Some tweets on macro-imprudent policies

I tweeted this to BIS in response to a speech by Mario Draghi, President of the European Central Bank and Chair of the European Systemic Risk Board, titled "Macroprudential policy in Europe" delivered September 26, 2019

Macro-imprudent policy 1:

Regulators have based their risk weighted bank capital requirements on that what’s perceived as risky is more dangerous to our bank systems than what is perceived, decreed or concocted as safe. That puts bank crises on steroids.

Macro-imprudent policy 2:

The risk weighted bank capital requirements are as procyclical it can get. Getting rid of these is the best countercyclical measure.

Macro-imprudent policy 3:

The 0% capital requirements assigned to all Eurozone sovereigns’ debts, even when these are not denominated in their own printable fiat currency. This WILL blow up the Euro and perhaps, sadly, the EU too.

Basel I, II, and III are all examples of pure unabridged regulatory statism

In July 1988 the G10 approved the Basel Accord. For its risk weighted bank capital requirements it assigned the following risk weights:

0% to claims on central governments and central banks denominated in national currency and funded in that currency. 

100% to claims on the private sector.

That means banks can leverage much more whatever net margin a sovereign borrower offers than what it can leverage loans like to entrepreneurs. That means banks will find it easier to earn high risk adjusted returns on their equity lending to the sovereign than for instance when lending to entrepreneurs. That means it will lend too much at too low rates to the sovereign and too little at too high rates to entrepreneurs.

In other words Basel I introduced pure and unabridged statism into our bank regulations. 

Basel II of June 2004 in its Standardized Risk Weight, for the same credit ratings, also set lower risk weights for claims on sovereigns than for claims on corporates.

In a letter published by FT November 2004 I asked: “How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

And the European Commission, I do not know when, to top it up, assigned a Sovereign Debt Privilege of a 0% risk weight to all Eurozone sovereigns, even when these de facto do not take on debt in a national printable currency.

And, to top it up, the ECB launched its Quantitative Easing programs, QEs, purchasing European sovereign debts.

At the end of the day, the difference between the interest rates on sovereign debt that would exist in the absence of regulatory subsidies and central bank purchases, and the current ultra low or even negative rates, is just a non-transparent tax, paid by those who save. Financial communism

And all this began one year before the fall of the Berlin Wall

ECB, IMF: Unbelievable, Greece’s “Memorandum on Economic & Financial Policies” does not include what Greece most needs

For more than a decade and still at this particular moment any European bank, including Greek banks, has been required to hold much more equity when lending to any Greek small business or entrepreneur, than when lending to any European sovereign or European corporation that possesses a good credit rating. 

And therefore European and Greek banks, scarce of equity, are not lending sufficiently to Greek small businesses or entrepreneurs… nor for that matter to other European small businesses or entrepreneurs.

And anyone who believes Greece (and Europe) can be pulled out of its current problems, by not giving fair access to its small businesses or entrepreneurs, has no idea of what goes on in the real economy. 

If there is something Greece (and Europe) needs, urgently, is to get rid of those odiously discriminating risk adverse equity requirements, those which have banks not financing the risky future any longer, but trampling stale water, only refinancing the supposedly safer past.

“A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926 

God make us daring!

PS. In relation to this you might be interested in: “Who did Europe in!”

PS. Here is a more complete explanation of what is wrong.

PS. Here is an alternative action plan for the ECB.

The tragic and not understood reality of a Mario Draghi ECB/SSM speech

Ladies and Gentlemen,

I am very pleased to welcome you to the inauguration of the Single Supervisory Mechanism.

The current “crisis has caused many of our fellow citizens to question whether the European project can keep its promise of shared economic prosperity.”

In particular, we needed to decisively and credibly address the weaknesses in the banking sector. That is: “key to protecting citizens and businesses as taxpayers, depositors and borrowers.

And so I am happy to announce that ECB and our dear colleagues in the Basel Committee and the Financial Stability Board, have decided to continue imposing on banks capital, which means equity, requirements based on perceived risk.

More ex ante perceived risk-more equity; less ex ante perceived risk-less equity. 

And that means that our banks will keep on earning higher rates of return on equity when lending to for instance our infallible sovereigns and to members of the AAAristocracy, than when lending to risky medium and small businesses, entrepreneurs and start-ups.

And, as you can understand, banks will keep on acting according to those incentives… they’ve got no choice.

What do you think about that?

Yes I hear you… it did not work that well in Basel II… and insufficient job creation persist. Yes indeed, but you all know we are the experts and we know we can’t be wrong, and so we must insist, until we prevail.

Good night… and do not forget to turn out the lights!

Après nous le deluge

G8, for the unemployed young ones sake, please wake up! We do not pray “God make us daring” for nothing.

G8, the world has not reached this far by avoiding taking risks. Current bank regulations which by allowing banks to hold much less equity against assets perceived as “absolutely safe” than against assets perceived as “risky”, allow banks to earn much higher expected risk-adjusted returns on equity when lending to The Infallible than when lending to The Risky. 

That has castrated our banks which makes it impossible for these to allocate economic resources efficiently in the real economy. That dooms our youth to unemployment. Never forget The Infallible of today were The Risky of yesterday.

That does not make our banks safer either, as it only guarantees that any absolutely safe-haven will, sooner or later, become dangerously overpopulated, and then catch our banks with their pants down, meaning with no capital. Just consider how Basel II did Europe in.

G8, please wake up and throw away current bank regulations issued by the Basel Committee. We do not pray “God make us daring” for nothing.

Mario Draghi. Do the structural reforms in bank regulations needed to allow job creators to do their job. Or shut up!

Pan Pylas, AP, reports that “Eurozone unemployment hits another record high”, December 1, 2012. 

And in this context that Mario Draghi, the president of the European Central Bank, the former chairman of the Financial Stability Board, and as such one of the most responsible for current bank regulations declared: “We expect, however, that progress in structural reforms, especially those that improve the functioning of labor markets, will help lower unemployment and facilitate new employment opportunities” 

Of course Draghi is partially right, but neither he nor any of his other bank regulating colleagues, has a right to preach anything to anyone about unemployment. 

He and the other overly risk-adverse nannies decided to allow banks to hold much less equity when lending to “The Infallible” than when lending to “The Risky”; which of course made the banks expect earn much higher risk-adjusted returns when lending to The Infallible” than when lending to “The Risky”. And that effectively locked out, from having a competitive access to bank credit, the “risky” job creating small businesses and entrepreneurs. 

What Draghi should do, now, besides stating his mea culpa, are to push for the structural changes to bank regulations that are needed for our job creators to have a chance to do their job… or just shut up and go home, wearing of course his cone of shame.

A question about the Wolfson Economic Prize

A £250,000 Wolfson Economics Prize competition has now been announced for the best answer to the following question: If member states leave the European Economic and Monetary Union, what is the best way for the economic process to be managed to provide the soundest foundation for the future growth and prosperity of the current membership? 

And, what if one believes no member state should have to leave the eurozone, because even though the eurozone undoubtedly presents many challenges, this crisis was primarily the result of bad banking regulations, and not of the eurozone? 

Let me explain. The only way the current imbalances could have resulted in building up the humongous European sovereign debt burdens, carried primarily by banks, was that the regulators allowed the banks to hold these exposures against zero or very little equity. This caused the banks to be willing to lend too much, at artificially low interest rates. 

If that is the case, at this moment, when some of the European sovereigns are rated as “riskier”, and therefore banks are required to hold more capital when lending to these, the possibilities are either that these debtors will find it much harder to work themselves out of any excessive debt position, and or, that the remaining safe-sovereign-havens also end up dangerously overcrowded. 

It is bad enough that bankers lent the umbrella to the European sovereigns when the sun was shining and now they want it back when it rains, for the regulators to do exactly the same. 

What solutions do I envision?

Perhaps a general and substantial haircut on all outstanding European sovereign debt, Germany included, which would allow the stronger countries to help out more in getting the eurozone economy going… and, of course, a total reversal, over a period of time, of the current capital requirements for banks based on ex-ante perceived risk of default, and which will go down in history as the mother of all failed and truly stupid bank regulation Maginot lines.

I have now received an answer to my query, it is: “The question stands as framed”

Unfortunately, it seems that the possibility of a solution that does not mean someone being expelled from the eurozone, is not acceptable.

The lunacy and the obscenity of current bank regulations

If risk models, credit ratings and market intuitions were perfect, then a bank would really not need any capital at all, since all risk considerations would have been correctly priced, in the interest rates, in the amounts and in the duration of the loans. But, since risk-models, credit ratings and market intuitions are often not perfect, the regulators should require the banks to hold some capital, to make sure that there is an adequate cushion provided by the shareholders who are profiting from the bank activity, before creditors and tax payers are called upon to help out.

Unfortunately the Basel Committee generation of bank regulators, did not base their capital requirements for banks on the possibility of mistakes, but on precisely the same risk models, credit ratings and market intuitions… requiring for instance minimal equity when the perceived risk of default of a borrower seemed minimal. In other words instead of helping to cushion for the mistakes the regulators, with their distortions, increased the probabilities of mistakes being made, and their financial consequences.

Also, the obscene bank bonuses, based on obscene bank profits, are more the product of some obscene low capital requirements, than the product of good banking. If you earn an expected margin of 1 percent lending to Greece, and leveraged that on your capital 62 times, as the banks were explicitly authorized to do, then your expected return on that bank equity would be 62 percent a year… who would not lend to Greece?

The bank regulators, who are the ones most responsible for causing the current financial crisis that is menacing the Western World, need to be paraded down Fifth Avenue and Champs-Élysées wearing cones of shame… and to be barred, for life, from all regulatory activity.

We urgently need regulators who also understand that risk-taking by the banks is like oxygen to our economies, and therefore understand the need for not rewarding any excessive risk-adverseness... so as to also avoid, the so dangerous overcrowding of the ex-ante safe havens.

Here´s a video that explains a fraction of the stupidity of our bank regulations, in an apolitical red and blue! http://bit.ly/mQIHoi

Who did the eurozone in?

There are of course many suspicious characters to blame for the eurozone’s pains, not the least the fact that it was created without any strong fiscal root system.

In November 1998, in an Op-Ed titled “Burning the bridges in Europe”, which title had to do with the fact there no escape-route from the euro had been considered. I also wrote there: “That the European countries will subordinate their political desires to the whims of a common Central Bank that may be theirs but really isn’t, is not a certainty. Exchange rates, while not perfect, are escape valves. By eliminating this valve, European countries must make their economic adjustments in real terms. This makes these adjustments much more explosive.”

But, there is one huge piece of evidence that is ignored by most of those trying to explain the current troubles. That evidence is the “risk-weights”, the smoking-gun which we find in the hands of the butlers in charge of regulating the banks, and who have their quarters in the Basel Committee for Banking Supervision. Yes, it was some butlers who did the eurozone in! 

The bank butlers, naturally concerned about the safety of the banks, imposed a basic bank capital requirement of 8 percent; applicable for instance when banks lent to European small unrated businesses. In this case that limited the leverage of bank equity to a reasonable 12.5 times to one. 

But, when banks lent to a sovereign, with credit ratings such as those Greece-Portugal-Italy-Spain had during the buildup of their huge mountains of debt, the bank butlers, because this lending seemed so safe to them, and perhaps because they also wanted to be extra friendly with the governments who appointed them, they applied a “risk-weight” of only 20 percent. And that translated into an amazingly meager capital requirement of 1.6 percent; and which allowed the banks to leverage their capital when lending to the infallible a mind-blowing 62.5 times. 

The result was that if a bank lent to a small business and made a risk-and-cost-adjusted-margin of 1 percent, it could earn 12.5 percent a year, not much to write home about. But, if instead it earned that same risk-and-cost-adjusted-margin lending to a Greece, it could then earn 62.5 percent on your bank equity… and that, as you can understand, is really the stuff of which huge bank bonuses are made of, and also the hormones that cause banks to grow into too-big-to-fail. 

And, as should have been expected, the banks went bananas lending to “safe” sovereigns. With such incentives, who wouldn’t? Just the same way they went bananas buying those AAA rated securities that were collateralized with lousily awarded mortgages to the subprime sector, and to which the bank-regulating-butlers also applied the risk-weight of 20 percent. And of course the governments also went the way of the banana-republics, and borrowed excessively. What politicians could have resisted such temptations? 

And it was these generous financing conditions, and all the ensuing loans, which helped to hide all the misalignments and disequilibrium within the eurozone… until it was too late. 

Now how could these bank-regulating-butlers do a criminally stupid thing like that? The main reasons were: the bank butlers only concerned themselves trying to make the banks safe, and did not care one iota about who the banks were lending to and for what purpose; they ignored that banks were already discriminating based on perceived risks so what they were doing was to impose an additional layer of risk-perception-discrimination; they completely forgot that no bank crisis in history has ever resulted from an excessive exposure to what was considered as “risky”, but that these have always been the consequence of excessive exposures to what, at the moment when the loans were placed on the banks balance sheet, was considered to be absolutely “not-risky”. 

Also, when the bank-regulating-butlers decided to outsource much of the risk-perception function to some few credit-risk-rating-butlers, two additional mistakes were made. First, they completely forgot that what they needed to concern themselves with was not with the credit ratings being right, but with the possibility of these being wrong; and second, that what they needed most needed to look at was not so much the significance of the credit ratings meant, but how the bankers would act and react to these. 

And the consequences of these regulatory failure in the eurozone, are worsening by the day, or by the nanosecond… because these bank capital requirements have the banks jumping from the last ex-ante-officially-perceived-no-risk-sovereign now turned risky, to the next ex-ante-officially-perceived-no-risk-sovereign about-to-turn risky … all while bank equity is going more and more into the red… and becoming more and more scarce. 

What could be done? One solution could be that of declaring a ten year new capital requirement moratorium on all current bank exposures; allowing the banks to run new lending with whatever new capital they can raise, while imposing an equal 8 percent capital requirement on any bank business, no risk-weighting. If there’s an exception, that should be on lending to small businesses and entrepreneurs, in which case they could require, for instance, only 6 percent of capital, because these borrowers do not pose any systemic risk, and also because of: when the going gets to be risky, all of us risk-adverse need the “risky” risk-takers to get going. 

But that requires of course a complete new set of bank-regulating-butlers… as the current should not even be issued any letters of recommendations. Let’s face it, after such a horrendous flop as Basel II, neither Hollywood nor Bollywood, would ever dream of allowing the same producers and directors to do a Basel III, and much less with only small script changes and the same actors.

The saddest part is that many of those in charge of helping Europe to get out of the current mess that they helped to create, might be busying themselves more with dusting off their own fingerprints.

If there is any place that deserves an occupation... that is Basel!

PS. Years later I learned that all this was just so much worse. EU authorities had assigned all eurozone sovereigns’ debts a 0% risk weight, even Greece’s, even if they were all taking on debt denominated in a currency that was not denominated in their own domestic/printable fiat currency. Unbelievable! And then EU authorities put the whole blame for Greece's troubles on Greece and did not even consider paying for the cost of their own mistake. Is that a way to build a union? No way Jose!