What would Hyman Minsky say if able to observe how his financial instability moments were put on steroids by bank regulators?

On Minsky moments

“In many cases even trying to regulate banks runs the risk of giving the impression that by means of strict regulations, the risks have disappeared. History is full of examples of where the State, by meddling to avoid damages, caused infinite larger damages”

“Old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, was much wiser than no burning at all, which only guarantees disaster and scorched earth, when fire finally breaks out, as it does, sooner or later. Therefore a regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.”

“Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds”

The Basel Committee’s credit risk weighted bank capital requirements cause our banks to be dangerously overexposed to what’s expected, and to be woefully unprepared for the unexpected. 

Current risk weighted bank capital requirements guarantee especially large bank crises, caused by especially large exposures to what’s perceived as especially safe but might not be, and is held against especially little capital.

"A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind."

Tombstones

Here rests a bank regulator who all his life believed that what bankers perceived as risky was more dangerous to our bank systems than what bankers perceived as safe. 

May his soul rest in peace.

Here rests a bank regulator who based the risk weighted bank capital requirements on bankers perceiving risk correctly, and not on that they could be wrong.

May his soul rest in peace.

Here rests a regulator who missed his lectures on conditional probabilities, and therefore did not set the risk weighted capital requirements conditioned on how bankers respond to perceived credit risks.

May his soul rest in peace.

Here rests a regulator who even though bankers respond to perceived credit risks, with size of exposures and risk adjusted interest rates, also wanted bank capital to double up on that same perceived risk

May his soul rest in peace.

Here rests a bank regulator who never understood the systemic risks he introduced into banking, by for instance assigning so much power to credit rating agencies, or his stress-testings on the stresses a la mode.

May his soul rest in peace.

Here rests a bank regulator who never understood his own risk aversion and confirmation bias stress, before stress testing banks on the possibility of his own regulations being wrong.

May his soul rest in peace.

Here rests a bank regulator who for the risk weighted bank capital requirements agreed with risk weights of 20% for dangerous AAA rated and 150% for innocous below BB- rated

May his soul rest in peace.

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

Here rests a bank regulator who caused banks to dangerously overpopulate safe harbors, and sent other investors and small time savers out on the risky oceans. 

May his soul rest in peace.

Here rests a bank regulator who by much favoring banks to finance the "safer" present over the "riskier" future, blocked millions of SMEs' and entrepreneurs' access to bank credit and with it to risk-taking… the oxygen of all development

May his soul rest in peace.

Here rests a statist bank regulator who believed a government bureaucrat knows better (Risk Weight 0%) what to do with credit he’s not personally responsible for, than an entrepreneur or SME (RW 100%)

May his soul rest in peace.

Here rests a bank regulator who for risk weighted bank capital requirements agreed with a low 35% risk weight to residential mortgages, which caused houses to morph from affordable homes to risky investment assets.

May his soul rest in peace.

Here rests a bank regulator with a Ph.D. who proved right Daniel Patrick Moynihan, who supposedly held “There are some mistakes only Ph.Ds. can make.

May his soul rest in peace.

Here lies a central banker who injected huge amounts of liquidity without understanding how risk weighted bank capital requirements distorted the allocation of credit

May his soul rest in peace.

Here lies a financial journalist who scared stiff he would never be invited to WEF in Davos, never questioned the risk weighted bank capital requirements. 

May his soul rest in peace.

Here lies an ordinary citizen who wanting so much to believe it true, swallowed lock stock and barrel the regulatory technocrats' populism imbedded in the risk weighted bank capital requirements

May his soul rest in peace.

Here rests a regulator who helped guarantee especially large bank crises, caused by especially large exposures to what’s perceived especially safe and might not be, and is held against especially little capital

May his soul rest...

Here rests a regulator who assisted by his central bank colleagues, helped set horrible Minsky moments on steroids
May his soul rest...

PS. A summary of The Basel Committee for Banking Supervision's mistakes

Bank regulations put Minsky’s “financial instability hypothesis” on steroids, boosting its speed towards “the moment”.

The Economist refers to Hyman Minsky’s important “financial instability hypothesis”, but concludes that it “would be a stretch to see that hypothesis becoming a new foundation for economic theory, “Minsky’s moment” July 30, 2016

That might be, but it should become an essential foundation of financial regulations because, by ignoring it, with the risk weighted capital requirements for banks, the regulators set the “boom that can sow the seeds of busts” on steroids.

Normally, without distortions, bank credit should be allocated to whoever offers the highest perceived risk adjusted rate. That of course might quite often not be true, because “a safe” can be riskier or safer than what it is perceived; just llke “a risky, could equally be safer or riskier.

But, when regulators decided banks needed to hold less capital against what was perceived, decreed or concocted as safe, than against what was perceived as risky, they dramatically distorted the allocation of bank credit to the real economy.

Suddenly the booms of what was perceived as safe got a tremendous boost, as banks could earn higher risk adjusted rates there; all while “the risky” saw their access to bank credit severely curtailed.

We only need to go the crisis of 2007-08 to see that what caused it, was all which had very low capital requirements because it was perceived as safe when placed on the bank’s balance sheets.

And of course, the power of those regulatory steroids, was further strengthen by the fact that so much decision power, over deciding what was safe and what was risky, was placed in the hands of some very few human fallible credit rating agencies.

PS. I was just a consultant from a developing country who happened to end up on the Board of the World Bank as an Executive Director, and so I can of course not aspire, by far, to receive the same attention as Hyman Minsky, but you might anyhow be interested in what were my very early opinions on these issues

PS. And here is my most recent aide memoire on what is monstrously wrong with Basel Committee’s regulations.

@PerKurowski

Hyman P Minsky stated the purpose of banks, but all Basel Committee regulators care about is avoiding credit risk.

John Lounsbury, having in his turn been informed by Joe Bongiovanni, has made us aware of a working paper by Hyman P Minsky, from October 1994, titled “Financial Instability and the Decline (?) of Banking: Public policy considerations” 

Lounsbury writes: “Minsky was concerned in the early 1990s that what he thought were the two roles of banking in a capitalist society were being performed to a decreasing extent by organizations that were chartered as banks.

The two primary functions of banking he describes as supplying the means of payments; and channeling resources into the capital development of the economy.

Minsky argued that this separation of banking from the real economy would diminish the role of central banks in influencing the economy in the traditional manner through monetary policy. Given this loss of influence through the traditional tools of "changing the availability or cost of financing". He felt that the variable remaining would be management of "uncertainty".

He argued that the changes in banking required regulation to be rethought”

And I ask, for the umpteenth time. What has the pillar of current bank regulations, the risk weighted capital requirements, to do with banks fulfilling efficiently those two primary functions?

The answer absolutely nothing but it is even worse than that, since the risk weighing totally distorts the allocation of bank credit to the real economy.

The current bunch of regulators holed up in that small mutual admiration club known as the Basel Committee for Banking Supervision, regulated our banks without even asking themselves what the purpose of our banks is.

They must be held accountable for that, and publicly paraded down our avenues wearing dunce caps.

It seems like it all started during a dinner in London on September 2, 1986

http://econintersect.com/pages/opinion/opinion.php?post=201603140225

The Minsky "displacement" that caused the ongoing crisis, was the credit risk weighted capital requirements for banks.

I cite from Charles P. Kindleberger’s “Manias, Panics and Crashes” 1978.

“Financial crisis are associated with the peaks of business cycles… the culmination of a period of expansion.

According to Hyman Minsky, events leading up to a crisis start with a ‘displacement’ some exogenous, outside shock to the macroeconomic system. The nature of this displacement varies from one speculative boom to another. It may be the outbreak or end of a war, a bumper harvest or crop failure, the widespread adoption of an invention with pervasive effects – canals, railroads, the automobile – some political event or surprising financial success, or a debt conversion that precipitously lower interest rates. But whatever the source of the displacement, if it is sufficiently large and pervasive, it will alter the economic outlook by changing profit opportunities in at least one important sector of the economy. Displacement brings opportunities for profit in some new or existing lines, and closes out others… a boom is under way.

In Minsky’s model, the boom is fed by an expansion of bank credit which enlarges the total money supply… Bank credit is, or at least has been, notoriously unstable and the Minsky model is based squarely on that fact.” End of quote

In 1999 in a Op-Ed in I wrote: “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse of our banks” 

And I have no doubt that the systemic error, the Minsky displacement that brought on the credit expansion that resulted in the financial crisis of 2007-08, was the introduction by regulators of credit risk weighted capital requirements for banks.

That facilitated a tremendous credit expansion by allowing banks to hold absolute minimum equity against assets perceived as safe. We are talking about zero percent when lending to sovereigns (Basel I 1988) to 1.6 percent when lending to the private sector rated AAA to AA (Basel II 2004).

And allowing for such minimum equity, while still lending the banking sector much implicit and explicit government support, made possible immense leverages and thereby immense risk-adjusted returns on bank equity on assets perceived as safe, while closing out the fair access to bank credit for all those perceived as “risky”, like the SMEs.

And today, soon a decade later, that “displacement” which completely distorted the allocation of bank credit to the real economy has not even been acknowledged much less corrected.

PS. Read Charles P. Kindleberger’s “Manias, Panics and Crashes” and you will not find one evidence that supports current credit risk weighted capital requirements for banks… unless perhaps they are 180 degrees the opposite: higher for what is perceived as safe and lower for what is perceived as risky.

PS. In the Wikipedia on Hyman Minsky, I do not agree with how Paul McCulley translates the Minsky's hypothesis to the subprime mortgage crisis ignoring the minimum bank capital requirements associated with the AAA rated securities backed with mortgages to the subprime sector.