No Martin Wolf, arrogance and stupidity were (and are) the real sins of bank regulators.

Martin Wolf in his recent book “The shifts and the shocks – What we’ve learned-and have still to learn-from the financial crisis” writes: “Regulators made errors of omission and commission:

Sins of omission are the result of excessively permissive regulations and supervision: they occur when regulators choose to ignore either gross malfeasance or excessive risk taking,

Sins of commission arise when regulators and lawmakers encourage financial institutions to take risks for political reasons.”

And Wolf holds that “Behind all this was the assumption that self-interest would, via Adam Smith’s invisible hand, ensure a stable, dynamic and efficient system… The application of these naïve ideas proved extraordinarily dangerous.

No! Mr. Martin Wolf. 

The first sin was the sin of arrogance by which regulators thought themselves capable to be the risk managers for the world and started to allocate credit risk weights that determined the capital (equity) requirements for banks.

And the second sin was stupidity, which took on two major expressions:

The first one not understanding that allowing different capital requirements against different assets would allow banks to earn different risk-adjusted returns on assets, and that had to distort the allocation of bank credit to the real economy.

The second, not being able to understand that the real dangers for the banking system do not loom among what was perceived as “risky”, but always among what is perceived as absolutely safe.

And the saddest part is that now, so many years after the outburst of the crisis, we have a book written by one of the mot influential columnists, which does not even mention these problems.

And it is not like no one has told Martin Wolf about this. For instance in July 2012, he himself writes: “Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk.”

And then there are more than hundred of letters over the years to him on this issue, many of which have been discussed in the interchange of emails.

And NO! Mr Martin Wolf. No one who could interfere in the allocation of bank credit like the regulators did, can be said to sincerely believe in the "invisible hand".

PS. Wolf touches on the fact of the safe being risky, by on page 252 writing: “the disaster came from what banks wrongly thought to be safe.” Yet he clearly does not understand its real meaning as he explains it as: “Risk-weighting is extremely unreliable, because the samples from which the weights are derived are always to small or irrelevant.” 

Apparently Wolf cannot come to grips with the notion that even perfect risk weights, can generate dangerous distortions, both for the economy and for the banks. That is so because if that perceived risk has already been cleared for, and so for to clear it again (now in the capital of banks) makes that perception to become over-considered. What if the risk aversion of one nannie was added to the risk aversion of other nannies? Would the kid ever be let out of his house?

Should not the taxman also create incentives to avoid stupid risk-taking like the Basel Committee does?

The Basel Committee allows banks to earn much higher risk-adjusted returns on their equity when lending to “the infallible” than when lending to “the risky”. And that is done by means of the portfolio invariant bank equity requirements based on perceived credit risk. 

And seemingly most of the world, if it does not ignore that, finds that regulatory risk-aversion which I find so dangerous, to be a swell idea (at least those in FT).

Now if these anti-risk supporters truly believe in the powers of these incentives, why do they not propose their taxmen to design similar policies?

For instance they should propose that dividends and capital gains from investments in absolutely safe companies should be taxed at a higher rate than those deriving from investments in risky companies. That should do it, eh?

Pope Francis, please go and explain “The Parable of Talents” to the members of the Basel Committee

At the European Parliament, Pope Francis spoke of a need to reinvigorate Europe, describing the continent as a "grandmother, no longer fertile and vibrant" and saying it risked "slowly losing its own soul".

"The great ideas which once inspired Europe seem to have lost their attraction, only to be replaced by the bureaucratic technicalities of its institutions," he said.

Indeed, but what else can you expect when bank regulators bureaucrats instruct banks not to lend to what seems "risky", that which most often includes the new and the future. And that they do by allowing banks to leverage immensely their equity, as long as they keep to what’s seems absolutely safe, that which most often includes the old and the history.

Had these regulations been in place earlier, Europe would not have become “a beacon of civilization” as Pope Francis believes it still is. Now it is with sadness we see regulators turning out its lights.

Next time Pope Francis would do better going to the Basel in order to explain The Parable of Talents to the members of the Basel Committee, those who have now castrated the European banks.

Lights are being turned out in Europe

PS. And Pope Francis could also remind regulators of Pope John Paul II, in his Apostolic Letter "Novo Millennio Ineunte" saying: Our hearts ring out with the words of Jesus when one day, after speaking to the crowds from Simon's boat, he invited the Apostle to "put out into the deep" for a catch: "Duc in altum" (Lk 5:4). Peter and his first companions trusted Christ's words, and cast the nets. "When they had done this, they caught a great number of fish" (Lk 5:6).

God make us daring!

PS. Here my letter to the Financial Stability Board

Real banking risks do not revolve around what is perceived “risky”, as experts think, but around the “absolutely safe”

What happened with the experts swearing by geocentrism, or the Ptolemaic system, that with the cosmos having Earth stationary at the center of the universe, when Galileo Galilei, Nicolaus Copernicus, Tycho Brahe and Johannes Kepler, convinced the world of the heliocentric model, that with the Sun at the center of the Solar System?

I ask it curious to know of what will happen with all those experts in the Basel Committee, the Financial Stability Board the IMF and places like the academia and the press; like for instance Mario Draghi, Stefan Ingves, Jaime Caruana, Mark Carney, Olivier Blanchard, José Viñals, Martin Wolf and so many other; when it is finally realized that the real serious risks in banking do not revolve around assets perceived as “risky”, as they all think, but around assets perceived as “absolutely safe”.

These regulators’ silly portfolio invariant credit risk based capital (meaning equity) requirements for banks, by impeding the fair access to bank credit of “the risky”, like small businesses and entrepreneurs, not only distorts and hurts the real economy; but they also guarantee major system crisis, since banks are then doomed to, sooner or later, to get caught with their pants down (meaning little equity), with huge exposures to something which was perceived as “infallible” but which has turned into something very risky… often precisely because of too much credit at too low interest rates.

Should it be "More risk more equity – less risk less equity" as these regulators argue?

No! I prefer no distortion, but, if anything, then just the opposite.

These current regulators they all confuse the world of ex-ante perceived risks with the world of ex-post realized dangers.

These regulators have never heard or understood Mark Twain’s “A banker is he who lend you the umbrella when the sun is out, and wants it back as soon as it looks like it is going to rain”

Bye bye Europe! Having introduced financial feudalism, Europe has gone back to the Middle Ages.

The AAAristocracy, those who posses or have access to an AAA rating; and the sovereigns, those who have declared themselves to be infallible have, with the witting or unwittingly cooperation of neo-vassal bank regulators, managed to introduce a system that guarantees them, more than ever, preferential access to bank credit.

That has been achieved by means of the portfolio invariant credit risk based capital, meaning equity, requirements for banks. More perceived credit risk - more equity; less risk - less equity. Because that insidious piece of regulation allow banks to earn more risk-adjusted returns on equity when lending to the AAAristocracy or when lending to the “infallible sovereign”, than when lending to the “risky”, like to small businesses and entrepreneurs.

And, as anyone should be able to understand, the more you subsidize the access to bank credit for some, in this case through regulations, the harder it is for those excluded to compete for it.

In short, a sort of financial feudalism has taken over Europe. 

And since that impedes fair access to bank credit, the land, to those Europe most needs to have it, its peasants, there is but one way it can go... and that is down down down.

And clearly this odious discrimination against the opportunities of the peasants, can only increase the inequalities in the society. 

But of course it will all come to an end, when the banks fail because of lending too much at too low rates, to a not so infallible sovereigns or to a false AAAristocrat... since that is why banks have always failed. Never ever have they failed by lending too much to peasants.

PS. It is not only Europe that is affected. The Basel Committee is spreading financial feudalism around the world... now even in America, "the land of the free", they have AAAristocrats... more precise yet AAArisktocrats

The tragic and not understood reality of a Mario Draghi ECB/SSM speech

Ladies and Gentlemen,

I am very pleased to welcome you to the inauguration of the Single Supervisory Mechanism.

The current “crisis has caused many of our fellow citizens to question whether the European project can keep its promise of shared economic prosperity.”

In particular, we needed to decisively and credibly address the weaknesses in the banking sector. That is: “key to protecting citizens and businesses as taxpayers, depositors and borrowers.

And so I am happy to announce that ECB and our dear colleagues in the Basel Committee and the Financial Stability Board, have decided to continue imposing on banks capital, which means equity, requirements based on perceived risk.

More ex ante perceived risk-more equity; less ex ante perceived risk-less equity. 

And that means that our banks will keep on earning higher rates of return on equity when lending to for instance our infallible sovereigns and to members of the AAAristocracy, than when lending to risky medium and small businesses, entrepreneurs and start-ups.

And, as you can understand, banks will keep on acting according to those incentives… they’ve got no choice.

What do you think about that?

Yes I hear you… it did not work that well in Basel II… and insufficient job creation persist. Yes indeed, but you all know we are the experts and we know we can’t be wrong, and so we must insist, until we prevail.

Good night… and do not forget to turn out the lights!

Après nous le deluge

Current capital (meaning equity) requirements for banks are unethical, regressive, dangerous, stupid and promote inequality

Allowing banks to hold assets perceived as absolutely safe against much less capital (meaning equity) than against assets perceived as risky, allows banks to earn much higher risk-adjusted returns on bank equity when lending to the “absolutely safe” like the infallible sovereigns and the AAAristocracy, than when lending to the “risky”.

And that effectively hinders the fair access to bank credit of the “risky”… like that of the small businesses and the entrepreneurs.

And that effectively curtails opportunities and promotes inequalities.

And that odious regressive regulatory discrimination of the risky, as if these were not already sufficiently discriminated against, is unethical; and kills opportunities, which leads to ever increasing inequalities.

And that regulatory distortion is extremely dangerous since it impedes the banks to allocate credit efficiently, which means the real economy will, more sooner than later, stall and fall.

And finally it is all so useless and so stupid… because never ever has a major bank crisis resulted from excessive bank exposures to what was perceived as risky; these have all resulted from excessive exposures to what was erroneously perceived as absolutely safe.

The Basel Committee, the Financial Stability Board and “The Parable of the Talents” Matthew 25:14-30

The governments, on behalf of us citizens, us taxpayers, support the banks in times of troubles, for instance by the Fed acting as a lender of last resort. And that can cost us citizens, us taxpayers, a lot.

But that risk of supporting the banks is not acceptable only in order to produce special profits to bank shareholders, or just to have the banks serve as a mattress where to safely stash away our money. It is accepted exclusively so that banks, by means of efficiently allocating bank credit, could help us to drive our economies forward.

And that willingness to support-the-banks-risk is, for its management, placed into the hands of bank regulators, like the Basel Committee and the Financial Stability Board.

But these regulators decided (on their own) that banks’ primary purpose was to avoid risks… something loony because that by itself would negate the reason for supporting the banks.

And so they concocted credit risk weighted equity requirements that made banks earn much higher risk-adjusted returns on equity when lending to those perceived as "absolutely safe", than when lending to "the risky".

And that regulatory risk aversion, besides stopping banks from lending to the risky, like to small businesses; also made banks lend excessively to what ex ante was perceived as absolutely safe, but that ex post turned out to be very risky, like AAA rated securities and Greece.

And that all resulted in a crisis that caused immense costs… this time without having generated sufficient and reasonable compensation in terms of creating sturdy economic growth.

And those risk adverse regulations now block our way out of the crisis... and might doom our young to become a lost generation.

And today in mass we were reminded of “The Parable of the Talents: Matthew 25:14-30, and of which I extract the following: 

14 “It will be like a man going on a journey, who called his servants and entrusted his wealth to them. 15 To one he gave five bags of gold, to another two bags, and to another one bag, each according to his ability. Then he went on his journey… 

24 “Then the man who had received one bag of gold came. ‘Master,’ he said, ‘I knew that you are a hard man, harvesting where you have not sown and gathering where you have not scattered seed. 25 So I was afraid and went out and hid your gold in the ground. See, here is what belongs to you.’

26 “His master replied, ‘You wicked, lazy servant! So you knew that I harvest where I have not sown and gather where I have not scattered seed? 27 Well then, you should have put my money on deposit with the bankers, so that when I returned I would have received it back with interest. 28 “‘So take the bag of gold from him and give it to the one who has ten bags. 29 For whoever has will be given more, and they will have an abundance. Whoever does not have, even what they have will be taken from them. 30 And throw that worthless servant outside, into the darkness, where there will be weeping and gnashing of teeth.’

And in today's sermon we later heard abut the dangers of caution and of playing it safe; and about the security that comes from risk-taking.

And there was a reference to Erikson’s Theory… with its Generativity that includes reaching out to others in ways that give to and guide the next generation, and a commitment which extends beyond self; versus Stagnation with its placing own comfort and security above challenge and sacrifice, and its self-centered, self- indulgent, and self-absorbed.

And we prayed for “courage so that we can walk in the way of the Lord”… and of course I was reminded of “God make us daring!”

And so I naturally identified with the “Master” in wanting to throw those “wicked lazy” bank regulators “outside, into the darkness, where there will be weeping and gnashing of teeth”

Pope John Paul II: Our hearts ring out with the words of Jesus when one day, after speaking to the crowds from Simon's boat, he invited the Apostle to "put out into the deep" for a catch: "Duc in altum" (Lk 5:4). Peter and his first companions trusted Christ's words, and cast the nets. "When they had done this, they caught a great number of fish" (Lk 5:6).

G20, the Financial Stability Board does not know what it is doing, or is simply hiding a monstrous regulatory mistake.

“In Washington in 2008, the G20 committed to fundamental reform of the global financial system. The objectives were to correct the fault lines that lead to the global crisis and to build safer, more resilient sources of finance to serve better the needs of the economy”

That is how FSB on November 14, 2014 introduces its report to the G20 leaders titled “Overview of Progress in the Implementation of the G20 Recommendation for Strengthening the Financial Stability”

And the letter that accompanies it states: “The job of agreeing measures to fix the fault lines that caused the crisis is now substantially complete.” 

But the sad fact is that the report does not even mention what in my opinion constitutes the most important fault line, and in not doing so, makes it also impossible for banks to serve the needs of the economy.

As I see it that "fault line" was the Perceived Credit Risk Weighted Equity Requirements for Banks. Here follows my explanation:

Banks already clear for perceived credit risks (in the numerator) by means of interest rates, size of exposure and other terms of contract.

And so, when regulators cleared for the same perceived risks in the equity (more risk more equity – less risk less equity) they allowed banks to earn much higher risk adjusted returns on equity when lending to those perceived as “absolutely safe”, than when lending to those perceived as “risky”

The following are some examples of risk weights and leverages based on the original 8% equity requirement and that are indicated in the Basel II approved in June 2004.

Infallible sovereigns: zero percent RW, allowing infinite leverage.

Members of the AAAristocracy: 20 percent RW, allowing a leverage of 62.5 to 1.

Financing of houses: around 25 percent RW, allowing a leverage of 50 to 1

Medium and small businesses, entrepreneurs and start-ups, and citizens: 100 percent RW, allowing a leverage of 12.5 to 1.

And there is a perfect correlation between the troubled bank assets that caused the crisis, and the presence of ultralow capital requirements.

And this monumental distortion in the allocation of bank credit is not even mentioned.

Either the FSB has not understood the problem, or it is hiding the truth about this horrendous regulatory mistake.

And even from the perspective of medium term stability of banks, these regulations are absolutely useless. That is so since all really serious bank crises never result from excessive exposures to what is perceived as risky, but always from excessive exposures to what has erroneously perceived as “absolutely safe”. And so, if anything one could even argue the equity requirements should be totally the opposite, higher for what is perceived as “absolutely safe” and lower for what is perceived as “risky”. 

And these risk weighted equity requirements are impeding bank credit from reaching where it is most needed and therefore wasting all the liquidity support provided by QEs and similar programs.

Yes regulators will tell you that Basel III has the Leverage Ratio which is not risk-weighted. What they do not understand though is that raising the floor, only increases the pressure of those living close to the roof... namely "the risky".

Bank regulators who as we all have prospered thanks to the risk-taking of the banks of our parents, are now negating that risk taking to our children.

As a consequence our banks are now not financing the risky future, only refinancing the safer past.

Risk taking is the oxygen of development, and these regulators have no right whatsoever to believe with astonishing hubris they can be the risk-managers of the word, and go behind our back, calling it quit, and so making our economy stall and fall.

Conclusion: Basel III has NOT fixed the distortions in the allocation of bank credit. In some ways it has even made it worse. And, to top it up the risk-adverse regulatory monsters also want to go after the insurance sector.

God make us daring!

20% credit risk weighted total loss-absorbing capacity (TLAC), is an assassination of the real economy

Mark Carney of the Financial Stability Board has just mentioned the possibility of 20% credit risk-weighted total loss-absorbing capacity for banks TLAC.

That, when lending to for instance one of the AAAristocracy who carries a risk weight of 20%, means the bank would need to hold 4% in TLAC.

But, when lending to a small business, which carries a risk weight of 100%, then the bank would need to hold 20% in TLAC... 5 times more! ...16% more!

This will of course mean that banks will lend too much to “the infallible” at too low interest rates, and never more to small businesses and other “risky” unless at extremely high relative interest rates.

That means in effect an assassination of the real economy

Why do bank regulators deny their children the risk-taking by banks that benefitted them?

“Mark Carney has pledged that taxpayer money should never again be used to prop up banks.” 

And the price for achieving that by discriminating against the "risky", will foremost be paid by the poor, increasing the inequalities. Good job!

The poor, “the risky” and the future are subsidizing the bank borrowings of “the absolutely safe”. Now how about that?

Governments guarantees to help bank creditors if banks fail, which in all essence is a support subsidy to the banks.

And, if banks fail, and government needs to pay up, it is argued that it is the taxpayers who must pay… and we usually leave it at that. 

But, when taxpayers pay, it is actually all who pay, and that means, in relative terms, especially the poor; because the wealthy have more deposits in the banks which are saved; and because the poor would probably be the one most to benefit with the taxes that could be collected, if the support subsidy was not needed to be paid.

But regulators also allow banks to hold less equity when lending to those from a credit point of view perceived as absolutely safe, than when lending to those perceived as risky; and that signifies that the support subsidy is effectively bigger for those perceived as absolutely safe than for those perceived as risky.

Finally, what has already made it, namely the history, has a lot more possibilities of being perceived as absolutely safe, than what needs an opportunity to be, namely the future.

All that translates into that the poor, those perceived as "risky" and the future, are subsidizing the bank borrowings of the “absolutely safe”… now how about that? And, if that is not a cruel way of fostering inequality, what is?

Is the Independent Evaluation Office (IEO) of the International Monetary Fund (IMF) independent enough?

In October 2014, the Independent Evaluation Office of the International Monetary Fund presents a report titled: “IMF responses to the financial and economic crisis: An IEO Assessment”

And it does not mention what I am convinced is the primary cause of the 2007-08 crisis; and also what most obstructs our way out of it. 

I refer to the Basel Committee for Banking Supervision’s credit-risk-weighted capital/equity requirements for banks.

These allowed banks to hold assets perceived as “absolutely safe” against extremely small capital (equity) requirements, which translated into extremely high leverages of equity (62.5 times to 1 and more). 

That allowed banks to earn much higher expected risk-adjusted returns on equity when lending to what was perceived as “absolutely safe” than when lending to what was perceived as “risky”, which translated, naturally, into dangerously high exposures to what was perceived as absolutely safe”.

And any simple observation of the crisis makes clear the direct relation that existed between bank assets in problem, and bank assets with low risk-weights. For instance: i. AAA rated securities backed with mortgages to the subprime sector in the US. ii. Real estate backed financing, like that in Spain. iii. Loans to “infallible sovereigns”, like to Greece.

And we have not been able to get out of that crisis because banks still need to hold much more equity when lending to what is perceived as “risky”, like to medium and small businesses, entrepreneurs and start-ups… and that has of course impeded the liquidity provided by central banks to reach where it is needed the most.

And this regulatory risk aversion that so much distorts the allocation of bank credit to the real economy, and is dooming our economies to stall and fall, is not even part of the IMF discussions on what to do.

And so those criticizing IMF for “austerity” are not addressing the worst one of these, namely the risk-taking austerity regulatory virus that has invaded our banks... slaying the animal spirit of our economies.

And so how do you think I feel about IEO. I have to doubt its real independency… I must suspect it is also into the pockets of a groupthink incapable of understanding, or not daring to consider the possibility that bank regulators could have been so utterly mistaken. Not daring to lay the blame for the crisis more on regulators than on the bankers.

It is in bank regulations, where the animal spirit is being slayed, where Keynes is most needed

John Maynard Keynes argued: One family whose breadwinner loses a job can and should cut back on spending to make ends meet. But everyone can’t do it at once when there’s generalized weakness because one person’s spending is another’s income.

But the same goes for risk-taking. The risk-taking by the few creates the opportunities for the many. In other words, nothing can be as risky as excessive risk-aversion.

Unfortunately bank regulators, with their credit-risk-weighted capital/equity requirements, have effectively instructed banks:

“Stop taking the risk of financing the ‘risky’!”… the medium and small businesses, the entrepreneurs and start ups… 

“Finance only the ‘infallible’!”… the sovereigns, the housing sector and the AAAristocracy.

Keynes stated: “If the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die.”

And so today, it is clearly in the Basel Committee for Banking Supervision, in the Financial Stability Board and in the IMF where Keynes is most needed; in order to demolish the obstacles that distort the normal risk-taking that should take place in our banks.

If children are evaluated better for safe piano playing than for risky sports, could that lead to a weaker society?

I ask that because, with respect to our banks, with their credit risk weighted equity requirements, bank regulators are giving banks much more incentives to dedicate themselves to financing what is ex ante perceived as absolutely safe, usually the past, than to explore the financing of what is perceived as risky, usually the future… and I have absolutely no doubt that a weaker and less sturdy real economy must result.

Current regulators looking to castrate of at least to de-testosterone our banks, have no idea what dangers they are creating for our economy and our society.

We need bank regulators to stop discriminating against the fair access to bank credit of those ex ante perceived as "risky", like the medium and small businesses, the entrepreneurs and start-ups.

We need bank regulators to stop favoring the access to bank credit of those perceived as "safe", like the "infallible" sovereigns, the house buyers and the members of the AAAristocracy.

And we need our banks to have more equity... not to make them less risky... but to allow them take more risks.