The missing (perhaps prohibited) regression!

Run a regression for all the different serious problem loans of banks around the world, like lousy securities disguised as splendid triple-A’s, loans to Icelandic banks, loans to the real estate sector in Spain, loans to a Greek government, and other similar… on the risk-weight of 20 percent or less established in Basel II, and which allowed the banks to finance what´s mentioned above holding only 1.6 percent or less in capital, which means an authorized leverage of bank capital 62.5 to 1 … and then draw your conclusions.

Turning the bank capital thumbscrews in Europe!

According to Basel II, until January 13, 2012 European banks could hold sovereign debt of Spain against zero capital and then, until May 13, they were required to hold a modest 1.6 percent in capital; currently, with Spain rated BBB+, they need to hold 4 percent, and, if Spain would be downgraded 3 notches more, to BB+, then they would be required to have 8 percent of capital. 

Of course, the more capital you must hold against any asset, the higher must the interest rate be in order to produce the same return on bank equity… which is one of the torture instruments of that so cruel economic torture chamber the Basel Committee bank regulators unwittingly designed. 

Of course, if and when banks are required to hold 8 percent in capital when lending to Spain, the same capital they are required to hold when lending to ordinary small businesses or entrepreneurs, then that would be a more real market rate… since all those lower earlier rates where in fact regulatory subsidized rates. 

And Europe still has the same set of regulators using the same paradigm writing up Basel III! Go figure that out.

The Paper... the most current version

Excessive Regulatory Risk Adverseness Caused the Crisis 5912

Greece… even if expelled from the Eurozone, is free to use the Euro

Though it would obviously not enjoy any seigniorage benefits, Greece, if expelled from the Eurozone can very well keep on using the Euro… so at least not having to waste money changing vending machines or feeding the fx-changers. 

Yes, obviously, it would have to earn the Euros it needs, and not survive on some Drachmas it can print, if it finds buyers for them, but, having to earn ones livelihood seems like a reasonable point where to start the reconstruction.

Europe…what if?

What if European bank regulators had imposed their 8 percent capital requirement for banks on all their assets (12.5 to 1 leverage) like they did for instance on loans to small businesses and entrepreneurs, instead of allowing the banks to hold some ex ante perceived as no risk assets against a meager 1.6 percent or less (62.5 to 1 leverage)?

Just for starters, European banks would not have invested in triple-A rated securities backed by lousily awarded mortgages to the subprime sector in the USA; would not have lent the outrageous amounts they did to Icelandic banks or Greece; and Spanish banks would not have overexposed themselves to the real-estate sector. Do you want me to continue?

Thank God for timely capital flight!

Because of the regulatory incentives of only having to hold 1.6 percent in equity when lending to Greece, which meant being allowed to leverage their bank equity a mind-boggling 62.5 to 1, German and other European banks lent to Greece like crazy and at crazy low rates. What would you have liked the Greeks to do?... the same nonsense?... so that even more money had been lost down the same drain? 

No thank God there was some intelligent and timely capital flight, and private Greeks placed at least some or their funds out of harm´s way. 

Now it is up to these private Greeks, to see how, with their diminished resources they can best help their homeland, in times when helping it might actually produce some good results. 

But, whatever it does, Europe first needs to put the sparkplugs back into its economic engine.

Those sparkplugs, the risk-takers, the “risky” small business and entrepreneurs, were forcedly removed by the regulators when they decided to base the capital requirements for banks on the perceived risks of default, as if those perceptions were not already discriminated for sufficiently by the banks. 

What these regulations delivered, as should have been expected, are dangerous obese bank exposures to what is officially perceived as not-risky e.g., government debts, and, for us and economic growth, equally dangerous anorexic exposures to what is officially perceived as “risky”. 

But, unfortunately, what does Mario Draghi of FSB and ECB, and his fellow failed bank regulators of the Basel Commitee, know about sparkplugs?

A Nobel Prize recall

Frankly, any Nobel Prize winning economist, like Joseph Stiglitz, who is capable of defining over and over again a crisis resulting from excessive and obese bank exposures to what was officially perceived as absolutely not risky, as a demonstration of excessive risk-taking by the banks, should be asked to return his Nobel Prize.

Risk taking provides the financial system with the Lebensraum it needs to grow sturdy

The better the credit ratings are, and the better our risk models are, the better will we stack our financial system, for a while, but then also the higher¸ in Nassim Taleb´s terms, its fragility, or its brittleness will be. 

If we want a flexible, a sturdy, or in Nassim Taleb´s terms an anti-fragile system, then our financial system need risk-taking, a lot of it, of many varied kinds. Risk-taking is not only the oxygen of economic growth it is also what allows our financial system the Lebensraum it needs.. 

Risk-taking is “anti-fragility”, which is why in our churches we can hear the prayer of “God make us daring!” Our current problem is that our nanny bank regulators in the Basel Committee completely forgot all about it… or perhaps they never knew.

PS. What I spoke and wrote about fragility

The great risk of risk aversion

As part of the civil society, whatever that now means, I attended the recent spring meetings of the World Bank and International Monetary Fund (IMF), this time on behalf of my granddaughter who, being just some months old, has not yet sufficient capacity to protest what could be a usurpation of representation. One of the topics to be discussed there was the creation of jobs, and, of course, I figured my granddaughter and those of her generation, would all like to have an abundant access to good jobs.

The world now faces a financial crisis of monstrous proportions, far from being solved, as a natural consequence of the excessive incentives that regulators gave to the banks to lend or invest in what was or is, officially, ex ante, defined as little or absolutely not risky ... for example Greece, "subprime" triple-A securities, Icelandic banks and other weeds that can turn out so dangerous, ex post. In other words, a crisis caused by regulation which contained an excessive risk aversion.

But the experts cannot think of anything else. In the "Report on the Global Financial Stability 2012" prepared by the IMF, to continue to speak about safe assets, and to ignore that nothing can be as dangerous for some havens inherently safe than exaggerate their safety, and therefore run the risk of turning them into overcrowded death traps.

And in their report they listed "potentially marketable assets inventory Insurance", and where it would seem that "potentially" was included just reluctantly. The list contains a total of 74.4 trillion U.S. dollars: 33.2 (45%) in sovereign bonds AAA / AA 5 (7%) in sovereign bonds A / BBB, 16.2 (21%) in securities with special guarantees; 8.2 (11%) in corporate bonds rated investment grade, 3.4 (5%) in other governmental or supranational debt, and 8.4 (11%) in gold.

By the way, since at its current price gold can only have value as an insurance for the case that the other assets end up not being worth anything, I do not really understand how gold and the other "safe" assets can be in the same list.

And some experts mentioned time and again, almost as “triple-A” sovereign bond salesmen, almost as if to avoid the need for their own central banks to buy these bonds, that one of the most acute problems of the financial system is the scarcity of safe assets. Of course, we all want safe assets, who not, but, much of its real shortage, also depends on that the regulators require their regulated entities to possess these "safe" assets, and so that we, the ordinary citizens, find it difficult to acquire such safe assets at safe prices.

But, returning to the job prospects of my granddaughter, the report is unfortunately completely silent on the urgent need we have of “risky" assets, such as loans to small businesses and entrepreneurs, and which, at the moment of truth, are those which can most generate the jobs to eliminate the immense risk of millions and millions of unemployed youth.

Please regulators, the world needs to take real risks, and not hide in the skirts of that artificial safety which only produces fragility. Without risk-taking there can be no stability! ...except, of course, of the type you can get in the grave.

Translated from El Universal, Caracas, April 26, 2012

October 2009, in FT: “Free us from imprudent risk-aversion and give us some prudent risk-taking”

God make us daring!

One gap that sure needs to be closed

The Spring Meetings of the World Bank and the International Monetary Fund of April 2012 are surrounded with various calls about “reducing gaps” 

Well one gap that surely needs to be closed, and where the World Bank and the IMF should be at the forefront, is the one odiously increased by senseless bank regulators, between those perceived ex-ante as “not-risky” the AAAristocracy, and those similarly perceived as “risky”... the new untouchables. 

Again, the two basic questions the bank regulatory establishment does not dare, want or know how to answer.

If banks already look at the credit information provided by credit ratings when setting interest rates, amount to lend and other terms, do you think it is intelligent for the regulators to also look at the same credit ratings, or similar risk perceptions, in order to define the capital requirements for banks? Is that not overdoing the nanny part a bit too much? Could that not lead to a dangerous overexposure to whatever is officially deemed as absolutely not risky? Like to triple-A rated securities and infallible sovereigns? 

And is not the whole idea of lower capital requirement for banks when the perceived risks are low just a dumb idea from the very start, knowing, as we do, that big systemic bank crises never ever occur because of excessive exposures to what is believed to be risky, but that they always occur because of excessive exposures to what was wrongfully believed as absolutely not-risky?

About cruise ships and banking regulations

Put it this way. If you go on a cruise would you want it to be insured against all risks or not? As I see it if it is completely insured, chances are that the captain could be a social relations captain, and if it is completely uninsured, the chances are much larger that the captain is a real marine captain. Your pick! 

When the regulators allowed the banks those ridiculous capital requirements of 1.6 percent or less, just to navigate those waters perceived as absolutely not-risky, precisely the waters where in fact all the major bank crisis have occurred, they basically provided the banks with a total insurance… causing social-relation and trading bankers to substitute for real bankers.

Financial repression

Financial repression, a term coined in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon, is used to describe several measures that governments employ to channel funds to themselves and which in a deregulated market, would go elsewhere. In other words it is a hidden non-transparent tax. 

How much financial repression is present by the fact that the banks need to hold immensely much less capital when lending to its “infallible” government than when lending to the “risky” citizens? We have no idea… as we are flying blind with instruments that long ago ceased to function.

Bank regulators should learn about risk compensation and shared space philosophy.

Risk compensation, nothing to do with bonuses, is an effect whereby individual people may tend to adjust their behavior in response to perceived changes in risk. Individuals will behave less cautiously in situations where they feel "safer" or more protected. It is an argument that might help to explain the apparent paradox that reduced regulation leads to safer roads. 

The perceived risk of default in finance, functions like a natural traffic light. If the perceived risk for default of a borrower is high, the light yellow or red, banks lend less, at higher interest rates and on tougher terms. If the perceived risk for default of a borrower is low, the light green, banks lend more, at lower interest rates and on more lenient terms. 

The regulators though, with their capital requirements for banks based on perceived risks, by allowing for extraordinarily low capital requirements when the perceived risk were low, working like a collider, induced the banks to drive through the green lights much faster and with much lesser care, which resulted of course in this the mother of all financial pile-ups 

After a bank crisis characterized, as usual, by monstrously large exposures to what was officially considered as absolutely safe, like triple-A securities and infallible sovereigns, risk compensation is something our bank regulators should look into much more closely. 

According to the Shared-Space urban design philosophy, safety, congestion, economic vitality and other similar issues can be effectively tackled in streets and other public spaces by allowing traffic to be fully integrated with other human activity, not separated from it. Shared-Space streets have no traditional road markings, signs or traffic signals, and the distinction between "road" and "pavement" is blurred. The behavior of its users is more influenced and controlled by natural human interactions than by artificial regulation. 

Hans Monderman, 1945-2008, the Dutch traffic engineer known for his prominent role in the Shared-Space approach, was quoted saying: "We're losing our capacity for socially responsible behavior... The greater the number of prescriptions, the more people's sense of personal responsibility dwindles... When you don't exactly know who has right of way, you tend to seek eye contact with other road users... You automatically reduce your speed, you have contact with other people and you take greater care."

These days, when with their Basel III the regulators are digging our banks even deeper in the hole of excessive perceived safety, and we want and need our bankers to be better bankers and better citizens, we sure wish the Basel Committee would at least listen to some Shared-Space specialists.

PS. Risk-weighted capital requirements for banks, is also like allowing cars to go at different speeds depending on safety features, rated by "experts" and, of course, driven by fallible humans!!!

Let us thank our lucky star the credit rating agencies were not that good

Bank regulators gave tremendous importance to credit ratings, especially in the Basel II package approved in June 2004. 

One of the problems with that is that if a credit rating has already been issued, and if it is good one, like an AAA, there is absolutely no incentive for a second opinion, as no one is going to pay the price of a second opinion that might differ from the first opinion, only once in awhile. And this is especially true if the First and Official Opinionater, has had access to privileged information about the borrower, as they very often have. 

Though we are indeed already suffering seriously the consequences of some of the credit ratings being wrong… can you imagine where we would be if they had delayed making their mistakes ten more years, and the banks and regulators had had the time to invest so much more trust in them? Can you imagine the altitude from which we would have fallen? 

Indeed there is someone looking after us! So at least let us be grateful for that and make amends! 

PS. What on earth do you think I was referring to, when in January 2003, in a letter to the Financial Times I wrote, “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds”?

Homeland Security, bad bank regulations could be used as a lethal weapon of terrorism

Mark Twain is attributed having said: “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain” and yes, we all know that bankers are characteristically risk-adverse. 

What then if someone somewhere concocted a biochemical agent that made the bankers even more risk-adverse, perhaps a testosterone reducer... a de-testosteroner. Would that not be classified as an act of terrorism, even if the chemist proved there was absolutely no bad intention?

But that is what effectively bank regulators did, when they allowed banks to have much less capital  (equity) when lending or investing in what was officially perceived as "absolutely safe", than the capital (equity) they were required to hold against any asset officially perceived as risky.

That allowed banks to earn higher risk-adjusted returns on equity when lending to "the infallible" than when lending to "the risky", something which introduced the mother of all distortions in how bank credit was allocated to the real economy.

As should have been expected, the result was a crisis that destroyed the economy of the US; by dangerously overcrowding the perceived safe-havens, like triple-A rated securities and infallible sovereigns (Greece); and by causing the equally dangerous underexposure to what is perceived as being risky, like in lending to small businesses and entrepreneurs. 

Honestly, is the willingness of the banks to take risks not a matter of national security for the Home Of The Brave?

Why do we so easily accept the distractionary explanation that the current crisis was caused by excessive risk-taking when so clearly all the serious losses have been in what was officially considered as the safest type of bank lending and investment?

PS. Here is a current summary of why I know the risk weighted capital requirements for banks to be dangerous nonsense.

PS. By the way, what would the Founding Fathers have said about this?

AI's ChatGPT seems to agree that would be a responsibility of Homeland Security

A fundamental question to the Republican candidates that has never been posed

Currently, the banks of the United States of America, the land of the brave and the home of the free, if they lend to an American small business or an American entrepreneur need to hold about 8 percent in capital, but, if lending to the US government they need zero capital.

Do you believe this is how it should be and do you believe this helps job creation?

Holy moly: Banks were drugged by Basel’s rulebook

LET’S suppose that the human, fallible credit rating agencies produce ratings that are absolutely perfect in terms of measuring the risk of default; and that banks use these ratings to choose who to lend to, at what rates and under what conditions.

But then let us add that bank regulators, such as those in the Basel Committee, believing they could act as risk-managers for the world, imposed on banks capital requirements based on perceived risks and specifically referring to the risks already reflected in the ratings.

The product is a hallucinogen, a bankers’ LSD. It increases the banker’s sensitivity to risk: he sees good credit ratings in much brighter lights; not-so-good ratings seem far scarier.

For anyone interested in finance and not engaged in regulatory group-think, the consequence of that hallucinogen must be excessive bank exposures to what is officially perceived as not risky – for instance, triple-A rated mortgage-backed securities or “infallible” sovereigns. The result is a dangerous overcrowding of the safe-havens and a growing bank underexposure to what is officially perceived as too risky: for instance, lending to small businesses and entrepreneurs. That is an equally dangerous outcome, because of the lost opportunities to create the next generation of jobs for our grandchildren.

All of these effects come about before we even enter into a discussion of the issue that the credit ratings are also sometimes wrong.

Regulators and experts have been able to spin this crisis as a result of excessive risk-taking when it is evidently the result of regulatory nannies suffering an excessive aversion to risk.

A couple of years into this crisis, now threatening to take the Western world down, the issue of how capital requirements drugged the banks is not even discussed, and, because of that, failed regulators are allowed to proceed with a Basel III, built upon precisely the same failed regulatory paradigm. Holy moly.

Who am I? In 1999, I wrote: “The possible big bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing gods, manage to introduce a systemic error in the financial system, which will cause its collapse.”

In 2003, I wrote again: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds.”

As an executive director of the World Bank, in October 2004, my formal written statement delivered at the board warned: “We believe that much of the world’s financial markets are currently being dangerously overstretched, through an exaggerated reliance on intrinsically weak financial models, based on very short series of statistical evidence and very doubtful volatility assumptions.”

I am someone who was much too right, much too early for his own good.

I am not someone who argues that bank regulators were an acceptable 8.17 degrees off target, but who argues they were 180 degrees wrong. In other words, one who wants to – Occupy Basel.

Per Kurowski is a Venezuelan citizen who served from 2002-04 as one of 24 executive directors at the World Bank

Basel's monstrous regulatory mistake

Published in City A.M.

“Margin Call” sells it as a surprised discovery of faulty volatility assumptions. Bullshit!

October 19, 2004, in a formal statement delivered as an Executive Director at the World Bank Board I wrote: 

“Phrases such as ‘absolute risk-free arbitrage opportunities’ should be banned in our ‘Knowledge Bank’. We (I) believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.” 

And I was even only a lowly financial and strategic consultant who had never worked in the area of investment banking or portfolio management.

As others who might have made similar warnings I was just too right too early… and therefore I and many others are now being ignored by all those who have an interest in wanting to explain the current crisis as a Black Swan event… and by those media producers who feel more comfortable with their Monday Morning Quarterbacks.