreneurs.

And that means that banks make much higher risk adjusted returns on equity when lending to the safe than when lending to the risky… and bonuses receiving bankers of course love it.

Some bankers, those who use very low equity requirements as hormone supplements, in order to grow into Too-Big-To-Fail-Banks, love it especially much.

And the bankers love it so much they do not care one iota about that this effectively blocks “The Risky” from gaining fair access to bank credit; or about that this pushes our economies more into the hands of the unholy alliance of governments, AAArisktocrats and some few TBTF-banks.

Yes, we citizens, we who need our banks to give small businesses, entrepreneurs and start-ups lots of access to bank credit, because that is how the future of our grandchildren is financed, we have been betrayed.

We are told that this is all in our best interest, because that is the way banks avoid taking the risks which would cause us tax-payers having to pay for supporting failed banks. Lies, lies, lies! 

What’s so good about low taxes when these regulations stand in the way of our possibilities of high pre-tax earnings? 

And, on top of it all, the real risk for banks never really exist for that which is perceived as "risky", it always derives from that which is perceived as "absolutely safe"… like “infallible sovereigns” and splendid credit ratings.

My comments for IMF's revision of its "Code of Good Practices on Fiscal Transparency"

Washington, February 4, 2013

International Monetary Fund

Dear Sirs,

You hold that “Fiscal transparency – defined as the clarity, reliability, timeliness, and relevance of public fiscal reporting and the openness to the public of government’s fiscal policy-making process - is a critical element of effective fiscal policymaking and risk management. Without comprehensive, reliable and timely fiscal information, governments cannot understand the fiscal risks they face or make good budget decisions. If citizens don’t have access to this information, they cannot hold governments accountable for those decisions.”

And the IMF, now seeking comments for the revision of its Code of Good Practices on Fiscal Transparency and related instruments specifically asks:

“Does the Code adequately address all of the most important aspects of fiscal transparency? What practices should be dropped? What practices should be added? Which practices should be updated to reflect recent developments in fiscal reporting standards and practices or the lessons learned from the crisis?”

In this respect I would submit that any “Good Practice on Fiscal Transparency” should also look to identify the presence of any hidden subsidies and or taxes that might affect government’s fiscal affairs, and, if possible, provide estimates as to their significance.

Specifically I refer to the fact that current bank regulations require banks to hold much more capital against assets perceived as risky, like loans to small businesses and entrepreneurs, than for assets perceived as “absolutely safe”, like loans to “infallible sovereigns”.

This translates into that a bank can leverage its equity man y time more the dollars paid by “the infallible sovereign” in risk-adjusted interests, than the same risk-adjusted dollars paid by “the risky”.

That translates directly into a regulatory subsidy of the government’s bank borrowings, paid by “the risky bank borrowers” by means of higher interest rates, and paid by the society at large by means of the opportunity cost that might be present in allowing the public sector to borrow much easier and much cheaper than the “risky” private sector, than what would have been the case in the absence of this regulations.

That translates into giving banks incentives to dangerously overpopulated safe-havens, and equally dangerous for the real economy, under explore some more risky but perhaps more productive bays; something which of course introduces a distortion that makes it impossible for banks to perform their utterly important function of allocating economic resources efficiently.

That also translates into that one of the most important theoretical rates there is in finance, the risk-free rate, usually approximated by the rate to the “most infallible sovereign” is a subsidized rate and which of course makes it impossible for the government and the markets, to know where the real risk free rate is. In other words one of the fundamental instruments needed to navigate the economy gives wrong readings.

Since there are also sovereigns who are deemed not so infallible and so against their borrowings banks are required to hold more capital, this also translates into an effective global capital control that helps to channel funds away from what is ex-ante perceived as risky into what is ex ante perceived as infallible. In other words these capital controls only help to increase the existing gaps between “the risky developing” and the “infallible developed”.

In conclusion I ask of the IMF to try to estimate all the fiscal effects of what is described above, or to respond publicly why in IMF’s opinion my arguments might be wrong, or plain irrelevant.

Sincerely,

Per Kurowski

A former Executive Director at the World Bank (2002-2004)

The subsidized risk-free rate

A theoretical rate, and a major benchmark in the world of finance, is the one which is known as the "risk free rate". Of course, since nothing is completely free of risk, it is normal, as an approximation, to use as that the interest rate which country perceived to have the strongest economies need to pay in order to service their debt, for example the United States. 

But I argue that this "risk free rate" has been consciously or unconsciously (I pray for the latter) manipulated by the Basel Committee on Banking Supervision, the Committee which seeks to be the manager of all world’s banking risks. 

This committee came up with, and the imposed, capital requirements for banks which depend on the risk of the various assets, primarily as perceived by the credit rating agencies and to whom they outsourced much credit analysis. 

When doing so the committee completely ignored, consciously or without thinking (I pray for the latter) that the perceived risks were already considered by banks when setting the interest rates, the amount of the loans and all other terms, let us say of the numerator. Consequently, when the regulators decided the same perception of risks also needed to be reflected in the capital, let us say in the denominator, they condemned the entire banking system to overdose on perceived risk. 

And that has meant that all those who are perceived as being more risky, be they countries, companies or citizens, have to pay higher interest rates and receive smaller loans, than what would have been the case in the absence of these regulations. 

And so also that all who are perceived as less risky, like “solid” sovereigns and corporations with high credit ratings, will pay much lower interest rates and receive many more and larger loans, than what would have been the case in the absence of these regulations. 

And the above distorted and dislocated world economies more than you could believe. Not only did it encourage a dangerous overcrowding of all safe-havens, but also by dangerously ignoring that risk-taking is the oxygen of any development, and that the "absolutely not risky "of today, were almost always the "risky" of yesterday. 

And this means that the "risk free rate" which we today observe in the market, is actually the "risk-free rate less the value of the Basel Committee’s regulatory subsidy”. 

And this means that the flight instruments which the markets and the central banks in the world use, simply do not give correct readings. 

How is this possible? "One has to belong to the intelligentsia to believe things like that: no ordinary man would be such a fool" George Orwell, Notes on Nationalism, 1945. 

Or, as Patrick Moynihan would have explained it: "There are some mistakes it takes a Ph.D. to make”

Translated from El Universal 

Here in Spanish http://bombaaaa.blogspot.com/2013/01/la-subsidiada-tasa-libre-de-riesgo.html

PS. https://subprimeregulations.blogspot.com/2015/07/the-financial-stability-board-makes.html
PS. https://subprimeregulations.blogspot.com/2016/10/since-bank-regulators-in-1988-decreed.html
PS. https://subprimeregulations.blogspot.com/2016/11/olivier-blanchard-agrees-there-is-need.html

PS. http://perkurowski.blogspot.com/2019/09/financial-communism.html