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

Where were they when needed?

On June 26, 2004 the central bank governors and the heads of bank supervisory authorities in the Group of Ten (G10) countries met and endorsed the publication of the International Convergence of Capital Measurement and Capital Standards: a Revised Framework, the new capital adequacy framework commonly known as Basel II.

The framework was primarily based on the concept that financial risk could be measured and that the measurement itself would not affect risks. It therefore represented one of the most astonishingly naive financial regulatory innovations in the history of mankind.

As an example, the framework stated that if a bank lent to a corporation that did not have a credit rating then it needed to have equity of 8 percent, resulting in an authorized leverage of 12.5 to 1. But, if the corporation had been awarded an AAA to AA- credit rating by a human fallible credit agency, then the loan would be risk-weighed at only 20%, effectively elevating the authorized leverage to an amazing 62.5 to 1.

We all know that the market always contains plenty of incentives for high-risk credit propositions to dress up as being of lower risk, and so, when these incentives were exponentially elevated by the regulators, the biggest race ever towards false AAAs got started.

It took just a couple of months for the home mortgages to the subprime sector to manage to dress up about the lousiest awarded mortgages ever as AAAs. And It took just a couple of years for the market to massively follow those AAAs over a precipice, detonating one of the most horrendous financial crisis the world has ever encountered.

Now, one of the questions we need to answer, in order to have a better chance of finding a sustainable solution to this crisis, and alert us to the many other future crisis that will most certainly threaten us, is where were all the financial experts, the tenured professors and the members of think-tanks, all of whom we pay, honor and invite to opine, and that said absolutely nothing about all this? How come they did not see that this crisis was doomed to happen? Or, if they saw it, why did they not speak out?

At the end of the day, the simple truth is that the costs of regulatory innovations far exceeded the costs of financial innovations, and that the benefit from financial innovations far exceeded the benefits from regulatory innovations. And so, if we cannot have much better and more intelligent regulations then we are better off without them altogether.