David A. Stockman’s “The Great Deformation” did not include what is perhaps the greatest deformation.

David A. Stockman’s The Great Deformation is a truly great book, except for the fact that sadly it misses out on what in my mind constitutes the greatest deformation… namely allowing for much much lower capital (equity) requirements for banks on exposures that are considered as “absolutely safe”, than what they are required to hold for exposures considered as “risky”.

That allows the banks to grow so as to end up as Too Big To Fail, and to earn much higher risk-adjusted returns when lending to “The Infallible”, than when lending to “The Risky”.

And that distorts completely the way credit is allocated within the real economy, so that too much at too low interest rates of it goes to the "The Infallible", like the sovereign and the AAAristocracy (or AAArisktocracy) and too little to at too high interest to "The Risky", like medium and small businesses, entrepreneurs and star-ups.

And that effectively increases the de-facto risk-adverseness of banks, in the home of the brave, and in all other countries were these truly lamentable regulations are applied. And if that is not a deformation, what is?

Stockman does not mention that because of Basel II, approved in June 2004, and what SEC approved for US investment banks, April 2004, the European banks and the US investment banks could hold AAA rated securities, or lend against these securities, holding only 1.6 percent in capital, meaning leveraging their equity a mind-boggling 62.5 times to 1. 

And a result, though Stockman, in Chapter 20, “How the Fed brought the gambling mania to America’s neighborhoods”, explains splendidly the tragedy of how extremely bad mortgages were awarded to the subprime and other sectors in the US, and then packaged into dubious AAA rated securities sold all over the world, he misses out completely on the main reason for why the world demanded these securities and all other “supper-safies” so much, that it completely lost its common sense.

Let me assure everyone that if the banks had needed to hold the 8 percent they have to hold when lending to their “risky” citizen, then the current US subprime, Greek sovereign, Spanish real estate, Cyprus' banks, and similar tragedies, would not have happened. It is as easy as that… which of course does not make it any easier to swallow.

I hope that in the next edition of “The Great Deformation” David Stockman at least rewrites his chapter 20 so as to include these considerations. It would be a shame not to do so in such a good book.

And I need to repeat it again: A nation were banks need to hold 8 percent in capital when lending to the citizens, but are allowed to lend to their government against zero capital, is a deformed nation.

PS. The risk weights of 0% for the Sovereign, 20% for the AAArisktocracy and 100% for We the People, is anathema to America.

God make us daring!

“L'economia castrata”: The castrated economy which resulted from when regulation nannies castrated our banks

What would you think of a military high command that ordered a testosterone reducer to be fed to the soldiers so they would expose themselves less to risks, and so fewer of them would die? Right! That would indeed be high treason, as it would guarantee defeat. 

But that is precisely what bank regulators have done to our banks: 

Current capital requirements for banks, based on ex ante perceived risk, allow banks to hold much-much less capital on assets perceived as “absolutely safe” than on assets perceived as “risky”. 

That allows banks to earn much-much higher risk-adjusted returns on equity, when lending to “The Infallible”, than when lending to “The Risky”; 

And that results in that banks will lend, even more than usual, at even lower rates than usual, to sovereigns, housing and the AAAristocracy; and even less than usual, at even higher rates than usual, to medium and small businesses, the entrepreneurs and start-ups. 

And those regulations signify, as you can understand, a powerful testosterone inhibitor. 

And so the regulators have effectively castrated the banks and as a result we have a castrated economy with growing dangerous obese exposures to what was or is officially deemed as “not-risky”, triple A rated instruments and “infallible” sovereigns and housing; and equally or even more dangerous anorexic exposures to what is officially perceived as “risky”, like small and medium businesses, entrepreneurs and start-ups. 

God save us! From dumb regulators who do not understand that risk-taking is the oxygen of any movement forward. 

And before we get the testosterone level of banks back to normal, there is no stimulus package that will work, and we will only be wasting away whatever little fiscal and monetary policy space remains. 

God make us daring!