A safer banking system compared to our current dangerously misregulated one with so many systemic risks on steroids

What is a safer banking system?

One in which thousand banks compete and those not able to do so fail as fast as possible, before some major damage has been done, while even, as John Kenneth Galbraith explained, often leaving something good in their wake. 

What is a dangerous banking system?

One were all banks are explicitly or implicitly supported, by taxpayers, as long as they follow one standard mode that includes living wills, stress tests, risk models, credit ratings, standardized risk weights... all potential sources of dangerous systemic risks.

A bank system in which whenever there is a major problem, the can gets kicked down the road with QEs and there is no cleaning up, and banks just get bigger and bigger.

One that make it more plausible that the banks will all come crashing down on us, at the same time, with excessive exposures to something ex ante perceived safe that ex-post turned out risky, and therefore the banks holding especially little capital.

But you don’t worry; the regulators have it all under control with their Dodd-Frank’s Orderly Liquidation Authority (OLA). “Orderly”? Really?

So that is why when I hear about banks “cheating” with their risk models I am not too upset, since that at least introduces some diversity. 

Also that cheating stops, at least for a while, the Basel Committee regulators from imposing their loony standardized risk weights of 20% for what has an AAA rating, and so therefore could be utterly dangerous to the system; and one of 150% for the innocuous below BB- rated that bankers don’t like to touch with a ten feet pole.

How did we end up here? That is where you are bound to end up if you allow some statist technocrats, full of hubris, to gather in a mutual admiration club, and there engage into some intellectually degenerating incestuous groupthink.

Statist? What would you otherwise call those who assign a 0% risk weight to the Sovereign and one of 100% to the citizen?

And it is all so purposeless and useless!

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

Useless? “May God defend me from my friends, I can defend myself from my enemies”, Voltaire

In essence it means that while waiting for all banks to succumb because of lack of oxygen in the last overpopulated safe-haven available, banks will no longer finance the "riskier" future our grandchildren need is financed, but only refinance the "safer" present and past.

In April 2003, as an Executive Director of the World Bank I argued: "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."

PS. FDIC... please don't go there!

Note: For your info, before 1988, we had about 600 years of banking without risk weighted capital requirements for banks distorting the allocation of bank credit to the real economy.

PS. The best of the Financial Choice Act is a not distorting, not systemic risks creating, 10% capital requirement for all assets. Its worst? That this is not applied to all banks.

PS. If I were a regulator: Bank capital requirements = 3% for bankers' ineptitude + 7% for unexpected events = 10% on all assets = Financial Choice Act
 

FDIC, don’t go there! The more similar living wills, stress tests & risk models are, the greater the systemic risks

I just received the FDICs “Supervisory Guidance on Model Risk Management"

It really scares me to read how concerned FDIC still is with how bankers’ develop and use their risk models, among these those for determining capital and reserve adequacy.

I just don’t get it! Let bankers do their job, which is to develop all the models they can that will facilitate their job as bankers, the best they can. And the more crazily diverse these risk models are, the better, as the less is their systemic risk.

FDIC should concern itself exclusively with the what if the bankers of some banks are not good enough when modeling.

And the same goes for living wills and stress tests. Force each bank to present what they think about that, and leave it like that.

In January 2003, while an ED of the World Bank, in a letter published by the Financial Times I argued: “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”

And in April 2003, commenting on the World Bank's Strategic Framework 04-06 I wrote: "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."

I still hold all that to be true… now more than ever!

FDIC, please, they are the bankers and you are the regulator (and insurer), don’t confuse the roles!

FDIC, please, don't insist on being a better banker than the bankers, just be their regulator!

I agree with much in Martin Wolf’s “The Shifts and the Shocks”

Basically because it fails to correctly explain how the current financial crisis came about; and therefore makes it a bit harder for us to get out of it, I object strongly, on many aspects, to Martin Wolf’s “The Shifts and the Shocks”

But that does of course not mean that I do not agree with much of what is said there and so, in this comment to which I will come back when in need (I read jumping from here to there), I will post those aspects which I most agree with:

For instance on page 252 Wolf writes: “Indeed, so long as the [bank] system allows leverage of 30:1, these businesses are designed to fail. The belief that failure of a business can be managed smoothly and without effects, with hybrid capital instruments, resolution regimes and living wills, is naively optimistic”. And I have annotated a clear “YES!” next to that.

And on page 253-4 Wolf writes: “Each institution may be diversified. But they will be vulnerable if all are diversified in the same way. Worse, being subjected to similar microprudential regulation makes it more likely that firms will end up being diversified in much the same way and exposed to many of the same risks”. Indeed! As someone who in 1999 wrote in an Op-Ed “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 all of our banks”… you can be sure I annotated a clear and big “YES!” next to that too.

Does really a bank´s "living will" make much sense?

Living wills: “Detailed plans that would enable banks to stipulate in advance how they would raise funds in a crisis and how their operations could be dismantled after a collapse”.

The whole concept of living wills for banks’ designed by the bankers themselves, for how to handle a collapse, seems to me a bit of a show by regulators to show they are doing something and to have something to put the blame on tomorrow…. “They gave us a bad living will” 

I mean if I was a regulator, and wanted to go down that route, I would at least have a third party to look into what could be done in the case a bank passed away, and now and again confront the managers of the bank with those plans, in order to hear their opinions.

For instance there is a world of difference between a living will where the dead are going to be the own executors of the will, and one in which the dead will be dead and others will take care of the embalming.

And talking about this should not the Fed or the FDIC first state what contingent plan they really want… one where the bank is placed on artificial survival mode, and for how long, or one where it is sold in one piece, by pieces or even cremated?

To me it would seem that the Fed and FDIC need to give much clearer instructions about what they want those bankers who are currently working under the premise the bank will live on forever to do… as I can very much understand bankers being currently utterly confused.

PS. And, to top it up, regulators should worry more about how banks live than about how they die. Thanks in much to the distortions created by the regulators with their risk-based capital requirements, the banks are not allocating credit efficiently and their legacy is therefore condemned to be poor. And… excuse me, that´s a far more serious problem.