Are these reasons not enough cause for impeaching the current bank regulators?

By setting higher bank capital requirements for what is already perceived as risky than against what could wrongly be perceived as safe, the regulators guarantee especially large bank crises, from especially big exposures to what’s perceived as especially safe, against especially little capital.

By the same token they guarantee more than ordinary access to credit for the “safer” present, which will cause bubbles, like in house prices, and less credit to the “riskier” future, like to entrepreneurs, which will weaken the real economy.

By the same token, giving the banks huge incentives to finance what’s safe, has expelled the rest of the economy, like pension funds and private savers into the shadow banking system, having to take on much more “risky” investments, like leveraged loans, for which they are much less prepared for than banks.

The litmus test any aspiring central banker or bank regulator should have to pass

Fact: Banks are allowed to leverage more with assets considered safe, like loans to sovereigns, the AAArisktocracy and mortgages, than with assets considered risky, like loans to SMEs and entrepreneurs.

So ask the candidates:

Does that mean “the safe” have even more and easier access to bank credit than usual; and “the risky” have even less and on more expensive terms access to bank credit than usual?

If the answer is no, disqualify the candidate.

If the answer is yes, then ask: 

Do you think that might dangerously distort the allocation of bank credit to the real economy? Or impede QE stimulus flow to where it could be most productive?

If the answer is no, disqualify the candidate.

If the answer is yes, then ask: 

In terms of what can pose the greatest risk to the bank system, would you agree with Basel II’s risk weights of 20% for what is rated AAA to AA and 150% for what is rated below BB-?

If the answer is yes, disqualify the candidate.

If the answer is no, then ask: 

Do you agree with a 0% risk weighting of sovereigns?

If the answer is yes, the candidate should be classified as an incurable statist, not independent at all, and accordingly dismissed.

If the answer is no, then one could proceed applying any other criteria considered relevant.

As a relevant criteria, the way the world looks, being a lucky person seems a quite valid one.

PS. How many of those currently in central banks, or in the Basel Committee for Banking Supervision, or in the Financial Stability Board would pass this test?

@PerKurowski

Should not science matter to bank regulators, at least a little?

I ask because though I am no scientist, far from it, have never really understood Einstein’s relativity theory, I know that if I were asked to regulate banks there would be two basic questions I would have to ask:

First, what is the purpose of our banks? Quite early someone would have mentioned John A Shedd’s “A ship in harbor is safe, but that is not what ships are for” and I would have ascertained that purpose to be, to allocate credit to the real economy, carefully but efficiently. 

Second, what has caused major bank crises? a. Unexpected events, like devaluations, b. criminal behavior, like lending to affiliates; and c. dangerously large exposures to something ex ante perceived as very safe but that ex post turned out to be very risky. Surely someone would have also cited Voltaire’s “May God defend me from my friends, I can defend myself from my enemies” as a reminder that what is perceived as risky is, precisely because of that perception, quite innocuous.

After that initial mini research, the last thing I would have come up with is the current risk weighted capital requirements, more risk more capital – less risk less capital, that which distorts the allocation of bank credit, for no stability purpose at all... much the contrary.

So again… should not science matter to bank regulators, at least a little?

To lower the real real-interests in order to stimulate the real economy, take away the too costly subsidies of public debt.

Would any serious economist discuss gas prices at the pump ignoring taxes? No!

Would any serious economist discuss milk prices ignoring various subsidies? No!

Then why have almost all serious economists been discussing low real interest rates on public debt ignoring regulatory subsidies? I have no idea!

In 1988, the Basel Accord, Basel I, for the purpose of setting the capital requirements for banks, decided that the risk weight of the sovereign was 0% and that of We the People 100%. 

That would hence mean that banks would be able to leverage much more their equity, and the value of any explicit or implicit government guarantees they received, with loans to the public sector than with loans to the private sector. 

That would hence mean banks could obtain higher risk-adjusted returns on equity when lending to the public sector than when lending to the private sector.

That would hence mean that the interest rates of bank loans to the public sector included a regulatory subsidy.

That would hence mean that the subsidies for the access to bank credit by the public sector was to be paid by taxing the private sector with more restricted or more expensive access to bank credit.

And that should hence have meant that in order to know the real real-rate on public debt, to the nominal rates, we would have to add the cost of the regulatory taxes paid by the private sector.

That has not been done! All references to the interest rates of public debt have been limited to using the nominal rates. That has led experts like Lawrence Summers, Lord Adair Turner, Martin Wolf and many other, to argue that the public sector should take advantage of extraordinary low rates in order to finance public investments, like in infrastructure.

That is very wrong! If we include the economic cost of restricting the access to bank credit over the decade and around the world, for many millions of SMEs and entrepreneurs, the current real real-interests rates on public debt could in fact be the highest ever.

So, if the Fed, ECB, BoE or any other central bank, really wants to lower the interests in order to stimulate the real economy, then they should begin by asking bank regulators to take away those so very costly subsidies of public debt.

Central bankers might start doing this, in the name of equality, since making it harder than necessary for “the risky” to access bank credit, can only help to increase inequality. 

If bank regulators get too anxious and nervous about this, central bankers can (gently) remind them that there has never ever been a major bank crises caused by excessive exposures to what was ex ante perceived as risky. 

But what if the central banker also wears the hat of bank regulator? Then he has a problem he needs to solve… maybe with the help of some outside counseling assistance?

Houston we’ve got a huge problem. Bank regulators and other experts don’t get it!

With Basel II, banks were authorized to leverage their defined equity:

Unlimited times when lending to AAA to AA rated sovereigns
62.5 times to 1 when lending to the AAA to AA corporates, the AAArisktocracy
35.7 times to 1 when financing residential housing
And only 12.5 times to 1 when lending to unrated citizens SMEs and entrepreneurs

And that of course allowed banks to earn quite different expected risk adjusted returns on equity not based on what the market offered, but based on what the regulators dictated.

And regulators, finance professors, FT editors and journalists, and many other experts simply do not understand that this distorts the allocation of bank credit to the real economy.

What are we to do?

Obama, Republican and Democratic candidates, you should be very concerned with the mindset of your bank regulators.

The pillar of regulations designed to keep the banking system safe, is the risk weighted capital requirements for banks. 

These, with Basel II, set the risk weight for ‘highly speculative’ below BB- rated assets to be 150%, while the corresponding risk weight, for ‘prime’ AAA rated assets, was set at 20%. 

For a basic requirement of 8%, that meant banks needed to hold 12% in capital against ‘highly speculative’ below BB- rated assets, while only 1.6 percent for ‘prime’ AAA rated assets. 

That meant banks could leverage their equity, and all the support they receive from society, 8.3 times to 1 when holding highly speculative’ below BB- rated assets; and a mind-boggling 62.5 times to 1 with ‘prime’ AAA rated assets. 

That of course distorts the allocation of bank credit to the real economy and, by favoring the access to bank credit for "The Safe", odiously discriminates against that of "The Risky", like SMEs and entrepreneurs. 

As is that has banks earning higher risk adjusted returns on what is perceived as safe than on what is perceived as risky, which means banks no longer finance sufficiently the riskier future but mostly stick to refinancing the safer past. ,

And by negating The Risky their fair access to productive bank credit opportunities, inequality can only increase.

But, what I really cannot understand is: How come mature men (and women) can believe that what is rated below BB-, meaning is perceived as ‘highly speculative’, and therefore very risky, can be more dangerous to the banking system, than what is rated AAA, meaning ‘prime’, and therefore perceived as absolutely safe?

No! There has to be something fundamentally wrong with the current mindset of the bank regulators.

Such crazy risk aversion to perceived credit risk should, in The Home of the Brave, be deemed unconstitutional.

Reporters, this question could evidence whether bank regulators know what they are doing.

The Basel Committee decided that in order to make banks safe, these need to hold more capital (equity) against assets perceived as safe from a credit risk point of view than against assets perceived as risky. 

For instance in Basel II a private sector asset rated AAA to AA carried a 20 percent risk weight while an asset rated below BB- had a 150 percent risk weight. That meant banks needed to hold 7.5 times more capital against a below BB- rated asset than against a AAA to AA rated asset.

Allowing banks to leverage their equity differently based on credit risks obviously distorts the allocation of bank credit to the real economy, something that by itself could also be very dangerous for the safety of banks.

And so, the only way those risk weighted capital requirements for banks could be justified, would be if they really made banks safer.

But ask any bank regulator, like Stefan Ingves, the current Chair of the Basel Committee the following:

Sir, would you be so kind so as to provide us with one example of a major bank crisis that has resulted from excessive bank exposures to assets that were perceived as risky when placed on the balance sheet of banks.

If they cannot answer, should that not be a sufficient indication that they might have no idea about what they are doing?

I mean I can think of many instances were bankers were lulled into a false sense of security by good credit ratings, but I cannot for my life imagine bankers building up excessive exposures to something rated below BB-. Can you?

When are we going to fine or shame the regulators, The Great Distorters, The Great Manipulators of bank-credit markets?

Of course I do not mind banks paying fines because of their misbehaving though I would like these fines to be paid with shares of the banks, since requiring these to be paid in cash, which weakens the banks, sounds like societal masochism to me.

But what I really would like to see, if not being fined, bank regulators being shamed for the horrible distortion, the horrible manipulation, their credit-risk-weighted requirements have caused to the allocation of bank credit to the real economy.

And all that distortion and all that manipulation for absolutely no reason… since major bank crises never result from excessive bank exposure to what is ex ante perceived as risky.

Just to think of all those potentially opportunity and job creating credits that have been and are negated to SMEs and entrepreneurs, only because regulators believe themselves able to manage the banking-risks for the world, makes me cry for all those Millennials, and their descendants, who will have to live with the consequences of these stupid risk-adverse Baby-boomers.

And some of these regulators are even ideological infiltrators… because how else can one describe anyone who comes up with the notion of assigning a zero-risk-weight to the government, and a 100 percent risk weight to the citizens who represent the only back-up of that government.

When are we going to get regulators concerned with banks allocating credit efficiently to the real economy?

I just wonder… because clearly current bank regulators do not care one iota about that.

If they did they would not have concocted their silly credit-risk-weighted equity requirements for banks which allow banks to earn much higher risk adjusted returns on equity lending to “the safe” that when lending to “the risky.”

And that of course means banks will lend much too much to "the safe" and much too little to "the risky"

Why is a forced debt reduction considered a “haircut”, while having to pay more taxes, accept inflation or negative interests is not?

Intro: If I am a European and have invested my savings in a bond issued by my sovereign, and then my sovereign cannot repay me without increasing the taxes on me, or printing the money that by means of inflation allows it to repay me with money worth less… is that not a slighted disguised but yet a very real haircut? 

Current bank regulators require banks to have much less equity when lending to the government than when lending to a small businesses or an entrepreneur. 

And we must presume that means regulators feel it is less risky to us citizens when banks lend to the government, and the use of that money is decided by bureaucrats, than when the spending of the money they are responsible for is decided by small businesses or entrepreneurs. 

I don’t get it. Do you?

Might that be because governments are less risky because they have the power to tax or to print money?

If so, why do regulators not explain to us how repaying by having to collect more taxes, or repaying through inflation, is de facto not quite similar to any regular “haircut”.

Really? Is a sovereign less risky because if it cannot repay its debt it can always tax some debt holders and other innocent bystanders more?

Really? Is a sovereign less risky because if it cannot repay its debt it can always print more money and repay you with money worth less?

Friends, are these bank regulators truly working for us citizens, or are they only working for government bureaucrats? Or is it only all about ideology?

PS. When credit rating agencies rate sovereigns, should they not realize that increased taxes and printing money inflation are de facto haircuts?

PS. If I purchase a 10-year US government bond paying 1.97%, and the Fed tells me it is pursuing a 2% inflation… is this a prepaid haircut?

PS. Should banks, insurance companies or pension funds be allowed to invest in bonds with negative interest.... meaning pre-announced prepaid minimum haircuts?

PS. Can somebody please raise some prices, so to make central bankers happy and get deflation out of their heads, and so that they allow us being paid at least some interest on our savings, when we , almost widows and orphans, save in something that is supposed to be safe?  

PS. And the above does not even touch on the haircuts provided by devaluations.

Before blaming any regulatory capture on bankers, look first to the parents of central bankers and regulators.

That is because the regulatory capture could very well begin with some overly sissy parents, whose risk-adverseness causes the risk aversion in their kids which makes them natural candidates to be central bankers and regulators.

And then their grown-up equally scared kids, prohibit banks from engaging in natural market risk-taking, like lending to entrepreneurs and start-ups. 

And that risk-adverseness takes the strength out of the real economy, and, at the end, only causes banks to take truly dangerously excessive risks on what regulators, with amazing hubris, consider themselves to be capable to deem as “absolutely safe”… like the infallible sovereigns (Greece), the AAAristocracy (securities collateralized with mortgages to the subprime sector) or real estate (Spain).

January 2015, the generous bank regulators, are going to get clobbered. And no risk-weights mumbo jumbo will save them.

In January 1, 2015, according to the Basel Committee, banks are to disclose their leverage ratio, not based on risk-weighted assets, but simply on total assets, and as of course, the banks should have done all the time.

And at that moment bank regulators who have been the most generous to their banks are going to get clobbered, and no risk-weighting mumbo jumbo is going to save them.

Children and grandchildren, the truth about your fathers and grandfathers who are bank regulators

Your fathers, or grandfathers who are bank regulators, actually thought that if banks were allowed to leverage more their equity with exposures to those perceived as absolutely safe, than for those perceived as risky, we would not have any more bank crises. 

And this they believed even though all bank crises in the world have resulted from excessive exposures to those perceived as “The Infallible” and never ever because of excessive exposures to “The Risky”. 

Sorry kids, I wish I had not to say this, but they were really stupid. For your sake, I hope it is not something genetically.

PS. If you think that I am being too severe with your fathers and grandfathers who are bank regulators, then think of all the fathers and grandfathers who are not bank regulators, and who will suffer seeing their children and grandchildren not finding a job, only because of senselessly risk-adverse regulations.

Banks regulators, please, more humility… and also read more Hayek

Friedrich Hayek in his essay of 1945 “The use of knowledge in society” wrote the following: 

“The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. 

The economic problem of society is thus not merely a problem of how to allocate "given" resources—if "given" is taken to mean given to a single mind which deliberately solves the problem set by these "data." It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality. 

This character of the fundamental problem has, I am afraid, been obscured rather than illuminated by many of the recent refinements of economic theory, particularly by many of the uses made of mathematics.” 

And this truth was completely ignored by our current generation of bank regulators, who arrogantly thought themselves capable to act as the risk managers for the whole world, and so haphazardly set their risk-weights which determined the effective capital requirements for banks, based on perceived risks.

Of course that distorted it all and the banking system blew up… but these regulators still think they are up to the task of managing risks… As I see it the only possibility we have to make them humbler, at least for a while, seems to be, unfortunately, humiliating them.

“Reasoned Audacity”

There, in “Berthe Morisot, or, reasoned audacity”, a book published by the Denis and Annie Rouart Foundation and the Marmottan Monet Museum (2005), is where I first saw the term “reasoned audacity”. And it took the breath out of  me, as did, of course, Edouard Manet’s portrait of his sister in law. 

Yes, absolutely, that´s it, I said to myself. If I was a regulator, “reasoned audacity” is what I would try to inspire the banks with, and not with the dysfunctional unreasonable risk-aversion current regulators are imposing, with their mindless capital requirements for banks based on perceived risks.

God make us daring!

Two whys on bank regulations

How can I, as an ordinary citizen, obtain a decent return on my savings when investing in safe securities, having to compete with banks who can leverage their equity more that 60 to 1 when they do so?

How can I, as an ordinary small businesses or entrepreneur, get a decent interest rate on my bank loans, when banks can leverage their equity so much more when lending to those officially perceived as not-risky? 

It is so unfair! Who are these bank regulators? Who invested them with so much power?

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.”

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. 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 the bank regulators, with their Basel Accord

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

TWO EXAMS

The bank regulator’s exam

1. Which type of bank clients can create such a massive exposure so as to generate a systemic bank crisis?

a. Those perceived as risky (small businesses and entrepreneurs)

b. Those perceived as not risky (triple-A rated)

2. The needs of which clients do we most expect our banks to attend to?

a. Those perceived as risky with no access to capital markets (small businesses and entrepreneurs)

b. Those perceived as not risky and with access to capital markets (triple-A rated)

The bank regulators, represented by those in the Basel Committee answered (a) to the first question, and totally ignored the second. As a consequence they imposed higher capital requirements on banks when lending to client “officially” perceived as riskier, and vice versa.

Our exam

1. How did the bank regulators do?

a. They failed miserably

b. They excelled!

2. If your answer is (a) but we are yet leaving our regulations in the hands of exactly the same regulators what does that say about us?

a. We’re stupid

b. We’re smart

Our crazy bank regulations explained in red and blue

Nannies care for risks perceived, regulators should care for the risks not perceived. So you tell me, the Basel Committee, the FSA and the FSB, what are they?