Basel's "Leverage Ratio" expressed as Debt to Equity Ratios (D/E)

Below what leverage ratios (LR) of x percent, in Basel terminology, approximately mean, in terms of normal traditional debt to equity (D/E) ratios, those usually applied to all other economic organizations.

LR of 2 percent = D/E of 49/1

LR of 3 percent = D/E of 32/1

LR of 4 percent = D/E of 24/1

LR of 5 percent = D/E of 19/1

LR of 6 percent = D/E of 16/1

LR of 7 percent = D/E of 13/1

LR of 8 percent = D/E of 11/1

LR of 9 percent = D/E of 10/1

LR of 10 percent = D/E of 9/1

My recommendation: Throw away all risk-weighting and adopt a leverage ratio of from 6 to 9 percent, which should fluctuate in an economic counter-cyclical way.

Poor Pakistan! Another developing country being held back by the Basel Committee

I read that “In order to further strengthen the capital related rules the State Bank of Pakistan (SBP) has decided to implement the Basel III reforms issued by the Basel Committee on Banking Supervision”

It is impossible for me to understand how a developing nation can adopt a bank regulatory framework which has, as its prime pillar, capital requirements which favor bank lending to The Infallible those already favored from being perceived as absolutely safe, and discriminate against The Risky, those already being discriminated against because they are perceived as risky.

If a developed and rich country, like France, wants to call it quits and not risk anything more, and accepts Basel II or III, and decide to castrate their banks, although that will not serve their real economy well, or save them from bank crises, that is their business… but, Pakistan?

In 2007 at the High-level Dialogue on Financing for Developing at the United Nations, I presented a document in titled “Are bank regulations coming from Basel good for development?" Unfortunately it received no attention, as the discussions which followed there were basically only focused on promoting, not development, but political agendas.

And little has changed since those meetings. For instance, even Professor Joseph Stiglitz, who chaired the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System, and who recently published a thick book titled "The Price of Inequality: How Today’s Divided Society Endangers Our Future" has still not understood how the risk-weighting of the capital requirements odiously favors bank lending to “The Infallible”, the haves, the old, the past, the AAAristocracy, those already favored by banks and markets, and thereby discriminates against “The Risky”, the not haves, the young, the future, those already discriminated against by banks and markets.

Developing nations, you need all your banks to exercise reasoned audacity and not to just follow the risk aversion instructions given by some overly anxious and nervous nannies, who have not even defined the purpose of the banks they regulate.

My comments to the Basel Committee on their paper titled “The Regulatory framework: balancing risk sensitivity, simplicity and comparability”

Members of the Basel Committee for Banking Supervision

In July 2013 you issued, for comments before October 11, 2014, a discussion paper titled “The Regulatory framework: balancing risk sensitivity, simplicity and comparability”

In reference to it let me declare that I totally reject, and protest, your whole perceived risk based capital requirement framework. It is based on the absolutely false premise that the perceived risks are not cleared for by banks in terms of interest rates, size of exposure and other contract terms.

Your perceived risk based framework, which re-clears for the same perceived risks in the capital (equity), only guarantees that banks will overdose on perceived risk, and makes it completely impossible for banks to help the society in allocating effectively bank credit in the real economy.

Your perceived risk based framework has also been the prime cause for the current crisis, as it, by allowing banks to make higher expected risk-adjusted returns on exposures to what is perceived as absolutely safe than on exposures to what is perceived as risky, has driven the banks to create excessive exposures to what is perceived as absolutely safe, which is precisely the kind of exposures that have caused all major bank crises in history, when the ex-ante perceptions, turn out ex-post to be wrong; in this case much aggravated by the fact that the capital of the banks will also be extremely small when such unfortunate thing occurs.

Your perceived risk framework has also, in my words, castrated the banks and introduced a risk-adverseness that is making of the developed countries, submerging countries.

As a private citizen I do not have the time or the resources to repeat all my arguments over and over again and so I refer you to my blog:

http://subprimeregulations.blogspot.com/

And in which, for a starter, you might find especially illustrating the following post

http://subprimeregulations.blogspot.com/2012/12/the-basel-ii-roulette-manipulation.html

And to follow up, you might want to read what was recently published in the Journal of Risk North Asia, Volume V, Issue II, Summer 2013

And please, before you regulate our banks one iota more, tell us what you think the purpose of our banks should be, to see if we agree.

Respectfully yours, sort of.

Per Kurowski

A former Executive of the World Bank (2002-2004)

PS. If I sound a bit disrespectful, forgive me, but I have been trying, for more than a decade now, to make you see the light. I do not ever shout in capital letters on the blogs, I am a grandfather, with a serious cv., but there has to be a way by which an ordinary citizen can get some answer, even from a Basel Committee.

http://subprimeregulations.blogspot.com/2013/04/questions-on-bank-regulations-which.html

PS. If I feel I have to add to these comments I will do it here…the link to this post.

The “convenient myth” which supports current bank regulations, needs to be debunked

Many bank executives and some regulators hold that not using risk-weights when calculating capital requirements for banks can tempt banks to move towards riskier loans that earn higher returns but are more likely to result in losses.

That is complete baloney and this so convenient for some banks myth needs to be urgently debunked.

As a start we just need to understand that any “perceived risk” can be cleared for by bankers by the interest rate they apply, the size of the exposure and other contracting terms. 

And so the truth is that lower capital requirements, permitted for something perceived as “absolutely safe”, and which allows the banks to achieve a higher expected risk-adjusted return on equity on those assets, will only help to push the banks to create excessive exposures, while holding very little capital, to precisely that type of exposures which have caused all the bank crises in history, namely assets which were ex-ante perceived as safe but that ex-post turned out to be risk. And, if in doubt, just try to find one single major bank crisis that has resulted from excessive exposures to what was ex-ante, not ex-post, perceived as risky.

The different capital requirements based on perceived risk which so much favors the access to bank credit of The Infallible and thereby discriminates against The Risky, also completely distorts the allocation of bank credit in the real economy. 

What would for instance a regulator, in the US or in Europe, answer if asked: Sir, why are the capital requirements for our banks lower when they lend to a foreign sovereign, than when they lend to our national small business and entrepreneurs, those who have never ever set off a major bank crisis?

European citizens should question why their real economy has to go down, down, down

Banks all over Europe are allowed to hold much less capital when lending to a European sovereign, or to one of the world’s AAAristocracy, than when lending to medium and small businesses in their own nation.

Which means that banks all over Europe make much more expected risk-adjusted returns on their equity when lending to a European sovereign, or to one of the world’s AAAristocracy, than when lending to medium and small businesses in their own nation.

Which means of course that banks all over Europe love lending to a European sovereign, or to one of the world’s AAAristocracy, and dislike lending to medium and small businesses in their own nation.

And which means of course that the real economy in Europe, is going down, down, down,

And which means that citizens in Spain should ask their bank regulators:

Why need Spanish banks hold much more capital when lending to Spanish small businesses than when lending to France?

And while they’re at it…Why should Spaniards trust more the French government than a French small business? 

And all European citizens of all other European countries should ask their bank regulators similar questions

God make us daring! That is indeed a prayer current European bank regulators do not even begin to understand the need for.

Poor rich Oprah Winfrey should get herself a buyer-power-rating, issued by one of few big agencies.

Sir, I refer to James Shotter´s “Swiss image suffers after asylum row and Winfrey furore” August 10.

Poor rich Oprah Winfrey considers herself discriminated against because of how a certainly much poorer sales assistant in an upmarket Zürich boutique, dared to express the opinion that a ludicrous expensive handbag was too expensive, instead of perhaps increasing its price 50 percent as any much more able vendor would have done.

Frankly, this whole affair is so incredibly petty when I compare it to that other official discrimination which also originates in Switzerland, through the Basel Committee. That one establishes that even though “The Infallible” borrowers are already much favored in the markets, and “The Risky” much disfavored, that banks are allowed to hold much less capital when lending to the former, and thereby earn a much higher expected risk-adjusted return on its equity, than when lending to the latter.

I guess that if these bank regulators were asked, they would suggest that Oprah Winfrey equips herself with an AAA buyer power rating, issued by one of few formidable buyer-power-rating agencies.

Of course, the instinct of any normal ludicrous expensive handbags store owner, upon seeing an AAA buying-power-rating, would be to increase the listed price of the handbag, but I am sure that our Basel Committee regulators could also come up with a way of favoring these ultra rich buyers, and thereby discriminate against those who, immensely poorer, just want to feel like an Oprah Winter holding that completely unaffordable handbag in their hands for some seconds.

It is truly amazing how much we can hear about any discrimination based on color or other factor, when compared how little the officially sanctioned discrimination based on perceived risks are not even debated. Could it be because we are ashamed of having to admit to ourselves that we have changed from being risk-taking into risk-adverse nations? 

In the name of my constituency, my granddaughter, I protest though: “Damn you BaselCommittee… for having castrated our banks”

The correct blog for this post is here

Four things the next Fed chair should absolutely know, and that the candidates most probably don’t know, yet.

The Fact: Current capital requirements for banks are much much lower for exposures to the “infallible sovereigns” and the AAAristocracy, than for exposures to small and medium businesses, entrepreneurs and start-ups.

The next Fed chair, whoever it is, should know that such different capital requirements for banks, based on perceived risks already cleared for by other means, produce different expected risk-adjusted returns on bank equity, and therefore completely distorts the process of allocating bank credit in the real economy, making it unreal.

The next Fed chair, whoever it is, should know that a financial transmission mechanism, when distorted as described above, stands no chance of producing a sturdy economic growth or generate sustainable employment. And, as a result, any quantitative easing becomes just a big waste.

The next Fed chair, whoever it is, should know that lower capital requirements for banks for what is perceived as “absolutely safe” than for what is perceived as “risky”, do not make any sense from a bank safety point of view. This is so because only exposures of the first kind can grow large enough to take the system down. And also because, when something ex-ante perceived as absolutely safe, ex-post turns out to be risky, as will happen sooner or later, then regulators will find the bank there with little or no capital at all.

The next Fed chair, whoever it is, should know that since banks need to hold much less capital when lending to the “infallible sovereign” than when lending to “risky” citizens, this translates into a subsidy of government borrowings, which means that current Treasury rates are not comparable to historical rates. In other words, the usual proxy for the risk-free rate is subsidized and distorted.

Imagine what much good some more “daring” bank regulations could do for the real economy.

Currently capital requirements for banks are much lower for exposures to what is perceived as “absolutely safe” than for what is perceived as “risky”. It may sound logical, but it is not.

That only helps banks to earn, for no good reason, much higher risk-adjusted returns on equity when lending to what is perceived as absolutely safe, than when lending to what is perceived as risky. And that only guarantees that when something ex ante perceived as absolutely safe, ex-post turns out to be absolutely risky, that banks will stand there holding humongous failed exposures against little or no capital.

Imagine instead if the capital requirements for banks were slightly lower for what is perceived as risky than for what is perceived as absolutely safe.

That would give the banks and all their extraordinary smart number crunchers the incentives to actively go out and look for opportunities in lending to the small and medium businesses, the entrepreneurs, the start-ups. Can you imagine what that could do to the dynamism of our real economy and the creation of jobs?

Yes I hear you “But would that not increase the risk for the banking system?” No! on two counts.

First, let us not forget we are talking here about exposures to what is perceived as “risky”, meaning Mark Twain’s banker unwillingly lending out the umbrella when it rains, and not about the truly potentially dangerous exposures to what is perceived as absolutely safe, meaning Mark Twain’s banker eagerly lending out the umbrella when the sun shines.

Second, let us not forget that there is nothing better to keep a banking system safe, than a healthy and sturdy real economy, and that no banks could survive, no matter how safe, if the real economy really comes tumbling down.

Friends, do not our young unemployed youngsters deserve some more daring bank regulations?

I sure think so.

The curious case of the not curious journalists

Even though absolutely all major bank crisis have resulted from excessive exposures to what was ex ante perceived as absolutely safe, and none from excessive exposures to what was ex ante perceived as risky, current capital requirements for banks are much higher for what is perceived as risky than for what is perceived as safe. And that sounds quite curious indeed.

And one could have thought that financial journalists, like those at the Financial Times, would find that sufficiently curious so as to at least ask a bank regulator for a satisfactorily understandable explanation.

But no, they do not. Is not that quite curious too?

On dangerous bulls, friendly cows, and silly current bank regulations

One entrance says “Beware, dangerous bull here” 

The other “Welcome, only friendly cows here”

If the visitors cannot read you could take some further measures to enlighten them about a danger but, if they can, should you do more? 

Should you on top of it all,  fine all those who visit the bull, and pay a premium to those visiting the cows?

At what point should you substitute your own vigilante concerns for those of any possible visitors?

And, if you do so, at what point will no one ever visit the bull and so that it could become even shyer of humans and therefore more dangerous? 

And, if you do so, at what point might so many be visiting the cows so that the visitors, or even the cows, might get trampled to death?

Those questions reflect some of the difficulties which were not considered by regulators with respect to their capital requirements for banks based on ex-ante perceived risk. 

If bankers can read and understand those perceived risks, how much more must a regulator do in order to fulfill his duty?

Cannot it be so that if regulators also layer their concerns on to of those of the bankers, the whole banking system might overdose on perceived risks?

And if it does, could that not mean that the bulls of bankers, the “risky”, the small businesses and entrepreneurs, will never get any bank credit and the real economy starts to crumble?

And if it does, could that not mean that some of the cows of banking, the “safe” sovereigns and AAAristocrats, get too much credit and therefore become dangerous?

Basel Committee and Financial Stability Board, do our banks, and the real economy, live on different planets?

Can banks really be safe if the real economy is bad? What about banks’ role in allocating resources to the real economy? Is the risk of banks not supporting adequately the real economy really irrelevant?

I ask this again (for the umpteenth time) because again the Financial Stability Board has produced a consultative document titled “Principles for An Effective Risk Appetite Framework” which navel gazes on a banks internal risk assessments, and completely ignores referencing to any purpose of the banks, other than that stupid one of avoiding risks.

Members of the Basel Committee, and of the Financial Stability Board, we can assure you that if our banks run into trouble while assisting our real economy growing sturdy, we can live with that, but, if our banks are safe, but for instance our kids do not have jobs, that is unacceptable.

Right now this save the banks and forget the real economy fixation, is murdering the developed economies which became developed precisely because of a lot of risk taking.

Currently regulators allow banks to hold less capital against some assets, those perceived as “safe”, than against other, those perceived as “risky”; and that allows banks to earn a higher risk-adjusted return on equity when lending to “The Infallible” than when lending to “The Risky”; and that has introduced distortions which makes it impossible for banks to efficiently allocate resources in the real economy. 

Basel Committee and Financial Stability Board, is it you do not understand, or is it you just don’t care?

Basel Committee and Financial Stability Board, your own “Risk Appetite Framework” is totally screwed up.

Hey! Regulators! Leave them banks alone! All in all you're just another brick in the wall.

Regulators turned our banks into cash-cows milking machines

Allowing banks to lend to what is perceived as “absolutely safe” holding less capital than when lending to what is perceived as “risky”, allows banks to earn a higher expected risk adjusted return on equity when lending to what is perceived as absolutely safe than when lending to what is perceived as risky.

And that of course makes banks want to lend even more than usual to The Infallible, the sovereign and the AAAristocracy, and to lend much less than usual to what is perceived The Risky, the small and medium businesses and entrepreneurs.

And that in all essence means that banks are extracting the benefits of the risk-taking of the past, without investing in the risk-taking needs of the future.

In other words banks are using the past as a cash-cow; in other words regulators allowed banks using something like the mother of all a reverse mortgages, and which guarantees that our economies will extract as much equity it can for current consumption as is possible, and so leave much less for the next generation. 

Damn the bank regulators, nobody authorized them to do what they are doing.

God make us daring!

FT, the Financial Times of London, is not interested in possibly the greatest financial horror story ever.

Banks are allowed by their regulators to hold much less capital (equity) against assets which are ex ante perceived as absolutely safe, like loans to some sovereigns and to the AAAristocracy, than against assets perceived as “risky”, like loans to small and medium businesses and entrepreneurs.

That translates directly into banks being able to earn a much expected higher risk-adjusted return on its equity when lending to “The Infallible” than when lending to “The Risky”.

And that translates directly into the danger that some of The Infallible might get too much bank credit and as a result run into problems which, if and when this occurs, will catch banks standing there naked, with precious little capital to cover them up with, signifying a huge systemic bank crisis.

And that also translates directly into The Risky getting much less access to bank credit and having to pay much higher margins than what would have been the case in the absence of these regulations, signifying, among other, less job opportunities for our youth.

That very dangerous risk-aversion, or call it exaggerated embracement of safety, which is destabilizing our banks, and threatening the future of economies developed based on risk-taking, could be the greatest financial horror story ever.

Strangely enough, the journalists in the Financial Times of London, and to whom collectively I have written more than a thousand letterson the subject, seem not to be much interested.

I wonder why?

In other words, helped along by FT and other, the Baby Boomers’ après nous le deluge regulatory mentality, has the world consuming its past without creating its future

Will there be a mega bank run January 2015?

On January 1, 2015, the Basel Committee has indicated that banks should report their leverage ratio, not based on risk-weighted assets, but simply on total assets, and as of course, the banks should have done all the time.

And that would mean that a lot of banks which have presented themselves to society with an acceptable 8 /15 to 1 asset to capital ratio will, unless they take precautions, then have show that naked, without risk weighting, their real leverage might well be in the 20/40 to 1 range. 

And that should scare the hell of a market that, day by day, like in Cyprus, is seeing more signs reading “bank creditors, caveat emptor, you won’t be bailed out like before”.

The US banks, thanks to FDIC requiring more capital, are on the way of being able to show the lowest leverages. Most European banks, being more firmly in the hands of the Basel Committee, or vice-versa, seem will not be so lucky.

Go back over the last five years, and you will find innumerable comments, by experts, including regulators, referring to the low leverages of banks, without them having the faintest idea of how the modern Basel II leverages had been construed, and without the faintest idea that current leverages, after risk-weighting, can in no way be compared with the historical leverages based on un-weighted assets. 

At least it looks like the time of funny leverages is soon over.

Comments on Basel Committee's “The regulatory framework: balancing risk sensitivity, simplicity and comparability” of July 8, 2013

Basel Committee for Banking Supervision

Sir,

These are comments made in reference to your July 8, 2013 consultation document “The regulatory framework: balancing risk sensitivity, simplicity and comparability”

I would like to begin by clearly stating that for a long time I have completely objected the capital requirements for banks based on ex ante perceived credit risks. I consider these capital requirements to be totally insane and much responsible for causing the current bank crisis, as well as for impeding us getting out of it.

And to that effect I enclose a short opinion recently published in the Journal of Regulation and Risk - North Asia, Volume V Issue II Summer 2013. The “Mistake” that shall not be named

That said I would also like, just as an example of what I criticize, refer to the following in the document.

“73. For example, in increasing ex ante risk sensitivity and expanding risk coverage, the framework has progressively sought greater alignment of regulatory capital with economic capital. This approach is implicitly premised on the suitability of economic capital as an appropriate measure for regulatory purposes. But the relationship between economic capital and regulatory capital may need reexamination in the light of the recent shift in the focus of regulation and supervision from ensuring the soundness of individual institutions to, additionally, safeguarding the stability of the banking system.”

First, what are you saying? That “safeguarding the stability of the banking system” was not understood to be the role of the Basel Committee for Banking Supervision before? Do those who appointed you really agree with that statement?

Second, your regulatory capital based on ex ante perceived credit risk, even in the case of an individual bank, is an utterly incomplete reflection of economic capital, since it does not consider facts like the size of the exposures, meaning the portfolio diversification/concentration, or the duration of those exposures, for instance the interest rate risk.

And then let me briefly and partially answer some of your specific questions

Q1. Does the current framework, with its reliance on the risk-based capital at its core, appropriately balance the objectives set out in paragraph 29?

No! The core of the current framework, risk-based capital is completely wrong.

For instance, when in 29 you write “These ideas should be assessed against the primary aims of the capital adequacy framework: that is, the capital adequacy framework should…. take into account the effects of capital requirements on banks' risk-taking incentives, eg when faced with regulatory constraints on their capital (and therefore the size of their balance sheet), to seek higher-risk assets as a means of boosting expected returns”, you do not seem to comprehend the real problem.

The fact is that banks, “when faced with regulatory constraints on their capital”, primarily seek assets which have a low capital requirement, in order to boost expected risk-adjusted returns on equity

Q2. Are there other objectives that should be considered in reviewing the international capital adequacy framework?

Yes, like the little matter of the purpose of the banks; like that the capital adequacy framework should not be allowed to distort the bank credit allocation to the real economy. 

Q3. To what extent does the current capital framework strike the right balance between simplicity, comparability and risk sensitivity, given the costs and benefits that greater risk sensitivity brings?

To no degree at all, especially since the “greater risk sensitivity it brings” is only a quite arrogant ex-ante presumption.

Q4. Which of the potential ideas outlined in Section 5 offer the greatest potential benefit in terms of improving the balance between the simplicity, comparability and risk sensitivity of the capital adequacy framework?

In my opinion, a simple leverage ratio of 8 to 10 percent, complemented by a reporting requirement which includes; a report of risk adjusted leverage based on standardized risk-weights, and issued strictly for approximate comparative purposes; and some additional information on its portfolio diversification and duration, and that can be helpful for the market to get a sense of the risk structure of the bank.

The transition to such a reality though would have to be managed with a lot of intelligence in order not to make things worse.

Q5. Are there other ideas and approaches that the Committee should consider?

Yes!

How did Basel I, II and III evolve? How can we make sure that the serious mistakes in them and that I attribute to incestuous group-think within a mutual admiration club, are not repeated?

There is a need for a critical mass of qualified creditors in the market who know they will not be bailed out automatically from a bank problem.

Who authorized the Basel Committee to act as a risk-manager of our banks and the world?

If you want to do it right, you need to work with a whole set of new regulators who have no vested interest in defending what has been done in the past… remember, neither Hollywood nor Bollywood would ever dream of entrusting a Basel III to those responsible for Basel II flop.

Am I to harsh and impolite in my criticism? Considering the suffering and the millions of unemployed youth resulting directly from your faulty regulations, I do not think so.

Sincerely

Per Kurowski

http://subprimeregulations.blogspot.com/

Rockville, Maryland, USA

PS. If you want to download the whole journal from which my opinion was extracted you can go tohttp://www.scribd.com/doc/149858219/Journal-of-Regulation-Risk-North-Asia-Volume-V-Issue-II-Summer-2013

My opinion in The Journal of Regulation and Risk North Asia Volume V Issue II Summer 2013

Here is the link to "The 'Mistake' that dares not to speak its name", my opinion about the Basel Committees' bank regulations.

And here the link where you can download, for free, the whole journal

In it, I would also recommend the articles by Andrew G. Haldane and Thomas M. Hoenig

Mr. President, Mr. Prime Minister. Here is how to best help to create jobs for our youth

Our banks, for reasons that have not been adequately explained, because regulators themselves do not understand these, allow banks to hold much less capital (equity) against exposures perceived ex ante as “absolutely safe”, than against exposures perceived as “risky”.

That allows banks to earn much higher expected risk-adjusted returns on equity when lending to “The Infallible”, like sovereign and the AAAristocracy, than when lending to “The Risky”.

That distorts and makes it impossible for banks allocate economic resources efficiently in the real economy. 

And it also serves no purpose, since all bank crises in history have resulted exclusively from excessive exposures to what was erroneously perceived ex ante as absolutely safe, none from excessive exposures to what was perceived as “risky”.

And that hinders “The Risky”, the small and medium businesses and entrepreneurs, those who could perhaps generate of those jobs our youth urgently need, from having access to bank credit in competitive terms.

And therefore we must urgently eliminate this regulatory discrimination against risk taking. We did not get to where we are by avoiding risks, much the contrary.

In order to do that, the best route includes a mixture of:

Increasing capital requirements for banks, on exposures to “The Infallible”

Temporarily lowering capital requirements for banks, on exposures to “The Risky”

Creating the incentives needed to stimulate and facilitate important capital increases in the banks.

If regulators just cannot resist from interfering, ask these to give banks instead the incentives of lower capital requirements, based on potential-of-job-creation-for-our-youth ratings.

As is, banks do not finance the future they only refinance the past. God make us daring!

Mr. Fed some few questions on Basel III, bank capital, mortgages, jobs, "the absolutely safe", and the "risky"

And so Mr. Fed you will still allow banks to hold less capital against mortgages than against loans to businesses, only because, like the Basel Committee, you feels the former poses less risk for our banks. But frankly, Mr. Fed, long term, for the economy, and for the banks… how safe are houses without jobs?

And Mr. Fed you will equally still allow for capital requirements that are much smaller for exposures to what is considered (ex-ante) absolutely safe, than for exposures considered "risky".

Mr. Fed, could it really be that you do not understand that allowing banks to earn higher expected risk adjusted returns on their equity on assets perceived as “absolutely safe”, than on assets perceived as “risky”, introduces the mother of all distortions, which makes it impossible for banks to allocate resources efficiently in the real economy? 

Mr. Fed could it really be that you do not understand how the previous distortion destroys most of the effects on the real economy your quantitative easing programs could produce? 

Mr. Fed could it really be that you do not understand that the most important factor in keeping the banking system strong and healthy is a strong and healthy real economy?

Mr. Fed could it really be that you do not understand that there are no dangers for the banking system in waters perceived as risky, and that all the dangers to it lie in waters perceived as absolutely safe.

Mr. Fed do you not know Mark Twain said “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so”?

Is not the interest that is not earned on public debt because of public policies a tax?

In terms of taxation, who is affected by a higher real tax rate?

Someone earning 5 percent in interest on public debt and, supposing a tax rate of 20 percent, then has to pay 1 percent in taxes, resulting in net earnings of 4 percent, or, 

Someone only earning only 3 percent on public debt, because of QEs, lower capital requirements for banks when lending to sovereign, and other fancy stuff causes lower interest rates on public debt.

You tell me, or better yet, tell them!

Three Qs and As on our banks

Q. What is the first worst that can happen to our banks, excessive exposures to the risky?

A. No, the “risky” never poses any risk of excessive exposures, The first worst is when something considered as “absolutely safe”, and to which therefore bank exposures could be huge, blows up in their face.

Q. What is then the second worst?

A. That when the first worst happens, the banks would not have the capital needed to cover for the losses.

Q. But, if then regulators, by setting quite decent capital requirements for banks for holding what is perceived as “risky”, but almost nonexistent for exposures to what is perceived as “absolutely safe”, make it more likely that the first worst and the second worst come together… is that not sort of dumb?

A. Yes, indeed, I take it back. The first worst thing that can happen to our banks, are dumb regulators.

Conclusion: Throw out Basel's capital requirements for banks based on perceived risk and use a simple and straightforward leverage ratio of between 8 and 10%