My tweet comments on Stephen Cecchetti's and Kim Schoenholtz's "The financial crisis, ten years on", Vox August 2017

"The financial crisis, ten years on"

Does a crisis start when the bomb is armed, the fuse is lit, the explosion occurs, or when the explosion is noted? http://voxeu.org/article/financial-crisis-ten-years#

In 2003 FT published a letter I wrote about the systemic risk of giving credit rating agencies so much power https://teawithft.blogspot.com/2003/01/credit-ratings-for-developing-nations.html

In 2004 the fuse was lit when Basel II authorized banks to leverage 62.5 times with what was rated AAA http://voxeu.org/debates/commentaries/impose-higher-bank-capital-requirements-what-has-best-credit-ratings

In August 2006 clearly the bomb had already exploded https://teawithft.blogspot.com/2006/08/long-term-benefits-of-hard-landing.html

Unfortunately it was not until July 2007 credit rating agencies woke up and in August that the fan started to spread out the shit.

There is only one 100 percent sure cause for the financial crisis 2007/08, and it is discussed less than 0.01 percent

The crisis exploded because of excessive exposures to AAA rated securities, real estate (Spain), loan to sovereigns (Greece) and short-term loans to banks (Iceland). They all one thing in common, namely that banks were required by regulators to hold very very little capital against these assets, and so banks could leverage very very much their equity with these assets, meaning that banks could expect to earn very very high risk adjusted returns on equity for these assets.

Had banks been required to hold the same level of capital against all assets, other crisis could have happened, but not one as large as the one in 2007/08.

So how much have you read about the problems related to the distortions produced by the risk weighted capital requirements in the allocation of credit to the real economy? Probably nothing!

Why? There are many explanations to that but, one of the most important, is that there is much more political interest in blaming bad bankers than laying it on good regulators.

Is this a problem? 

Yes, those regulations are still in place and so could still lead banks to create similar dangerously large exposures to something perceived or deemed safe. 

And since that still favors The Safe over The Risky, those who could most help us get our economies moving again, the SMEs and the entrepreneurs, have a lousy access to bank credit.

Right now banks are not financing the risky future, they are just refinancing the safer past, that which might soon turn risky, because of excessive financing.

PS. Here is a more extensive aide memoire on the mistakes in the risk weighted capital requirements for banks.

Regulators introduced into banking a very serious systemic error that is being totally ignored

Banks used to evaluate all credit applications based on the same own bank capital, because that was on the margin true. And so all borrowers could compete with their cost and risk adjusted interest rates offers, on equal terms. Not any longer.

Since the introduction of the risk weighted capital requirements for banks, more perceived risk more capital – less risk less capital, the offers from different borrowers will be evaluated based on different levels of bank capital.

Since the offers provided by The Safe can be leveraged more by the banks than the offers provided by The Risky, The Safe have now a regulatory advantage that, when compared to The Risky, allows them a preferential access to bank credit.

And that seriously distorts the allocation of bank credit to the real economy. “The Safe” get more and cheaper access to bank credit while The Risky, like the SMEs and entrepreneurs, they get less and more costly bank credit. 

To argue that to be a very serious systemic error seems very obvious to me but, in all the discussions on bank regulations, that error has been completely ignored. Why?

For instance, I might have written to the Financial Times and its various reporters and columnists over a thousand letters about it, but its editor has preferred to keep total silence. It must be because of something much more important than perhaps FT thinking little me a nuisance since I write too many letters to the editor.

And of course, in terms of bringing more stability to the banking system, that regulation is absurd and useless. The risk for the system of what is ex ante perceived as safe, but that ex post could be very risky, is clearly much higher than the risk for the system of what is ex ante already perceived as risky.

And of course, the creation of predatory regulations that subsidize The Safe and penalize The Risky, can only accentuate existing inequalities

Professor Richard Thaler, do not give lousy regulatory Econs, the excuse of only having misbehaved cause they are Humans

Professor Richard Thaler opens his great and fun ”Misbehaving” with ”Virtually no economists (Econs) saw the financial crisis of 2007-08 coming” and then explains that it all has much to do with human behavior (Humans).

But hold it there Professor, plain lousy Econs should not be given the easy way out justifying it all with them only having misbehaved because they are Humans.

That a bank crisis had to explode, sooner or later, was perfectly predictable. 

It used to be that each dollar in net risk adjusted margin paid by those perceived as safe and those perceived as risky was worth the same.

But with the introduction of credit-risk weighted capital requirements for banks that changed.

For instance in Basel II, the net risk adjusted margin dollars paid by those rated AAA to AA were worth 62.5 equity leverages (ELs), while the dollars paid by unrated borrowers, for instance SMEs, were only worth 12.5 ELs.

And so of course banks would sooner or later have too much assets against little capital in what was perceived as safe, and too little assets exposure against decent capital in what was perceived as risky.

And any econ, with his Optimization +Equilibrium = Economics should be able to tell you that.

The problem with the regulators in the Basel Committee for Banking Supervision, the Financial Stability Board and the IMF is that they were plain lousy Econs

Basel II data for calculating the Els:

AAA-AA rated had a 20% risk-weight which times Basel II’s basic capita requirement of 8% results in a specific 1.6 capital requirement meaning bank equity could be leveraged 62.5 times to 1. 

Unrated borrowers had a 100% risk-weight which times Basel II’s basic capita requirement of 8% results in a specific 8% capital requirement, meaning bank equity can then be leveraged 12.5 times to 1. 

PS. I just remembered I made a similar argument to Professor Thaler backin 2008

We’ve heard a lot about predatory lending, and it should be avoided, but why allow predatory regulations?

An audit report from the office of inspector general of the FDIC broadly defines predatory lending as "imposing unfair and abusive loan terms on borrowers”

Regulators know very well that those perceived as risky have to pay higher risk premiums and have less access to bank credit than those perceived as safe. 

Nonetheless regulators currently also require banks to hold much more capital against loans to those perceived as risky, when compared to what they need to hold against assets perceived as safe. And as a direct consequence those perceived as risky, when compared to those perceived as safe, will have to pay even higher interests and have even less access to bank credit. 

Since that imposes unfair and abusive loan terms on borrowers… it should be regarded as predatory regulations… and of course, to top it up, by negating fair access to the opportunities for credit of those perceived as risky, these also represent a driver of inequality.

Let me quote here two passages from John Kenneth Galbraith’s “Money: Whence it came where it went” 1975.

First: “For the new parts of the country [USA’s West]… there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business...[jobs created]

It was an arrangement which reputable bankers and merchants in the East viewed with extreme distaste… Men of economic wisdom, then as later expressing the views of the reputable business community, spoke of the anarchy of unstable banking… The men of wisdom missed the point. The anarchy served the frontier far better than a more orderly system that kept a tight hand on credit would have done…. what is called sound economics is very often what mirrors the needs of the respectfully affluent.”

Second: “The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… Bad banks, unlike good, loaned to the poor risk, which is another name for the poor man.”

And finally, let me just add that never ever are truly dangerous financial bank excesses built up with assets perceived as risky; these are always caused by excessive bank exposure to what is perceived ex ante as safe but that ex-post tum out to be risky… and so all this odious regulatory discrimination against the risky… is all for nothing.

PS. “If one is pretending to knowledge one does not have, one cannot ask for explanations to support possible objections” John Kenneth Galbraith dixit.

One of the greatest myths is that if Greece had collected all taxes, Greece would not have been in trouble.

Greece is not in trouble because of the taxes it did not collect. Greece is in trouble because its government squandered away funds it borrowed. And because the Greek government was able to borrow so much, thanks to the loony bank regulations. 

For instance, if a German bank wanted to lend to a German entrepreneur, according to Basel II it needed to hold 8 percent in capital, which meant it could leverage its capital 12.5 to 1 times, but, if it lent to Greece, the way Greece was rated at the time, it only had to hold 1.6 percent in capital, which meant it could leverage its capital a mind-boggling 62.5 times to 1. No unregulated or shadow bank would ever manage to do that. 

And that meant, sort of, that if the bank could earn a risk and transaction cost adjusted margin of 1 percent when lending to a German small entrepreneur, it could expect to earn 12.5 percent on its capital, but, if it expected to earn the same margin lending to Greece, it could earn a whopping 62.5 percent on its equity per year. And that is of course a temptation that not even the most disciplined Prussian would be able to resist. And of course what Greek (and many not Greek) politician can resist the temptation of abundant and cheap loans? 

And so had all Greeks paid all their taxes that would have made no difference, in fact, since the Greek government could then have been able to show greater fiscal income, it could have justified keeping credit ratings great for a longer time, which meant having taken on even bigger debts.

Or did the Greek politicians think the loans Greece took on would be repaid by them being able to make of the Greeks exemplary tax–paying-citizens in just some few years? If they did, then they are more stupid than any ordinary politicians.

And now what? Yes Greeks, pay your taxes! But of course only after Greece creditors have accepted a reasonable deal based on a very substantial haircut, and only after you are sure your government will not keep squandering away your taxes.

It is of course very understandable that many Greeks are mad at those who have not paid their taxes but, let’s face it, on the other hand, the way things have turned out, those taxes that were not paid in earlier, might come in very handy now, and will, hopefully, we pray, be put to a much better use.

PS. This post was made before I realized that reality was much worse. Instead of applying to Greece the risk weights dependent on credit ratings that Basel II ordered, EU authorities assigned to all Eurozone sovereigns' debts, including Greece's a 0% risk weight, this even when none of theses nations can print the euro. So European banks, when lending to Greece, did/do not have to hold any capital at all. Now how crazy is that?

PS. At the end of the day the EU authorities kept total silence about their mistake and blamed Greece for it all. What a sad European Union L

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

Is “Inside job” doing an inside job on us?

“Inside Job” the Oscar winning documentary on the financial crisis that has put the global financial stability in jeopardy touches upon most issues and actors involved, spending even several minutes of the role of cocaine and prostitutes. Yet, amazingly, it does not mention even once the Basel Committee for Banking Supervision, the global bank regulator and that in my opinion is the one most to blame for the crisis.

Should it? In one of the opening scenes of “Inside Job” refers to the Securities and Exchange Commission’s meeting on April 28, 2004 when the SEC authorized the investment banks to dramatically increase their leverage, among other when investing in securities backed by mortgages to the subprime sector. That SEC resolution explicitly made an explicit reference that it has all to be done “consistent with the Basel Standards”.

Is “Inside job” doing an inside job on us?

The regulators, the banks and the sharks and their baits

The world’s bank regulators in the Basel Committee, assumed with unbelievable hubris the role of risk managers of the world; ignoring that perceived risks are not dangerous to the system, only those not-perceived are, authorized the banks to leverage their capital 60 times or more, when investing in or lending to anything related to a triple-A rating.

As should have been expected, the banks, carrying the minuscule life-vests ordained, in pursuit of easy profits, huge bonuses and too big to fail growth rates, entered massively the triple-A rated waters … where the sharks has baited them some triple-A rated securities collateralized with lousily awarded subprime mortgages paying juicy interests… and a true bloodbath ensued.

The saddest part of the story though, is that our banks are still regulated by the same regulators using precisely the same tools applied the same way… just more of it.

We need to fire the self appointed supreme risk manager of the world!

When the Basel Committee on Banking Supervision decreed capital requirements for banks that resulted from assigning risk-weights based on the risk of default, as perceived by the credit rating agencies… with incredible hubris they took upon themselves to act in the role of supreme risk manager of the world.

How have they been doing? Worse than lousy! Basel II failed monumentally only 3 years after its approval in June 2004.

As an Executive Director in the World Bank, 2002-2004, and in many published articles since 1997, I protested loudly the regulatory paradigm that the Basel Committee is built upon, and I warned precisely about those risks that caused the current crisis.

With whatever credibility that should give me I guarantee you that the Basel Committee, with their Basel III, is only digging us and our banks further down into the hole where they placed us.

The role of a bank regulator is not to guard us against those risks of default perceived by credit rating agencies, and which are therefore also perceived by the markets and by the banks. No bank crisis has ever resulted from excessive lending or investments in what is perceived as risky… they have all resulted from excessive lending or investment in what was ex-ante perceived as not risky. Therefore the fundamental role of a bank regulator is to take precautions against those risks that might not have been perceived.

The role of a bank regulator, more than guard us against bank failures, is to guard us against the risk that the banks and whom the tax payers lend so much support to, do not serve their purpose for the society… and the Basel Committee has not yet said even one single word about what the purpose of the banks should be.

Let absolutely no one regulate before they do state the full purpose of the entities they are regulating… and that “purpose” has of course been deemed acceptable to us.

The bank crisis and the Basel Committee banking regulations explained to a golfer

Once there was a Golf Club with a somewhat narrow golf course and where, even though the members were very careful, sometimes the hooking or slicing of the golf balls into adjacent holes, caused some serious accidents.

The Club’s Board was ordered to find a solution. To that effect the elected members of the Board consulted with some Experts and asked for recommendations. The Experts told the Board “most of the slicing and hooking is the product of bad players and so, if you want to solve this problem, you need to get rid of them”. Knowing this idea would not be received with much enthusiasm, and could in fact pose a direct threat to their reelection as members of the Board, they all decided to immediately delegate the “how to” to a Committee of Experts.

The Committee of Experts decided they needed to appoint some Golf-Player Rating Agencies (GPRAs) to rate the real quality of the players and thereafter created a parallel handicap adjustment requirement that effectively eliminated the bad players… without these even noticing it. According to their ratings, the AAA rated players had their normal handicap increased by 5 strokes, while the players rated B- or worse had their normal handicaps officially reduced by 5 strokes.

It worked! Though, just initially… Since having to play with a very low handicap was pure hell for a bad player, most of the bad players rapidly decided to change clubs and, as a result, the Club gained immense recognition for having the best players and being the safest club in the country… and the Committee of Experts was wildly acclaimed for having true experts. We will never ever have more accidents in our Club… was the Board’s self congratulatory message at the year’s end… four years ago.

But life is life, even among golfers, even in a golf club… and so the membership of the Club started changing. For instance, many great golfing has-beens around the country were attracted by a system that so clearly could help to pro-cyclically prolong their golf-life, just like many never-able-to-be-good players were also attracted by the possibility of joining a club renowned for having exclusively good golf players… and so they all started to read up and converse with the GPRAs about what was necessary in order to be conveniently rated.

There was such an avalanche of enquiries that the GPRAs got confused and overworked and started to make mistakes… to such an extent that the Club rapidly became overcrowded with dubiously rated golf-players. This would, of course, not have meant anything in the old days, but, since everyone had been duly informed that the accidents had been forever eliminated and that therefore there was no need for being careful… the accident rate shot up and rapidly turned, three years ago, into a pandemic disaster that threatens even the survival of the Club… and aggravated by the fact that the beginners and the decent-bad players, those who really are the heart and soul and economical support of a golf club, want nothing to do with a club that has a handicap system that so harshly discriminates against them, and have therefore joined other clubs.

But, golfing friends, the saddest part of this story is that since the logic of “getting rid of bad players and allowing only good players” sounds so very attractive and so very logical, the Board has not even today understood what they did wrong and so they insist on using exactly the same Committee of Experts to come up with better solutions. And the Committee of Experts is currently studying only refinements of their original handicap adjustment requirement formulas because, as “experts”, they cannot under any circumstances acknowledge that they were so fundamentally wrong.

And, unfortunately, the local media has not been sufficiently “without fear and without favour” to dare to really fundamentally question the wisdom of the local Club´s Board or of the Committee of Experts.

The short and true story of the financial crisis

This crisis originated in what are supposedly very safe assets, houses and mortgages, in what is supposedly the strongest and financially safest country, the USA, and in what are supposedly the absolute safest instruments, the triple-A rated. When we then hear even Nobel Prize winners talking about excessive-risk taking, it should be clear to all of us that something very serious has happened to risk. It happened in Basel.

The Basel Committee on Banking Supervision, in their irrational fear of bank defaults, while forcing the banks to have 8 percent of equity when lending to “risky” small companies or entrepreneurs, completely ignored the fact that bank crisis originate only where ex-ante risks are perceived as low, and allowed the banks to hold only 1.6 percent in capital when investing in triple-A rated securities, like those backed with lousily awarded mortgages to the subprime sector, or when lending to sovereigns rated A+ to A like Greece, and which implied allowing the banks to leverage 62.5 to 1, 

Of course, needing less capital when doing business with the “less risky”, made the profitability of bank business with the “less risky” shoot up to the skies, and so the banks forgot all the small businesses and entrepreneurs, and gorged up anything that had a good rating on it… until they choked on the triple-As and the Greeces of the world.

God make us daring!

Scary indeed!

Over 90 percent of the direct explanation of this crisis is to be found in the more than two trillions lost over a very short period of time, in triple-A rated securities collateralized by lousily awarded mortgages in the subprime sector. The marketability of these securities, and of the value of an AIG´s triple-A ratings, had been so extremely, almost obnoxiously, increased by the Basel Committee when they, in June 2004, with Basel II, allowed the banks to invest in these securities requiring only a 1.6 percent of a quiet loosely defined capital, signifying that the banks could leverage their equity over 60 times, signifying that if a bank expected to made a .5 percent margin on a triple-A rated securities they could make over 30 percent of return on their equity.

I just saw the “Inside Job” the film about “The Global economic crisis of 2008 cost ten millions of people their savings, their jobs, and their home. This is how it happened”. The movie is promoted as “Scarier than anything Wes Craven and John Carpenter have ever made”

Covering in a good and expensive production almost all under the sun, like money laundering by Riggs bank for Pinochet, academicians writing papers without disclosing that they have been paid to do so, the role of prostitutes and cocaine in finance, as well as most of the other actors we have seen related to this crisis over the last couple of years, the movie does not mention, not even once, the Basel Committee and it brethren the Financial Stability Board; just like the recent over 2.000 pages of financial reform approved by the US Congress does not mention them either.

Since the Basel Committee and the Financial Stability Board are now preparing Basel III, that is indeed as scary as it gets!

Mary and Richard Corliss of the Time opine “If you´re not ENRAGED by the end of the movie, you weren´t paying attention”. I paid much attention and by the end of the movie I was also enraged AT the movie.

Members of the Basel Committee consider yourselves insulted and challenged

The Basel Committee of Banking Supervision, that extremely important global regulatory agency, instructed the credit rating agencies to set up their warnings sign of perceived risk of default, ordered the banks to follow these signs, and then proceeded to calibrate the capital requirements of banks as if the banks did not see them. Somewhat like setting up traffic-lights all over town and synchronizing them under the assumption that drivers are blind.

Of course, if the regulators wanted to calibrate adequately for the default risk of any bank exposure to any credit rating, they could only do so by taking into account how the banks would react to those credit ratings…as well as considering the banks’ relative exposure to the different credit ratings. If a bank lends only to triple-A rated clients then its systemic danger, is only represented by its triple-A rated clients.

Since perceived risk is cleared in the market through the interest rates charged, this has signified that the relative profitability for the banks of lending to what is perceived as not risky, like what has a triple-A rating, increased dramatically, while the relative profitability for the banks of lending to what is perceived as more risky, like unrated small business and entrepreneurs, decreased.

Knowing as we should know that no bank crisis has ever resulted from excessive lending to what is perceived risky and that they have all resulted from excessive investments to what is perceived ex-ante as not risky, applying the Basel Committee’s current regulatory paradigm of capital requirements based on risk results clearly in counterfactual and stupid regulations. Also, since the most important role of commercial banks is to help satisfy the financial needs of those who are perceived as more risky and have not yet access to the capital markets, the odious discrimination against these clients (who are already paying much higher interest rates into the capital of banks) is doubly stupid.

If by any chance the issue of regulating on climate change would fall in the lap of an entity like the Basel Committee… we would all be toast.

For over a decade, even as an Executive Director of the World Bank 2002-2004 and always under my own name and indicating my email, I have presented many arguments against the current central regulatory paradigm use by the Basel Committee, that of capital requirements based on perceived risk of default, and called it stupid, stupid, stupid!

And by the way, if the regulators absolutely have an existential need to calibrate for risks, what is so particularly risky with defaults? Is not the risk of not creating jobs or the risk of increased un-sustainability worse? Does not just to think of a world without defaults make you shiver?

Having said that, not once, in all these years, has anyone identified as having anything to do with the Basel Committee ever denied my accusations, presented any counter-argument, or shown the least willingness to discuss the issue. Is it not strange? Could it really be that little me is right and these so expert experts are so utterly wrong? I dare them to prove me wrong!

In October 2010, during the annual meetings of the International Monetary Fund I publicly asked “Right now, when a bank lends money to a small business or an entrepreneur it needs to put up 5 TIMES more capital than when lending to a triple-A rated clients. When is the IMF to speak out against such odious discrimination that affects development and job creation, for no good particular reason since bank and financial crisis have never occurred because of excessive investments or lending to clients perceived as risky?” Dominique Strauss-Kahn, IMF’s Managing Director, answered in no uncertain terms that “capital requirement discrimination has no reason to be”, and so it seems that there are also other who agree with that the Basel Committee stands there completely naked without a functional regulatory paradigm.

In this moment when an extremely serious financial crisis affects the world and when the Basel Committee is digging us even deeper in the hole they placed us in, would we all not feel more comfortable if the Basel Committee at least agreed to a public debate on what I criticize?

Therefore…members and professionals of the Basel Committee consider yourselves slapped on the face with a glove and dared to accept the challenge. Wear with dignity your cones of shame!

Want a more detailed explanation? Listen to this home made video
http://subprimeregulations.blogspot.com/2010/09/the-financial-crisis-simple-why-and.html

Per Kurowski   @Per Kurowski

PS. I appreciate any help I could get in provoking the Basel Committee to respond to this challenge

PS. Risk taking is the oxygen of any development. God Make Us Daring!

PS. Has the Basel Committee just suffered the Nut Island effect? 

PS. US Congress, what are you up to? Over 2.000 pages of financial reform and you do not even mention once the Basel Committee which has so messed up the capital requirements of your banks.

PS. A small numeric example: If banks were allowed to leverage only 12.5 to 1 when lending to triple-A rated clients, which is what they were allowed to leverage when lending to small businesses under Basel II, then if they made a .5% margin, they would obtain return on capital of 6.25% lending to AAAs, decent but nothing to write home about, less pay bonuses on. But since they were allowed to leverage 62.5 to 1 they could, with the same .5% margin then make a return of capital of 31.25%. No wonder banks stampeded wanting the AAAs!

PS. A visitor from outer space, observing that banks are required to have 8% of equity when lending to a small businesses, but zero% when lending to a triple-A rated sovereign as the US, would he be at fault thinking he had landed on a communistic planet? With such an arbitrary discrimination in favor of the public sector, do you really know the real market interest rates on public debt?

PS. Since I am no regulator, or a PhD with published research on the subject, here are some of my early opinions on these regulations, which should evidence that I am far from being  very few pieces just another Monday morning quarterback:

http://subprimeregulations.blogspot.com/
http://financefordevelopment.blogspot.com/
http://baselcommittee.blogspot.com/
http://teawithft.blogspot.com/search/label/subprime%20banking%20regulations
http://www.theaaa-bomb.blogspot.com/

What the G20 or the US Congress or the regulators do not understand they cannot fix.

Have you ever heard about a financial crisis that happened from lending or investing in anything considered risky? Of course not, these have all started with lending or investments to something that offered more returns than what its perceived very low risk merited. Even the infamous Dutch tulips, in their own bubble time, would probably have been rated AAA.

That is why the current paradigm of assigning lower capital requirements to what the credit rating agencies perceive as having lower risk, like if they possessed some extraterrestrial sensorial abilities others don’t, is plain ludicrous. That only increases the expected returns from what is perceived as having no risk… precisely what would be prescribed for a financial heart-attack.

And since the Congress and the G20 do not yet get that, do not hold your breath waiting for any major progress in financial regulatory reform.

Also, to allow financial regulators to focus so excessively on the risk that lies closest to their heart, namely the risk of default, is, in a world with so many other risks, like the AAA rated BP can attest to, plain scandalous.

The biggest risk for society is that our banks will not perform efficiently their role in allocating capitals and it is always better for them to fail when taking real and worthy risks than to survive or fail taking useless Potemkin risks!

62.5 to 1!

The regulators they authorized a leverage of 62.5 to 1!

Uploaded by PerKurowski

In a truly free market this particular financial crisis would never have happened

I am not against regulations but when looking at how to re-regulate the financial markets after this crisis it really behooves us all to acknowledge the fact that in a really free financial market this particular financial crisis would never have happened.

In a free financial market there would have been no official endorsement of the illusion of safety like the one generated by the bank regulators when they created the minimum capital requirements for banks based on risk and that led many to believe that, as far as the risks goes, the banks had been equalized. And of course neither would the market have suffered the distortions that originated in the regulatory arbitrage of these capital requirements.

In a free financial market no one would have given so much credibility to some few credit rating agencies paid by the issuers of debt and therefore there would have been no opportunity to peddle in the market such an extraordinary amount of such extraordinary lousy awarded mortgages to the subprime sector.

The question!

On one side, given the very accommodative stance of central banks, there was an ocean of resources.

On the other, side given the honest to good real greed of intermediaries for pushing through deals even if that means bending the meaning of common sense, there were an ocean of homes to be sold and purchased.

The channel that allowed for the two oceans to crash into each other and create this ultimate financial tsunami were the AAA ratings awarded by the credit rating agencies that had been themselves empowered to do so by the financial regulators.

In a letter to the Editor of the Financial Times published May 11, 2003 I said “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".

To me my comment illustrated what should be a natural concern for financial regulators expected foremost to be wise… but they did not seem to care.

To me my comment illustrated what should be a natural concern for influential economists and financial experts… but no one said anything.

How come?

In being able to answer that question, forthrightly, lies the way out of our current financial predicaments and our only chance for not ending up even worse.

In making the truly responsible truly accountable lie our best chances for taking that way out.

Mr. Alan Greenspan and friends. Look at what old soldiers do and learn to fade away. We do not need your search for excuses.

About the SEC, the human factor, and laughing

A couple of days ago, our SEC reported that their pension fund had also been the victim of a fraudulent stock-managing firm, and that they had lost a lot of money.

I also read recently about the Mars Climate Orbiter spaceship that, after having required an investment of 125 million dollars, had to be declared as a total loss due to a technical confusion derived from simultaneously applying metric and English measures.

If what happened to NASA or what happened to our SEC is of any mutual comfort to them, I don’t care, but what I do hope is that they have learned a bit more about humility.

I bring this opinion to the table since I recently heard that our SEC was now establishing higher capital requirements for stockbroker firms, arguing that “. . . the weak have to merge to remain. We have to get rid of the rotten apples so that we can renew the trust in the system.” As I read it, it establishes a very dangerous relationship between weak and rotten. In fact, the financially weakest stockbroker in the system could be providing the most honest services while the big ones, just because of their size, can also bring down the whole world. It has always surprised me how the financial regulatory authorities, while preaching the value of diversification, act in favor of concentration.

The SEC should not substitute the need for capital in place of the need for ethics, nor should it allow that fraudulent behavior hides amid the anonymity of huge firms. In this respect, let us not forget that the risk of social sanctions should be one of the most fundamental tools in controlling financial activities.

If there is a relation between weakness and a rotten apple, it could really be in the SEC itself, since, though they frequently complain about the lack of resources, that doesn’t stop them from transmitting institutional messages about how well they are fulfilling their responsibilities. Perhaps the best thing that the SEC could do is to stop all their actions that are creating a false sense of security in the investor, acknowledging the absence of any supervisory capacity, and instead stamp each share prospectus with a big “BUYERS BEWARE.”

We read an article in Newsweek (“Giving Big Blue a Shiner, November 1999), about the surprising 20% drop in value that IBM shares had suffered in just one day. It also states that this drop was not in any way the result of any especially surprising event. The purported lesson of the article was “To teach not to take too seriously the investigative capacity of Wall Street and to remember to laugh next time you hear that the stock-market is a rational place where the big investors know what they are doing.” I would also like to suggest remembering to laugh next time a regulator presumptuously assures you he is doing his job.

And last I want to comment on another risk of regulations. Reading about accidents in nuclear reactors in Japan and about the risks of proliferation of nuclear weapons there is no doubt that the fears of a nuclear Big Bang are being renewed.

That said, 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 the collapse of the OWB (the only bank in the world) or of the last financial dinosaur that survives at that moment.


Currently market forces favors the larger the entity is, be it banks, law firms, auditing firms, brokers, etc. Perhaps one of the things that the authorities could do, in order to diversify risks, is to create a tax on size.

Here the version in Spanish: