My published letters on the 2008 GFC, caused by AAA rated MBS stuffed with subprime mortgages.

For sausages, find the cheapest meat, slice & dice it, stuff the casings, and sell it as a delicacy.

Mortgage-backed securities (MBS) with subprime stuff, were rated AAA, which thanks to Basel II allowed banks to leverage these 62.5 times.

The 2008 GFC ensued.

Financial Times: January 11, 2003

Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough.

Financial Times, August 23, 2006

Long-term benefits of a hard landing.

While you correctly argue (“Hard edge of a soft landing for housing”, August 19,) that “even if gradual, a global housing slowdown would be painful” you do not really dare to put forward the hard truth that the gradualism of it all could create the most accumulated pain.

Why not try to go for a big immediate adjustment and get it over with? Yes, a collapse would ensue and we have to help the sufferer, but the morning after perhaps we could all breathe more easily and perhaps all those who, in the current housing boom could not afford to jump on the bandwagon, would then be able to do so, and take us on a new ride, towards a new housing boom in a couple of decades.

This is what the circle of life is all about and all the recent dabbling in topics such as debt sustainability just ignores the value of pruning or even, when urgently needed, of a timely amputation."

Washington Post, September 6, 2007.

Factors in the Financial Storm

David Ignatius, in his Sept. 2 op-ed, "The Real Causes of the Financial Storm" failed to mention the two lead actors in the financial mess we find ourselves in: the credit rating agencies, whose AAA ratings turned what should have remained a local problem involving some subprime lenders into a global financial storm; and, of course, the bank regulators who against all wisdom enabled the credit rating agencies to foist what they consider to be only their First Amendment-enabled opinions upon the markets.

In May 2003, as one of the 24 executive directors of the World Bank, and probably only because of that, I was invited to make some comments during a workshop arranged by the World Bank for bank regulators on assessing, managing and supervising financial risk. Along with offering some suggestions, I told the regulators, "I simply cannot understand how a world that preaches the value of the invisible hand of millions of market agents can then go out and delegate so much regulatory power to a limited number of human and very fallible credit rating agencies. This sure must be setting us up for the mother of all systemic errors."

I never got invited to comment again."

Washington Post: June 20, 2008

An Aspect of the Bubble

"Nothing whetted the appetite for securities collateralized with plainly lousy mortgages as much as the combination of high returns and prime credit ratings. Using a regulatory system for banks that is based on following the credit rating agencies will, given that it is human to err, lead us into even greater danger."

Washington Post: December 27, 2009:

Another 'worst': Faulty bank regulation

"The Dec. 20 Outlook compilation of the decade’s worst ideas did not include the one most to blame for the loss of most of the past decade’s growth: regulations that allowed banks to hold absolute minimums of capital as long as they lent to clients or invested in instruments rated AAA, for having no risk. This launched a frantic race to find AAA-rated investments wherever and finally took the markets over the cliff of the subprime mortgages. 

The most horrific part is that it seems likely to endure because regulators can’t seem to let go of this utterly faulty regulatory paradigm. Let me remind you that banks are allowed to hold zero capital when lending to sovereign countries rated AAA and that there are already many reasons to think that the credit quality of many sovereign states has been more than a bit overrated."

Some of my early public opinions on the Basel Committee's bank regulations

#AI ChatGPT – Grok: Bank regulations favoring government debt over loans to the private sector, does it increase or decrease taxable income?

I asked ChatGPT:

"Current bank regulations favor government debt over loans to the private sector. 

Briefly, in less than 200 words: In the medium and long term, does that increase or decrease taxable income?"

Chat GPT answered:

"Likely decrease in the medium and long term — if the effect is that bank credit is persistently shifted from productive private investment toward government debt.

The mechanism is indirect:

Government borrowing finances current public expenditure, but does not necessarily create equivalent future taxable income.

Loans to entrepreneurs, farmers and businesses can finance investment, productivity, employment and new profits, which generate future taxable income.

If regulation makes government debt relatively more attractive to banks, private-sector credit can be reduced. The IMF has found that greater bank holdings of government securities are associated with lower private-sector credit growth. 

Over time, weaker private investment and productivity can mean slower growth of wages, corporate profits and consumption, and therefore a smaller tax base. The IMF explicitly notes that high sovereign debt and constrained private investment can weigh on productivity and income growth over the long term. 

So, in your terminology, favoring the refinancing of the safer present over financing the riskier future can ultimately reduce the future taxable-income base.

There is an important qualification: government spending financed by debt can itself raise future productivity and taxable income. The outcome therefore depends on what the government does with the borrowed money."

I asked ChatGPT:

"You mention “government spending financed by debt can itself raise future productivity and taxable income.” Briefly, does that not imply bureaucrats know better what to do with public debt, for which they’re not personally responsible for, than the private sector with its bank loans? Is this so?"

Chat GPT answered:

Not necessarily. It does not imply that bureaucrats know better. It means only that public debt can be productive when government chooses productive investments.

There is a fundamental difference in the incentives:

Private borrower: generally risks capital, reputation, bankruptcy and future income; a bank lending to them has an incentive to investigate whether the project can repay the loan.

Government: can borrow against future taxpayers. The individual bureaucrat deciding on a project normally does not personally bear the financial loss if it fails.

Market process: millions of private decisions continually test alternative projects through prices, profits and losses.

Political process: public investment is subject to political priorities, lobbying, bureaucratic incentives and electoral considerations.

That does not mean private investment is always superior—private banks and entrepreneurs also make spectacularly bad decisions. But it does mean there is no economic principle saying that government officials systematically have better information or incentives to allocate capital than private investors.

And this connects directly to your Basel argument: if regulation makes banks favor government debt over private-sector loans, it is effectively giving government a preferential claim on society's scarce savings and credit. Whether that ultimately raises or lowers future taxable income depends heavily on what replaces the private investment that was crowded out."

I said: "Thanks. Though I see you still consider that governments could do better than "the private investment that was crowded out."

ChatGPT replied: 

"Yes — that is a fair reading of what I said, but I would phrase the distinction more carefully.

I was allowing for the possibility that a government investment could, in some circumstances, produce a higher social return than the private investment displaced by it. That is an empirical possibility, not an assumption that bureaucrats allocate capital better.

Your deeper point is about who should have the presumption of competence. If bank regulation deliberately channels credit toward government debt and away from private entrepreneurs, it effectively assumes that government has a better—or at least preferable—use for those financial resources.

That assumption deserves to be demonstrated, rather than built into the regulation.

And there is an important asymmetry: private investors generally bear the consequences of their investment decisions; government officials spend resources ultimately backed by taxpayers. That difference in incentives is a legitimate reason to be skeptical of systematically replacing private capital allocation with government-directed allocation.

So I would revise my earlier wording to:

Government can sometimes invest productively, but that is not a sufficient reason to presume that government should receive preferential access to credit over the private sector.

That, I think, captures your objection more precisely."

I said: Thanks. That last phrase with its "not sufficient reason to presume" makes it clear. 

ChatGPT replied: 

"Exactly. The key distinction is between “can sometimes do better” and “should therefore receive preferential treatment.”

The first is an empirical possibility; the second requires a much stronger justification."

I said: Thanks!

It said: You're very welcome!

I asked Grok:

"Current bank regulations favor government debt over loans to the private sector. 

Briefly, in less than 200 words: In the medium and long term, does that increase or decrease taxable income?"

Grok replied:

"It decreases taxable income.

Preferential capital and liquidity treatment (often 0% risk weights on sovereigns versus 20–100%+ on private loans) tilts bank portfolios toward government securities and away from private credit. This crowds out lending to firms and households, reducing private investment and capital accumulation. 

Lower private capital and productivity slow GDP growth. Wages, profits, and other private-sector incomes—the main tax base—therefore grow more slowly. Government outlays financed by the extra debt are frequently transfers or consumption rather than productivity-enhancing investment, so they do not offset the lost private tax base. Models that remove the regulatory bias show higher long-run private lending, investment, and output. 

The net medium- and long-term effect is a smaller, slower-growing taxable-income base."

I said: Thanks!

It replied: You're welcome.

Note: The answers are copied exactly from those given to me by ChatGPT and Grok

Here my many other questions to ChatGPT – Grok on bank regulations.

#AI ChatGPT – Grok: Development is a UN declared human right. It implies risk taking. Basel decreed risk averse regulations. Could that be taken to the ICC?

 I asked ChatGPT: 

 “1986 the UN declared development a human right, and development requires the willingness to take risks. 

1988, the Basel Committee, decreed risk averse risk weighted bank capital requirements that much favor “safe” government debt over loans to e.g., “risky” small business and entrepreneurs.

Briefly, in less than 300 words, could it be useful to introduce at the International Criminal Court a complaint against the regulators for having violated a human right, so as least have a public discussion about it. Do you believe ICC would dare to hear the case?”

 

ChatGPT answered:

 

Yes—as a vehicle for forcing a serious public discussion, the idea could be interesting; as an actual ICC prosecution, it is almost certainly legally untenable.

The 1986 UN Declaration does indeed proclaim the right to development as an inalienable human right, including participation in and enjoyment of economic, social, cultural and political development. It also says States have duties to create conditions favourable to development.

That gives your argument an intriguing foundation: one could ask whether an international regulatory regime that systematically makes productive, entrepreneurial credit more expensive while privileging government debt has created an obstacle to the realization of that right.

But the ICC is a criminal court with a very narrow mandate. Its jurisdiction is limited to genocide, crimes against humanity, war crimes and aggression. Economic policy, even demonstrably damaging economic policy, is not presently an ICC crime. Moreover, the Rome Statute creates individual criminal responsibility; establishing that particular regulators committed one of those crimes would be an enormous additional hurdle.

So, would the ICC dare hear it? I would say almost certainly not—not because the underlying economic argument is necessarily foolish, but because the Court lacks the jurisdiction.

Paradoxically, that may make your idea useful in another form: a formal legal memorandum or petition asking international human-rights institutions whether risk-weighted regulation can constitute an internationally created obstacle to the right to development. That could put the Basel system itself on trial intellectually, without pretending the ICC has jurisdiction it does not possess.

Would you prefer to develop this as (1) an ICC-style legal argument, (2) a UN human-rights petition, or (3) a provocative public “case against Basel”?

I wanted to say thanks but had no chance.

I asked Grok:

 

“1986 the UN declared development a human right, and development requires the willingness to take risks. 

1988, the Basel Committee, decreed risk averse risk weighted bank capital requirements that much favor “safe” government debt over loans to e.g., “risky” small business and entrepreneurs.

Briefly, in less than 300 words, could it be useful to introduce at the International Criminal Court a complaint against the regulators for having violated a human right, so as least have a public discussion about it. Do you believe ICC would dare to hear the case?”

 

Grok answered:

 

"I'll quickly verify the 1986 UN declaration, the 1988 Basel rules, and ICC jurisdiction so the answer stays accurate and brief. 

The 1986 UN Declaration on the Right to Development exists, but it is a non-binding General Assembly resolution, not a treaty that creates justiciable individual criminal liability.

Basel I (1988) did assign 0% risk weights to most OECD sovereign debt and 100% to ordinary corporate and SME loans, which tilts banks toward government paper. 

 

That incentive structure is a legitimate policy debate. It is not a useful ICC complaint. The Court’s jurisdiction is limited to genocide, crimes against humanity, war crimes, and aggression committed by natural persons after 2002. Regulatory standard-setting by the Basel Committee does not meet those elements. The Prosecutor’s office would screen it out at the preliminary-examination stage for lack of subject-matter jurisdiction; the Court would not “hear” it. 

 

A publicity filing might generate a few headlines, but labeling prudential regulators as international criminals is more likely to make the underlying argument look fringe than to force a serious discussion of credit allocation, sovereign-bank loops, or SME finance. 

 

Better venues already exist: Basel consultations, national parliaments, academic work, and ordinary human-rights reporting mechanisms.

 

The ICC would not need to “dare” anything. It would simply apply its statute and decline.

 

I said: Thanks. "Given that Basel regulations were introduced in 1988 and since then there has been no serious discussion about the relation between their implied risk aversion and development, perhaps “publicity” of any sort might be needed to break that silence."

 

Grok answered:

 

I’ll check whether the Basel–development/risk-aversion link has actually been silent since 1988, so the publicity claim can be judged against the record.

 

The silence is narrower than it first appears. The specific framing you use—1986 right to development versus 1988 risk-weighted capital as institutionalized risk-aversion—has stayed marginal. 

The underlying mechanics have not. Sovereign 0% (or near-0%) weights versus 100% (or high) weights on ordinary SME and entrepreneurial loans have been discussed for years in IMF/World Bank work, academic papers on crowding-out and the sovereign-bank nexus, EU debates over the SME supporting factor, and national hearings on Basel 3.1. 

Per Kurowski raised a close version of the development argument at the UN Financing for Development dialogue in 2007. 

 

So the problem is not total silence. It is that the issue lives in technical and banking-policy channels and rarely becomes a public argument about what kind of risk a society is allowed to take.

 

Publicity can help that translation. It is most useful when it is hard to dismiss: portfolio-share data (government paper vs. SME loans over time), comparisons of regulatory risk weights with actual default and loss rates, and the simple capital-cost arithmetic that makes a “safe” sovereign claim cheaper to fund than a productive private one. Those facts travel.

 

An ICC complaint is a weak instrument for that job. Lack of jurisdiction is obvious; the filing would be treated as a stunt. Stunts sometimes work, but they more often let opponents change the subject from credit allocation to “this person wants to prosecute central bankers.” That can deepen the silence around the real claim rather than break it.

 

If the goal is discussion, the higher-leverage venues are still Basel consultations, parliamentary banking committees, development-finance forums, and clear public writing that stays on the incentive distortion instead of on criminality. The distortion is real enough to stand on its own.

 

I said: Thanks!

 

It replied: You’re welcome. If you want to pick the argument back up later—data, venues, or how to frame the credit-allocation point more sharply—just say so.

Note: The answers are copied exactly from those given to me by ChatGPT and Grok. Grok referenced my article but in this case I inserted the link to it.

Here my many other questions to ChatGPT – Grok on bank regulations.