Please, let us not favor financing our houses more than the jobs our kids and grandchildren need

I refer to Avinash Persaud’s “Breaking the Link between Housing Cycles, Banking Crises, and Recession”

Avinash Persaud correctly states: “This story is not just about mortgages but also about the overall allocation of liquid and illiquid assets across the financial system” March 2016

Yes, indeed it is. I have for soon two decades criticized that the Basel Committee's concept of risk-weighted capital requirements for banks, dangerously distorts the allocation of bank credit.

Persaud writes: “Under Basel I, in the calculation of the amount of risk-weighted assets a bank had to fund with capital, securitized mortgages had a risk weight of 20 percent while nonsecuritized mortgages had a risk weight of 50 percent.” And Persaud translates that into “This allowed banks to earn fees and net interest margins on holding 2.5 times more credit”

A more precise description is that Basel I assigned a 50% weight to loans fully secured by mortgage on residential property that is rented or is (or is intended to be) occupied by the borrower, and Basel II reduced that to 35 percent. And Basel II also introduced that security or any financial operation that could achieve an AAA to AA- rating, was assigned a 20 percent weight.

And I translate that as: With Basel I and II’s standard risk weight of 8 percent, anything that has a risk weight of 100%, like loans to unrated SMEs and entrepreneurs, means banks can leverage its defined capital 12.5 times to 1 (100/8). 

But if it has access to a 20 percent risk weight, the bank can leverage its defined capital 62.5 times to 1 (100/1.6)

And banks, naturally, operate to maximize risk-adjusted returns on equity (and bonuses to the bankers).

And so there can be no doubt banks will allocate much to much credit, in much to easy conditions to mortgages and AAA rated securities (and to sovereigns with a zero percent risk weight) and much too little credit, in much to harsh relative terms, to what is risk weighted more than that like, SMEs and entrepreneurs.

And so, while I fully share Persaud’s argument about preferring insurance companies to banks to finance mortgages, so as to minimize maturities mismatches, my concerns go much further than his.

I do not want to favor, in any way shape or form, the “safe” financing of mortgages, whether by banks or insurance companies, over the “risky” financing of the job creation our children and grandchildren need.

PS. What would houses be worth if there was no financing available for buying houses? I ask because mortgages might now be financing more the credit available for buying houses than the real intrinsic value of houses. Oops!

PS. A memo on the many mistakes of current risk weighted capital requirements for banks

World Bank and IMF, is the stability of banks really a good growth (or stability) strategy?

The most important “New Growth Strategy” that has been put in effect by global authorities during the last decades, is the one based on the notion that as long as our banks are stable, the economy will grow and everything will be fine and dandy.

And, in order to foster that stability of the banks, the Basel Committee for Banking Supervision designed a system of ex ante perceived credit-risks weighted capital (equity) requirements, which translates into: more-risk-more-equity, less-risk-less-equity. 

And that allows banks to be able to earn much much higher risk-adjusted returns on equity when lending to “the infallible” than when lending to “the risky”.

And, of course, the result was just as could have been expected… huge exposures to the infallibles, like to AAA rated securities (subprime mortgages USA), sovereigns (like Greece) and real estate (Spain)… and no exposures at all to the risky, like to medium and small businesses, entrepreneurs and start ups.

So how has that strategy worked? I would dare say “quite lousily”… but I might be wrong… because I see most of you feel like it is ok for those responsible for Basel I and Basel II, to now have a go at Basel III, that is if they are not to take up even higher responsibilities, like that of chairing the ECB.

I have always thought that risk taking was the oxygen of development, and that secular stagnation, deflation, mediocre economy, unemployment, underemployment, managed depression and all similar obnoxious creatures, were all direct descendants of risk aversion. But, then again I might be wrong, especially considering that the world’s premier development bank, has not objected one iota to that artificial regulatory risk aversion 

Looking back at history I have also always thought that what really posed dangers to the stability of banks, was what is perceived ex ante as absolutely safe. That because there is were the real dangerously large exposures could be found, never among the risky, But, then again I might be wrong, especially considering that the world’s premier financial stability agent, has not objected one iota to that structure of incentives for the allocation of the portfolios of banks.

It will be very interested to hear what renowned experts like Andreu Mas-Collel, Dani Rodrik, Philippe Aghion, Arvind Subramanian, Ivan Rossignol will have to say about that when, on October 14, they discuss in Washington: “New Growth Strategies: Delivering on Their Promise?” Sorry I can't be there (well not that sorry, since I will be in Paris :-))

PS. And, while you’re at it, if you can spare a second, give a thought to whether the risk-weighted bank capital requirements are helpful in order to decrease inequality or financial exclusion… or if perhaps they may serve as drivers of that.

PS. And, while you’re at it, if you can spare a second, give a thought to whether injecting some purpose into bank capital requirements could do some good, like instead of using credit ratings, using perhaps potential of job creation ratings, sustainability of planet earth ratings, and good governance and ethics ratings of governments.

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.

No! Bank regulators, much more than they deregulated, just regulated amazingly bad.

Here is an interview by Econ Focus of Richmond Fed with Mark Gertler, which repeats the falsehood of bank regulators believing too much in the market.

Gertler: The biggest mistakes probably involved too much deregulation.

Econ Focus: What do you think is the best explanation for the policies that were pursued? 

Gertler: At the time, I think it was partly unbridled belief in the market — that financial markets are competitive markets, and they ought to function well, not taking into account that any individual is just concerned about his or her welfare, not about the market as a whole or the exposure of the market as v a whole. 

I am sorry. That is simply not true. 

Anyone with any reasonable belief in the market being able to allocate credit adequately in the economy… would never ever have interfered by means of setting the capital requirements for banks based on risks which were already cleared for by banks. 

That resulted in banks earning much higher risk-adjusted returns on equity when financing what is ex ante perceived as “safe”, than when financing what is ex ante perceived as “risky”, something which of course distorts all common sense out of bank credit allocation.

For instance, Basel II had it that if a European bank made a loan to a medium and small business, an entrepreneur or a start up, then it needed to hold 8 percent in capital, a leverage of 12.5 to 1, but, if it purchased AAA rated securities, then it needed to hold only 1.6 percent in capital, a leverage of 62.5 to 1. And that of course had Europe buying the securitized subprime mortgages like if there was no tomorrow… and so did the investment banks when authorized by the SEC to follow the Basel rules.

In other words... bank regulators did not believe in the markets... they believed in themselves being the Masters of the Universe, capable of managing risks for the whole banking world.

In other words... bank regulators instead of concerning themselves with any "unexpected losses", which is what they should do, decided to also manage the expected losses.

In other words... bank regulators were just amazingly bad. In terms of Bill Easterly... God save us from the tyranny of experts.

“The World Development Report 2014 - Risk and Opportunity”, seems to completely ignore what is dumb and dangerous with Basel Committee´s risk adverse bank regulations

In its introduction, Jim Yong Kim, the president of the World Bank, expresses his “hope that the WDR-2014 will lead to risk management policies that allow us to minimize the danger of future crisis and to seize every opportunity for development.”

Sir, though WDR 2014 will surely contribute importantly in many ways and in many areas, unfortunately, with respect to the "Financial Sector", it does little, or even nothing, to help to achieve those goals. This is so because it seems to completely ignore the absolutely mistaken principles of current bank regulations being disseminated around the world. With their dumb and dangerous risk-aversion, these regulations attempt directly against development and stability. More than manage risks, those regulations have generated enormous risks.

More than 10 years ago, April 2003, when commenting on The World Bank’s Strategic Framework 2004-06, in a written statement which I delivered as an Executive Director of the World Bank, I opined the following: 

"The Basel Committee dictates norms for the banking industry that might be of extreme importance for the world’s economic development. In its drive to impose more supervision and reduce vulnerabilities, there is a clear need for an external observer of stature to assure that there is an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth. The World Bank seems to be the only suitable existing organization to assume such a role."

Unfortunately, the World Bank, or any other institution, did not assume such a role, and as a consequence we have landed ourselves with the most dumb and dangerous bank regulations possible.

Before explaining it, let me, just as a reference for why I deserve being listened to, point to a similar statement at the Board on October 19, 2004, and in which I so correctly and timely warned: 

“We believe that much of the world’s financial markets are currently being dangerously overstretched though an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”

The pillar of the Basel Committee’s bank regulations, is capital requirements for banks based on ex ante perceived risks of borrowers. These allow banks to hold much much less capital against assets perceived as “absolutely safe”, “The Infallible”, than against assets perceived as belonging to “The Risky”. A more capable regulator, would be much more concerned about what bankers do with the risks they perceive, and with what happens when those ex ante perceptions, turn out, ex post, to have been wrong.

And those risk-weighted capital requirements result directly in that banks are able to earn much much higher risk adjusted returns on equity, when lending to some sovereigns, housing or the AAArisktocracy, than when lending to the medium and small businesses, entrepreneurs and start-ups. Something like rewarding children with chocolate cake when they eat ice cream, and punishing them with spinach when they eat broccoli... and declaring being surprised when kids turn out obese. And it is all like drastically changing the payouts on roulette bets, and believing the game of roulette will remain the same. 

And since the assessments of safeness and riskiness were to be done by very few human fallible credit rating agencies, on January 2003, in a letter published in the Financial Times, I also warned:

"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. Friends, as it is, the world is tough enough." 

And so those regulations doomed of course the banks to, sooner or later, create excessive and dangerous bank exposures to something that would have erroneously been considered as “absolutely safe”; like AAA rated securities backed with lousily awarded mortgages to the subprime sector, banks in Ireland, real estate in Spain, and sovereigns, like Greece. And doomed the banks to have especially little capital when the biggest disasters struck. It even did the eurozone in. Just a little empirical research on what causes bank crises, would have concluded that... never ever, those ex ante perceived as risky.

And, of course, that also doomed those who though “risky”, are the true dynamos of the real economy, and the best possible creators of the next generation of sturdy jobs, and who are those most in need of bank credit, to have their competitive access to bank credit severely curtailed. And that has effectively placed the economy in a shutdown mode… and whatever movement we might detect in it, might have to do with the sad fact that it is heading down down, on a very slippery slope.

And this truly odious regulatory discrimination is only helping to increase the gap between the past, the developed, the haves, and the future, the developing, the have nots. In other words it excludes more than it includes. WDR-2014 writes: “All too often risk management strategies prove ineffective (or introduce other risks) because they are not coordinated among all relevant policy stake holders”. Indeed! And I ask… who consulted bank regulations with “The Risky” borrowers?

But not one word about all that in WDR-2014!

The WDR-2014 does state though: “Stability. The Achilles’ heel of the financial system is its propensity for crisis”. And that is wrong! Its Achilles’ heel is the propensity to try to delay the crises. May 2003, at the World Bank in a workshop on bank regulations, I told those present: 

“A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.” 

And the WDR-2014 does propose creating a "National Risk Board", "an integrated, permanent risk management agency that deals with multiple risks." That might have some advantages, but it also reminds me of why, in November 1999, I had to write 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 its total collapse"

Jim Yong Kim also writes: “This year’s WDR cautions that the greatest risk may be taking no risk at all”. And he is absolutely correct. But, unfortunately, the great institution he presides, the world’s premier development bank, seems not to fully understand that risk-taking is in fact the oxygen of development.

And, therefore, the World Bank has done nothing to stop the members of the Basel Committee, and of the Financial Stability Board, those who with so much hubris believe themselves capable of being the financial risk-managers of the world, from applying their so truly risky risk-adverse bank regulations.

Let me end by reminding you that these regulators, those who after the Basel II flop are still allowed to work on Basel III (neither Hollywood nor Bollywood would be so dumb), were the real enablers of our current bank crisis. If in doubt, just ask yourselves whether the market, in the absence of any bank regulations, would have allowed banks to leverage 50 to 1?

God make us daring! We need bankers capable of reasoned audacity! World Bank, step up to your duties!

Per Kurowski

PS. IMF is also completely disoriented by current bank regulations. They have for instance no idea of what would be the real market interest rates on public debt, for instance in the US, if banks needed to hold the same amount of capital against it, as they are required to hold against a loan to a citizen.

PS. I hear you. "Per, how can this be?" Well, Patrick Moynihan said “there are mistakes only PhDs can make; and George Orwell that “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” But I personally think, this is the typical thing to happen, when the wish of not criticizing colleagues in ones networks, crosses the path of those not wanting to admit they do not understand one thing of the mumbo jumbo that is being said.

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

You, the bank regulating scientists, would you please explain something to a layman?

Below what I saw while walking around in the Washington Zoo with my constituency (my grandchild) and which inspired me to ask our bank regulation scientists friends a question.

Smithsonian scientists learn a lot by observing animals. 

Now its your turn to WATCH AND LEARN

So now it is with you bank regulator. You are the scientist. Scientist learns a lot, by observing banks and bankers. So please explain.

Observe what type of bank exposures have caused all major bank crises:

1. One or many of those ex ante considered risky, and that ex-post turned out to be risky?

2. One or many of those ex ante considered risky, and that ex-post turned out to be safe?

3. One or many of those ex ante considered absolutely safe risky, and that ex-post turned out to be safe?

4. One or many of those ex ante considered absolutely safe risky and that ex-post turned out to be very risky?

And now, you bank scientists answer us non bank scientists. 

For what type of exposures would the empirical evidence suggest the capital requirements for banks should be higher?

Aha! 

And so then explain to us, in easy terms, why you, the Basel Committee for Banking Supervision, the Supreme Global Bank Supervisor, set rules which allowed the banks to have much much less capital for what was ex ante perceived as "absolutely safe", than for what ex ante is perceived as risky?

Please?

PS. My own humble opinion is that our bank regulation scientist friends have got themselves trapped in quite a bit of confusion. They keep on analyzing the possible failure of bank borrowers and not, as they should, the reasons for why banks fail, as entities or in allocating credit to the real economy. And that is of course not the same thing, or, as they say in French, c’est pas la même chose… For instance instead of looking at the ex ante credit ratings of bank borrowers they should look at what bankers do when they see those same credit ratings.

In other words, the regulators instead of analyzing so much the ex ante creditworthiness of bank borrowers, to determine their risk weights, should have analyzed, at least a little, the ex-post explanations for why banks fail and for why bank crises occur. Holy moly!

PS. As I see it: The world (with its banks) is much better off thinking that the risky are less risky than we think them to be, than that the "safe" are as safe as we think.

Young! Fight for your right that the society, through its banks, takes the risks you need for your future

Today I refer to the global tragedy of rising youth unemployment. I contend that to a large extent it is caused by the appalling banking regulations of the Basel Committee.

These regulations require banks to hold much more capital (equity) for assets considered "risky" than for those that are perceived as "absolutely safe". And that, no matter what you might think, makes no sense.

As a result the banks obtain much higher risk-adjusted returns on their assets, when lending to “the infallible” than when lending to "the risky”. Something which simply means favoring those already favored by the market, and discriminating those already discriminated by the market. And the consequences are dire.

That alone ensures that when one of those ex ante "infallible" is, sooner or later, ex post, found out to be risky, the bank will stand there naked, with little or no equity to cover up for huge exposures.

And worse, it shatters the chances of banks efficiently allocating credit resources in the real economy... which as you understand means low job creation.

In Washington, in October, there will be a "Youth Summit". In a world where there are so many old people much more concerned about their own welfare, than with the prospects of the young, the summit may not receive sufficient attention .

The summit invites people between 18 and 35 years to submit proposals on development cases, highlighting the challenges faced in real life development organizations. One of these is titled "A better financial product for micro entrepreneurs, young people and small businesses."

And since as "old" I cannot compete, I here try to squeeze by a proposal:

Bank Regulators: Eliminate capital requirements based on perceived risk. With these you only encourage banks to lend more and in better terms to the "absolutely safe". Accept the fact that risk-taking is the oxygen of all development.

Apart from it all your risk aversion is useless. All the major problems with banks, past, current and future, will always result from what you regulators, and the bankers, considered as “absolutely safe”; like sovereign, real estate and AAA credit ratings holders. We have never ever experienced a banking crisis that has resulted from excessive loan exposures to “the risky”, micro-entrepreneurs and small businesses.

And, regulators, if you absolutely must distort the market, in order to justify your salaries, or feed your egos, then at least let the banks hold less capital only in accordance to ratings which indicates the potential of generating employment for the youth, or the sustainability of the environment.

At least banking would in that case be fulfilling a social purpose much more important than being the financier of the AAAristocracy.

“The risky" have the right to bank credit on competitive terms, and that without being relegated to use specialized microfinance entities.

The banks cannot afford not to take the risk on “the risky". On that depends, the creation of the future jobs of our youth, the "infallible" of tomorrow, and even the existence of truly safe banks.

Note: The summit is organized by the Junior Professional Associates at the World Bank (JPA), the United Nations Foundation, Athgo a NGO in Los Angeles, and YEN , a network created by the World Bank , the United Nations and the International Organization Labour Office (ILO ).

Translated from El Universal, Caracas, August 29, 2013

PS. In fact there is no way that when the young finally understand the hurt that is being done to them, that they will not revolt… and then perhaps suggest to us older the reinstatement of an “Ättestupa”

More:

http://subprimeregulations.blogspot.com/2013/06/g8-for-unemployed-young-ones-sake.html
http://subprimeregulations.blogspot.com/2013/02/how-many-young-in-europe-are-unemployed.html
http://subprimeregulations.blogspot.com/2012/10/the-world-banks-world-development.html
http://perkurowski.blogspot.com/2012/04/we-need-worthy-and-decent-unemployments.html
http://perkurowski.blogspot.com/2011/04/young-unemployed-forever.html
http://perkurowski.blogspot.com/2006/07/on-faith-based-organizations-as.html
http://subprimeregulations.blogspot.com/2014/11/the-basel-committee-financial-stability.html

Basel's "Leverage Ratio" expressed as Debt to Equity Ratios (D/E)

Below what leverage ratios (LR) of x percent, in Basel terminology, approximately mean, in terms of normal traditional debt to equity (D/E) ratios, those usually applied to all other economic organizations.

LR of 2 percent = D/E of 49/1

LR of 3 percent = D/E of 32/1

LR of 4 percent = D/E of 24/1

LR of 5 percent = D/E of 19/1

LR of 6 percent = D/E of 16/1

LR of 7 percent = D/E of 13/1

LR of 8 percent = D/E of 11/1

LR of 9 percent = D/E of 10/1

LR of 10 percent = D/E of 9/1

My recommendation: Throw away all risk-weighting and adopt a leverage ratio of from 6 to 9 percent, which should fluctuate in an economic counter-cyclical way.

Davis Polk quite faulty analysis of the Brown-Vitter Bill

Davis Polk when analyzing the Brown-Vitter Bill evidences that they, like most discussants of the issue, have not yet understood the very dangerous implications for the banking system which results from risk-weighing bank assets so as to determine their specific capital requirements for banks. With respect to this they write the following: 

“The Brown-Vitter leverage ratio is too blunt an instrument for prudential financial regulation because it is not capable of distinguishing between risky and non-risky assets, and could result in two banks with vastly different risk profiles holding exactly the same amount of capital. 

By making a leverage ratio the centerpiece of its capital framework, the Brown-Vitter bill represents a deliberate departure from the risk-based capital framework, notwithstanding the fact that the risk-based approach has been endorsed and adopted by all major economies around the world."

Let me explain a couple of real street life facts to these lawyers who have so clearly been captured by some desk illusions. If they then need more they can always go to my blog or call me. 

The perceived risks which are considered for setting the risk-weights are already cleared for by the banks on the assets side of the balance sheet, by means of interest rates (risk-premiums) amount of exposure and other terms. So therefore, forcing the banks to clear for the same perceived risks on the other side of the balance sheet, in their equity, only guarantees banks will overdose on perceived risks. 

When banks are able to hold less equity for “safe” asset than for the “risky” that translates directly into the expected risk adjusted return on bank equity on assets perceived as safe will be much higher than the same expected risk adjusted return on equity on assets perceived as “risky”, something which obviously introduces huge distortions and which make it impossible for the banks to perform their vital social function of allocating resources as efficiently as possible in the economy. 

The following question could also help to shed some light on this issue: “Do you approve that those who by being perceived as “The Infallible” are already much favored, should be additionally favored by the banks, and that those who by being perceived as “The Risky” are already discriminated against, should be additionally discriminated against by the banks?” Davis Polk, how do you think US Congressmen, in “the land of the brave” would respond to that? 

Davis Polk writes: 

“The inherent disadvantage of a leverage ratio such as the one in the Brown-Vitter bill is its inability to distinguish between risky and non-risky assets. Imagine two banks with exactly the same amount of tangible common equity and exactly the same amount of total assets. Bank A’s assets primarily consist of U.S. Treasury bonds backed by the full faith and credit of the U.S. government. Bank B’s assets primarily consist of the junior tranches of commercial real estate securitizations and equity exposures. 

The two banks would have exactly the same leverage ratio under the Brown-Vitter bill, notwithstanding their entirely different risk profiles. In contrast, under a risk-based capital framework, Bank B’s risk-based capital ratio would be lower than Bank A’s risk-based capital ratio, reflecting Bank B’s riskier balance sheet” 

And my question to Davis Polk would be: How do you know for sure Bank B is riskier than Bank A? What if Bank A held some long term U.S Treasury bonds and interest rates increased? Is not the US Government's strength a direct result of the audacity of its risk-taking citizens? 

Davis Polk also writes: 

“The Brown-Vitter rose-colored glasses view of U.S. banking history in the 19th century is contradicted by the facts” 

Well, Davis Polk, if you were to go to history then you would see that all major bank crisis have always been detonated by excessive exposures to what was ex-ante perceived as belonging to “The Infallible”, but turned out ex-post not to be, and never ever by excessive bank exposures to what ex-ante was perceived as part of “The Risky”. And just look at the current crisis… all bank assets that have created problems were those for which regulators allowed low capital requirements. And not a single of all bank exposure to “The Risky” has caused a capital insufficiency to appear. 

No, you in Davis Polk, instead of admiring so much what the Basel Committee has been up to, should really start to question their lack of wisdom. 

In November 1999, in an Op-Ed I wrote “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 its collapse” 

And that is precisely what the Basel Committee did when it concocted the risk-weighted capital requirements, and no one questioned it sufficiently on it. Davis Polk, after the 2007-08 shock are you going to help the regulators to set us up for the next one? If we let them it seems it can only get worse, since now with Basel III they also want to add liquidity requirements based fundamentally on the same perceived risks. 

Davis Polk. I know you are lawyers… but do you really believe the US became what it is by having the banks avoiding risks? If the banks do not help society to take the risk it needs for the real economy to move forward, and to create the next generation of jobs our kids and grandchildren will need... who is going to do that? You and me? 

PS. Does this mean that I agree with the entire Brown-Vitter bill and with nothing of what Davis Polk states? Of course not! For instance I believe that capital requirements between 8 and 10 would suffice if we got rid of all of risk weighting? And I also think much thought should be given to how to help banks raise equity fast, so as to get over that problem and not allowing it to be a drag on the economy for years.

PS. Oh I forgot to mention the fact that minuscule capital requirements, resulting from minuscule risk-weights, are the best growth hormones ever for the too-big-to-fail banks.

US, it is not easy to remain “the land of the brave”, with castrated banks singing in falsetto

I came late to DAVID A. STOCKMAN´s Sundown in America, in the New York Times, “State-Wrecked: The Corruption of Capitalism in America” March 30, comments were closed. 

But this is what I would have commented, again, for the umpteenth time. 

America, be careful you do not turn into “the land of the pusillanimous”…since that is where you are heading with current bank regulations.

The day when bank regulators came up with, or accepted, the idea that banks could hold less capital against what was perceived as “absolutely not risky”, than against what was perceived as “risky”, even though those perceptions were already being cleared for by means of interest rates, size of exposures and other contractual terms, that day they castrated the banks. 

And friends, it is not easy to remain “the land of the brave” with your banks singing in falsetto.

http://subprimeregulations.blogspot.com/2013/03/there-is-plentiful-of-vested-interest.html

Why is Ben Bernanke (and his bank regulating colleagues) so inconsistent?

Ben Bernanke, the Chairman of the Fed, in a recent speech at Jackson Hole, refers to the possible costs the “the possibility that the Federal Reserve could incur financial losses should interest rates rise to an unexpected extent”, as a result of its balance sheet policies. 

Bernanke diminishes that very real possibility by arguing: to the extent that monetary policy helps strengthen the economy and raise incomes, the benefits for the U.S. fiscal position would be substantial. In any case, this purely fiscal perspective is too narrow: Because Americans are workers and consumers as well as taxpayers, monetary policy can achieve the most for the country by focusing generally on improving economic performance rather than narrowly on possible gains or losses on the Federal Reserve's balance sheet. 

And I must then ask why on earth Bernanke is unable to apply that same reasoning to our banks? Is not the purpose of the banks also that of helping to improve the performance of the economy? 

The sad fact is that our banks are currently constrained, by means of capital requirements based on perceived risk, from lending to the small business and entrepreneurs, those that mean so much to the real economy, only because regulators like Bernanke, worried sick, have foolishly decided these borrowers are too risky for the banks, when compared to lending to the absolute safe, like the AAA rated and the infallible sovereigns. 

The consequence of that is that if a bank lends to a Solyndra, it is required to hold more capital that if it lends to the government, so that a government bureaucrat can lend to a Solyndra. Frankly, a mind, if prone to believing in conspiracy theories, could not be blamed too much for suspecting that communism was being brought in, through the backdoor, by bank regulations. 

But setting aside any thoughts about foul play, what this regulations will create, and indeed have already created, are obese bank exposures to what is officially perceived as absolutely safe and anorexic exposures to the so needed and important “risky”. 

Bernanke ends by stating “The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years.” 

Mr. Bernanke, let me then inform you that, in my humble opinion, because of your bank regulations, you and your colleagues are very much responsible for very much of that unemployment. Have you never thought of capital requirements for banks based on potential of job creation ratings?

Conclusion: The Milton Friedman helicopter approach, of dropping money from the sky, would be a much wiser approach for Ben Bernanke and the Fed to use than their QE’s, since that way some funds at least could reach the “risky”, like the small businesses and entrepreneurs, and not all get stuck with the officially perceived “absolutely safe”

It’s the stupid bank regulations stupid!

Those perceived as “not risky”, they have always paid lower interest rates, gotten larger loans, on softer terms, and attracted that type of large bank exposures that has caused all major bank crises, when some of them turn out to be very-risky. And so why, Mr. Bright Bank Regulator, do you allow the banks to hold less capital when lending to the “not risky”? That way the "not risky" get even lower interest, even larger loans, on even softer terms and we risk an even major systemic crisis, when some of these “not-risky”, like the triple-A rated securities, the infallible sovereigns like Greece, Icelandic banks, Spanish real estate borrowers and what awaits us, turn out to be very risky. Why are you so chummy with the dangerous not-risky, are you stupid? 

Those perceived as “risky”, like the small businesses and entrepreneurs, they have always paid higher interest rates, gotten smaller loans, on harsher terms, and never ever caused a major bank crisis. And so why, Mr. Bright Bank Regulator, do you require the banks to hold more capital when lending to the “risky” than when to the “not risky”, and so that the "risky" get charged even higher interests, get even smaller loans, on ever hasher terms, and so have even less chance of helping us to generate the growth and job opportunities we need, and, like now, help us out of the crisis generated by some “not-risky” ex-ante, turning very-risky, ex-post. Why do you treat the useful risky so bad, are you stupid? 

Mr. Bright Bank Regulator, if you absolutely must mess around with market signals, so you feel you have earned your salary, then why do you not at least base the capital requirements for banks on job creation and environmental sustainability ratings. That way these would at least serve a purpose.

Thank God for timely capital flight!

Because of the regulatory incentives of only having to hold 1.6 percent in equity when lending to Greece, which meant being allowed to leverage their bank equity a mind-boggling 62.5 to 1, German and other European banks lent to Greece like crazy and at crazy low rates. What would you have liked the Greeks to do?... the same nonsense?... so that even more money had been lost down the same drain? 

No thank God there was some intelligent and timely capital flight, and private Greeks placed at least some or their funds out of harm´s way. 

Now it is up to these private Greeks, to see how, with their diminished resources they can best help their homeland, in times when helping it might actually produce some good results. 

About cruise ships and banking regulations

Put it this way. If you go on a cruise would you want it to be insured against all risks or not? As I see it if it is completely insured, chances are that the captain could be a social relations captain, and if it is completely uninsured, the chances are much larger that the captain is a real marine captain. Your pick! 

When the regulators allowed the banks those ridiculous capital requirements of 1.6 percent or less, just to navigate those waters perceived as absolutely not-risky, precisely the waters where in fact all the major bank crisis have occurred, they basically provided the banks with a total insurance… causing social-relation and trading bankers to substitute for real bankers.

Financial repression

Financial repression, a term coined in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon, is used to describe several measures that governments employ to channel funds to themselves and which in a deregulated market, would go elsewhere. In other words it is a hidden non-transparent tax. 

How much financial repression is present by the fact that the banks need to hold immensely much less capital when lending to its “infallible” government than when lending to the “risky” citizens? We have no idea… as we are flying blind with instruments that long ago ceased to function.

Stop the Basel Committee from peddling its hallucinogen, its banker’s belladonna

Capital requirements for banks which allow for very little bank equity when the credit ratings are good, and require more of it when they are not, is a very dangerous hallucinogen, in that it increases the sensitivity of the banks to the signals the credit ratings emit. 

This, the banker’s belladonna, is precisely the cause of the monstrous crisis that is threatening the whole Western World. Its consumption causes growing excessive dangerous bank exposures to what is officially perceived ex-ante as not risky, like to triple-A rated securities and to infallible sovereigns, and a growing, equally dangerous, bank underexposure to what is officially perceived as risky, like of the lending to small businesses and entrepreneurs. 

We need bank regulators who know that a risk signal can only be valid if interpreted adequately. Occupy Basel!

http://subprimeregulations.blogspot.com/2011/04/basels-monstrous-regulatory-mistake.html

A letter from a citizen to Mme Christine Lagarde

Dear Mme Christine Lagarde.

I wish you all the best of luck as the new Managing Director of the International Monetary Fund… albeit that luck I wish not only for yourself, but also because at this moment it really behooves us all that you’ll have lots of it.

But, just as another of the most humble stakeholders in the IMF, an ordinary citizen, and since IMF has a fundamental role in leveraging knowledge and ideas with respect to the world’s financial system, I would beg you to consider the following that I feel is crucial for yours and our chances of success.

Currently the “capital requirements for banks” are set by discriminating borrowers based on their “perceived risk of default”, mostly as perceived by the credit rating agencies. More perceived risk, more capital, and vice-versa.

But, this is not logical, given the fact that what regulators need not to concern themselves much with the risks that are perceived, but should concern themselves mostly with the risks that are not perceived.

And, it is also not logical, given the fact that there has never ever been a financial crisis resulting from excessive lending to what is perceived as “risky”, since, except for cases when fraudulent behavior has been present, they have all resulted from excessive lending to what is perceived as “not-risky”. Just look at the current crisis, 100% caused by leveraging the perceived as "not-risky" and then discovering these, later, as being very-risky!

And, it is also not logical, given that those perceived as “risky” are already compensating the capital accounts of the banks by means of paying higher risk-adjusted interest rates.

And, it is also not logical, given that it imposes on those deemed as “risky”, like the small business and entrepreneurs, the need to pay additional interest margins to banks, which I currently calculate in the order of 270bp, just to compensate for the regulatory advantages given to those who are perceived as “not-risky”, the triple-A rated.

And, it is also not logical, given that those deemed as “risky”, like the small business and entrepreneurs, with little or no access to capital markets, are often those whose credit needs we most expect our banks to serve.

Mme Lagarde, if you absolutely think bank regulators must interfere by defining capital requirement for banks in ways that discriminate among borrowers, then… why not have the regulators discriminate the capital requirements for banks based on the potential of the different borrowers to generate the next generation of decent jobs?

Again, wishing you (and us) the best of luck

Yours sincerely,

Per Kurowski

A former Executive Director at the World Bank (2002-2004)

Our crazy bank regulations explained in red and blue

Basel‘s monstrous regulatory mistake

The regulators notwithstanding that the market and the banks already considered the credit ratings when setting their risk premiums and interest rates, considered exactly the same information when setting their capital requirements for the banks. This double consideration, which would have been wrong even in the case of perfect credit ratings, leveraged incredibly the systems dependence on the human fallible credit ratings.

And now, more than three years into the crisis, the Basel Committee, FSB, FAS, Fed, IMF, World Bank, PhDs and finance experts, specialized journalists, like all those in FT, and most other who have and give opinions on the issue of bank regulations, have yet to say one single word about a mistake that really makes it impossible to construe any worthy bank regulation on top of it.

One really wonders what world we live in, when the regulators is turning our whole banking system sissy... and making it impossible for banks to allocate credit efficiently to the real economy.

Postscript: Basel Committee, please listen to Violet Crawley, don't be so defeatist, it’s so middle class.

https://youtu.be/g9XQ3_LCl-Q