My tweets to IMF and World Bank on risks and bank regulations during their Annual Meetings 2019

@IMFNews @WorldBank #IMFmeetings #WBGMeetings

The world needs the IMF and World Bank to hold a continuous and intensive back and forth debate, a give and take, on risk-taking. 

“A ship in harbor is safe, but that is not what ships are for.” John A. Shedd.

http://teawithft.blogspot.com/2009/10/please-free-us-from-imprudent-risk.html

The World Bank, as the world’s premier development bank should always make clear that risk taking is oxygen needed for moving forward.

And the IMF, as guardian of the world’s financial stability, is responsible for that risk taking not getting out of hands. 

http://subprimeregulations.blogspot.com/2003/03/financial-sector-assessments-program.html

That debate has sadly not been forthcoming.

That resulted in the acceptance of the credit risk weighted bank capital requirements. 

That introduced a regulatory risk aversion, dangerous both for the financial stability and for economic growth.

For financial stability, by creating excessive bank exposures to what’s perceived, decreed or concocted as especially safe, against especially little capital.

For the economy, by reducing the “risky” but vital SMEs’ and entrepreneurs’ access to bank credit.

A synchronized financialization: 

"A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind."

http://subprimeregulations.blogspot.com/2003/03/my-comments-on-world-banks-strategic.html

A synchronized disaster:

“Perceiving risks wrong: What happens when markets misprice risk?”

Wrong question! When markets see risks, it stays away 

Correct question! “Perceiving safety wrong: What happens when markets (and regulators) misprice safety?

http://subprimeregulations.blogspot.com/2019/07/risk-weights-are-to-access-to-credit.html

Should our nannie state tax all risk-taking at higher rates, as current bank regulators do?

Motorcycles, in terms of deaths per miles driven, are much riskier than cars. Should society therefore levy a special risk tax to compensate it for the unnecessary early death of its members? (Even though we know more people die in car than motorcycle accidents) 

Since sport injuries have a cost for the society should we tax sports based on their injury rates? For instance applying a 10 percent risk tax on cricket and one of only 1 percent on croquet (pesky squirrels).

If one assumes that the risks involved with any activity are not adequately perceived or considered, one could of course construe a case for those taxes. But, should we dare to assume risks are not already perceived and cleared for if we therefore could end up with a very risky too risk adverse society?

And I ask all this because taxing risk-taking is exactly what current regulators do with their risk weighted capital requirements for banks.

They now require banks to hold more capital against what is already perceived as riskier (motorcycles) than against what is perceived as safe (cars). This translates into banks having much higher possibility of maximizing their returns on equity with what is “safe” than with what is “risky”; which de facto is a tax on “the risky”.

Consequences? Banks build up dangerously large exposures to what is perceived, decreed, or concocted as safe, like sovereigns, AAArisktocracy and mortgages; and to small exposures, or even no exposure at all to what is perceived as risky, like SMEs and entrepreneurs.

Clearly if the risks are already perceived and considered by bankers, in the size of the exposure and the interest rates charged, to then also have the capital reflect the perceived risks, cause these risks to be excessively considered; resulting in an excessively risk-adverse banking system.

Just consider that already, partly because of the higher risk perceptions, many more people die in car than in motorcycle accidents. 

Think of a society where no one drives motorcycles or plays cricket because the risk-taxes are too high, and all keep to cars and crocket. Is that the kind of society that will be strong enough to survive? Is that what we want?

I am sorry but there is no more figurative way to express it. The Basel Committee for Banking Regulations and their affiliated regulators have effectively castrated our banking system. Will that make us safer? Of course not! 

Our banks will dangerously overpopulate safe-havens; in which they will die from lack of oxygen.

Our economies are going to dwindle into nothing, when denied the oxygen of risk-taking necessary for all development.

Friends, we must urgently get rid of these dangerously inept bank nannies.

How the Western civilization is being lost because of regulatory induced risk aversion.

Mark Twain has been attributed opining that bankers lend you the umbrella when the sun shines and want it back as soon as it looks it could rain.

And never ever has there been a bank crisis caused by excessive exposures to something perceived as risky when placed on banks’ balance sheets.

But that did not stop scared lack of testosterone bank nannies to also require banks to hold more equity when lending to the risky than when lending to the “safe”.

So what happened? 

As banks earned much higher risk adjusted returns on the safe they could not resist the AAA rated securities backed with mortgages to the subprime sector, or sovereigns like Greece. And so a typical bank crisis, that of excessive exposures to what was ex-ante perceived as safe but that ex post turned out very risky ensued. 

In this case the crisis was made specifically worse, by means of the lower equity banks had been authorized to maintain. For example in the case of the AAA rated securities, Basel II, because of the standardized risk weights, banks were required to only hold 1.6% in capital, meaning an authorized leverage of 62.5 to 1. 

But much worse, since banks of course find it harder to earn higher risk adjusted ROEs on more capital, they have abandoned lending to risky SMEs and entrepreneurs, those who open up new roads on the margins of our economy, and so of course slower economic growth results.

Lack of testosterone, risk aversion, is not a fundamental value of the Western civilization. On the contrary in churches we sometimes sang, or at least used to sing, “God make us daring!”

@PerKurowski

Why are excessive bank exposures to what’s perceived safe considered as excessive risk-taking when disaster strikes?

In terms of risk perceptions there are four basic possible outcomes:

1. What was perceived as safe and that turned out safe.

2. What was perceived as safe but that turned out risky. 

3. What was perceived as risky and that turned out risky.

4. What was perceived as risky but that turned out safe.

Of these outcomes only number 2 is truly dangerous for the bank systems, as it is only with assets perceived as safe that banks in general build up those large exposures that could spell disaster if they turn out to be risky.

So any sensible bank regulator should care more about what the banks ex ante perceive as safe than with what they perceive as risky.

That they did not! With their risk weighted capital requirements, more perceived risk more capital – less risk less capital, the regulators guaranteed that when crisis broke out bank would be standing there especially naked in terms of capital. 

One problem is that when exposures to something considered as safe turn out risky, which indicates a mistake has been made, too many have incentives to erase from everyones memory that fact of it having been perceived as safe.

Just look at the last 2007/08 crisis. Even though it was 100% the result of excessive exposures to something perceived as very safe (AAA rated MBS), or to something decreed by regulators as very safe (sovereigns, Greece) 99.99% of all explanations for that crisis put it down to excessive risk-taking.

For Europe that miss-definition of the origin of the crisis, impedes it to find the way out of it. That only opens up ample room for northern and southern Europe to blame each other instead.

The truth is that Europe could disintegrate because of bank regulators doing all they can to avoid being blamed for their mistakes.

Banks, regulators and sovereigns, colluded to introduce, statism, risk aversion and complacency.

It's hard to pinpoint the exact meaning of complacency, especially as that sentiment could have different origins. I am not really sure what it means to Tyler Cowen, but to me, complacency, is quite often only a more comfortable and somewhat hypocritical expression of a “Please don’t rock the boat” wish.

I now quote extensively from Tyler Cowen’s “The complacent class” (page 13)

“One thing most Americans agree on it politics–for all the complaining about the bank bailouts–is that there should be more guaranteed and very safe assets. The Federal Reserve Bank of Richmond has estimated that 61 percent of all private-sector financial liabilities are guaranteed by the federal government, either explicitly or implicitly. As recently as 1999, this figure was below 50 percent. We’re also more and more willing to hold government-supplied, risk free assets, even if they offer very small or zero yields… Plenty of commentators suggest that something about this isn’t right, but again the push to fix it is extraordinarily weak, especially since that would mean someone somewhere would have to take significant financial losses.

There is a Zeitgeist and a cultural shift well under way, so far under way in fact that it probably needs to play itself out before we can be cured of it. The America economy is less productivity and dynamic, Americans challenge fundamental ideas less, we move around less and change our lives less, and we are all the more determined to hold on to what we have, dig in, and hope (in vain) that, in this growing stagnation, nothing possibly can disturb our sense of calm.”

Is it really so as Cowen seems to argue, that the Home of the Brave, that which has developed based on considerable doses of risk-taking by risk-takers, now comes to this complacency on its own... or was it entrapped?

I argue the latter. One way or another, regulators managed to sell to a financially naïve political sector the concept that it was possible for bank regulators, or for the more sophisticated banks’ risk models to determine real-risks, and so introduced risk-weighted capital requirements… topping it up by putting aside all considerations as to whether this could distort the allocation of credit to the real economy.

In 1988 America induced and signed up on the Basel Accord, Basel I. That ruled that for the capital requirements banks needed to hold, the risk weight of the sovereign was to be zero percent, 0%; for mortgages to the residential housing 55%; and for loans to We the People 100%.

In 2004, with Basel II, the risk-weight for residential mortgages was reduced to 35%; We the People were also split up in “the safe”, the AAA rated, the AAArisktocracy with a risk weight of 20%; passing through a risk-weight of 100% for those not rated ordinary citizens; and topping it out at 150% for those rated below BB-.

What did this mean? First that regulating technocrats, sent out the falsely tranquilizing message to the market of “Don’t worry, banks are now risk-weighted”. Second, that statists told banks: “We scratch your back and you scratch ours… the State guarantees you, and you lend to the State as cheap as possible”. 

Of course that immediately resulted in that banks would search out any assets that were decreed, perceived or concocted as safe; as with these banks could leverage more and therefore obtain higher risk adjusted returns on equity… which much explains the much increased appetite for “safe assets”, in America and Europe.

Of course that meant that the sovereign would by artifice receive much more bank credit, at much lower rates than usual; making a joke of that “risk-free-rate” used in finance. 

Of course that immediately resulted in that banks would avoid all assets officially perceived as “risky”, like loans to SMEs and entrepreneurs, as with these banks could leverage much less and therefore obtain lower expected risk adjusted returns on equity… which of course affected the productivity and the dynamism of the real economy, in America and Europe.

Of course that meant banks would prefer financing the construction of the “safe” basements were young unemployed can live with their parents than the riskier future that could create the jobs they need… which reduces mobility as more and more get to be chained to houses with artificially high prices.

And a truly sad part of all these induced statism and risk aversion is that it does not lead to any more bank stability, much the contrary. Major bank crises are caused by unexpected events (e.g. devaluations), criminal behavior (e.g. loans to affiliate) and excessive exposures to what was ex ante perceived as very safe but that ex post turns out to be very risky, among others because being perceived as very safe often causes it to receive too much bank credit.

What caused the 2007-08 crisis? Excessive exposures to what was perceived or decreed as safe as AAA rated securities and sovereigns like Greece.

What has caused stagnation thereafter? Lack of lending to SMEs and entrepreneurs, those best equipped to open up new paths.

Where banks in on this? Answer would banks like being able to earn the highest risk adjusted returns on equity when holding what they perceived as the safest? Of course they would, that sounds like bankers’ wet dreams come true.

I find “The Complacent Class” to be a fun and very useful book, and it could help get very important and needed debates going. That said I would like to see Tyler Cowen substantially updating the second edition of it, by including that dangerous risk aversion and complacency imposed on banks and on America (and Europe) by its regulators.

Bank regulators should be forced to see “Hell on Wheels” and read John Kenneth Galbraith’s “Money: Whence It Came, Where It Went”

In the TV series Hell on Wheels, its main character, Cullen Bohannon, when asked to testify before the US Senate about all the obvious corruption of Thomas ‘Doc’ Durant, someone absolutely not Bohannon’s friend, someone absolutely not one having been sanctimonious or behaved according to any social norms, repeats, over and over again, to the great chagrin of his interrogators: “The Transcontinental railroad could not have been built without Thomas Durant”

And John Kenneth Galbraith wrote in his “Money: Whence it came where it went” 1975 the following: “For the new parts of the country [USA’s West]… there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business...[jobs created]

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

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

Therefore I cannot but conclude in that bank regulators should be forced to see “Hell on Wheels” and read John Kenneth Galbraith’s “Money: Whence It Came, Where It Went”. That in order to, hopefully, be able realize that with their risk weighted capital requirements for banks, these will not finance the risky future, but only refinance the safer past and present and, as a result, the economy will stall and fall. 

To add insult to the injury, bank regulators are doing all this in the belief that bank crises result from excessive exposures to what is perceived as risky, which is utter nonsense. Bank crises have always, and will always, result from uncertainties; that which includes unexpected events, like devaluations earthquakes and regulators not knowing what they are doing, criminal behavior and excessive exposures to something ex ante perceived as safe but that ex post turned out to be very risky.

“If you see something, say something”. Someone should run to the Homeland Security of the Home of the Brave and denounce that, most probably, unwittingly; some serious terrorism is taking place by means of dangerously risk adverse faulty bank regulations.

Must one go on a hunger strike to have the Basel Committee or FSB answer some very basic questions?

Before regulating banks did you ever define their purpose? I know we all want them to be safe but, as John Augustus Shedd said: “A ship in harbor is safe, but that is not what ships are for.” 

By allowing for different capital requirements based on ex ante perceived risks of assets, banks will be able to leverage their equity (and the support given by authorities) differently, which will cause quite different expected risk adjusted returns for different assets, than would have been the case in the absence of this regulation. Were you never concerned about how this would distort the allocation of bank credit to the real economy? 

Since ex ante perceived risk were already considered by bankers when deciding on the amounts of exposures and interest rates, when you decided that the perceived risk was also going to determine capital requirements, you doubled up on perceived risk. Don’t you know that any risk, even if perfectly perceived, causes the wrong actions if excessively considered? 

In the case of larger and more “sophisticated” banks, you allowed these to use their own internal risk models to determine capital requirements. (Something like allowing Volkswagen to calculate their own emissions) Was it not naïve of you to believe banks would not naturally aim for lower capital requirements, in order to increase their expected risk adjusted returns on equity?

What’s perceived as safe can be leveraged into being utterly dangerous, only because of that perception; while what’s perceived as risky is automatically less dangerous, precisely because of that perception. Or as Voltaire said: “May God defend me from my friends, I can defend myself from my enemies”. In this respect can you explain the logic behind your standardized Basel II risk weights of 20% for what is AAA to AA rated, and 150% for what is rated below BB-? 

In the same vein what empirical research did you carry out to determine that what is perceived ex ante as risky has caused major bank crises? I ask because as far as I know these have always been caused by unexpected event, like natural disasters or devaluations, by fraudulent criminal behavior, or by excessive exposures to what ex ante was considered as safe but that ex post turned out to be very risky. 

In other words since bank capital is there for the unexpected is it not dumb to require it based on the expected?

A risk weight of 0% for the sovereign, and 100% for We the People clearly implies you regulators all believe government bureaucrats make better use of bank credit than the private sector. Are you really such statists? Did you never consider that such dramatic rearrangement of economic power needed approval by for instance a Congress or a Parliament… or even a referendum? 

Finally do you really believe that with such risk adverse regulations, layered on top of banker’s own risk aversion, our economies would have developed as they did? Don't you see that banks are no longer financing the riskier future but only refinancing the "safer" present and past? Don't you see this decrees inequality?

PS. FT’s / Financial Times Establishment, notwithstanding my soon 2.500 letters to it on “subprime bank regulations” has also steadfastly refused to help me get answers to these questions.

PS. And here is one evidence of that I have posed my objections during formal consultations by the Basel Committee

PS. And I dreamt I got this letter with their answers!

PS. And I am 100% for the 10% on all assets capital requirement for small banks in the Financial Choice Act. I just hope it was applied to all banks, foremost the biggest, as these need it the most, as we need these to be better capitalized the most.

Jeb Hensarling asks: How we can make the economy work for working people? Here’s my answer:

Jeb Hensarling, the chairman of the Financial Services Committee asks: How we can make the economy work for working people

Here’s my answer:

Get rid of the risk-weighted capital requirements for banks!

These only distort the allocation of bank credit to the real economy.

These only help finance the “safe” basements where jobless kids can live with their parents but not the “risky” new job creation they would need to afford to become parents too. 

These stop banks from financing the risky future and make these only refinance the "safer" past and present.

Where would America, the Home of the Brave, have been if its banks had been subjected all the time to this type of regulatory risk aversion?

“A ship in harbor is safe, but that is not what ships are for.” John A Shedd, 1850-1926

The risk weighting has de facto decreed inequality

God make us daring!

Besides it is all for nothing. Bank crisis are caused by unexpected events, criminal behavior and excessive exposures to what was ex ante perceived as very safe when placed on the banks’ balance sheets, but that ex post turned out to be very risky. Never ever are bank crisis the result from excessive exposures to what was ex ante perceived as risky. “May God defend me from my friends, I can defend myself from my enemies” Voltaire

Now, if you are rightly concerned that getting rid of the risk weighting would initially create such bank capital shortages that it would put a serious squeeze on credit; then grandfather the current capital requirements for all their current assets, and apply a fixed percentage, like for instance 8%, on all new assets… including public debt, since a 0% risk weight for the Sovereign and 100% for We the People seems to me, I beg your pardon, an insult to your Founding Fathers.

Finally, if regulators absolutely must distort, so as to think they earn their salaries, may I suggest they use job-creation and environmental-sustainability ratings instead of credit ratings, which are anyhow already cleared for by banks.

Europe beware, to reward banks for less risky business models is way too risky and no way to build a future.

I now read that Valdis Dombrovskis, the EU’s financial-services chief said it’s important to make sure the rules continue to “reward banks with less risky business models” “Bank Regulators Face Santiago Showdown on Capital Overhaul” Bloomberg, November 17.

NO! That is precisely what is wrong with current risk weighted capital requirements for banks. It guarantees that safe-havens will become dangerously overpopulated against little bank equity; and that for the economy more productive though riskier bays, like SMEs, will remain equally dangerously unexplored.

It guarantees the building of many basements for jobless youth to stay with their parents and not the financing of the job creation that could allow those kids the possibility to afford being parents too.

It hinders the financing of the riskier future in order to refinance the “safer” present and past.

Risk-taking is the oxygen of all development. Where would Europe be if these regulations had been with us since banks' inception more than 600 years ago?

If banks cannot afford to immediately adjust their capital to larger capital requirements and so therefore credit to the economy would be affected, grandfather the current requirements for all existing assets, but then see to that all new bank assets are freed from the distortions the risk weighted capital requirements produce.

Should regulators stop banks from using their own risk models to set the capital requirements? Of course they should! That whole notion is about as silly as it gets. It is like allowing children to decide on the nutrition value of ice cream, chocolate cake, broccoli and spinach.

Any risk manager that has any idea of what he is doing, begins by identifying clearly the risks that one cannot afford not to take. The risk that banks take allocating credit as efficiently as possible to the real economy, is such a risk.

“A ship in harbor is safe, but that is not what ships are for.” John A Shedd, 1850-1926

God make us daring!

Free us from imprudent risk aversion!

PS. Besides it would be so useful if regulators just looked at what has caused all major bank crisis in history; namely unexpected events, criminal behaviour and excessive exposures to what was ex ante perceived as very safe when placed on the banks’ balance sheets but that ex post turned out to be very risky. Never ever have bank crises resulted from excessive exposures to what was perceived as risky. Therefore the current Basel risk weights of 20% for AAA rated and 150% for the below BB- rated is as loony as it gets.

PS. And if regulators absolutely must distort, so as to feel they earn their salaries, may I suggest they use job-creation and environmental-sustainability ratings, instead of credit ratings that are anyhow cleared for by bankers.

PS. And frankly, is not 0% risk weight for the sovereign and 100% for We the People too statist, even for Europe?

Mr R Gandhi, ignore the Basel Committee’s mutual admiration club, and concentrate on the needs or your India.

Mr R Gandhi, Deputy Governor of the Reserve Bank of India, at the FIBAC 2016 in a speech titled “New horizons in Indian banking”, Mumbai, 17 August 2016 said the following: 

“I regret that at the very end of these two days deliberations on future of banks, I have to paint such a dismal future for your existence as banks….One big area, you vacated and / or let others to occupy by your lackluster attitude is there for your rightful reclaim, if only you make concerted and conscious effort. That is SME financing. Small and medium sized enterprises (SMEs) are a major, yet often overlooked sector by formal financial institutions. The SMEs reportedly account for more than half of the world’s gross domestic product (GDP) and employ almost two-thirds of the global work force. However, they are the neglected lot world over. As reported by the International Financial Corporation (IFC), a “funding gap” of more than $2 trillion exists for small businesses in emerging markets alone...

I can only conclude with the idea that if you make yourself socially relevant, not just relevant in economic sense alone, you can have hopes to exist”

Holy moly. unless Mr R Gandhi is simply thickheaded and does not understand, he should be ashamed of trying to blame the banks for this ignoring his own responsibilities as a regulator.

Who told banks to get out of SME financing? The bank regulators did; by requiring banks to hold much more capital when lending to SMEs than when lending to those perceived as safer. That made it difficult for banks to earn competitive risk adjusted returns on equity lending to the SMEs.

Who made banks socially irrelevant? The bank regulators did, by regulating banks without ever having defined their purpose… like that of allocating credit efficiently to the real economy.

And since risk-taking is the oxygen of any development, a developing country like India is one of those who could least afford to introduce regulatory risk aversion. Not as if those developed can either, but at least they have reached higher altitudes before starting to climb down their mountains.

In 2007, at the High-level Dialogue on Financing for Developing at the United Nations, I explained why the Basel regulations were harmful to development, and my opinion was even reprinted in October 2008 in the Icfai University Journal of Banking Law.

Sadly though, as happens with most central bankers and regulators from developing countries, they end up more interested in being accepted by their peers in the developed countries, and in belonging to their mutual admiration club, than in doing what is best for their own countries.

It is prudent for our banks to take risks on the not so creditworthy, especially if these are up to something worthy

In a recent article in the Financial Times a bank was mentioned to be “an exemplar of prudence…[because] The target loan loss ratio is zero; [and] low loan losses, in turn, allow the bank to offer competitively priced loans and personalized service to creditworthy customers.”

To me that points clearly to what’s wrong with banks nowadays. “A target loan loss ratio of zero”… might allow “to offer competitively priced to creditworthy customers” but it will clearly not offer sufficient opportunities of credit to the not so creditworthy, those which includes too many risky SMEs and entrepreneurs, but also that could help provide the proteins the economy needs to move forward, in order not to stall and fall.

And the real truth is that, in the medium and long term, the creditworthy could benefit much more by banks taking much more risks on the not creditworthy, especially if these seem to be up to something worthy, than by they just getting low priced loans.

And if to the “zero loss loan target” you then add the distortion in the allocation of bank credit caused by the risk weighted capital requirements for banks, you might get a feel for why our economies seem to stagnate. 

Those regulations require the banks to hold more equity when lending to someone perceived risky, than when lending to someone perceived safe. And so that results in banks earning higher expected risk adjusted returns on equity when lending to someone perceived, decreed or concocted as safe, than when lending to someone perceived as risky. And that signifies that, around the world, millions of “risky” SMEs and entrepreneurs are not given the opportunity they might deserve and we might need for them to get.

As is, the banking system no longer finances the “riskier” future but only refinances the “safer” past, and that is as imprudent as can be, at least for our grandchildren.

Those bankers who with reasoned audacity take chances on the future are good servants of the society. Those who only maximize return on equity by diminishing the required capital and avoiding risks are, in the best of cases, absolutely boring.

And don’t get me wrong; I do not want to endanger our banking system, it is just the opposite. The forgotten truth is that major bank crises never ever result from banks building up excessive exposures to what ex ante is perceived as risky, it is not in the nature of bankers, as Mark Twain explained in terms of sun, rain and umbrellas.

The big crises always result from unexpected event of because of excessive exposures to something erroneously considered as safe.

PS. With their risk weighted capital requirements the regulators decreed inequality.

Nothing promotes secular stagnation as much as the regulatory promotion of risk aversion

J. Bradford DeLong, in “The Scary Debate Over Secular Stagnation: Hiccup ... or Endgame?” published October 19, 2015 in the Milken Institute Review, refers to that Martin Feldstein, at Harvard back in the 1980s, taught that "badly behaved investment demand and savings supply functions," could have six underlying causes:

1. Technological and demographic stagnation that lowers the return on investment and pushes desired investment spending down too far.

2. Limits on the demand for investment goods coupled with rapid declines in the prices of those goods, which together put too much downward pressure on the potential profitability of the investment-goods sector.

3. Technological inappropriateness, in which markets cannot figure out how to properly reward those who invest in new technologies even when the technologies have enormous social returns – which in turn lowers the private rate of return on investment and pushes desired investment spending down too far.

4. High income inequality, which boosts savings too much because the rich can't think of other things they'd rather do with their money.

5. Very low inflation, which means that even a zero safe nominal rate of interest is too high to balance desired investment and planned savings at full employment.

6. A broken financial sector that fails to mobilize the risk-bearing capacity of society and thus drives too large a wedge between the returns on risky investments and the returns on safe government debt.

J. Bradford DeLong points out that Kenneth Rogoff in his debt supercycle focuses on cause-six; Paul Krugman in “return of depression economics” focuses on five and six; and Lawrence Summers with “secular stagnation” has, at different moments, pointed to each of the six causes.

And then J. Bradford DeLong writes: “Rogoff has consistently viewed what Krugman sees as a long-term vulnerability to Depression economics as the temporary consequences of failures to properly regulate debt accumulation. Eventually, a large chunk of debt thought of as relatively safe is revealed to be risky, and financial markets choke on the lump. As the riskiness of the debt structure is revealed, interest rate spreads go up – which means that interest rates on assets already known to be risky go up, and interest rates on assets still believed to be safe go down."

And Rogoff is later quoted with "In a world where regulation has sharply curtailed access for many smaller and riskier borrowers, low sovereign bond yields do not necessarily capture the broader 'credit surface' the global economy faces,"

And here is when I just have to intervene: Of course, stupid credit risk weighted capital requirements for banks have impeded the mobilization of the so vital risk-taking willingness and capacity of the society, that which has traditionally been much exercised by its banking sector. That it did by driving a large wedge between the banks’ ROEs for risky investments, like loans to SMEs and entrepreneurs, and the returns on “safe” investments, like loans to governments, AAArisktocracy and the financing of houses.

And “stupid” it is: “Eventually, a large chunk of debt thought of as relatively safe is revealed to be risky, and financial markets choke on the lump”. The capital requirements, that are to guard against the unexpected, were based on the expected, the perceived credit risks.

Dare to read more here about the mind-blowing regulatory mistakes that have been ignored by the experts.

PS. Anyone who talks about low interest rates on public debt without considering the regulatory subsidy implied with: risk weight of sovereign = 0%, and risk weight of We The People = 100%, is either a full-fledged statist or has no idea of what he is talking about.

PS. #4 "the rich can't think of other things they'd rather do with their money" is one of the reasons I much favor the Universal Basic Income concept.

Basel Committee, dare subject your risk weighted capital requirements for banks to a referendum… or at least dare answer my objections.

You hold: More ex ante perceived credit risk more capital, less ex ante perceived credit risk less capital.

I hold: It is not the ex ante perceptions of risk that matter, it is only the ex-post realities that do. And in this respect, what is perceived as risky is in fact usually safer than what is perceived as safe.

I hold: Bank capital should be there against unexpected losses not against expected credit risk losses.

I hold you never analyzed what causes bank crises you just analyzed what problems bank borrowers could face, and that far from being the same. 

I hold: To allow banks to leverage differently their equity and the support society and taxpayers give these differently, based on ex ante perceived credit risks; which allows banks to earn higher risk adjusted returns on equity on what is perceived as safe than on what is perceived as risky, distorts dramatically the allocation of bank credit to the real economy.

I hold like John A Shedd: “A ship in harbor is safe, but that is not what ships are for.” 

I hold like Voltaire: “May God defend me from my friends [AAA rated]: I can defend myself from my enemies [BB- rated]”

I hold that because of the dumb risk aversion in your regulations, banks no longer finance the riskier future our children needs to be financed, they only refinance the, for the short-time being, safer past.

I hold that when you set the risk weights of sovereigns at zero percent, but that of the citizens at 100 percent, you introduced statism through the back door. In fact Sovereign = 0% and We The People = 100% sounds sort of like a regulatory Ponzi scheme.

To sum up, Basel Committee, I hold you have clearly evidenced you have no idea of what you are doing.

God make us daring!

When it comes to discrimination, EU cares more about the access to a monastery than about the access to bank credit

If I had the right to vote I would have voted for Britain to stay in EU. But I would have hoped for that this option had won by just one vote, so that there was huge pressure on EU to clean up its act. It sorely needs it.

For instance, the European Commissioner for Internal Market and Services is in charge of promoting free movement of capital and therefore has a lot do to with the extremely important area of regulating the financial services. 

It is a topic of much interest for me since, for more than a decade, I have argued that the Basel Committee’s risk weighted capital requirements for banks, is impeding the free movement of capital with disastrous consequences for the real economy.

But in 2012, during a conference in Washington by the then Commissioner Michel Barnier, I was handed a brochure that presented, as a success story of his office, the following: 

“A French citizen complained about discriminatory entry fees for tourists to Romanian monasteries. The ticket price for non-Romanians was twice as high as that for Romanian citizens. As this policy was contrary to EU principles, the Romanian SOLVIT centre persuaded the church authorities to establish non-discriminatory entry fees for the monasteries. Solved within 9 weeks.” 

And then I knew for sure something smelled very rotten in the EU, with its full of hubris besserwisser not accountable to anyone technocrats.

How can they waste time on such small time discrimination when those borrowers ex ante perceived as risky, and who therefore already got less bank credit and at higher interest rates, now suffer additional discrimination caused by regulators requiring banks sot hold more capital when lending to them that when lending to those ex ante perceived as safe? And on top of it all, for absolutely no reason, since dangerous excessive bank exposures, are always built up with assets perceived as safe.

Barnier, as Frenchman should know Voltaire’s “May God defend me from my friends: I can defend myself from my enemies.” But now bank regulators tell banks “trust much more your friends”, the AAA rated, and to which in Basel II they assigned a risk weight of 20%; and “beware even more of your enemies”, the below BB- rated, and which were given a risk weight of 150%.

As a result banks can leverage more their equity with “safe” assets than with “risky” assets, and so they now earn higher risk adjusted returns on equity when lending to sovereigns, members of the AAArisktocracy or financing houses, than when lending to SMEs and entrepreneurs.

And as a direct consequence of this regulatory risk aversion, banks do not any longer finance the riskier future, they only refinance the for the short time being safer past.

So there is no wonder EU is not doing well. And if Brexit helps to push for the reform that are needed, then Britain should be given an open invitation to return to it at its leisure.

PS. During the Washington conference I just could not refrain from asking what the French citizen did for 9 weeks while waiting for SOLVIT to come to his rescue.

PS. Lubomir Zaoralek the minister of foreign affairs of the Czech Republic in FT “Europe’s institutions must share the blame forBrexit” July 1. Hear hear!

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

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

So here is the question: 

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

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

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

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

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

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

And this is just an appetizer on all the Basel Committee for Banking Supervision’s idiotic mistakes.

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