Friday, September 24, 2010

And now they are “Razzle Dazzle 'em, Razzle Bazzle III 'em” us


What really detonated this crisis? The fact that because of the risk-weights the banks needed only to hold 20% of the basic capital requirements when investing in triple-A rated securities backed by the lousily awarded mortgages to the subprime sector. Would it have happened if the risk-weight for those investments had been 100%? Of course not!

And the fact that the risk-weights are not even mentioned in Basel III points to its absolute irrelevance… except of course that the higher, the better, the stronger the basic capital requirements for banks are, the bigger is the regressive discrimination produced by its arbitrary risk-weights against those who, notwithstanding the fact that they have never ever caused any major bank crisis, are perceived as presenting a bigger risk, like the small businesses and entrepreneurs.

The regulatory paradigm on which the Basel Committee stands will quite soon be discovered as one of the biggest regulatory failures ever, and all the experts will be looking for ways how to disassociate from them.

This is so because those regulations are primarily based on requiring the banks to have more capital when risk are perceived as high while allowing for much lower capital when risks are perceived as low, even though all financial and bank crisis in history have occurred from excessive investments in what is perceived as having low risk. 

Only what is perceived as having a low risk can grow into systemic risk. A high perceived risk always takes care of itself and does never grow to be a systemic threat.

The regulators fixated themselves so much on stopping a bank from failing, that they ignored the system. Besides, who would like to live in a world where banks did not fail?

Currently small businesses and entrepreneurs, only because of the arbitrary, regressive and discriminatory capital requirements, need to pay the banks 2 percent more per year in order to provide the banks with the same return on capital that a loan or an investment to a triple-A rated client yields them. And this on top of the higher interests the small businesses and entrepreneurs anyway have to pay. Crazy!

To top it up… a visitor from outer space, if observing our bank regulations which require a bank to hold 100% of the standard capital requirement when lending to a small business but only 0% of it when lending to its triple-A rated government would most likely conclude that planet earth is communistic… and laugh at how we currently can have no idea what the real interest rate on public debt would be without this regulatory favor. 

We’ve have all been “Razzle Dazzle 'em, Razzle Bazzle 'em”… So let us urgently get out of that trance!

If you got the time let me invite you to a brief lesson on how bank regulators have become so fixated on seeing the gorilla in the room that they completely lost track of the ball.