Houston, we’ve got another problem: Our central bankers’ are flying blind

In February of 2011, Alan Greenspan gave the keynote address during an event at the Brookings Institution on “Reforming the Mortgage Market”. He ended his speech by expressing that he really would like to know what the real mortgage rates would be in the US, without any of those many distortions which affect it.

I got no chance to question him in public but at the end of the event I managed to ask him: 

“Mr. Greenspan, would you likewise not want to know what the most important interest rate in the market, the interest rate on US Treasuries would be without distortions?” 

He looked at me and asked “What do you mean?” I told him: “I mean that interest rate which would result if banks were required to hold as much capital when lending to the US Treasury as they are when lending to a US citizen, a small businesses or entrepreneurs.” I felt for a moment Greenspan nervously doubting, but then he answered “Yes, I would!” 

And that is one of the sad facts today. Central banks, in the US and Europe, are basically flying blind, because they have not the faintest idea about what their real Treasury rates would be without the regulatory subsidies in favor of public borrowings they have introduced. 

And then we hear so much nonsense about this being a great time for public indebtedness because rates are so low… Rates low? Has no one factored in all the opportunity costs for the economy and job creation of all those small businesses and entrepreneurs who did, and do still not have access to bank credit in competitive terms? 

PS. So, Houston, we sure have got ourselves another serious problem.

PS. Might someone at long last be waking up?

Mark Twain, the bankers, and the nannies of the Basel Committee. What a sad tale.

I guess you have all read Mark Twain’s description of bankers as those who lend you the umbrella when the sun shines and want it back when it rains. And that most definitely rang true for someone as me trying to get banks to cooperate giving credit to my small and medium sized businesses and entrepreneur clients. 

But then along came the nannies of an outfit known as the Basel Committee, and their advisor the Financial Stability Board and said that that banker mode was still way too risky for them. And the nannies and, told the bankers that if they lent to those the sun was shining upon, the absolutely not risky, then they only needed 1.6 percent or less in capital, which meant they could leverage their equity 62.5 to 1 or even more in some cases, but if they dared lend to the “risky” who it seemed could be rained upon, then they needed 8 percent in capital and could only leverage 12.5 to 1. 

And, we all saw what happened. Here we are now with our banks up to their necks in dangerous excessive, really obese, exposures to what was erroneously perceived as “absolutely not-risky”, and anorexic exposure to those officially perceived as “risky”, like the small businesses and entrepreneurs, precisely those our young most count on generating the next generation of good jobs for them. 

Is it not a sad tale? Especially for a Western World that has become what it is thanks to risk-taking? Especially for an America that feels proud being known as the “land of the brave”? I wonder what Mark Twain would have to say about those nannies and the parents who entrust them with their banks?

Houston, we’ve got a problem: The IMF is lost in space.

The IMF has just published their Global Financial Stability Report: Chapter 3 is titled: The Reform Agenda: An interim report on progress toward a safer financial system, and Chapter 4: Changing Global Financial Structures: Can they improve economic outcomes? 

Even though the report mentions “the banks’ likely increase in their allocation to safer but low-yielding assets to accommodate regulatory requirements” it completely fails to understand the distortions that precisely this causes in the economy. In fact, the word distortion does not even appear in the report. 

And, if there is anything current regulations have done, that is to distort the economic efficient resource allocation so much, by favoring banks holding assets that ex-ante are perceived as “not-risky”, against banks holding assets that ex-ante are perceived as “risky”. 

Basel II allowed a bank to leverage its equity 62.5 to 1, if the asset had an AAA rating, but only 12.5 to 1, if it was unrated. And which means that the profitability for banks, their return on equity, when holding “not-risky” assets, becomes much higher than when holding “risky” assets, like loans to small businesses and entrepreneurs. And, if this is not hugely distortive, I do not know what is. 

Distortive, and utterly useless… since we know that no major bank crisis ever, has resulted from banks holding excessive assets that, when acquired, were perceived as “risky”, these have all resulted, no exceptions, from banks holding excessive assets that, when acquired, were perceived as "absolutely not-risky".

IMF does a lot of empirical research, but the research they have completely failed to do, is to run a simple regression between all the current problem assets, and the fact that these were ex-ante perceived as “not-risky”, and so therefore the banks were allowed to hold much less bank equity. That should have given them a clue.

And so, about five years after the beginning of the crisis, the IMF does yet not understand why a crisis that was doomed to happen, because of plain dumb regulations, happened. 

The Independent Evaluation Officer of the IMF (IEO) in their report “IMF Performance in the Run-Up to the Financial and Economic Crisis: IMF Surveillance in 2004-07” of 2011 wrote: 

“The IMF’s ability to correctly identify the mounting risks was hindered by a high degree of groupthink, intellectual capture, a general mindset that a major financial crisis in large advanced economies was unlikely, and inadequate analytical approaches. Weak internal governance, lack of incentives to work across units and raise contrarian views, and a review process that did not “connect the dots” or ensure follow-up also played an important role, while political constraints may have also had some impact.” 

It would sure seem that no one in IMF read that report. What a shame!

PS. And by the way Houston we've got another serious problem too

Should not bank regulations meet some minimal ethical standards?

Without any type of bank regulations those perceived as “risky” would pay higher interest rates, have access to smaller loans, and need to accept harsher terms than those perceived as “not-risky”. And that is how it should be, anything else would not make any sense. 

But with the current capital requirements based on ex-ante perceived risk, those officially perceived ex-ante as “risky”, like small businesses and entrepreneurs, need to pay even higher interests, have their access to bank credit even more curtailed, and need to accept even harsher terms, than would be the case without any bank regulations… and that my friend, does not seem ethical to me. 

Nor does it make any sense... since never ever have major bank crisis resulted from excessive bank exposure to what was perceived ex ante as “not- risky”, these have all resulted, no exclusions, from excessive exposure to what was ex-ante perceived as “absolutely not-risky”.

And, of course, these dumb regulations can only help to increase the cliff between the “not-risky-haves” and the “risky-not-haves”

And, of course, these dumb regulations, can only curtail the job creation powers of small businesses and entrepreneurs.

PS. My 2019 letter to the Financial Stability Board

Widows and orphans have been locked out from safe investments

It used to be that the safest investments, the absolutely not-risky, that paid low interests, were reserved for what was known as widows and orphans, those unable to shoulder risk. And banks and other investors took care of the “risky”

Not any longer! With capital requirements for banks that are much lower when banks hold assets deemed as “absolutely not-risky” than when they hold assets deemed as risky, the banks have been induced to earn their return on equity among those perceived as “absolutely not risky”.

You tell me, what return could there be left for a widow and orphan from holding an AAA rated security when banks can hold those same securities against basically no equity of their own at all?

Capice? If not…. perkurowski@gmail.com

The bank regulators are to blame for outlandish bankers' bonuses

Time ago, when banks were banks, a banker needed to be able to carefully analyze the credit risk of his client, and then offer a competitive rate so as not to lose the business. That lead to tight profit margins which needed also to be shared with shareholders, and so there was never really much room for big banker bonuses. 

But then came the regulators and decided that banker did not really have to lend to the “risky” any longer in order to make profits, because since they would be required to hold much less capital when lending to those officially perceived as “not-risky”, the return on equity when doing so, would shoot up, and, to top it up, with less capital, there was of course also less shareholders to have to share those higher margins with. 

And banker bonuses shoot up into the sky, especially for those banker-traders who had not the slightest idea of how to analyze credit risk. 

Do you find that hard to understand?... then let me phrase it as a question. 

Where do you think there is more room for huge banker bonuses, in the lending to the “risky” where banks need to hold 8 percent in capital, or in lending to the “absolutely not-risky” where banks are allowed to hold only 1.6 percent, or less, in capital?

How on earth have German bank regulators avoided being blamed for bad German bank lending to Greece?

If German banks had only two clients, German small businesses and Greece, and where required to hold 8 percent in equity, 12.5 to 1 leverage, they would lend their funds to whoever produced the highest risk-adjusted return on that 8 percent equity. 

But if German regulators told the German banks that though in the case of the German small businesses they still needed to hold 8 percent of equity, in the case of Greece, only because regulators considered Greece to be safe given its ratings, German banks had only to hold 1.6 percent of equity, allowing them 62.5 to 1 leverage… who do you think German banks would lend to? 

It is amazing how German bank regulators have avoided to be held accountable for what happened. That same question holds of course for the bank regulators of most other countries.

One reasonable and one very stupid efficient resource allocation methods for the banks

If banks need to hold for instance 8 percent of equity against any asset, they will allocate their funds in accordance to what assets produce the largest risk-adjusted returns on that equity. 

If banks, on the contrary, as is the case with Basel II, need to hold 8 percent of equity against assets perceived as “risky”, being able to leverage their equity 12.5 to 1, but can hold other assets deemed as “not risky” with only 1.6 percent in capital, and in that case being able to leverage their equity 62.5 times to 1, they will allocate their funds in accordance to whatever assets produce the largest risk adjusted return on the particular bank equity which regulators have decided should be held for the different assets. 

And only fools could believe that both systems have a chance to perform a resource allocation that is effective for the economy. The current method is a resource allocation completely distorted by the regulators own risk perceptions. 

We can be certain that if these capital requirements, which favor what is perceived as “not-risky” and discriminate against what is perceived as “risky” remain, this will guarantee us flabby economies, lack of jobs, and set our countries on a downward slope which condemns us to perish in some dangerously overpopulated safe-haven. 

Who do bank regulators think they are, unqualified and unauthorized, with immense hubris, playing risk managers for the world and destroying our economies?

Do conservatives and progressives not know or care about how regulators, with their silly risk weights based on perceived risk which determine the capital requirements for banks, so fundamentally distort the markets? 

Do conservatives and progressives not know or care about how regulators, with their silly risk weights based on perceived risk which determine the capital requirements for banks, so fundamentally increase the inequality between the “risky” and the “not-risky”? 

Does the Congress not know or care about how the regulators, with their silly risk weights based on perceived risk which determine the capital requirements for banks, effectively intrude in its domain and create subsidies for the “not-risky” and taxes for the “risky”? 

Are the current bank regulators really unqualified as risk managers? Absolutely yes!

The number one rule in any risk management must be to identify what risks you cannot risk not to take.

Regulators who do not define the purpose of what they are regulating cannot know one iota about risk-management. Or is it that they don’t care about our economies falling to pieces, as long as the banks stand there in shining armors among the rubble? 

Regulators who care about the perceived risks of bank assets, and not about how bankers react to the perceived risk of assets, have no idea of what they are up to. 

Regulators who give banks immense incentives to hold assets perceived as “not-risky” ignoring that all bank crisis ever have resulted, exclusively, from banks holding excessive assets that had erroneously been perceived as absolutely “not-risky”, have no idea of what they are up to. 

Regulators who do not know that when they allow a bank to hold less capital when an asset is perceived as “not-risky” discriminates against the access to bank credit of the “risky” like small businesses and entrepreneurs, and fundamentally distort the markets, have no idea of what they are up to. 

Regulators who do not understand that helping the “risky” to access bank credit is a fundamental part of building a growing and strong economy and jobs, and that favoring bank lending excessively to what is perceived as “not-risky” will only make for a flabby and imploding economy, have no idea of what they are up to. 

Risk managers who do not understand that risk-taking is a fundamental part of building a flexible and sturdy system, and that going excessively solely for what is perceived as “not-risky” makes for a

fragile system, have no idea of what they are up to.

Unauthorized? Yes! You tell me who authorized them to do what they did. Any volunteer?

What did the regulators really do? Scared witless by the possibility that bankers would expose themselves too much to assets deemed as “risky”, something that bankers never or very rarely do, they created huge incentives for banks to concentrate on assets that were, ex ante, perceived as “not risky”. In doing so, they fomented an incredible dangerous highly leveraged bank exposure to the “not risky”, and a truly anorexic exposure to the “risky”, like to the small businesses and entrepreneurs, something which has placed us almost over the brink of disaster.

What did the regulators really do? They created the prime cause for why now the US and other sovereigns are saddled by immense, almost unserviceable public debt burdens.

What did regulators really do? As I see it, by excessively promoting bank credit to “super-safe” sectors, like real estate in Spain, and to “infallible” sovereigns, like Greece, they have almost singlehandedly taken the eurozone down.

Sincerely, I am sick and tired of regulators who do not seem to care where they are taking our Western World, as long as they keep their “important” bureaucratic posts within their little mutual adoration club, apparently not accountable to anyone. 

Sincerely, I am sick and tired of those incapable of grasping the possibility of our current bank regulators being so fundamentally wrong, so that they, even when they proclaim “Without fear and without favor” do not even dare to ask the questions that needs to be asked.

Sincerely I am sick and tired, and anguished, about my children and grandchildren having to grow up in a world were so much de-facto power lies in the hands of some petit bank regulating bureaucrats.

The mother of all lacks of confidence

We so often hear about the lack of confidence, of so many, being the largest obstacle to manage to fully recover from this crisis. But, one of the most significant lacks of confidence, indeed the mother of them all, is not even mentioned. I refer to the lack of confidence in bankers, and the markets, shown by bank regulators.

Bank regulators, scared witless by the possibility that bankers would expose themselves too much to assets deemed as “risky”, something that bankers never or very rarely do, created incentives for bankers to concentrate on assets that were, ex ante, perceived as “not risky”. In doing so they fomented an incredible dangerous highly leveraged bank exposure to the “not risky”, something which has basically already placed us over the brink of disaster. 

What could help us is for bank regulators to show more confidence in those so useful and needed “risky”, like the small business and entrepreneurs, those who bring energy and vitality to the economy... but no!, the current generation of worried to death nannies of bank regulators just don’t seem to have that in them.

“Reasoned Audacity”

There, in “Berthe Morisot, or, reasoned audacity”, a book published by the Denis and Annie Rouart Foundation and the Marmottan Monet Museum (2005), is where I first saw the term “reasoned audacity”. And it took the breath out of  me, as did, of course, Edouard Manet’s portrait of his sister in law. 

Yes, absolutely, that´s it, I said to myself. If I was a regulator, “reasoned audacity” is what I would try to inspire the banks with, and not with the dysfunctional unreasonable risk-aversion current regulators are imposing, with their mindless capital requirements for banks based on perceived credit risks... being correctly perceived.

God make us daring!

Educating Martin Wolf (and others in dire need of it): Stupid Bank Regulations 101

When banks are allowed to hold less capital against assets perceived ex-ante as “not risky” the regulators are effectively discriminating against banks holding assets ex-ante perceived as “risky”, like loans to small businesses or entrepreneurs. 

And that amounts to a distortion of the market. The direct effects of that distortion is that those perceived as not risky will have an ampler and cheaper access to bank credit than what would have been the case without these regulations, and those perceived as “risky”, will have a scarcer and more expensive access to bank credit that would have been the case without these regulations.

In other words, it signifies a regulatory subsidy to those already benefitted by the market and banks from being perceived as “not risky”, and a regulatory tax on those already being taxed by the market and banks because they are perceived as "risky".

In other words we´ve got ourselves a much ignored class-war carried out under the cover of bank regulations by the "not risky" against the "risky".

And that discrimination against what is perceived as risky, must of course negatively impact the economy and the creation of jobs, which both thrive precisely based on the risk-taking. 

And all for no good purpose at all, because never ever has a major bank crisis resulted from excessive exposures to what was ex ante perceived as risky. 

And all that regulatory nonsense, or even worse than nonsense, is a direct result of not specifying clearly what the purpose of our banks is. Surely it cannot be to survive in an economy where everything else fails.

And, if regulators absolutely must interfere, because it is in their nature, then why don´t they do it with a purpose, and for instance set the capital requirements for banks based on potential-for-jobs-for-youth ratings?

And, if regulators absolutely must interfere, and must to do so based on perceived risks then why not do so based on how bankers react to perceived risk. Although in that case it would seem that the capital requirements for banks should be higher for any asset perceived as “absolutely not-risky” and lower for any asset perceived as “risky”.

Also as is, no one has any idea of what the real market interest rates are. For instance what would be the UK Treasury rate if banks needed to hold as much capital when lending to the UK Treasury, than when lending to a UK citizen? 

Research assignment (choose one of the two) 

1. Make a regression between the major problem assets during the crisis and the low capital requirements for holding those assets, and then explain what inferences can be drawn from the results. 

2. Investigate who could have authorized bank regulators to award subsidies on access to bank credit to the “not-risky” or tax the access to bank credit of the “risky”. Alternatively you could investigate who could have authorized bank regulators to earn more, by means on higher leverage, when lending to the “not-risky” than when lending to the “risky”.

PS. There will be a quiz on this soon 

Current capital requirements for banks, based on perceived risk, can signify, unwittingly, and only in terms of its destructive power, 9/11 styled financial terrorism

Capital requirements for banks, which are higher when banks lend to those perceived as “risky” than when they lend to those perceived as “not risky”, cause the following: 

A regulatory tax on the access to bank credit imposed on the “risky”, most often the not-haves, most often the periphery. 

A regulatory subsidy paid to the “not-risky”, most often the haves, most often the center, on their access to bank credit. 

And that produces a huge distortion of our financial markets, and our small businesses and entrepreneurs, those we need to find our young the next generation of jobs, find it harder and more expensive than usual to access bank credit.

And, it’s all for nothing, since all major bank crisis only occur from excessive and truly obese exposures to what was erroneously perceived as absolutely not-risky. 

As I see it, those capital requirements can amount to, an unwitting, and only in terms of its destructive powers, 9/11 styled, terrorist act against our economies. 

What on earth is the “land of the brave” doing allowing its regulators to discriminate against the “risky”? 

Does the US congress have any idea about the tax and subsidies paid by these non-elected regulators? 

Is Europe going back to the Dark Ages?

I do get nervous, when someone made me read, Article 32 of the Regulations of the European Financial Stabilisation Mechanism, ESM, which stated the following: 

“5. The archives of the ESM and all documents belonging to the ESM or held by it, shall be inviolable.”

And, who is Elizabeth Warren to speak about “The system is rigged”?

If there is something that you can really accuse the financial system of being rigged by, that are the capital requirements for banks based on perceived risks. These requirements favor immensely those already being favored by the markets, namely those borrowers perceived as “The Infallible”, and thereby discriminate immensely against those already being discriminated against by the markets, namely those borrowers perceived as “The Risky”, like small businesses and entrepreneurs. 

And that odious discrimination, constitutes a regulatory wedge which only increases the existing the inequalities and reduce the opportunities, as the “The Infallible” are most often the haves, and, the “The Risky”, the not haves. 

And since Elizabeth Warren, having been involved with regulations for such a long time, has not uttered a word against that regulatory discrimination, I am not sure what moral right she has to speak out about “The system is rigged”?

What nonsense is believing in a "level playing field", and then not speaking out against colleagues and regulations un-leveling it? What has regulatory discrimination against those perceived as "risky" to do with "giving everyone a fair shot"? What has this extreme regulatory risk-adverseness to do with the need to "restore the values that built the nation"? Is not just betting on The Infallible "betting against the American people"?

She said in her recent Democratic Convention speech: “I talk to small business owners all across Massachusetts. Not one of them—not one—made big bucks from the risky Wall Street bets that brought down our economy.” And I must say: “No, Elizabeth Warren, of course they did not, they were too busy having to pay all that extra interest rates to the banks that the bank regulations caused.” 

She said in her recent Democratic Convention speech: “We turned adversity into progress because that's what we do” And I must say: “No, Elizabeth Warren, you did not! You were among those many regulators who want to turn progress into risk-adversity! And this, amazingly, in the land of the brave!” 

But, let me be absolutely clear, I could use exactly the same arguments against all those on the other side of the political spectrum who extol the benefits of a free market, but who also keep absolute silence about this dirty regulatory intervention and distortion of the market. And so they should shut up too!

Does this mean I do not support the Consumer Financial Protection Bureau? Of course I support it! Only that I believe that one of that Bureau´s first responsibilities, is to see that those perceived as “risky”, are not also discriminated against by the regulators.

Albert Einstein dixit: “No problem can be solved from the same level of consciousness that created it”

15 percent bank capital - 15 years tax exoneration - $500bn

The Western world needs, urgently, traditional bank capital, not that silly modern stuff. 

In this respect, whichever bank agreed to hold 15 percent in capital, against any asset, no matter how safe or risky these might be perceived, I would grant it 15 years exoneration from corporate and dividend taxes. 

This is just an idea, this is just how I feel today mind you, on this Labor without jobs day of 2012.

There is a world of productive risk-taking waiting out there to get our youngster their generation of good jobs… let’s give them a chance.

I would love to see $500bn in this type of fresh bank capital...which could be leveraged into over $3 trillion in loans which do not discriminate more based on perceived risks than what they should ordinary do in a free market.

That could mean a fresh start for our economies and a stop to that war current bank-nannies are waging against the "risky".

A conversation with a prominent, probably brilliant, though mostly silent and invisible bank regulator

You must all have heard Mark Twain’s description of a banker; he who lends you the umbrella when the sun shines and wants it back when it rains. 

But, over the last couple of decades, bank regulators, by allowing banks to have less capital when an asset is perceived as safe, began to even pay the bankers more to lend the umbrella when the sun shines; and, by requiring banks to hold more capital when something is perceived as risky, to even charge the bankers more for not taking the umbrella back fast when it rains. 

And that silliness is the result of regulating banks without defining the purpose of the banks... and of regulators considering the credit ratings, instead of considering what bankers do when they consider credit ratings.

Frankly, who authorized bank regulators to do to our banks what they did?