Thursday, January 26, 2012

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?

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?

Tuesday, January 24, 2012

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

Monday, January 16, 2012

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

“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.

Stop the Basel Committee from peddling its hallucinogen, its banker’s belladonna

Capital requirements for banks which allow for very little bank equity when the credit ratings are good, and require more of it when they are not, is a very dangerous hallucinogen, in that it increases the sensitivity of the banks to the signals the credit ratings emit. 

This, the banker’s belladonna, is precisely the cause of the monstrous crisis that is threatening the whole Western World. Its consumption causes growing excessive dangerous bank exposures to what is officially perceived ex-ante as not risky, like to triple-A rated securities and to infallible sovereigns, and a growing, equally dangerous, bank underexposure to what is officially perceived as risky, like of the lending to small businesses and entrepreneurs. 

We need bank regulators who know that a risk signal can only be valid if interpreted adequately. Occupy Basel!

Thursday, January 12, 2012

In banking, when will the shadows take over?

Bank regulators, in Basel II, allow the banks to lend to a corporate rated AAA holding only 1.6 percent in capital but require them to have 8 percent when lending to a BBB rated corporate. That discrimination, when compared to what would have happened in an undistorted market, results of course in much more lending and at cheaper rates to the “safe” AAAs, and much less and more expensive lending to the BBBs.

That of course led to the current crisis of overexposures to what is perceived ex-ante as absolutely not risky; and the continuously dangerous overcrowding of safe havens, like lending to AAAs and infallible sovereigns; and the insufficient exploration of risky but potentially rewarding bays, like lending to small businesses and entrepreneurs. 

The question is, how much can you discriminate against risk-taking in the formal banking sector before the shadow banking, “la banca sommersa”, takes over?

Friday, January 6, 2012

Another letter in The Washington Post: Handcuffed by a triple-A rating

Handcuffed by a triple-A rating

The headline on Mohamed El-Erian's Jan. 1 op-ed asked, "Who will save the triple-A rating?" This makes for a good opportunity to remind everyone that the United States, and the Western world, did not become what they are by sticking to the super-safe. They did it by allowing their risk-takers to take risks. A triple-A credit rating is a result, not a precondition.

If the United States is going to lose its triple-A rating because it is taking the kind of risks that are necessary to make the wheels of its development move forward, creating jobs for our grandchildren, that should be welcome. But if it is going to continue the current pattern, set out by loony bank regulators, of blindly avoiding perceived default risks and dangerously overcrowding the safe havens, then it is lost.

The expert financiers worrying about a triple-A rating are also navel-gazing. Much more important than a triple-A for the United States is the fact that this country is, by far, the foremost military power in the world. Lose that supremacy and all hell breaks loose. Keep it and a BBB rating could do.

Washington Post
Here other of my letters in the Washington Post on this issue:
September 6, 2007: Factors in the Financial Storm
June 20, 2008: An Aspect of the Bubble
December 27, 2009: Another 'worst': Faulty bank regulation
May 1, 2013: An American approach to banking
December 23, 2014: Let the market rule on risky trades
November 11, 2015: Reverse-mortgaging the future
August 9, 2016: Banks, regulators and risk
April 16, 2017: When banks play it too safe 

Wednesday, January 4, 2012

What would Mark Twain say about our current bank regulations?

Do you remember Mark Twain’s saying about the banker lending you the umbrella when it shines and taking it away when it rains? Well now thanks to bank regulators the banks are also earning immensely higher risk-adjusted returns on their equity lending the umbrella when it shines than when lending it when it rains. How come? 

Currently, if a bank lends to a small business or an entrepreneurs, those deemed officially as “risky” by the regulators, it is required to have about 8 percent in capital, but, if lending to an officially ex-ante deemed not risky, like the triple-As or the infallible sovereigns, the banks needs to hold very much less capital, sometimes even zero. 

Does this make our banks more productive? Of course not! We risk-adverse citizens, have always been grateful for the service our banks provides the society, channeling our savings to those who can generate economic growth, and decent jobs for our grandchildren… which basically means taking risks on small businesses and entrepreneurs, not lending to what is so “not-risky” it can easily raise funds elsewhere. 

Does this make our banks safer? Of course not! No systemic bank crisis has ever occurred because of excessive exposures to what is ex-ante perceived as risky, these, exactly like the current one, have always resulted because of excessive exposure to what was ex-ante perceived as absolutely not risky, and ex-post turned out to be very risky… often because the safe-havens became dangerously overcrowded. 

And so what would Mark Twain say now? Since after this crisis, that threatens the whole Western World, we insist in using the same failed regulators using the same failed regulatory paradigm, he would just elegantly (through a time machine) defer to Albert Einstein’s "we can't solve problems by using the same kind of thinking we used when we created them" and, of course, “insanity is doing the same thing over and over again and expecting different results”.