In America, in the Home of the Brave, in democracy, how can this have been going on, for over three decades?

“Assets assigned the lowest risk [in 1988], for which bank capital requirements were therefore nonexistent or low, were what had the most political support: sovereign credits & home mortgages… A ‘leverage ratio’ discouraged holdings of low-return government securities” Paul Volcker “Keeping at It” 2018.

That de facto means banks can leverage more their capital/equity with government debt and residential mortgages than with loans to small businesses and entrepreneurs. 

That de facto means banks can easier earn risk adjusted returns on capital/equity with government debt and residential mortgages than with loans to small businesses and entrepreneurs.

That de facto means banks have been given incentives to hold more government debt and residential mortgages than when holding loans to small businesses and entrepreneurs.

That de facto means banks will hold government debt and residential mortgages against much lower risk adjusted interest rates than those charged on loans to small businesses and entrepreneurs.

That de facto implies bureaucrats know better what to do with bank credit for which repayment they’re not personally responsible for than small businesses and entrepreneurs with theirs.

That de facto implies residential mortgages are more important than loans to those who can create the jobs and incomes, by which make down-payments, repay mortgages, service utilities & live.

In America, in the Home of the Brave, in democracy, how can this have been happening, for over three decades, and no one objects?

What would its Founding Fathers have said?

Some unasked questions that all nominees to the Federal Reserve Board, and of course its current members, should be dared to answer

Intro: The Federal Reserve’s risk weighted bank capital requirements allow banks to hold much less capital, translating into being able to leverage much more with assets perceived (or decreed) as safe e.g., Treasuries, residential mortgages and those with an AAA rating, than with e.g., small businesses, entrepreneurs and assets rated below BB-.

Q. With what assets do you think all those excessive bank exposures that have and could cause really serious bank crisis are built up with: with those perceived as safe or with those perceived as risky?

Intro: When times are rosy, these risk weighted bank capital requirements, allow banks: to lend dangerously much to what’s perceived as very safe; to hold much less capital; to do more stock buybacks and to pay more dividends & bonuses.

Q. Does this not sound like that when times turn bad, banks will stand naked when they are most needed? 

Intro: It is much easier for banks to obtain the risk adjusted returns on equity they look for with assets they can leverage more, and so therefore banks will naturally prefer these, that is unless assets which could be leveraged less, provide additional risk adjusted margins.

Q. Do you think it is more important for banks to finance residential mortgages than to finance those loans to small businesses that could help people get the jobs with which service mortgages and pay utilities?

Intro: The Fed when in 1988 it accepted the Basel Committee’s risk adverse bank capital requirements, it decreed weights of 0% the federal government and 100% “We the people”. 

Q. Do you think the Founding Fathers of The Home of the Brave would agree with regulators imposing risk aversion on its banks; and with bureaucrats knowing better what to do with credit for which repayment they’re not personally responsible for than American small businesses?

Q. Do you have an opinion on how much the strength of the US dollar depends on the United States remaining being perceived as the foremost military power in the world, and of course on its willingness and capacity of exercising such power?

Please, if I may, one last question:

Q. Where do you think America would be, if these bank regulations had been in place the last couple of centuries?

@PerKurowski

Where would the Home of the Brave be, if all its immigrants had been met by risk-adverse bank regulations?

In his Washington Post May 27 op-ed, “Subsidizing America’s most important product," George F. Will referred to “Joseph Schumpeter an immigrant from Austria” whose theory was that “the principal drivers of social dynamism are… innovators — inventors of new things and companies” and added that “The common denominator [of it] is the restless, risk-taking spirit of a talented few.”The de facto spirit of the risk weighted bank capital requirements in the United States can currently be summarized in the following way: 

“We regulators allow you banks to leverage your capital a lot, and therefore earn high risk adjusted returns on equity, with what’s safe, e.g., Treasuries and residential mortgages. But, as a quid pro quo, you need to stay away from what’s risky, e.g., small businesses and entrepreneurs”

So, let me ask: Where would the Home of the Brave be if all its immigrants had been met by such regulatory risk adverseness?

PS. Not the first time I have asked myself that question.

PS. John Kenneth Galbraith wrote: “For the new parts of the country [USA’s West] … there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business... [jobs created]. “Money: Whence it came where it went” 1975

PS. And at the World Bank I argued time and time again: “There’s a clear need for an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth.”

PS. God make us daring!

PS. And, to top it up, in The Land of the Free, that risk aversion came hand in hand with outright statism

My Fourth of July 2019’s tweets to the United States of America

This Fourth of July 2019, here below, are three tweets in which, to the United States of America that I admire and am so grateful to, I express my very heartfelt concerns.

In 1988 America signed on to the Basel Accord’s risk weighted capital requirements for banks. 

These gave banks huge incentives to finance what was perceived as safe, and to stay away from the “risky”. 

It is so contrary to a Home of the Brave opening opportunities for all.

And bank regulators decreed risk weights: 0% sovereign, 100% citizens

That implies bureaucrats know better what to do with credit than entrepreneurs

That has nothing to do with the Land of the Free, much more with a Vladimir Putin’s crony statist Russia

America, where do you think you would be if you had welcomed all your immigrants with risk weighted bank capital requirements?

PS. “grateful to”? Had my father, a polish soldier not been rescued by American’s from a German concentration camp April 1945, I would not be.

PS. As one of those millions Venezuelan in exile, I know my country’s future much depends on America’s will to support its freedom.

Banks, regulators and sovereigns, colluded to introduce, statism, risk aversion and complacency.

It's hard to pinpoint the exact meaning of complacency, especially as that sentiment could have different origins. I am not really sure what it means to Tyler Cowen, but to me, complacency, is quite often only a more comfortable and somewhat hypocritical expression of a “Please don’t rock the boat” wish.

I now quote extensively from Tyler Cowen’s “The complacent class” (page 13)

“One thing most Americans agree on it politics–for all the complaining about the bank bailouts–is that there should be more guaranteed and very safe assets. The Federal Reserve Bank of Richmond has estimated that 61 percent of all private-sector financial liabilities are guaranteed by the federal government, either explicitly or implicitly. As recently as 1999, this figure was below 50 percent. We’re also more and more willing to hold government-supplied, risk free assets, even if they offer very small or zero yields… Plenty of commentators suggest that something about this isn’t right, but again the push to fix it is extraordinarily weak, especially since that would mean someone somewhere would have to take significant financial losses.

There is a Zeitgeist and a cultural shift well under way, so far under way in fact that it probably needs to play itself out before we can be cured of it. The America economy is less productivity and dynamic, Americans challenge fundamental ideas less, we move around less and change our lives less, and we are all the more determined to hold on to what we have, dig in, and hope (in vain) that, in this growing stagnation, nothing possibly can disturb our sense of calm.”

Is it really so as Cowen seems to argue, that the Home of the Brave, that which has developed based on considerable doses of risk-taking by risk-takers, now comes to this complacency on its own... or was it entrapped?

I argue the latter. One way or another, regulators managed to sell to a financially naïve political sector the concept that it was possible for bank regulators, or for the more sophisticated banks’ risk models to determine real-risks, and so introduced risk-weighted capital requirements… topping it up by putting aside all considerations as to whether this could distort the allocation of credit to the real economy.

In 1988 America induced and signed up on the Basel Accord, Basel I. That ruled that for the capital requirements banks needed to hold, the risk weight of the sovereign was to be zero percent, 0%; for mortgages to the residential housing 55%; and for loans to We the People 100%.

In 2004, with Basel II, the risk-weight for residential mortgages was reduced to 35%; We the People were also split up in “the safe”, the AAA rated, the AAArisktocracy with a risk weight of 20%; passing through a risk-weight of 100% for those not rated ordinary citizens; and topping it out at 150% for those rated below BB-.

What did this mean? First that regulating technocrats, sent out the falsely tranquilizing message to the market of “Don’t worry, banks are now risk-weighted”. Second, that statists told banks: “We scratch your back and you scratch ours… the State guarantees you, and you lend to the State as cheap as possible”. 

Of course that immediately resulted in that banks would search out any assets that were decreed, perceived or concocted as safe; as with these banks could leverage more and therefore obtain higher risk adjusted returns on equity… which much explains the much increased appetite for “safe assets”, in America and Europe.

Of course that meant that the sovereign would by artifice receive much more bank credit, at much lower rates than usual; making a joke of that “risk-free-rate” used in finance. 

Of course that immediately resulted in that banks would avoid all assets officially perceived as “risky”, like loans to SMEs and entrepreneurs, as with these banks could leverage much less and therefore obtain lower expected risk adjusted returns on equity… which of course affected the productivity and the dynamism of the real economy, in America and Europe.

Of course that meant banks would prefer financing the construction of the “safe” basements were young unemployed can live with their parents than the riskier future that could create the jobs they need… which reduces mobility as more and more get to be chained to houses with artificially high prices.

And a truly sad part of all these induced statism and risk aversion is that it does not lead to any more bank stability, much the contrary. Major bank crises are caused by unexpected events (e.g. devaluations), criminal behavior (e.g. loans to affiliate) and excessive exposures to what was ex ante perceived as very safe but that ex post turns out to be very risky, among others because being perceived as very safe often causes it to receive too much bank credit.

What caused the 2007-08 crisis? Excessive exposures to what was perceived or decreed as safe as AAA rated securities and sovereigns like Greece.

What has caused stagnation thereafter? Lack of lending to SMEs and entrepreneurs, those best equipped to open up new paths.

Where banks in on this? Answer would banks like being able to earn the highest risk adjusted returns on equity when holding what they perceived as the safest? Of course they would, that sounds like bankers’ wet dreams come true.

I find “The Complacent Class” to be a fun and very useful book, and it could help get very important and needed debates going. That said I would like to see Tyler Cowen substantially updating the second edition of it, by including that dangerous risk aversion and complacency imposed on banks and on America (and Europe) by its regulators.

A pre-reading it comment on Mercatus Center’s Tyler Cowen’s “The Complacent Class”

Note: I have not read Tyler Cowen’s “The Complacent Class: The Self-Defeating Quest for the American Dream” yet, as it is still not available. If it contains something that would contradict the following comment that would be great welcomed news. 

In Foreign Affairs we can read: “Tyler Cowen’s timely and well-written book points to a central feature of contemporary American life: since the 1980s, U.S. society has become less dynamic and more risk averse. The quest for safety and predictability has made the country both more and less comfortable than before. Although many (perhaps even most) Americans enjoy the stability and security that the status quo provides, increasing numbers feel thwarted by the lack of opportunity and slow economic growth that characterize their increasingly static society.” 

And I ask, how could that not be when bank regulators introduced risk weighted capital requirements for banks? That primarily happened in 1988 with Basel I and in 2004 with Basel II. 

And the risk weights imposed were such as: Sovereign 0%, AAA-risktocracy 20%, residential houses 35%, We the People, like unrated SMEs and entrepreneurs 100%, and below BB-rated 150%.

That clearly gives banks all the incentives (higher allowed leverages) to finance and refinance much more what is ex ante perceived, decreed or concocted as safe, most often what derives from something that already is known and exists; and to stop financing the unknown riskier future. In other words those regulations imposed risk aversion on the Home of the Brave. 

That, in the short term, not only guarantees a static society, but worse, medium and long term, it causes a falling society. 

It is perfectly understandable that those with Statist inclinations, and who in the 0% risk weight for the sovereign must see their wet dreams come true, don’t say a word about the distortions in the allocation of bank credit those regulations cause… and this even though this regulation actually decrees that inequality they so much tell us they abhor. 

But, that professors from a Mercatus Center at George Mason University that presents itself as “the world’s premier university source for market-oriented ideas”, keeps hush about this all, really makes me sad. 

But, that professors from a Mercatus Center at George Mason University that presents itself as “the world’s premier university source for market-oriented ideas”, keeps hush about this all, really blows my mind. What keeps them from seeing the problem? A peculiar confirmation bias?

PS. In 2011 I already commented about this to Tyler Cowen, when sending him by email what I wrote to Martin Wolf with respect to his "The Great Stagnation"

PS. Here is another occasion in which the Mercatus Center, in my opinion, failed to speak up.

PS. And there is enough evidence on the web about how I have commented on this issue, time after time, on blogs run by Professors of the Mercatus Center.

Bank regulators should be forced to see “Hell on Wheels” and read John Kenneth Galbraith’s “Money: Whence It Came, Where It Went”

In the TV series Hell on Wheels, its main character, Cullen Bohannon, when asked to testify before the US Senate about all the obvious corruption of Thomas ‘Doc’ Durant, someone absolutely not Bohannon’s friend, someone absolutely not one having been sanctimonious or behaved according to any social norms, repeats, over and over again, to the great chagrin of his interrogators: “The Transcontinental railroad could not have been built without Thomas Durant”

And John Kenneth Galbraith wrote in his “Money: Whence it came where it went” 1975 the following: “For the new parts of the country [USA’s West]… there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business...[jobs created]

It was an arrangement which reputable bankers and merchants in the East viewed with extreme distaste… Men of economic wisdom, then as later expressing the views of the reputable business community, spoke of the anarchy of unstable banking… The men of wisdom missed the point. The anarchy served the frontier far better than a more orderly system that kept a tight hand on credit would have done…. what is called sound economics is very often what mirrors the needs of the respectfully affluent.”

And Galbraith also opined in his book that: “The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… Bad banks, unlike good, loaned to the poor risk, which is another name for the poor man.”

Therefore I cannot but conclude in that bank regulators should be forced to see “Hell on Wheels” and read John Kenneth Galbraith’s “Money: Whence It Came, Where It Went”. That in order to, hopefully, be able realize that with their risk weighted capital requirements for banks, these will not finance the risky future, but only refinance the safer past and present and, as a result, the economy will stall and fall. 

To add insult to the injury, bank regulators are doing all this in the belief that bank crises result from excessive exposures to what is perceived as risky, which is utter nonsense. Bank crises have always, and will always, result from uncertainties; that which includes unexpected events, like devaluations earthquakes and regulators not knowing what they are doing, criminal behavior and excessive exposures to something ex ante perceived as safe but that ex post turned out to be very risky.

“If you see something, say something”. Someone should run to the Homeland Security of the Home of the Brave and denounce that, most probably, unwittingly; some serious terrorism is taking place by means of dangerously risk adverse faulty bank regulations.

Jeb Hensarling asks: How we can make the economy work for working people? Here’s my answer:

Jeb Hensarling, the chairman of the Financial Services Committee asks: How we can make the economy work for working people

Here’s my answer:

Get rid of the risk-weighted capital requirements for banks!

These only distort the allocation of bank credit to the real economy.

These only help finance the “safe” basements where jobless kids can live with their parents but not the “risky” new job creation they would need to afford to become parents too. 

These stop banks from financing the risky future and make these only refinance the "safer" past and present.

Where would America, the Home of the Brave, have been if its banks had been subjected all the time to this type of regulatory risk aversion?

“A ship in harbor is safe, but that is not what ships are for.” John A Shedd, 1850-1926

The risk weighting has de facto decreed inequality

God make us daring!

Besides it is all for nothing. Bank crisis are caused by unexpected events, criminal behavior and excessive exposures to what was ex ante perceived as very safe when placed on the banks’ balance sheets, but that ex post turned out to be very risky. Never ever are bank crisis the result from excessive exposures to what was ex ante perceived as risky. “May God defend me from my friends, I can defend myself from my enemies” Voltaire

Now, if you are rightly concerned that getting rid of the risk weighting would initially create such bank capital shortages that it would put a serious squeeze on credit; then grandfather the current capital requirements for all their current assets, and apply a fixed percentage, like for instance 8%, on all new assets… including public debt, since a 0% risk weight for the Sovereign and 100% for We the People seems to me, I beg your pardon, an insult to your Founding Fathers.

Finally, if regulators absolutely must distort, so as to think they earn their salaries, may I suggest they use job-creation and environmental-sustainability ratings instead of credit ratings, which are anyhow already cleared for by banks.

Ms. Elizabeth Warren, the banking system is rigged; foremost in favor of the State and banks, and against the young.

Senator Elizabeth Warren, in remarks given to AFL-CIO council on November 10, while trying to explain what lay behind the election of Donald Trump as president said: “Working families across this country are deeply frustrated about an economy and a government that doesn’t work for them. Exit polling on Tuesday found that 72 percent of voters believe that, quote, ‘the American economy is rigged to advantage the rich and powerful.’ The polls also made clear that the economy was the top issue on voters’ minds. Americans are angry with a federal government that works for the rich and powerful and that leaves everyone else in the dirt.”

Yes, the American economy is rigged, but at least with respect to the bank system, not exactly in the way most believe it is. I explain.

For the purposes of setting the capital requirements for banks, regulators, the Basel Committee, have decided, among others, on the following risk weights:

The sovereign (the central government and its bureaucrats) = 0%

Those rated AAA to AA (the AAArisktocracy) = 20%

Houses = 35%

The not rated, like citizen’s and SMEs = 100%

Those rated as extremely risky, like below BB-, = 150%

A lower risk weight results in having to hold less capital (equity); 

That means bank can leverage their equity more; 

That results in banks earning higher risk adjusted returns on equity; 

That therefore means banks will lend much more to what has a low capital requirements; 

In this case that means banks will lend much more than they would otherwise have done, to what is perceived, decreed or concocted as safe; and much less than the would otherwise have done to what is ex ante perceived as risky.

And so Yes! The banking system is rigged.

First and foremost, rigged in favor of the State; suggesting that when government bureaucrats use bank credit they do so much more efficiently, and generate much less risk, than if similar credit is used by the private sector/We the People.

Then rigged in favour of the banks; because being allowed to make the highest risk adjusted returns on equity on what is perceived as safe, must be a dream come true for all those bankers, described by Mark Twain, as wanting to lend you the umbrella when the sun was out, and wanting it back as soon it looked it could rain

Rigged in favor of the AAArisktocracy; by believing that a few human fallible credit rating agencies will always get it right, and that credit ratings, based on an ex ante very low risk perception, guarantees a very low ex post risk.

Rigged in favour of those buying houses, for instance basements were unemployed youth can live with their parents.

It is rigged against We the (risky) People

It is rigged against SMEs and entrepreneurs; negating the “risky” credit opportunities, it is a major driver of inequality.

It is foremost rigged against the young; because it makes banks refinance more their parents “safer” past and present, than their “riskier” future.

And all that risk aversion... in the Home of the Brave. America would never ever have become what it is, with this senseless bank regulation. Risk-taking is the oxygen of all development. 

God make us daring!

America "The Home of the Brave" is going down, because of bank regulators' silly/sissy credit risk aversion.

Banks use to decide whom to lend to, based on who offered them the highest risk adjusted interest rates. 

Not any more. Now banks have to calculate what those risk adjusted interest rates signify in terms of risk-adjusted rates of return on their equity. That is because with their risk weighted capital requirements, regulators now allow banks to hold less capital, and therefore be able to leverage more their equity, when engaging with The Safe than with The Risky.

And those perceived, decreed or concocted as belonging to The Safe, include sovereigns (governments), members of the AAArisktocracy and the financing of houses.

And those belonging to The Risky are SMEs, entrepreneurs, the unrated or the not-so good rated, and citizens in general.

And that of course has introduced a regulatory risk aversion that distorts the allocation of credit to the real economy. By guaranteeing “The Risky” will now have too little access to credit, that dooms the economy and the banks to slowly fade away.

But the banks and the economy could also disappear with a Big Bang. That because by giving banks incentives to go too much for The Safe, sooner or later, some safe havens will be dangerously overpopulated, and we will all suddenly find ourselves there gasping for oxygen.

In essence, because of this regulation, banks no longer finance the riskier future; they just refinance the (for the time being) safer past.

How did this happen? There are many explanations but the most important one is that regulators never defined the purpose of the banks before regulating these.

“A ship in harbor is safe, but that is not what ships are for.” John A Shedd, 1850-1926

PS. That also goes for the rest of the world. For instance the Eurozone was done in with it.

PS. Should this not be an issue for Homeland Security?

PS. Is that regulatory discrimination legally allowed?

PS. Risk-taking is the oxygen of all development

God make us daring!

Here is a fuller explanation of why the Basel Committee's bank regulators are idiots... or something much worse! 

Patrick McHenry, next time ask Fed’s Janet Yellen about the legality of risk weighted capital requirements for banks

Patrick McHenry (R-North Carolina) asked Fed chair Janet Yellen about the Fed's legal authority to  implement negative rates… And seemingly it is a bit unclear. 

But he should also have asked:

Is it really legal for the Fed to support bank regulations that require banks to hold more capital against loans to The Risky than against loans to The Safe?

I ask since that allows banks to leverage more their equity and the support we gve them when lending to The Safe than when lending to The Risky.

And that allows banks to earn higher expected risk adjusted returns on equity when lending to The Safe than when lending to The Risky 

And therefore that favors the access to bank credit of those perceived as safe, and thereby discriminates against the fair access to bank credit of those perceived as risky.

Are not The Risky already discriminated enough by the sole fact they are perceived as risky and therefore receive less and more expensive credit?

Does not the real economy suffer when the allocation of bank credit is distorted this way?

Has this not introduce a regulatory risk aversion in The Home of the Brave?

And how does this make banks more stable? Are not the big bank crises always detonated by something perceived as very safe that later turn out very risky?

Obama, Republican and Democratic candidates, you should be very concerned with the mindset of your bank regulators.

The pillar of regulations designed to keep the banking system safe, is the risk weighted capital requirements for banks. 

These, with Basel II, set the risk weight for ‘highly speculative’ below BB- rated assets to be 150%, while the corresponding risk weight, for ‘prime’ AAA rated assets, was set at 20%. 

For a basic requirement of 8%, that meant banks needed to hold 12% in capital against ‘highly speculative’ below BB- rated assets, while only 1.6 percent for ‘prime’ AAA rated assets. 

That meant banks could leverage their equity, and all the support they receive from society, 8.3 times to 1 when holding highly speculative’ below BB- rated assets; and a mind-boggling 62.5 times to 1 with ‘prime’ AAA rated assets. 

That of course distorts the allocation of bank credit to the real economy and, by favoring the access to bank credit for "The Safe", odiously discriminates against that of "The Risky", like SMEs and entrepreneurs. 

As is that has banks earning higher risk adjusted returns on what is perceived as safe than on what is perceived as risky, which means banks no longer finance sufficiently the riskier future but mostly stick to refinancing the safer past. ,

And by negating The Risky their fair access to productive bank credit opportunities, inequality can only increase.

But, what I really cannot understand is: How come mature men (and women) can believe that what is rated below BB-, meaning is perceived as ‘highly speculative’, and therefore very risky, can be more dangerous to the banking system, than what is rated AAA, meaning ‘prime’, and therefore perceived as absolutely safe?

No! There has to be something fundamentally wrong with the current mindset of the bank regulators.

Such crazy risk aversion to perceived credit risk should, in The Home of the Brave, be deemed unconstitutional.

Optimism? No! Use of credit risk weighted capital requirements for banks reflects a severe pessimism about the future

Had banks not held excessive financial exposures related to AAA rated securities backed with mortgages to the subprime sector, or to loans to sovereigns like Greece, the greatest bank crisis of our times would not have happened… and there can be no doubt about that.

Those excessive financial exposures, to assets that were ex ante perceived or deemed as safe, should have been an expected consequence of allowing banks to earn much much higher risk adjusted returns on equity on these assets, than what they could earn for instance on “risky” loans to SMEs and entrepreneurs.

That resulted from regulators allowing banks to hold much much less capital (equity) against “The Safe” than against “The Risky”; by which banks could leverage their equity many many times more with supposedly safe assets than with supposedly risky ones.

And the cost of the greatest bank crisis of our times is still underestimated and is still growing, because it does not include the cost of all those growth opportunities the world, as a consequence, missed and misses by not lending to “risky” SMEs and entrepreneurs.

Favoring with regulations what’s safe over what’s risky, something that also promotes inequality can only be the result of a deeply ingrained risk adverse pessimism. Therefore, while these faulty regulations are still in place, referring to a feeling of optimism about the future is a contradiction in terms.

The economy is, by going for the “safe” carbohydrates, growing obese. A muscular growth requires the intake of “risky” proteins.

Banks are no longer financing the riskier future they are just refinancing the safer past.

How come the Home of the Brave (and Europe) that became what it is because of its willingness to take risks, has accepted this senseless regulatory risk aversion?

Bank capital should cover unexpected losses but what is perceived as safe, has always a greater potential of delivering these than what is perceived as risky and therefore avoided.

How come those most guilty for the greatest bank crisis of our times have not been named, much less held accountable?

Here are 7 questions on bank capital regulations that US Congressmen and Governors should ask the Fed, FDIC and OCC.

Gentlemen 

We have been made aware that currently banks are required to hold more capital, meaning equity, when lending to those perceived as safe from a credit risk point of view, like many sovereigns and private entities with good credit ratings, than what banks need to hold in capital when lending to those perceived as more risky, like SMEs and entrepreneurs.

Notwithstanding that sounds intuitively as quite reasonable, one can also argue the following:

Those perceived as safe from a credit point of view, without these regulations, already count with the benefit of larger loans and lower interest rates; while those perceived as risky have less access to bank credit and have to pay higher interest rates. Mark Twain’s saying that a banker is he who lends you the umbrella when the sun shines, but wants it back when it looks like it is going to rain, comes to mind.

So these capital requirements allow banks to leverage more their equity, and the support they in many ways receive from society, many times more when lending to The Safe than when lending to The Risky; and so banks can earn much higher risk adjusted returns on equity when lending to The Safe than when lending to The Risky.

As a result, these capital requirements enlarge the natural differences in access to bank credit between The Safe and The Risky. For instance we could say these regulations artificially favors American banks lending to European sovereigns and highly rated corporations, over lending to American small businesses and entrepreneurs.

And so we must ask you:

Q. Is such regulatory risk-aversion, which distorts the allocation of bank credit, a valid principle for regulating banks in the Land of the Free and the Home of the Brave?

Q. Do we not owe our descendants the same willingness to take risks as that which our fathers allowed our banks to take to get us here?

Q. Cannot it be said of such regulations, by creating incentives for these to refinance the safer past, impede banks from financing the riskier future?

Q. Is not fair access to bank credit an indispensable part of generating the opportunities that helps to reduce inequalities?

Q. Do we not have something called the Equal Credit Opportunity Act, Regulation B, which would seem to forbid this type of regulatory discrimination?

Q. Since the purpose of capital requirements for bank is to shield it against unexpected losses, how can it be you base these on the expected credit losses?

Q. Since what is perceived as risky never generate dangerous excessive financial exposures, that honor goes to what is perceived as safe but ends up being risky, do these regulations really help to build up a safer banking system?

Thank you... oh by the way, since I also heard that your capital requirements are portfolio invariant it just occurred to me to also ask: Should we not require banks to hold capital against the risk of their exposures instead of the credit risk of their assets?

Stop the risk aversion and pro-government bias of bank regulations. Deceitfully it plunders our young's future.

A friend told me I had to read Mark R. Levin´s “Plunder and Deceit”, and when I saw it was subtitled “Big governments exploitation of young people and the future” I immediately ordered a copy. 

And in its first chapter I read about the intergenerational continuum of the past, the living and the unborn… and I knew the author and I, at least in this respect, shared very similar concerns.

And just looking through the index, I knew I had to add a chapter to this book titled: “God make us daring!”

Why? Because the most important driving force on the intergenerational continuum is the willingness of those of us here now, to take the risks needed today in order for the tomorrows of our descendants to be brighter and brighter.

But, unfortunately, tragically, our most important societal financiers of risk-taking, the banks, have been instructed not to attend to the credit needs of The Risky, but to keep financing solely The Safe. How come? 

Regulators imposed capital requirements on banks that are much higher for what is perceived a risky, from a credit risk point of view, than for what is perceived as safe. That allows banks to leverage their equity and the support these receive from the society much more when lending to The Safe than when lending to The Risky. And that of course allows banks to earn much higher risk adjusted returns on equity when lending to The Safe, than when lending to The Risky.

And so regulators have impeded the fair access to bank credit of those perceived as risky, like SMEs and entrepreneurs, and therefore banks are no longer helping out financing the future of our young people, they are only refinancing the past.

And, to top it up, with that so amazingly unnoticed historical event of the Basel Accord of 1988, regulators decided the risk-weight for sovereigns was zero percent, while the risk-weight of citizen 100 percent. And with that these statist/communists de facto made our banks to operate under the assumption that government bureaucrats use bank credit more efficiently than the private sector.

And the credit-risk-aversion and pro-government bias introduced in our bank regulations, has our western civilization going down and down

In April 2013 the Washington Post published the following letter I wrote:

“It suffices to remember the saying about “a banker being that chap who lends you the umbrella when the sun shines but wants it back as soon as it looks like it is going to rain” to know that those assets perceived as safe are already much favored over those perceived as risky. The risk weights applied by the Basel regulations and based on exactly those same perceived risks only increase the gap between “The Infallible” and “The Risky.” 

And that is why I very much salute the bill by Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.) that looks to “require more capital and better capital but also limit the ‘risk-weighting’ of assets.” More capital is a perfectly legitimate requirement, but the imposition of risk weights is fundamentally incompatible with “a land of the brave.” The United States did not become what it is by avoiding risks.”

Unfortunately, in the Home of the Brave, the interests of bankers making their dreams of very high returns with very little risks come true, seems to trump the needs of its younger. 

America: Why do you saddle your young and brightest with huge education loans, if you’re not willing to allow banks financing those who might generate the jobs your young need in order to service that debt?

US Congressmen and Governors: How come you allow your banks to hold less capital when financing sovereigns and members of the AAArisktocracy, than when financing your own small unrated local businesses?

US bank regulators: Have you never heard of the Equal Credit Opportunity Act (Regulation B)?

A verse of a Swedish Psalm 288 reads: 

“God, from your house, our refuge, you call us 

out to a world where many risks await us.
As one with your world, you want us to live.
God make us daring!”

PS. And all this risk adverse and pro-sovereign regulations for nothing! Major bank crisis do not result from excessive exposures to what was perceived as risky, these always result, no exceptions, from excessive exposures to what was erroneously perceived as very safe. Just look at the AAA rated securities backed with mortgages to the subprime sector... and Greece.

Financial regulations, if wrong, could destroy the economy of a nation, and is therefore an issue of utmost importance for national security.

Suppose military regulations which implicitly stated that those who avoided taking direct risks when fighting the enemy, for instance by using drones, had much better possibilities to advance in the ranks than those who dared to risk hand to hand combat. Would this not impact negatively, at least in the long term, the strength of the Home of the Brave?

And should bank regulators not have to consider the dangers of introducing distortions in credit allocation, which might weaken the economy and thereby weaken the defense of the nation?

In 1988, the G10, a group which includes United States, decided to introduce risk-weighted capital requirements for banks; where “risk” means credit risk, and “capital” means bank equity. As a consequence, those bank assets with a low risk-weight require banks to hold less equity than those assets with a high risk-weight.

The initial big risk-weight differentiation, in 1992 with Basel I, was that loans to the central governments of the OECD nations had a cero risk-weight, while loans to the private sector carried a 100 percent risk-weight. In 2004, with Basel II, many more risk buckets were added and in the private sector the risk-weights were set from 20 to 150 percent.

And it all sounds like prudent bank regulations… more-risk-more-equity - less-risk-less-equity. But, unfortunately, bank regulators, I pray unwittingly, did not notice that by doing that, they were introducing an extremely dangerous distortion of how bank credit was allocated to the real economy.

It signified that the equity of a bank, to which we have to add the value of the support a society and taxpayers lend the banks, could be leveraged many times more for assets with a low risk weight, than with assets with a high risk-weight. 

And that meant banks could earn much higher risk adjusted returns on equity on assets that carry a low risk-weight than on assets with a high risk-weight.

Just for a starter it meant that regulators effectively instructed banks to allocate more credit to the central government than to the private sector… implying thereby of course that a government bureaucrat has more capacity to allocate financial resources efficiently to the real economy than a private agent, like a SME or an entrepreneur

And anyone who thinks this regulatory risk aversion will not affect the strength of the USA’s economy, has no idea about how the USA got to be strong

And to top it up, it is all for nothing, since all major bank crises have always resulted from too big exposures to something that was perceived as “safe” that turned out risky, and never ever from excessive bank exposures to something perceived as risky.

Really; are the risk weighted bank capital requirements with decreed weights: 0% Federal Government, 100% We the People, in accordance to the US Constitution?

 

@PerKurowski

A message sometime ago to Homeland Security

A letter on the issue of defense in the Washington Post

I have a very specific question for President Obama on his State of the Unions address.

President Obama in his State of the Union Address — Remarks As Prepared for Delivery states:

“Will we accept an economy where only a few of us do spectacularly well? Or will we commit ourselves to an economy that generates rising incomes and chances for everyone who makes the effort?”

And which makes me ask: Are we supposed to keep bank regulations who so much favors the infallible sovereigns’ and the AAArisktocracy’ access to bank credit, when compared to that of the “risky” small businesses’ and entrepreneurs’?

To me it is amazing to see how much regulatory aversion against “the risky” exists in the home of the brave.

http://subprimeregulations.blogspot.com/2010/04/please-explain.html

http://subprimeregulations.blogspot.com/2013/11/have-risk-weights-of-current-bank.html

http://subprimeregulations.blogspot.com/2012/07/complaint-i-presented-to-consumer.html

Is telling banks “make your profits where it’s safe and stay away from what’s risky” an un-American act of cowardice?

I have heard many comments indicating as an “un-American act of cowardice”, that Sony cancelled the release of “The Interview”, after North Korean government hackers penetrated the studio's computers and threatened to attack theaters that showed the movie. 

I will not get into that but I would though take this opportunity to pop a question of my own on that epithet.

Currently regulations allow banks to hold much less capital (meaning equity) against assets perceived as absolutely safe than against assets perceived as risky; which allows banks to leverage their equity much more against assets perceived as absolutely safe than against assets perceived as risky; which of course means that banks will make much higher risk-adjusted returns on equity on assets perceived as absolutely safe than on assets perceived as risky… and which effectively means regulators are telling the banks “Go and make your profits where it is safe and stay away from the risky”. 

With that are not regulators inciting the banks in the Land of the Free and the Home of the Brave to commit un-American acts of cowardice?

Janet Yellen, are you really so unaware you are also one of the equal opportunities killers?

On October 17, 2014 Federal Reserve Chair Janet Yellen spoke about “Perspectives on Inequality and Opportunity” In it she said: 

“Owning a business is risky, and most new businesses close within a few years. But research shows that business ownership is associated with higher levels of economic mobility. However, it appears that it has become harder to start and build businesses. The pace of new business creation has gradually declined over the past couple of decades, and the number of new firms declined sharply from 2006 through 2009… One reason to be concerned about the apparent decline in new business formation is that it may serve to depress the pace of productivity, real wage growth, and employment. Another reason is that a slowdown in business formation may threaten what I believe likely has been a significant source of economic opportunity for many families below the very top in income and wealth.” 

Unbelievable! Janet Yellen, even though she is extremely connected to bank regulations, seems not to have the faintest idea of how these effectively block the creation of new businesses, by unfairly discriminating the access to bank credit of those who are perceived as risky… like new businesses. 

Janet Yellen (and others at the Fed), let me explain it for you: 

The pillar of current bank regulations is credit risk weighted capital (equity) requirements for banks… more-perceived-credit-risk more equity – less-perceived-credit-risk less equity. 

And that translates into banks being allowed to earn much much higher risk adjusted returns on equity when lending to the “absolutely safe” than when lending to the risky” 

And that translates directly into that those who are perceived as “risky”, like new businesses, and who, precisely because they are perceived as “risky”, already have to pay higher interests and have lesser access to bank credit, will then have to pay up twice for that perception…and so will then need to pay even higher interests and then get even less access to bank credit. 

And that is odious discrimination, a great driver of inequality… and a killer of the equal opportunities the poor so much need in order to progress. 

And of course, let us not even think of what the Fed’s QE’s have done in terms of un-leveling the playing fields. The fact is that had it not been for how the financial crisis management favored foremost those who had most, Thomas Piketty’s "Capital in the Twenty-First Century”, would have remained a manuscript. 

And Janet Yellen thinks: “it is appropriate to ask whether this trend [of widening inequality] is compatible with values rooted in our nation's history, among them the high value Americans have traditionally placed on equality of opportunity.” 

Frankly to hear someone who favors regulatory risk-aversion, daring to speak about American values, in the “home of the brave”, in the land built up on the risk-taking of their daring immigrants… is sad.

I am sure that the US Congress would never ever approve what you bank regulators are up to, if aware of it, and much less if asked formally

What would the reactions be if capital requirements for banks discriminated against gays, sick, black people or women?

PS. To me it is amazing how bank regulators in America can so blitehly ignore the Equal Credit Opportunity Act (Regulation B)

In “The home of the brave” banks are given incentives to avoid “The Risky” and to stock up on “The Infallible”

I refer to Kevin Dowd’s “Math Gone Mad”, Policy Analysis of the Cato Institute, September 2014

Dowd’s conclusion “The solution to these problems is legislation to prohibit risk modeling by financial regulators and establish a simple conservative capital standard for banks based on reliable capital ratios instead of unreliable models”, is completely in line with which I have been arguing for more than a decade, except for that I would use the word “sensible” instead of reliable… since reliability is good to have, but it cannot be the final objective of our banks.

“A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

I agree of course with all the examples Dowd gives about how the credit allocation to the real economy is distorted by regulations, but I would make even clearer the fact that what can most help to bring stability banks is a sturdy economy… and current credit risk-weighting of capital has only managed to introduce, in the home of the brave, a senseless risk-aversion… which will only weaken it… which will only reduce its chances of creating the next generation of jobs our youth needs

But also, current regulations are based on a principle that sounds so very logical, “more-risk-more-capital and less-risk-less-capital”, so too few take time needed to think about it; and regulators are so unwilling to admit mistakes that would show them not having been marginally wrong, but 180-degrees wrong. And, in this respect, the paper might be strengthened by some additional arguments, and by providing some idea on how to motivate and facilitate the legislator to act.

The first is that if banks’ individual risk management is correct, then regulators have nothing to fear. Their problem begins when the banks’ risk management fails. For instance, regulators have no special reason to concern themselves with the credit-worthiness of the clients of the banks’, as their concern should be the creditworthiness of the bank, which is by far not the same. A bank with a well-diversified exposure to many risky borrowers might be immensely safer than a bank with a few large exposures to those perceived as absolutely safe. One of the unbelievable surreal failings with the current risk-weighted capital requirements is that, by the regulators own admission, these are portfolio invariant.

Also it is precisely the fact that the risk-weights used for the capital requirements clear for precisely the same risks already cleared for by the banks, through interest rates and size of exposures, which originates the most severe distortions. As a result banks now earn much higher risk adjusted returns on equity when lending to The Infallible than when lending to The Risky. The regulators, also by their own admission, have used expected losses as a substitute for the unexpected losses, and this represents of course one amazing intellectual regulatory mistake.

I have, even as an Executive Director of the World Bank objected to these regulations, long before Basel II was approved. And I have tried to extract answers from the regulators by all means possible, with very little luck. Therefore, as a tool to begin breaking down the wall, I would suggest legislators request from regulators the answer to some very simple questions, which would evidence how crazy it all is…but they should brace themselves because, once one finds out how incredibly wrong current bank regulations are… it is truly scary. And I would also request from regulators that when they stress test banks balance sheets, they also take notice of what is not any longer on banks’ balance sheets… since that is a part of a stress test of the economy at large.

And, one of the most important lessons to extract from it all this is the… “How could it happen?” and so that never again a small group of unelected bureaucrats will get the chance to influence global markets in this way, with no real accountability. I have often said that if the world would allow a Basel Committee on Climate Change to decide what to do in this way… then earth would most definitely be toast.

Finally when Dowd suggests “a minimum capital ratio of 15 percent” (I could do with even less) the most important part is how to get from here to there, a journey costing at least a trillion dollars only in the US and that poses many dangers, and that perhaps requires a full change of the regulatory team… since we know that Hollywood would never ever authorize those responsible for a monumental box-office flop like Basel II, to follow up with a Basel III production, using the same scriptwriters.

PS. As curiosa let me mention that the Dodd-Frank Act, in all its many pages, does not even mention the Basel Committee’s regulations to which the US is a signatory.