“Age of Easy Money” ignored the risk weighted bank capital/equity requirements.

I’m stunned. 1:54 hours of a very interesting “Age of Easy Money”, that does contain one single reference to the credit risk weighted bank/equity requirements which distorted the allocation of bank credit and allowed bureaucrats and asset owners, to live on Easy Street.

James Jacoby: With all due respect, I wonder if you could be a little bit more explicit with me. What will the Fed own when it comes to the vulnerability of the system?

Neel Kashkari: Well, I reject the thesis. I actually don't think it's been the Fed's monetary policy that has led to these vulnerabilities. I think it's been incomplete regulatory policy that has led to these vulnerabilities.

My comment: Central banks’ monetary policies, e.g., liquidity injections, have to pass many corianders/strainers before reaching the economy. The most important one, bank credit allocation. Think of risk weighted bank capital requirements as one of these.

Then think of central bankers not caring about the fact that coriander/strainer contains different sized holes. Larger for “safe” government debt, residential mortgages and AAA rated assets; smaller for “risky” loans to small businesses and entrepreneurs. 

Sheila Bair: The entire business community has had a taste of bailouts. I fear that now, the Fed stepping in, not just to bail out Wall Street, but the entire corporate America, is starting to be embedded into people's thinking. People talk about the survival of capitalism, but this is the biggest threat to capitalism. In good times, when anybody can make money, you reap those profits. In bad times, the Fed just keeps stepping in. You have this never-ending ratchet up. The markets never correct.

James Jacoby: It's like a no-lose casino.

Sheila Bair: It is. It is a no-lose casino. That's exactly right

My comment: No! Its more of a doomed casino. In a roulette table, the payouts are all a direct function of the probabilities of any one of the outcomes. E.g., black or red, 50% chance, a payout of 1 plus the bet; any single number, a payout of 35 plus the bet. Imagine then that a casino regulator arguing that the gamblers should be saved from losing too much, decreed that the pay out on “safe” bets, e.g., black or red, should double. The casino would be doomed.

That’s what the perceived credit risk weighted bank capital requirements do. These allow banks to leverage much more their equity, increasing the payout, with assets perceived (or decreed, or concocted) as safe than with assets perceived as risky.

James Jacoby: Was there a concern at the White House that the Fed was running the economy too hot for too long?

Brian Deese: That is a question that I will institutionally not answer.

James Jacoby: Why?

Brian Deese: Because one of the hallmarks of our system is the independence of monetary policymaking.

My comment: Independence? Hah! Here follows the confession that seemingly shall not be heard.

“The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages… The American “overall leverage” approach had a disadvantage as well in the eyes of shareholders and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return US government securities." Paul Volcker in “Keeping at it” 2018.

My questions, to all: 

Where would the market’s “risk-free” interest rates be, if not allowing banks to earn higher risk adjusted returns on government debt? 

Would government debt (government spendings) have become as large, if not allowing banks to earn higher risk adjusted returns on government debt? 

Where would house prices be if not allowing banks to earn higher risk adjusted returns on residential mortgages?

Christopher Leonard: The financial system globally has been built around extremely low, ultra-low interest rates for 10 years.

My comment: And around bank regulations based on that what’s perceived (or decreed or concocted as safe) is more dangerous to our bank systems than what’s perceived as risky. What would Mark Twain have opined about that?

Mohamed El-Erian: In 2022, we've had this very unusual situation whereby you've made double-digit losses on both risky assets, stocks, and risk-free assets, U.S. Treasuries. That's not supposed to happen.

My question: Should it suffice for regulators to argue that what’s safe is not supposed to become risky?

Mohamed El-Erian: A big issue for retirement plans, pension systems, because no matter how well you diversified your portfolio, there was no risk mitigation in it at all.

My question: How much of current bank regulations that so much favors the refinancing the “safer” present, over the financing of the “riskier” future (a reverse mortgage) have also seeped through to contaminate retirement plans and pension systems? 

Nouriel Roubini: We have had literally a few decades of ever-increasing bubbles that have been fed and supported by central banks. And not only have we had bubbles, but we've had bubbles that have been fed by excessive leverage, excessive private and public borrowing and excessive risk-taking.

My comment: All of that, except “excessive risk-taking”. What happened was the buildup of excessive exposures to assets that were perceived, decreed or concocted as safe.

Rana Foroohar, Associate editor, Financial Times: When interest rates start to rise and the tide pulls out, as Warren Buffet would say—

Charles Duhigg: The New York Times: You don't know who's swimming naked—

My comment: With bank capital/equity requirements mostly based on perceived credit risks, not misperceived risks or unexpected events, e.g., covid, war, inflation, one should know banks will stand there naked, just when they’re needed the most, just when its hardest to raise bank equity.

James Jacoby: So I guess the question though is how much disruption in the financial markets are you willing to tolerate now that they're adjusting to this new interest rate environment, after more than a decade of zero rates?

Neel Kashkari:

We live in a market economy.

My comment: “A market economy”, with risk weighted bank capital requirements and Quantitative Easing? Sorry you have not the faintest idea of what a market economy is. Have you ever left your desk and walked on Main-street?

James Jacoby: Are you basically saying that we should be preparing right now? That there would be a bursting of this massive credit bubble?

Jim Millstein: It's happening right in front of us. It may—It's happening right now.

My opinion: Yes! What can be done? Not a full plan, but here's a start:

1. Zero dividends, buy-backs and big bonuses, before banks have ten percent in capital against ALL assets.

2. Debt to equity conversion should be one of the most important resolution tools.

Female newsreader: In breaking news, a U.S. Federal Reserve has bailed out the Silicon Valley Bank, which had collapsed over the weekend.

Joe Biden: There are important questions of how these banks got into the circumstance in the first place.

My comment: SVB was holding a high number of Treasury and other government bonds — amounting to more than half of its assets. Mr. President dare to ask its regulators: How much capital/equity/skin-in-the game, did SVB's shareholders need to hold against that?

James Jacoby: How do you think we’ll look back at this era of easy money?

Steven Pearlstein: Unfortunately, I think we may look back on it as something of a golden era, because cheap and free money, without consequences, is great. But in other ways, we will think about it as a lesson for the future, which is that it was a mistake.

My comment: Yes, and those after us will recognize it as a violent violation of that social intergenerational contract Edmund Burke spoke about. 

Mohamed El-Erian: I think that we're going to look back on this era as being totally exceptional historically, and one where we didn't fulfill its potential. We lost sight of something critical: We lost sight of how we grow our economy in a sustainable and inclusive fashion.

My comment: Absolutely, and all because bank regulators focused solely on the safety of banks and totally ignored what their real purpose is; way more important than safe mattresses in which to stash away cash.

Christopher Leonard: When you have a society with the middle struggling and the rich realizing almost unimaginable gains, it starts to corrode the civic foundation. People start to feel like this cliche you hear all the time: that the system is rigged.

My comment: It is rigged. The more creditworthy have always paid lower risk adjusted interest rates than the less creditworthy, and that's as it should be. But credit risk weighted bank capital/equity requirements, have also decreed the less creditworthy to be less worthy of credit. And that's not how it should be.

Mohamed El-Erian: This is a political problem.

My comment: Absolutely. It was all about empowering a Bureaucracy Autocracy.

Bank capital requirements with decreed risk weights; 0% Federal Government – 100% We the People. What would America’s Founding Fathers have opined on that?

@PerKurowski In all this, where do I come from?