You the Basel Committee, and you the Financial Stability Board, are you really as smart as you think you are?

Even though you, as bank regulators, never have problems with bank’s risk models that function and credit ratings that are correct, and only have problems when bank’s risk models malfunction and credit ratings prove incorrect, with your capital requirements based on ex-ante perceived risk, you decided to bet all our banking system on bank’s risk models functioning perfect and the credit ratings being perfectly correct… was that such a smart move guys? 

Even though you, as a bank regulators, must have known that except for when outright fraud is  present, all major bank crisis, no exceptions, have resulted from excessive bank exposures to what was perceived as absolutely safe, and none from excessive exposures created to something ex-ante perceived as risky, you decided that the bank needed to hold much more capital when investing or lending to something risky than when investing or lending to something perceived as absolutely safe… was that such a smart move guys? 

Even though you, as bank regulators, must have known about Mark Twain’s accurate description of a banker as the fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain” and that this was often a hinder for those that though perceived as risky are often on the margin the most important players of the real economy decided to give the bankers even further incentives to lend while it is sunny and to withdraw their credit even faster at the slightest indication that it could possibly rain…. was that such a smart move guys? 

What can I say but to quote Axel Oxenstierna: “An nescis, mi fili, quantilla prudentia mundus regatur?”, “Do you not know, my son, with how little wisdom the world is governed?”, “¿No sabes, hijo mio, con que poca sabiduría el mundo esta gobernado?”, “Vet du inte, min son, med hur litet förstånd världen styrs?” 

In March 2003, while being an Executive Director at the World Bank (2002-2004) and when discussing the implications of Basel II bank regulations I stated: “As the financial sector grows ever more sophisticated, making it less and less transparent and more difficult to understand for ordinary human beings, like EDs, it is of extreme importance that the World Bank remains prudently skeptical and vigilant, and not be carried away by the glamour of sophistication. In this particular sense, we truly believe that the World Bank has a role to play that is much more important than providing knowledge per-se and that is the role of looking on how to supply some of the wisdom-of-last-resort.”

Unfortunately, the whole world is, in dumb open-mouthed amazement, suffocating under the weight of too much knowledge that no one finds time to reflect upon. 

Can we please ask for a time out in order to discuss these quite loony and dangerous Basel bank regulations from scratch? I ask this because when now adding your Basel III liquidity requirements, also based on the ex-ante perceived risk, you seem intent on digging us further down in the hole were you have placed our economies.

If knowledge suffices then wisdom is worthless

If knowledge suffices then wisdom is worthless and sure enough our bank regulators placed more value on knowledge than on wisdom; which is the only way how you can explain such foolish behavior as empowering the credit rating agencies with so much power over the financial flows of the world.

See where this has gotten us. All the very sub-prime awarded mortgages to borrowers that classified as subprime would have not been able to go anywhere had they not been blessed as prime collaterals for other securities.

One reason that stops the world from realizing the foolishness of it all is that the credit rating agencies are private, and we have all been Pavloved into establishing a connection between private and free efficient markets. The truth though is that the private credit rating professionals are only outsourced bureaucrats working for some pompous Ministry of Financial Risk Elimination.

P.S. God make us daring!

The dark side of knowledge

We heap praises on our knowledge economy but we must not forget that in some circumstances not knowing might be blissful for the society, or at least easier for it to handle. Let me briefly illustrate what I mean by referring to health insurance and credits. 

If we all share the same health insurance plan then we do all, in solidarity, share in our respective good or bad health. But if insurance companies are allowed to discriminate between us then little by little we will be divided in many groups depending on our health prospects, as determined by what we could call the health-rating agencies. 

When the health market limits itself to segment for instance between smoking and not smoking this does not have any serious implications since smoking is (supposedly) a voluntary decision and so the deterrent effect of having to pay a higher insurance premium because you smoke might not be that bad. Of course the volunteerism argument can also become exaggerated as currently there are insurance companies that offer even hefty discounts depending on how many hours you work out at the gym. 

But, if the health insures would be allowed to use all those genetically mapping discoveries that are just around the corner, then we might dangerously end up with some citizens insurable at very low rates, some at higher and some not insurable at all. And the question we will then have to answer as a society, is how to counteract the logical desperation of the latter. 

Something of the same happens with credits, like mortgages. It used to be that depending on your income, as a potential home buyer you could classify for more or less of borrowings, but the interest rate to be paid on the loan did not differ much or even anything at all between a “good” borrower and a “not so good” one. Not any longer. The knowledge economy now classifies the market in many different type of credit risks and although this is has been sold as something that creates more opportunities for poor buyers it might not necessarily be so. 

A thousand dollars paid each month servicing a mortgage during 15 years, when discounted at 11 percent per year, because the borrower is deemed “risky”, is worth 88.000 dollars today. Exactly the same payments, discounted at only 6 percent because the borrower is deemed creditworthy, are worth 118.500…35 percent more! And here lies one of the real problems of the subprime debtors… not only do they have less money, but the little money they have is also worth less. 

Now add to the above that the credit ratings might not even reflect correctly the repayment capacity of the borrowers and we can see how as a society we might be drawn into a totally unsustainable structure. 

And so what are we to do about this fact that knowledge in some cases works as a regressive tax in our society? Are we better off going back into obscurity? Of course not! What we need to do though is to arm us with a lot more with the humility we need to be able to recognize that handling all this new found knowledge requires a lot of wisdom…of that sort that can not easily be purchased in any databank or by accessing any experts with a PhD.

PS. Human genetics made inhuman
PS. If knowledge suffices then wisdom is worthless