Could a hostile power create bank regulations capable of destroying our Western financial system? It would seem so :-(

David Bookstaber in his “The End of Theory”, 2017 refers to the following question:

“If you were a hostile foreign power, how could you disrupt or destroy the U.S. financial system? That is how do you create a crisis?

Well one way to do it begins, as does any strategic offensive, with the right timing. Wait until the system exposes a vulnerability. Maybe that is when it’s filled with leverage, and when assets become shaky.”

Then Bookstaber suggests: “create a fire sale by pressing down prices to trigger forced selling…freeze funding by destroying confidence… maybe pull out your money from some institutions with some drama… and to make money, short the market before you start pushing things off the cliff”

That is Bookstaber’s interesting tale on what “turned the vulnerabilities of 2006 and 2007 into the crisis of 2008, and nearly destroyed our system.” “And we didn’t need an enemy power; we did it all by ourselves.

But what if it all had started with a hostile foreign power taking over bank regulations in order to create the vulnerabilities?

I mean like telling banks they could hold 1.6% in capital or less, meaning a 62.5 to 1 or more leverage, against assets with an AAA rating (like some fatal MBS) or against sovereigns, like Greece. That would give banks the chance to earn fabulous expected risk adjusted margins on those assets, and therefore build up huge exposures to these against very little capital (equity).

I ask, because that was exactly what the Basel Committee for Banking Supervision did with its Basel II of 2004.

And to top it up their AAA-bomb was so powerful that, because it discriminates against the access to bank credit of “the risky”, like SMEs and entrepreneurs, the economy would find it almost impossible to recover on its own; and the crisis-can had to be kicked further and further down the road, with Tarps, QEs, fiscal deficits and silly low interest rates? 

http://theaaa-bomb.blogspot.com

How come American citizens did not protest the Basel Accord’s 1988 in your face statism?

I refer to:

Confidential Memorandum:

Attack of American Free Enterprise System

Date: August 23, 1971

To: Mr. Eugene B. Sydnor, Jr., Chairman, Education Committee, U.S. Chamber of Commerce

From: Lewis F. Powell, Jr.

It mentions "The Ideological War Against Western Society"

But I sure have a question for you all

In 1988, by means of the Basel Accord, Basel I, for the purpose of setting the risk weights applicable to the credit risk weighted capital requirements for banks, the regulators defined a zero percent risk weight for the OECD sovereigns (governments) and a 100 percent risk weight for the citizen (the private sector)

That meant that governments would have more favorable access to bank credit than the citizens; which de facto implied that government bureaucrats use bank credit more efficiently than citizens.

There were protests from other sovereigns who also wanted to be awarded a zero percent risk weight… but how come no American citizens protested this in your face statist regulation?

Is not the strength of a sovereign solely the reflection of the strength of its citizens?

That distortion subsidizes government debt; with the subsidy paid for all those in the private sector who as a consequence will, in relative terms, have less and more expensive access to bank credit?

Is this of no interest to America?

If so then America is not what I had learned to believe and admire.

Is the problem with our bank regulators a lack of testosterone?

We have read a lot about excessive testosterone levels producing excessive risk taking, for instance in banks. But, could a deficiency of testosterone equally produce an excessive risk aversion.

Let me explain. Even though the credit risks perceived by bankers are already cleared for by means of the size of the exposure and risk premiums, current bank regulators imposed on banks higher capital requirements for what is perceived as risky than for what is perceived as safe. 

And the above is like adding up the risk aversion of two nannies before deciding what the children can do; and so of course the children are not allowed to do much; and so of course banks will lend too much to the “safe” and too little to the “risky”… and so of course there is a monstrous distortion of the allocation of bank credit to the real economy.

To top it up, it does not serve any stability purpose, since all major bank crises have always resulted from excessive exposures to what was erroneously considered “safe” and never ever to something correctly perceived as risky.

This, being so scared of what is perceived as risky and so little suspicious of what is perceived as safe, is so loony that perhaps it points to a hormonal imbalance. Could it be that current bank regulators have a serious lack of testosterone?

I, as many others, suffer from too much risk aversion, and so I could be suffering from that lack of testosterone too. But, in me, that deficiency presents no major problem, except perhaps for my kids who might therefore not inherit what they could inherit. But, when the testosterone deficiency is present in those who regulate our banks, then we are talking about that kind of systemic illnesses that can even bring a Western world down on its knees.

God make us daring!

PS. Again. If you lend too much to what is perceived as risky and too little to what is perceived as safe, then it might be because of excessive testosterone… why then can if you lend too much too what is perceived as safe, and too little to what is perceived as risky, not be a lack of testosterone?

The Basel Accord was an important turning point for the bad for the whole Western civilization...and it has sadly been ignored

In 1988, the G10 countries, signed up on the Basel Accord. With it, with Basel I, the regulators imposed on banks capital requirements based on ex-ante perceived credit risks.

And the risk weight assigned to the private sector was 100 percent, while the risk weight assigned to their governments was zero percent.

That meant banks needed to hold NO capital when lending to their governments, but 8 percent when lending to the private sector (the basic Basel 8 percent standard capital requirement, multiplied by the risk weight).

That meant that banks could leverage their equity and the support they explicitly and implicitly received from taxpayers infinitely, when lending to their governments, but only about 12 to 1, when lending to the citizens.

That meant in essence, that the regulators decreed that government bureaucrats would be able to use bank credit much more efficiently than the private sector.

That meant in essence, that the free Western world signed up to communistic precepts.

Is that not a historic turning point for our Western World? Tell me, how many times have you heard this being discussed?

And then, in 2004, with Basel II, regulators decided that the risk weight for those private sector borrowers rated AAA to AA was to be 20 percent, while for the unrated ordinary citizens and their SMEs, it remained 100 percent.

And that meant that regulatory risk aversion was also introduced with respect to bank credit to the private sector in the Western world... making it impossible for SMEs and entrepreneurs to have fair access to bank credit.

And since that its been going down down down and these two sad historical event are still being ignored.

Any civilization unwilling to take risks will stall and fall.

God make us daring again!

With their regulatory repression of banks, the Basel Committee and the Financial Stability Board are slaying our economies.

“Banks if you lend to a risky small business or an entrepreneur (broccoli) we will force you to hold more equity (spinach) but, if you lend to our dear safe mother government (ice-cream), we will reward you by allowing you to hold much less equity (chocolate-cake).”

The economies of Europe, of the whole Western world, are unwittingly being submitted to euthanasia by bank regulators too dumb (hopefully) to understand what they are doing.

Our economies, dieting solely on carbs, are being immobilized by growing obesity (as evidenced for instance by  negative interest rates) and any of these days they will suffer a heart-attack.

The most important behavioral, cognitive psychology, research program ever

Bank system crises never ever result from excessive exposures to what is perceived as risky, these always results from the buildup of excessive exposures to what was ex ante perceived as safe.

And yet bank regulators imposed on banks credit-risk-weighted equity requirements that are much higher for what is perceived as risky than for what is perceived as safe.

That is very clearly a monstrous mistake. It means that is something really bad happens to banks where that usually happens, regulators have made sure banks will stand there especially naked, with no equity to cover themselves up with. 

And my thesis is that the at-first-sight, Daniel Kahneman's “System 1: Fast, automatic, frequent, emotional, stereotypic, subconscious” standard basic intuition of “risky-is risky and safe-is safe”, is way too strong so as to permit opening a more reflective “System 2: Slow, effortful, infrequent, logical, calculating, conscious” analysis… and this most specially if that means questioning some other members of a mutual-admiration/ mutual-importance-reinforcement club. 

And that is the subject I would like to see researched by experts in behavioral finance and in cognitive psychology.

But why do I call this “the most important research program ever”?

Easy! Those regulations allow banks to leverage the back-stop supports that for instance central banks give more on assets perceived as safe than on assets perceived as risky; and that means banks will obtain higher risk-adjusted returns on their equity on assets perceived as safe than on assets perceived as risky.

That has introduced a regulatory risk aversion that seriously distorts the allocation of bank credit to the real economy.

And since risk-taking is the oxygen of any development, and what helped to bring the Western world to where it is, suspending it, de facto prohibiting banks from taking risks on the “risky”, our economies will first stall and then fall. And I hope you’d agree that’s not entirely unimportant.

Reading Daniel Kahneman's "Thinking Fast and Slow"
https://www.americanbanker.com/opinion/basel-iii-doubles-down-on-basel-iis-mistake

PS. Confirmation Bias

Unfortunately, with respect to believing the West decadent, it would seem Putin is right.

Edward Lucas of the Daily Mail suggests: “Putin believes the West is finished: overstretched, decadent and discredited. The truth is we are not losing this spate of arm-wrestles because we are weak, but because our willpower is weak.”

In terms of “decadent”, it seems Putin could unfortunately be right.

I say this because to impose larger equity requirements on banks when lending to “the risky” than when lending to “the safe” as the Basel Committee does; and thereby allow banks to earn higher risk-adjusted returns on equity when lending to the safe than when lending to the risky, is besides being something very dumb, a very clear sign of decadent risk aversion.

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.

There was the Western world, tagging along quite nicely, when BAM! in 1988, it got hit by the Basel Accord Asteroid.

The first consequence of the impact, Basel I 1992, was bad enough as it ordained that all bank lending to those designated as “infallible sovereigns”, was to require banks to hold much less equity than any lending against “the risky citizens”

The second impact, Basel II 2004, was even worse because it mandated that all bank lending to those private belonging to the AAArisktocracy was to require banks to hold much less equity than any lending against some lowly unrated citizens.

And that meant that lending to small businesses and entrepreneurs, the driving forces which kept the Western world moving forward, so as not to stall and fall, was not going to be able more to generate banks sufficient risk-adjusted returns on their equity… and so that kind of lending was abandoned.

And now the Western world is drowning in excessively dangerous exposure to what is perceived as absolutely safe, at silly low rates, while no banks are lending to the tough risky risk-takers the Westerns world needs to get going, most especially when the going is tough.

Unless it wakes up fast to what its bank regulators have done to it, the Western world, as we knew it, will be long gone.

If you think Basel III has solved it… forget it, with it we are only being dug deeper in the hole we’re in.

There is, might really be unwittingly, a high treason going on, against the western world, against the Judeo Christian civilization.

I was born a coward. Or at least quite risk adverse. And the many risk I have taken, is mostly because of blissful ignorance, or a glass of wine too much.

But I have always known about the importance of risk-taking, which is why I have always been grateful that my world was able to ride on the coattails of daring risk-takers; and that is why I often complained that Mark Twain was too right when he, supposedly, described bankers as those who lend you the umbrella when the sun is out, and want it back as soon as it seems it is going to rain.

But then came some bank regulators and really messed it up. Even more wimpy than I, they decided banks could hold less capital when lending to what was perceived as safe than when lending to what was perceived as risky, which meant banks would be able to earn much higher risk-adjusted returns on what was perceived as “safe” than on what was perceived as ”risky”. 

And, of course, that meant banks stopped giving credits in competitive risk-adjusted terms to the medium and small businesses, entrepreneurs and start-ups, to those that keep our bicycle moving forward, not stalling, not falling.

And now I fret for my daughters, and I fret even more for my grandchild, soon grandchildren, because I know that if my western world, my Judeo-Christian civilization, stays in the hands of adversaries to risk taking, it will just go down, down, down.

Regulators, if you really must distort, why not do it for a purpose in mind? Why not use, instead of credit ratings, job for our youth ratings?

Mamma Mia!

Do you hold any views on the issue of risk aversion vs. willingness to take risks in the Judeo-Christian tradition?

Current bank regulators, by allowing banks to hold much less capital (equity) when lending to someone perceived as “safe” than when lending to someone perceived as “risky”, have caused the banks to earn much higher risk adjusted returns on equity when lending to “the infallible” than when lending to “the risky”.

This, as I see it has introduced a serious risk aversion, or an unwillingness to take the risk which constitutes the oxygen of development, and that is very dangerous to the western world… where in its churches we used to sing “God make us daring”.

Are there any historians out there who have special knowledge on the issue of risk aversion vs. willingness to take risks in the Judeo-Christian tradition?

Please?

If the Basel Committee had had anything to do with it we, the Western World, would not be cycling.

If the largest of the apprehensions of our mother and of our grandmother about cycling had determined our bicycling, we would still be cycling.

But, if the apprehensions of our mother and our grandmother about cycling had been added up, we would not been cycling.

And that is another way to explain how, when our bankers apprehensions about lending to “the risky”, those reflected in higher interest rates, smaller loans and tighter conditions, got added up to our bank regulator’s apprehensions about risks, those reflected in the capital requirements... it all resulted in our banks not lending to “the risky”, like to the medium and small businesses, entrepreneurs and start-ups.

We need to stress test our bank regulators too! How? Analyze what assets banks do now not have on their balance sheets... thanks to the regulators' interfering and arrogantly playing risk managers for the world

God save us from these regulators.... God please make us daring!

The silly doubling down on ex ante perceived risks is killing the Western economies... and not so softly

The interest rates, the size of the exposures and all other terms of assets that banks put on their balance sheet, are a function of their ex ante perceived risks, like those reflected in credit ratings.

But current bank regulations also determines that the capital (equity) banks are required to hold against those assets, are also to be a function of risk weights determined from ex ante perceived risk, like those of credit ratings.

And that fundamental mistake of doubling down on the same ex ante perceived risks, like those in credit ratings, potentiating risk aversion, is killing the western economies as we knew them... and not so softly.

Trusting excessively ex ante perceived risks, regulators have allowed banks to hold much much less capital against assets perceived ex ante as “absolutely safe”, than against assets perceived as risky. And that resulted in that banks earn much much higher risk adjusted returns on equity on “The Infallible”, like exposures to sovereigns, housing sector and the AAAristocracy, than on The Risky, like medium and small businesses, entrepreneurs and start ups.

And that means that banks have dangerously leveraged up much too much on The Infallible and, equally dangerously, much too little on The Risky.

And so when one of “The Infallible” ex post turns out to belong to “The Risky”, as always happens sooner or later, often precisely because it has had too much access to bank credit, then the banks stand there naked with almost no capital.

And so “The Risky”, those who on the margins of the real economy most need and should have access to bank credit, in order to help our economies to move forward, they will not get it.

In essence this all means that banks will not help to finance the western economies future, but only help to refinance its past.

Senator Patrick Moynihan is quoted with saying “There are some mistakes it takes a PhD to make”. Unfortunately most of us equally seem to believe “There are mistakes, so dumb, these just cannot be made by a PhD”.

We baby-boomers extract as much equity as possible from the risk-taking our parents allowed banks to take, while refusing now to allow banks to take the risks our grandchildren need.

The Western world is being brought to its knees by mad bank regulators

The Western world is the result of risk-taking in all shapes and forms… “God make us daring!” ends one of the psalms sung in its churches… and we honor the successful and feel for the unsuccessful. 

But regulators, concerned only with bank failures, decided on capital requirements for banks based on perceived risk. And with these they gave the banks additional incentives to embrace lending to those perceived as “not-risky”, like the triple-A rated and “infallible” sovereigns, and to further avoid the “risky”, like the small business and entrepreneurs. And with this they stuck a dagger in the very soul of the Western world. 

And the dagger proved also to be more than useless for its initial purpose. Since it is precisely when banks embrace too much something that is perceived as absolutely not risky, that they fail en masse, the regulators doomed the world to this the mother of all systemic bank crises. 

The survival of the Western world now needs to begin by rescuing the possibilities of its risky risk-takers to take the risks we depend upon as a society, and that requires to allow the “risky” to compete for bank credit without regulators discriminating against them. 

And that begins by firing the nannies in the Basel Committee and in the Financial Stability Board, and renaming the latter immediately the Financial Functionability Board so that the regulators do not forget what they are there for.

"No ordinary man could be such a fool"

My daughter Alexandra, an art fanatic, on hearing my explanation about the mistake of the Basel Committee, pointed me to “The forger’s spell”, a book by Edward Dolnick about the falsification of Vermeer paintings. Boy was she right! 

In that book Dolnick makes a reference to having heard Francis Fukuyama in a TV program saying that Daniel Moynihan opined “There are some mistakes it takes a Ph.D. to make”. And he also speculates, in the footnotes, that perhaps Fukuyama had in mind George Orwell’s comment, in “Notes on Nationalism”, that “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” 

And that comprises about the most appropriate explanation I have yet seen so as to understand why our bank regulators were able to commit their huge mistake that got us into this financial and economic crisis that threatens the Western World, namely to base their risk weighted capital requirements on the expected and not on the unexpected.

No “ordinary man” would have told his children to beware about what he knew his children were afraid of, and stimulated them to go more where they already wanted to go as it seemed safe to them… which is precisely what the current risk weighted capital requirements for banks do. They cause too large bank exposures whenever the perceived risk of default of the borrower is low, and too small or even nonexistent exposures whenever the perceived risk of default is high. 

And then, just like to force it down our throats, Dolnick writes “Experts have little choice but to put enormous faith in their own opinions. Inevitably, that opens the way to error, sometimes to spectacular error.”

Dolnick also mentions that the psychologist Leon Festinger once marveled: “A man with conviction is a hard man to change. Tell him you disagree and he turns away. Show him facts or figures and he questions your sources. Appeal to logic and he fails to see your point”. 

All of which also leaves me with the problem that seemingly no ordinary financial reporters, like those in FT, can really come to grips with believing, or even daring to believe, that experts could be such fools.

PS. And of course, John Kenneth Galbraith and Upton Sinclair Jr added explanations

PS. No matter how insightful Francis Fukuyama seems to be, with his "End of History", he shows he did not see the statism introduced in the Western world in 1988 by bank regulators, with their Basel Accord

PS. Alexandra Kurowski 2016, M.A. in Modern and Contemporary Art and the Market, Christie’s Education New York,

PS. Here is a memo on the abundant lunacy contained by the risk weighted capital requirements for banks