Trade wars will mean new tariffs

There is another tariff war that is being dangerously ignored. 

The July 6 editorial "A splendid little tariff war?" rightly held that "tariffs create all sort of inefficiencies, unintended consequences and uncertainty."

The risk-weighted capital requirements for banks also translate de facto into subsidies and tariffs, which have resulted in a too much-ignored allocation of bank credit war. 

One consequence is that those perceived as risky, such as entrepreneurs, have their access to bank credit made more difficult than usual, and our economy suffers. Another is that by promoting excessive exposures to what is especially dangerous, because it is perceived as safe, against especially little capital, guarantees that when a bank crisis results, it will be especially bad. 

In terms of Mark Twain's supposed saying, these regulations have bankers lending out the umbrella faster than usual when the sun shines and wanting it back faster than usual when it looks like it is going to rain.

Letter published in the Washington Post

Here other of my letters in the Washington Post on this issue:
September 6, 2007: Factors in the Financial Storm
June 20, 2008: An Aspect of the Bubble
December 27, 2009: Another 'worst': Faulty bank regulation

January 6, 2012: Handcuffed by a triple-A rating
May 1, 2013: An American approach to banking
December 23, 2014: Let the market rule on risky trades
November 11, 2015: Reverse-mortgaging the future
August 9, 2016: Banks, regulators and risk
April 16, 2017: When banks play it too safe 

December 30, 2018: Affordable homes or investment assets?

Here is what those who believe risk weighted capital requirement for banks is smart must be thinking.

Are you one of them?

The pillar of current bank regulations is risk weighted capital requirements for banks: More perceived credit risk more capital – less perceived credit risk less capital.

Below what those who believe risk weighted capital requirement for banks is smart, must be thinking. Are you one of them?

That though with banks so many other aspects are risky, like the possibility of cyber attacks, the only thing that matters are credit risks.

That even though banks perceive credit risks, and adjust for that with risk premiums and the size of their exposures, that’s not enough, banks must also adjust for the same perceived risks in their capital.

That lending little at high-risk premiums to something perceived risky, is riskier than lending a lot at very low risk premiums to something perceived safe.

That bankers, no matter what Mark Twain thinks, love to lend out the umbrella when it rains and abhor doing so when the sun shines.

That it is the specific credit risk of the assets that matter, and not how banks manage those risks.

That the expected credit risks are good estimators of the unexpected losses banks need to hold capital against.

That the safer an asset is perceived the less is its potential to deliver unexpected losses.

That the riskier and asset is perceived the greater is its potential to deliver unexpected losses. 

That as long as banks do not fail, the rest, like if they allocate bank credit efficiently to the real economy or not, does not matter. 

That even though a bank is required to hold more capital lending to someone perceive risky than when lending to the AAArisktocracy, that has nothing to do with inequality.

That even if a sovereign depends on its citizens, the sovereign can have a zero risk weight while the citizens, like SMEs and entrepreneur should have a 100 percent risk weight.

That though all major bank crises have occurred because of excessive exposures to what was erroneously perceived as safe, that has nothing to do with tomorrow's bank crises.

That even though no major crisis has have occurred because of excessive exposures to what ex ante was perceived as risky, that has nothing to do with tomorrow's bank crises.

That if you, to the banker’s natural risk aversion, add on the regulators natural risk aversion, you will not risk getting an excessive risk aversion that could be dangerous for the real economy.

That if the perceived credit risk is correct, it does not matter how much importance you give to that perception.

That if you play around with the odds of roulette it will survive as a viable game

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?

The Basel Committee’s credit risk weighted capital requirements for banks… explained by Mark Twain

Many hold that Mark Twain said: “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain”... and so

The so anxious Basel Committee for Banking Supervision thought banks lend out their umbrella much too little when the sun was out, and much too much when it looked like it was going to rain.

And so even though banks already cleared for credit risk perceptions, by means of risk premiums and size of exposures, the bank nannies decided that the capital banks should be required to have, should also consider those same credit risk perceptions; more risk more capital – less risk less capital.

And that means banks can now leverage much more their equity, and the societal support they receive, for instance by means of deposit guarantees, when lending out the umbrella on sunny days than when lending it out on rainy days.

And so banks are lending out less than ever the umbrella when it looks like to rain… and as a consequence the real economy is getting wet and getting a cold.

And all for nothing since never ever have major bank crises resulted from too much lending of the umbrella on days perceived as rainy, but always from too much lending when a sunny day was announced, but the weatherman got it all wrong.

I ask, where would we be if our forefathers’ banks had been subject to credit-risk weighted capital requirements?

What were (are) regulators in the Basel Committee smoking when they set their capital requirements for banks?

The capital requirements for banks are primarily, almost exclusively, to cover for Unexpected Losses (UL), since the Expected Losses (EL) are covered by means of risk premiums, size of exposures and other terms.

And this the bank regulators know as we read in “An Explanatory Note on the Basel II IRB Risk Weight Functions”.

It states: “Banks are expected in general to cover their EL on an ongoing basis, e.g. by provisions and write-offs, because it represents another cost component of the lending business. The UL, on the contrary, relates to potentially large losses that occur rather seldom. According to this concept, capital would only be needed for absorbing UL… [and so] it was decided to follow the UL concept and to require banks to hold capital against UL only.”

But then the strangest thing happened! The regulators, when calculating those UL decided to do this all with formulas that used the EL, and so, inexplicably, they came up with capital requirements that indicate the potential of higher UL for higher EL.

And that just cannot be. It is clear that the safer an asset is perceived, the larger its potential to deliver UL. It is also clear that many of UL in a bank can derive from causes completely unrelated to the intrinsic riskiness of assets… like for instance a cyber-attack.

And, as a result of the confusion, the current capital requirements for banks are much higher for assets perceived as “risky” than for assets perceived as “safe”, with the following consequences:

Banks are able to create huge exposures, against very little capital, to what is ex ante perceived as safe but that ex post could turn out risky, and that is precisely the stuff major bank crises are made of.

The allocation of bank credit is much distorted since using Mark Twain’s analogy bankers will now lend out the umbrella even more than usual when the sun is out and want it back faster than ever as soon as it looks like it is going to rain.

Just look at how much those in the sun, like AAA rated securities, real estate and governments (like Greece) have been able to borrow, when compared to the much tightened borrowing conditions for SMEs and entrepreneurs.

And so nowadays, thanks to our regulators, banks are not financing the riskier future but are mainly busy refinancing the safer past… Friends, where are the jobs for our grandchildren come from?

Mark Twain vs. The Basel Committee for Banking Supervision… Who do you think is right?

Mark Twain is supposed to have said: “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain” 

The Basel Committee though, with its credit risk weighted capital requirements for banks, evidently argues: A banker lends you the umbrella when it rains but want it back when the sun shines”. 

I mean, otherwise, as regulators wanting banks to hold capital against unexpected losses, would it require banks to hold much more capital when lending to “the risky”, those in the rain, than when lending to “the safe”, those enjoying the sun? 

I side a hundred percent with Mark Twain… because I have never ever seen a major bank crisis that has resulted from bankers lending too much to those they perceive as being in the rain, these have always resulted from lending too much to those they believe find themselves in the sun.

If you think that would seem to mean I believe those in the Basel Committee have no idea of what they are doing… you are absolutely right… I don’t.

It is tragic. The direct consequences of what the Basel Committee is doing, is that banks will now earn much higher risk adjusted returns on what is in the sun than on what is in the rain, and therefore only lend the umbrella to those they see in the sun, and stay away entirely from lending to those they see in the rain... like to all the "risky" SMEs and entrepreneurs, those  who could create the future jobs our grandchildren will need.

Are credit-risk weighted equity requirements for banks just regulators’ soothing blankets and teddy bears?

Bruce Hood, in “Essentialism” in “Thinking” edited by John Brockman, 2013, writes: “The reduction in funding in this country has impacted upon my field quite dramatically (behavioral sciences)… Now we have to justify with a view to application”.

Great! And do I have an application to suggest!

Bank regulators succumbed entirely to the intuition of if-more-risky-then-more-equity and if-less-risky-then-less-equity completely ignoring that for the banking system as such, what is ex ante perceived as risky poses little risks. It is what is perceived as “absolutely safe” but that later can pop up as very risky that which contains the true dangers.

And so regulators decided banks needed to hold much more equity against what is perceived as risky than against what is perceived as risky; and that resulted in that banks are now making much higher risk-adjusted returns on equity on what is perceived as safe than on what is perceived as risky.

And that leveraged the natural risk adverseness of banks into the skies; that one to which Mark Twain refers to as “they lend you the umbrella when the sun shines and what it back as soon it looks like it is going to rain”.

And, since our economies move forward thanks to for instance the risk-taking of banks on small businesses and entrepreneurs, the Western world is now stalling and falling.

Hood refers to among other to work he’s done with Paul Bloom about “bizarre behavior you find in children of the West [with their] emotional attachments to blankets and teddy bears [when] they need to self-soothe.” 

And it hit me that it could be an extraordinarily application if Hood and Bloom researched whether these bank regulations are the equivalent self-soothing instruments to regulators. Because if so then we would have some arguments in hands to go and tell the members of the Basel Committee for Banking Supervision and the Financial Stability Board that it is their role to regulate banks as society needs banks and not so to help them be calm when they suck their thumbs.

PS. The Western world was built upon a lot of risk-taking, among others by its banks... but in 1988 it got hit by the Basel Accord asteroid.

US Congress, you are the legislators, so who of you ordered the banks in the home of the brave to become credit risk adverse?

Fact: Banks give larger loans, charging lower interest rates and allowing for leaner terms to those perceived as absolutely safe, than when lending to those perceived as risky. And that so much, that your Mark Twain described bankers as those who lend you the umbrella when the sun shines but want it back as soon as it seems it might rain.

Fact: Your regulators now allow banks to hold much less capital for what from a credit risk perspective is perceived as “absolutely safe” than against what is perceived as “risky”.

Fact: And that means banks can leverage their equity much more when lending to those perceived as “absolutely safe” than when lending to those perceived as “risky”.

Fact: And that means banks will earn much higher expected risk adjusted returns on their equity when lending to those perceived as “absolutely safe” than when lending to those perceived as “risky”.

Fact: And that means banks will lend almost exclusively to those perceived as “absolutely safe”, and basically nothing at all to those perceived as “risky”.

Fact: And that seems as far away as can be for the home of the brave which became a great land of the free primarily because of risk-takers… as few risk adverse crossed the ocean to reach its coasts.

And so the question: Who of you US legislators ordered the banks in the home of the brave to become even more risk adverse than what Mark Twain held these to be?

And legislators, if you are somewhat confused by these comments, may I suggest you invite your bank regulators to an open hearing to explain their main scripture, “The Basel Committee on Banking Supervision´s Explanatory Note on the Basel II IRB Risk Weight Functions of July 2005” to you. 

But then you might really going to be scared.

PS. Here is an updated list on the many mistakes with risk weighted capital requirements

What if Mark Twain knew about the capital requirements for banks in Basel I, II and III, based on ex ante perceived risks?

If Mark Twain resurrected, and read about what our current bank regulator came up with, in terms of capital requirements based on perceived risk, which allow the banks to earn much much higher risk-adjusted returns on equity when lending to “The Infallible”, than when lending to “The Risky”, he would need to expand on his opinion on bankers, to something like what follows:

“A bank regulator is one who likes the banker to lend out the umbrella when the sun shines, even more than what a banker likes to do that, truly amazing; and one who wants the banker to take that umbrella back when there is the slightest indication it could rain, even faster than what the banker would like to do, equally truly amazing.”

Mr. Fed some few questions on Basel III, bank capital, mortgages, jobs, "the absolutely safe", and the "risky"

And so Mr. Fed you will still allow banks to hold less capital against mortgages than against loans to businesses, only because, like the Basel Committee, you feels the former poses less risk for our banks. But frankly, Mr. Fed, long term, for the economy, and for the banks… how safe are houses without jobs?

And Mr. Fed you will equally still allow for capital requirements that are much smaller for exposures to what is considered (ex-ante) absolutely safe, than for exposures considered "risky".

Mr. Fed, could it really be that you do not understand that allowing banks to earn higher expected risk adjusted returns on their equity on assets perceived as “absolutely safe”, than on assets perceived as “risky”, introduces the mother of all distortions, which makes it impossible for banks to allocate resources efficiently in the real economy? 

Mr. Fed could it really be that you do not understand how the previous distortion destroys most of the effects on the real economy your quantitative easing programs could produce? 

Mr. Fed could it really be that you do not understand that the most important factor in keeping the banking system strong and healthy is a strong and healthy real economy?

Mr. Fed could it really be that you do not understand that there are no dangers for the banking system in waters perceived as risky, and that all the dangers to it lie in waters perceived as absolutely safe.

Mr. Fed do you not know Mark Twain said “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so”?

Democrats and Republicans… for the sake of America, agree at least on eliminating bank regulations which discriminate against "The Risky” and in favor of "The Infallible"

The access to bank credit has been rigged against those perceived as "risky", like small businesses and entrepreneurs, by means of requiring banks to hold much higher capital when lending to them compared with what the banks need to hold when lending to those perceived as “not risky”. 

This, in a country that became what it is, thanks to risk-taking, and which also likes to refer to itself proudly as “the land of the brave”, is a direct affront to the American courage and spirit of entrepreneurship.

This, is what most neutralizes the impact of fiscal and QEs stimulus, and which most stands in the way of job creation.

Why cannot Democrats and Republicans set aside their differences for one second, and agree on eliminating any bank regulations which discriminate against those perceived as “risky”? 

Would they do so, there would be no reason to concern themselves with a heightened risk in the financial sector, since never ever has a major bank crisis resulted from excessive exposure to those perceived as “risky” (consult your Mark Twain), these have always resulted from excessive exposures to what was ex ante erroneously considered as “absolutely-not-risky”.

Republicans could sell it to their side, correctly, as an elimination of regulatory distortions that impede the markets to efficiently allocate economic resources. 

Democrats could sell it to his side, also correctly, as an elimination of a discrimination against the “risky-not-haves” and in favor of the “not-risky-haves” which drives increased inequality.

Both parties need to understand that discriminating against "The Risky" and in favor of "The Infallible" is about as Un-American it gets... in fact it is outright immoral!

http://perkurowski.blogspot.com/2008/08/discrimination-based-on-financial.html

A small question about bank regulators

In relation to bank regulations I have frequently found myself in need to comment that never ever has a major bank crisis resulted from excessive exposure to those perceived as “risky” (consult your Mark Twain), these have always resulted from excessive exposures to what was ex ante erroneously considered as “absolutely-not-risky”. 

But, between us... are not bank regulators supposed to know this very basic stuff? 

Where did all our current bank regulators, those who are writing up Basel I, Basel II, Basel 2.5, Basel III or what have you, study their Bank Regulations 101? Who checks the CVs of these appointees, or do they appoint themselves? Might they just have dropped in like any Chauncey Gardiner?

Chauncey: "If you do not like weeds use pesticide on them and fertilize the flowers" Basel Committee: "Ah, smart! If we want our banks to avoid risks, we need to pay them a lot in return on their equity to make them grow us the not-risks we so much desire"

Mark Twain, the bankers, and the nannies of the Basel Committee. What a sad tale.

I guess you have all read Mark Twain’s description of bankers as those who lend you the umbrella when the sun shines and want it back when it rains. And that most definitely rang true for someone as me trying to get banks to cooperate giving credit to my small and medium sized businesses and entrepreneur clients. 

But then along came the nannies of an outfit known as the Basel Committee, and their advisor the Financial Stability Board and said that that banker mode was still way too risky for them. And the nannies and, told the bankers that if they lent to those the sun was shining upon, the absolutely not risky, then they only needed 1.6 percent or less in capital, which meant they could leverage their equity 62.5 to 1 or even more in some cases, but if they dared lend to the “risky” who it seemed could be rained upon, then they needed 8 percent in capital and could only leverage 12.5 to 1. 

And, we all saw what happened. Here we are now with our banks up to their necks in dangerous excessive, really obese, exposures to what was erroneously perceived as “absolutely not-risky”, and anorexic exposure to those officially perceived as “risky”, like the small businesses and entrepreneurs, precisely those our young most count on generating the next generation of good jobs for them. 

Is it not a sad tale? Especially for a Western World that has become what it is thanks to risk-taking? Especially for an America that feels proud being known as the “land of the brave”? I wonder what Mark Twain would have to say about those nannies and the parents who entrust them with their banks?

On bankers and weathermen

Do you remember Mark Twain’s banker, he who wants to lend you the umbrella when the sun shines but wants to take it back as soon as it seems like it is going to rain? Well that banker would surely be taking some notice of what the weathermen opined, in order to set the interest rates, the amounts and the other terms of the loan. 

But what if the regulators also told this banker that if the weatherman spoke of sun, his bank was allowed to hold very little capital, which meant being able to leverage its equity much more, but, if he spoke of rain, it was then required to hold much more capital and leverage less? 

Obviously, since a banker must love returns on bank equity, since otherwise he would be booted, that would doom Twain’s banker to choke on sunny forecasts (like AAAs and infallible sovereigns), and avoid like the pest all possible rains (like small business and entrepreneurs)… only to find out, much too late, that weather reports are not always that accurate. 

And so shall we exclude using weather forecast from bank capital requirement calculations, or shall we regulate the weatherman… so that he gives our bankers absolutely accurate forecasts… so that our Mark Twain banker can trust these even more?

Ps. here a letter published by the Financial Times in January 2003.

Homeland Security, bad bank regulations could be used as a lethal weapon of terrorism

Mark Twain is attributed having said: “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain” and yes, we all know that bankers are characteristically risk-adverse. 

What then if someone somewhere concocted a biochemical agent that made the bankers even more risk-adverse, perhaps a testosterone reducer... a de-testosteroner. Would that not be classified as an act of terrorism, even if the chemist proved there was absolutely no bad intention?

But that is what effectively bank regulators did, when they allowed banks to have much less capital  (equity) when lending or investing in what was officially perceived as "absolutely safe", than the capital (equity) they were required to hold against any asset officially perceived as risky.

That allowed banks to earn higher risk-adjusted returns on equity when lending to "the infallible" than when lending to "the risky", something which introduced the mother of all distortions in how bank credit was allocated to the real economy.

As should have been expected, the result was a crisis that destroyed the economy of the US; by dangerously overcrowding the perceived safe-havens, like triple-A rated securities and infallible sovereigns (Greece); and by causing the equally dangerous underexposure to what is perceived as being risky, like in lending to small businesses and entrepreneurs. 

Honestly, is the willingness of the banks to take risks not a matter of national security for the Home Of The Brave?

Why do we so easily accept the distractionary explanation that the current crisis was caused by excessive risk-taking when so clearly all the serious losses have been in what was officially considered as the safest type of bank lending and investment?

PS. Here is a current summary of why I know the risk weighted capital requirements for banks to be dangerous nonsense.