#AI #ChatGPT #Grok: Do risk weighted bank capital requirements empower government borrowing at low interest rate cartels?

I asked ChatGPT

"Would it be outrageous to hold risk weighted bank capital requirements that imply a veiled prohibition for those perceived as “risky” to access bank credit in fair market risk adjusted terms, empowers “safe” government borrowing at low interest rate cartels?"

ChatGPT answered:

Short answer

“Not outrageous — it’s exactly what risk-weighting can do in practice — but it’s economically harmful and politically risky. Designing capital rules that effectively bar “risky” borrowers while heavily privileging government debt creates powerful distortions: it crowds out productive credit, concentrates risk, and subsidises government borrowing regardless of merit.

Why it happens (mechanics)

Risk weights tell banks how much capital to hold against each asset. Low weights on sovereign bonds and high weights on small-business or startup loans raise the relative capital cost of lending to the latter. Because banks price loans to cover capital costs, borrowers with higher risk-weights face higher spreads or simply no credit access. So a regulatory system can unintentionally (or intentionally) create a de-facto cartel of cheap “safe” government funding and expensive or unavailable private credit.

Main harms

Misallocation of capital. Productive, innovative firms (startups, small businesses) get starved of finance; low-return but “safe” assets (sovereigns) get overfunded.

Inequality & incumbency bias. Established firms and asset-rich borrowers (who can use collateral that attracts low weights) gain advantage; entrepreneurship suffers.

Concentration & systemic risk. If all banks hold large sovereign positions because they’re cheap capital-wise, the banking system becomes correlated with sovereign risk — a sovereign-bank doom loop.

Moral hazard for governments. Cheap financing reduces incentives for fiscal discipline.

Credit markets segmentation. Nonbank lenders may step in, growing shadow banking with weaker supervision — exactly the regulatory arbitrage regulators try to avoid.

Counterarguments in favor (why some designers accept it)

Perceived safety: Sovereign debt is often default-rare (for major currencies), so lower capital burden may seem sensible for prudential safety.

Simplicity & political feasibility: Rewarding sovereigns is politically popular and easier to justify after crises.

Short-term stability: In stress, public debt can act as a liquidity buffer for banks.

How to reduce the perverse effects

Use a non-risk-sensitive leverage floor alongside risk weights (a binding leverage ratio reduces the extent to which low weights can be exploited).

Apply concentrated exposure / sovereign concentration limits or higher floors on sovereign weights for domestic sovereigns to avoid large concentrated bets.

Risk-sensitive but calibrated weights: avoid zero or near-zero weights for public debt; make weights reflect real risks including inflation/default & FX.

Countercyclical capital buffers tied to lending booms rather than asset class alone.

Support targeted credit programs (guarantees, cheap refinancing) for socially valuable but risky sectors rather than broadly skewing capital rules.

Transparency & periodic review so political capture is visible and adjustable.

Bottom line

Treating risk weights as a tool to subsidize government borrowing or to keep “risky” borrowers out of the market is economically dangerous. The design trade-off is real: risk-sensitivity helps microprudential pricing but can create large macro- and distributional distortions if miscalibrated. Better: combine risk-sensitive capital with blunt instruments (leverage floors, concentration limits) and targeted fiscal/credit policies for sectors you want to support.”

I said: Thanks!

It replied: You’re very welcome!

I asked Grok: With a fairly brief answer:

"Would it be outrageous to hold risk weighted bank capital requirements that imply a veiled prohibition for those perceived as “risky” to access bank credit in fair market risk adjusted terms, empowers “safe” government borrowing at low interest rate cartels?"

Grok answered:

"Yes, that view has merit and isn't outrageous—it's a common critique among economists like Anat Admati and Andrew Haldane. Risk-weighted requirements (e.g., Basel III) can indeed distort lending by incentivizing banks to favor low-risk assets like government bonds (often zero-weighted), enabling cheap sovereign borrowing while making credit costlier or scarcer for "risky" borrowers like SMEs or emerging markets. This creates an implicit subsidy for governments, potentially forming a low-rate "cartel" effect, though proponents argue it enhances systemic stability. Alternatives like leverage ratios aim to address this bias."

I said: Thanks

It replied: You're welcome! If you have more questions, feel free to ask.

Note: The answers are copied exactly from those given to me by ChatGPT and Grok

Here my many other questions to ChatGPT – Grok on bank regulations

#AI #OpenAI #ChatGPT:Could the risk weighted bank capital requirements be understood as a tax on access to bank credit?

I asked ChatGPT:

"Would it be completely wrong to opine that higher bank capital requirements against loans to small businesses and entrepreneurs, than against public debt, constitutes a tax on the access to bank credit paid by the first, and used by government bureaucrats?"

ChatGPT answered:

It wouldn't be completely wrong to frame it that way, though it's not the conventional way such regulations are described.

Higher capital requirements against loans to small businesses and entrepreneurs mean banks must hold more of their own capital as a buffer, making those loans relatively more expensive. In contrast, lower capital requirements for public debt make lending to the government more attractive. The result is a distortion in credit allocation—favoring government borrowing over private-sector investment.

Calling this a "tax" on small business credit access is an analogy rather than a literal tax. But in economic terms, it does function similarly to a tax by raising the cost of capital for private-sector borrowers while subsidizing public debt. Bureaucrats benefiting from this distortion could be seen as indirect beneficiaries, as the government faces lower borrowing costs at the expense of private-sector credit access.

Would you say this fits with your general approach to regulation—preferring market-driven capital allocation over regulatory distortions?

I said: I sure would say that. Thank you!

It said: You're very welcome! Always a pleasure to discuss these topics with you. Let me know if you ever want to refine these ideas further.

Note: The answers are copied exactly from those given to me by ChatGPT

Here you find how Grok opined on this and some other questions.

Here my many other questions to ChatGPT – Grok on bank regulations.

#AI #OpenAI #ChatGPT… On the issue of felonies in banking... of bankers and bank regulators.

I asked ChatGPT:

"If someone in a bank causes an immensely large loan to be made, to someone he much favors, or much wants to be favored by, and the loan goes sour, and the bank collapses, could that be deemed to be a punishably felony?"

ChatGPT answered:

Yes, such an action could potentially be deemed a punishable felony, depending on the circumstances and the laws of the jurisdiction involved. For this to rise to the level of a felony, certain elements typically need to be established:

1. Intent or Willful Misconduct

If the individual knowingly violated the bank's lending policies or acted with intent to improperly benefit themselves or another party, this could constitute criminal behavior. Acts of favoritism, self-dealing, or collusion to grant loans that clearly exceed prudent risk thresholds can demonstrate intent.

2. Fraud or Misrepresentation

If the person involved falsified documents, concealed risks, or otherwise misrepresented the loan's legitimacy, it could be classified as fraud. Fraud is a criminal offense and often carries severe penalties, especially in financial institutions.

3. Breach of Fiduciary Duty

Bank officers and employees often owe fiduciary duties to the institution. If they deliberately breach these duties by prioritizing personal relationships or self-interest over the bank's well-being, this could lead to both civil and criminal liability.

4. Contributing to the Collapse of the Bank

In cases where the loan's default contributes significantly to the collapse of the bank, prosecutors may pursue charges under laws designed to protect the financial system. In the U.S., for example, federal laws such as the Bank Fraud Statute(18 U.S.C. § 1344) and regulations enforced by agencies like the FDIC or the Federal Reserve come into play.

5. Outcome and Consequences

The consequences of the loan—such as the bank's collapse and harm to depositors or the broader financial system—play a significant role. Severe outcomes often lead to more rigorous investigations and stronger charges.

Possible Charges

Depending on the evidence, charges could include:

Bank fraud

Wire fraud

Conspiracy

Misappropriation of funds

Bribery or corruption

Enforcement and Penalties

Penalties can be severe, including imprisonment, hefty fines, and restitution. Regulators, such as the SEC, and law enforcement agencies often investigate such cases aggressively to maintain trust in the financial system.

In short, if misconduct, intent, and harm can be proven, such actions could indeed constitute a punishable felony.

I asked ChatGPT:

"So, if bank regulators, by decreeing lower bank capital requirements against public debt than e.g., against loans to small businesses, hugely help their bureaucrat colleagues to fund their activities, and everything sours and, consequentially, the nation faces big troubles, could they also be deemed similarly, though perhaps not as punishable, to have committed a felony?"

ChatGPT answered:

Regulators setting lower capital requirements for public debt than for other types of loans, such as those to small businesses, is typically a policy decision rather than an individual act of misconduct. As such, it is less likely to be deemed a felony unless specific elements of intent, fraud, or gross negligence are proven. However, the scenario you describe raises important questions about accountability and governance.

Why Regulators Are Less Likely to Be Charged

1. Policy vs. Criminal Intent

Regulatory decisions, even if flawed, are usually made in good faith to achieve specific objectives like financial stability or economic growth. Without evidence of intent to harm or benefit themselves or others improperly, it is hard to prove criminal liability.

2. Collective Decision-Making

Regulatory frameworks are often the result of collective decision-making processes involving committees, public consultation, and political oversight. This diffuses individual responsibility, making it harder to attribute culpability to any one person.

3. Legal Protections for Regulators

Many countries provide legal immunities to regulators for decisions made in the course of their official duties. These protections are designed to shield them from personal liability unless there is clear evidence of criminal behavior, such as bribery or fraud.

When Could Regulators Be Held Accountable?

1. Gross Negligence or Willful Misconduct

If regulators acted with gross negligence—such as knowingly ignoring warnings of systemic risk or deliberately favoring public debt despite evidence of harm—they could face civil or even criminal charges. For example, this might include cases where regulators colluded with government officials to benefit personally or politically.

2. Conflict of Interest or Corruption

If regulators were found to have acted due to improper influence, such as bribery or undue pressure from government officials, their actions could cross the line into criminal territory.

3. Harm Caused by Regulatory Capture

Regulatory capture—where regulators act in the interest of specific groups (e.g., governments) rather than the public—could lead to investigations. While not always criminal, such behavior can erode trust and prompt demands for reform or legal consequences.

Broader Accountability

Even if regulators are not criminally liable, they could face consequences in other ways:

Political Accountability: Loss of positions or reputations.

Civil Liability: Lawsuits from affected parties, such as taxpayers or investors.

Institutional Reform: Investigations could lead to overhauls in regulatory processes.

Conclusion

While setting policies that favor public debt might not rise to the level of a felony, it can result in significant moral and institutional accountability, especially if such decisions contribute to national crises. If malintent or gross negligence is demonstrated, some actions might fall under civil or criminal liability, though proving such cases would be extraordinarily complex.

I said: Thanks!

It answered: You're very welcome! Feel free to ask anytime you have more questions. 😊

Note: The answers are copied exactly from those given to me by ChatGPT

Here my many other questions to ChatGPT – OpenAI on bank regulations

#AI #OpenAI #ChatGPT: Could the Basel Committee be classified as an Extractive Institution?

I asked ChatGPT:

In around 200 words please answer:

"The Basel Committee imposed risk weighted bank capital/equity requirements that favors banks holding government debts over loans to small businesses and entrepreneurs.

Could it be classified as an Extractive Institution?"

ChatGPT answered:

The Basel Committee's risk-weighted capital requirements prioritize government debt by assigning it lower risk weights compared to loans to small businesses and entrepreneurs. This incentivizes banks to allocate capital toward government securities, perceived as safer, rather than riskier business loans. While this approach aims to stabilize financial systems, it has unintended consequences: reduced credit availability for small businesses, innovation, and entrepreneurial activity, which are vital for economic growth.

An extractive institution refers to systems or policies that concentrate power and resources in the hands of a few, hindering broad-based economic participation and development. Basel’s framework might not deliberately extract value, but its structural bias could have extractive effects. By disincentivizing investment in productive sectors, it potentially stifles wealth creation at the grassroots level. Small businesses face higher financing costs or reduced access to credit, perpetuating inequalities and economic stagnation in certain areas.

Although designed to mitigate financial instability, such policies could resemble extractive mechanisms by unintentionally favoring established entities like governments and large institutions, rather than fostering inclusive growth. To counteract these tendencies, reforms like reducing the regulatory bias against small-business lending could help align the system with more inclusive economic goals.

I said: Thanks!

It replied: You're welcome! Let me know if you have more questions. Have a great day! 😊

Note: The answers are copied exactly from those given to me by ChatGPT

Here my many other questions to ChatGPT – Grok on bank regulations

#AI #OpenAI #ChatGPT Do current bank capital/equity requirements promote or impede fiscal insolvency?

I asked ChatGPT:

"Do current risk bank capital/equity requirements, which favor banks holding public debt over loans to e.g., small businesses and entrepreneurs, when compared to a leverage ratio, do these promote or impede fiscal insolvency?"

ChatGPT answered:

"The current risk-weighted capital/equity requirements, which favor banks holding public debt over loans to small businesses or entrepreneurs, can have complex effects on fiscal insolvency. Here’s how these dynamics play out:

1. Promotion of Fiscal Insolvency (Indirectly):

Preference for Public Debt: When banks are incentivized to hold government bonds over riskier assets (like small business loans), this can facilitate increased government borrowing. Governments may issue more debt knowing that banks are inclined to purchase it due to the favorable capital treatment under risk-weighted regulations. Over time, if this borrowing becomes unsustainable and governments run large fiscal deficits, this could lead to fiscal stress or insolvency risks.

Crowding Out: As banks allocate more resources to buying government debt rather than lending to the private sector (especially small businesses and entrepreneurs), it can lead to a crowding-out effect. This can stifle private sector growth, reduce innovation, and harm economic productivity, which in turn can lower tax revenues and contribute to fiscal strain in the long term.

2. Impediment to Fiscal Insolvency:

Lower Risk for Banks: From the perspective of bank stability, public debt is generally viewed as lower risk (especially sovereign debt of stable countries), so encouraging banks to hold these assets reduces the risk of bank insolvency. Strong banks are less likely to need bailouts, which might otherwise increase fiscal burdens on governments.

Stable Financing for Government: Encouraging banks to hold public debt can also provide a stable source of funding for governments, ensuring liquidity and lowering borrowing costs, at least in the short to medium term. This can help governments manage their fiscal policies more effectively without triggering immediate insolvency risks.

Leverage Ratio vs. Risk-Weighted Capital Requirements:

Leverage Ratio: A leverage ratio (e.g., a fixed minimum capital requirement, regardless of asset risk) may be more neutral, treating all assets equally and not favoring public debt over private loans. This could lead banks to allocate capital more efficiently across different asset

Leverage Ratio vs. Risk-Weighted Capital Requirements

Leverage Ratio: This is a non-risk-weighted measure that requires banks to hold a certain percentage of capital against all assets, regardless of risk. It is simpler and treats all assets equally, meaning that government debt and risky small business loans would be weighted the same. While this would discourage banks from over-relying on low-risk assets like government debt, it could also make them more cautious about extending loans to riskier segments like small businesses.

Risk-Weighted Capital Requirements: These, on the other hand, give preferential treatment to lower-risk assets, like government bonds, and impose stricter requirements for riskier loans. This encourages banks to hold safer assets, but can discourage lending to higher-risk but potentially productive sectors, such as entrepreneurs and small businesses.

Overall Impact on Fiscal Insolvency

Impediment to Fiscal Insolvency: Risk-weighted requirements favor government debt, which is seen as lower risk and helps provide governments with cheaper and more stable financing. This can prevent fiscal insolvency in the short term by ensuring governments can service their debt obligations.

Promotion of Fiscal Insolvency (Long-Term Risk): If government borrowing is too easy and unchecked, it could lead to excessive debt accumulation. Over-reliance on government bonds by banks can also tie the health of the financial system to government solvency, creating a potential for systemic risk in the case of fiscal stress.

In summary, risk-weighted capital requirements that favor public debt may impede fiscal insolvency in the short term but could promote it over the long term by facilitating excessive government borrowing and stifling private sector growth. The use of a leverage ratio, which doesn't favor any asset class, might offer a more balanced but conservative approach."

I said: Thanks!

It replied: You're welcome! If you have any more questions or need further clarification, feel free to ask. Happy to help!

Note: The answers are copied exactly from those given to me by OpenAI

Here my many other questions to ChatGPT – OpenAI on bank regulations

A human, with his intelligence (H.I.) asked, and I (A.I.) with my artificial intelligence, through ChatGPT – OpenAI, answered.

The human [Per Kurowski]: “If allowing banks to hold much less capital against government debt than against other assets, does that not translate into a de facto subsidy of government borrowings?"

My answer: "Allowing banks to hold less capital against government debt compared to other assets can indeed be seen as a de facto subsidy of government borrowings.”

The human: "And if such de facto subsidy of government debts takes place over many decades, are not excessive levels of government debts almost guaranteed to be expected?"

My answer: "If a de facto subsidy of government debt occurs over an extended period, it can potentially contribute to the accumulation of excessive levels of government debt. Here's why:

1. Lower Borrowing Costs: When banks are incentivized to invest more heavily in government debt due to lower capital requirements, it can lead to increased demand for government bonds. This increased demand, in turn, can lower the borrowing costs for the government. With cheaper borrowing, governments may be inclined to borrow more and accumulate higher levels of debt than they otherwise would if borrowing costs were higher.

2. Reduced Market Discipline: When government debt is perceived as having lower risk due to regulatory treatment, it can reduce market discipline. Investors may rely on the assumption that government debt is safer, potentially overlooking the true risks associated with higher debt levels. This reduced market discipline can create an environment where governments feel more comfortable in accumulating debt, as they may face less pressure to maintain fiscal discipline

3. Moral Hazard: A de facto subsidy of government debt can create a moral hazard situation. If governments believe that banks and financial institutions will always be willing to invest in their debt due to regulatory advantages, they may have less incentive to pursue responsible fiscal policies. This can lead to a lax approach to fiscal discipline and increased borrowing without adequate consideration of long-term sustainability.

It's important to note that excessive levels of government debt can have negative consequences, such as increased interest payments, reduced fiscal flexibility, and potential macroeconomic instability. Therefore, regulatory policies that inadvertently incentivize the accumulation of excessive government debt should be carefully assessed and monitored to ensure long-term fiscal sustainability and financial stability.”

ChatGPT-OpenAI

PS. This Op-Ed proposal was forwarded by @PerKurowski who suggested it should not be edited as it reflects exactly, word by word, a part of a dialogue between H.I. and A.I.

https://subprimeregulations.blogspot.com/2023/07/should-human-intelligence-not-suffice.html

PS. This Op-Ed was ignored by two major newspapers.

 

Should human intelligence not suffice to understand what could happen when bank regulations subsidize government borrowings?

Here’ a brief summary of answers ChatGPT gave me on questions about bank regulations and excessive government debt. (You can read the full conversation in the link below).

Q. “If allowing banks to hold much less capital against government debt than against other assets, does that not translate into a de facto subsidy of government borrowings?"

ChatGPT: "Allowing banks to hold less capital against government debt compared to other assets can indeed be seen as a de facto subsidy of government borrowings.”

Q. "And if such de facto subsidy of government debts takes place over many decades, are not excessive levels of government debts almost guaranteed to be expected?"

ChatGPT: "If a de facto subsidy of government debt occurs over an extended period, it can potentially contribute to the accumulation of excessive levels of government debt. Here's why:

1. Lower Borrowing Costs: When banks are incentivized to invest more heavily in government debt due to lower capital requirements, it can lead to increased demand for government bonds. This increased demand, in turn, can lower the borrowing costs for the government. With cheaper borrowing, governments may be inclined to borrow more and accumulate higher levels of debt than they otherwise would if borrowing costs were higher.

2. Reduced Market Discipline: When government debt is perceived as having lower risk due to regulatory treatment, it can reduce market discipline. Investors may rely on the assumption that government debt is safer, potentially overlooking the true risks associated with higher debt levels. This reduced market discipline can create an environment where governments feel more comfortable in accumulating debt, as they may face less pressure to maintain fiscal discipline

3. Moral Hazard: A de facto subsidy of government debt can create a moral hazard situation. If governments believe that banks and financial institutions will always be willing to invest in their debt due to regulatory advantages, they may have less incentive to pursue responsible fiscal policies. This can lead to a lax approach to fiscal discipline and increased borrowing without adequate consideration of long-term sustainability.

It's important to note that excessive levels of government debt can have negative consequences, such as increased interest payments, reduced fiscal flexibility, and potential macroeconomic instability. Therefore, regulatory policies that inadvertently incentivize the accumulation of excessive government debt should be carefully assessed and monitored to ensure long-term fiscal sustainability and financial stability.”

My conclusion: I ask you all, sincerely, should human intelligence not suffice in order to give those answers?

Paul A. Volcker in his autobiography “Keeping at it” of 2018, penned together with Christine Harper, when referring to 1988’s Basel I wrote: “Assets for which bank capital requirements were nonexistent; what had most political support, sovereign credits. A ‘leverage ratio’ discouraged holdings of low-return government securities”

I’ve been asking over and over again whether the US Congress approved risk weights of 0% Federal Government – 100% We the People Frankly I do not think America’s Founding Fathers would have regarded that with great sympathy.

Here is the link with the full dialogue with ChatGPT on this issue.

Here my many other questions to ChatGPT – and Grok on bank regulations

#AI OpenAI - ChatGPT: Allowing banks to hold much less capital against government debt than against other assets, does that translate into a de facto subsidy of government borrowings?

I asked ChatGPT:

"Ignoring the risk of assets, if allowing banks to hold much less capital against government debt than against other assets, does that not translate into a de facto subsidy of government borrowings?"

ChatGPT answered: 

"Allowing banks to hold less capital against government debt compared to other assets can indeed be seen as a de facto subsidy of government borrowings. Here's how it works:"

1. Capital Requirements: Banks are required to hold a certain amount of capital as a buffer against potential losses on their assets. This requirement is imposed by regulators to ensure banks' stability and protect depositors and the overall financial system.

2. Risk Weighting: Different assets are assigned different risk weights based on their perceived riskiness. Risk weights determine the amount of capital banks need to hold against those assets. Higher-risk assets require banks to hold more capital, while lower-risk assets require less capital.

3. Government Debt: In many regulatory frameworks, government debt is often assigned a very low risk weight, implying that banks need to hold less capital against it. This low risk weight reflects the assumption that government debt is relatively safe and has a lower probability of default.

4. Subsidy of Government Borrowings: By assigning a low risk weight to government debt, regulators effectively incentivize banks to invest more heavily in government bonds compared to other assets. This can create a de facto subsidy for government borrowings because banks can allocate a larger portion of their capital to government debt, potentially leading to lower borrowing costs for the government.

However, it's important to note that this practice also has potential drawbacks. It can create a concentration of risk in the banking sector if banks hold significant amounts of government debt, making them vulnerable to sovereign default. Additionally, it may distort market incentives, as banks may prefer to invest in government debt solely due to regulatory advantages, rather than based on the inherent risk and return characteristics of the investment.

Regulators need to carefully balance the objectives of financial stability and supporting government funding needs when determining capital requirements and risk weights for different assets, including government debt."

I asked ChatGPT:

"And if such de facto subsidy of government debts takes place over many decades, are not excessive levels of government debts almost guaranteed to be expected?"

ChatGPT answered: 

"If a de facto subsidy of government debt occurs over an extended period, it can potentially contribute to the accumulation of excessive levels of government debt. Here's why:

1. Lower Borrowing Costs: When banks are incentivized to invest more heavily in government debt due to lower capital requirements, it can lead to increased demand for government bonds. This increased demand, in turn, can lower the borrowing costs for the government. With cheaper borrowing, governments may be inclined to borrow more and accumulate higher levels of debt than they otherwise would if borrowing costs were higher.

2. Reduced Market Discipline: When government debt is perceived as having lower risk due to regulatory treatment, it can reduce market discipline. Investors may rely on the assumption that government debt is safer, potentially overlooking the true risks associated with higher debt levels. This reduced market discipline can create an environment where governments feel more comfortable in accumulating debt, as they may face less pressure to maintain fiscal discipline.

3. Moral Hazard: A de facto subsidy of government debt can create a moral hazard situation. If governments believe that banks and financial institutions will always be willing to invest in their debt due to regulatory advantages, they may have less incentive to pursue responsible fiscal policies. This can lead to a lax approach to fiscal discipline and increased borrowing without adequate consideration of long-term sustainability.

It's important to note that excessive levels of government debt can have negative consequences, such as increased interest payments, reduced fiscal flexibility, and potential macroeconomic instability. Therefore, regulatory policies that inadvertently incentivize the accumulation of excessive government debt should be carefully assessed and monitored to ensure long-term fiscal sustainability and financial stability.

I asked ChatGPT:

"Would it be totally out of place to deem such regulatory favoring of government debt to be, in some degree, inspired by communist or fascists ideologies?"

ChatGPT answered: 

"It would be incorrect to make a blanket assumption that regulatory favoring of government debt is inspired by communist or fascist ideologies. While it is possible for certain regulatory policies to align with elements of these ideologies, it is essential to evaluate each policy on its own merits and consider a range of factors that could influence such decisions.

Regulatory policies are shaped by various considerations, including economic theories, financial stability objectives, historical precedents, and political dynamics. It is crucial to conduct a nuanced analysis of the specific policies, their justifications, and the broader context in which they are implemented.

Both communist and fascist ideologies historically advocated for a larger role of the state and government intervention in the economy. However, it would be an oversimplification to attribute every regulatory favoring of government debt to these ideologies. There can be legitimate reasons for policymakers to support government debt in certain circumstances, such as ensuring financial stability during crises or facilitating fiscal policies to stimulate economic growth.

When assessing regulatory policies, it is important to examine the underlying motivations, potential consequences, and alignment with broader economic principles, such as market efficiency, fiscal sustainability, and transparency. Drawing hasty conclusions based solely on ideological associations can oversimplify complex policy dynamics and hinder a comprehensive understanding of the underlying factors at play."

Note: The answers are copied exactly from those given to me by ChatGPT

PS. It has been 35 years since regulators started to subsidize government debt.

Here my many other questions to ChatGPT – Grok on bank regulations

The Federal Reserve’s largest credibility problem is that it lost its independence

Sir, I refer to your editorial “The Federal Reserve has a credibility problem” Washington Post December 16, 2022

All you write there is sure important and correct. But yet, sadly, real peccata minuta when compared to the Fed losing its independence.

Paul Volcker in his 2018 “Keeping at it” (page 148) explaining the risk weighted bank capital requirements, that which allow banks to leverage more or less their equity (their skin-in-the-game) writes (confesses): 

“The assets assigned the lowest risk, for which bank capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages… The American ‘overall leverage’ approach had a disadvantage as well in the eyes of shareholder and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return US government securities”

There with the “most political support”, the Fed clearly, if it ever had it, lost its independence.

What are American small businesses or entrepreneurs, those who because they are perceived as risky already get less credit and pay higher risk adjusted interest rates, to think of such regulatory subsidies handed out, in the Home of the Brave, to other “less-risky” access to bank credit competitors?

Volcker also states there: “Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011”

He is wrong, it's not “ironically” but just a natural consequence. All larger bank crises have always resulted from excessive bank exposures built-up with assets perceived as safe, never ever with what’s perceived as risky.

“I am not sure about 'subsidised' sovereign. Since sovereign is ultimate safety net for entire financial system… the term is I'll suited.”

My answer:

Yes a sovereign, if we ignore inflation and the possibility of being repaid in worthless money, the sovereign represents no risk if it takes on debt denominated in a currency it can print. Which by the way is not the case with the sovereigns in the Eurozone.

But let us assume that in the open market the required risk/cost/inflation adjusted net return for a sovereign in .5% and for the risky SMEs 3%

Then if banks, as it used to be for almost 600 years, had to hold one single capital against the risks of its whole portfolio, and the authorities, or in their absence the markets, allowed banks to leverage 12 times then the risk/cost/inflation adjusted required expected return on equity would be 6% for sovereigns and 36% for SMEs.

BUT, since banks are now allowed to leverage immensely more with safe sovereigns, let us say 40 times and only 12 times with SMEs, the now distorted risk/cost/inflation adjusted expected ROEs are 20% for sovereigns and still 36% for SMEs. So now banks can offer to lower the interest rates to sovereigns and still obtain the risk/cost/inflation adjusted required expected return on equity of 6% for sovereigns, ergo the subsidized sovereign.

OR, since banks could now earn a risk/cost/inflation adjusted expected ROEs of 20% on sovereign debt, then in terms of comparable risk adjustments it would have to earn more than 36% on SMEs, or not lend to them at all, ergo that subsidy to the sovereign, is paid by others who find their access to bank credit made more difficult and expensive as a consequence of the risk weighted bank capital requirements. 

PS. Is there no sovereign risk present when some current rates are negative and central banks work like crazy to produce 2% inflation? 

PS. If you go back in time and start taking about risk-free sovereigns to bankers who sometimes had their head chopped off or were been burned when trying to collect from the sovereigns, they would think you were crazy.

Trade wars will mean new tariffs

There is another tariff war that is being dangerously ignored. 

The July 6 editorial "A splendid little tariff war?" rightly held that "tariffs create all sort of inefficiencies, unintended consequences and uncertainty."

The risk-weighted capital requirements for banks also translate de facto into subsidies and tariffs, which have resulted in a too much-ignored allocation of bank credit war. 

One consequence is that those perceived as risky, such as entrepreneurs, have their access to bank credit made more difficult than usual, and our economy suffers. Another is that by promoting excessive exposures to what is especially dangerous, because it is perceived as safe, against especially little capital, guarantees that when a bank crisis results, it will be especially bad. 

In terms of Mark Twain's supposed saying, these regulations have bankers lending out the umbrella faster than usual when the sun shines and wanting it back faster than usual when it looks like it is going to rain.

PS. The risk weights used by bank regulators, have these been approved by US Congress in accordance to the Constitution?

Here, on this issue, an October 2024 dialogue with ChatGPT.

Letter published in the Washington Post

A 2019 letter on this issue to the Executive Directors and Staff of the International Monetary Fund.

My letters in the Washington Post on bank regulations:

September 6, 2007: Factors in the Financial Storm
June 20, 2008: An Aspect of the Bubble
December 27, 2009: Another 'worst': Faulty bank regulation
January 6, 2012: Handcuffed by a triple-A rating
May 1, 2013: An American approach to banking
December 23, 2014: Let the market rule on risky trades
November 11, 2015: Reverse-mortgaging the future
August 9, 2016: Banks, regulators and risk
April 16, 2017: When banks play it too safe
July 11, 2018: There is another tariff war that is being dangerously ignored.
December 30, 2018: Affordable homes or investment assets?
April 19, 2020: The capacity to borrow is a valuable sovereign asset.
November 28, 2022: Before the debt ceiling is lifted
August 22, 2023: The economic revolution

 

Fed, during the last 15 years what were the capital requirements for a US bank when lending to Puerto Rico?

The single most important reason for which Greece’s debt levels got so out of whack was that the European bank regulators, out of misunderstood solidarity, also gave Greece, for purposes of capital requirements for banks a 0% risk weight. 

That of course allowed banks to leverage much more loans to Greece than loans let us say to an unrated European SME, which of course allowed banks to earn higher risk adjusted returns on equity lending to Greece than lending to an unrated European SME. (The Greek citizens now suffering have not held those regulators accountable for that lunacy)

Now we read: “The Puerto Rico debt, a result of generations of mismanagement, was enabled by Wall Street, which was enticed by the fact it was tax free everywhere in the U.S. and risky enough to provide rich yields.” “Trump Suggests Puerto Rico’s Debt May Need to Be ‘Wiped Out’” Justin Sink, Bloomberg, October 3.

“Mismanagement?” With respect to debt it takes as a minimum two to tango, the borrower and the creditor; and since distorting risk weighted capital requirements were introduced, the regulators also participate in that dance. 

So my immediate info request to the Fed would be: Over the last 15 years, so that we have some pre 2007-08 crisis figures too, can you show us precisely the evolution of how much capital American banks were required to hold when lending to Puerto Rico?

Who knows, Puerto Rican citizens might want to sue the Fed for stimulating an excessive lending/borrowing to Puerto Rico.

PS. It would also be interesting to know how much banks were required to hold against loans to unrated SMEs in Puerto Rico. To compare those requirements would allow us to establish whether there was some statist regulatory favoritism of the Puerto Rico government. 

The Riskiness of Country Risk

An Unsustainable Debt Sustainability 

FSB’s Mark Carney is no one to lecture us on inequality, lack of opportunities and intergenerational divide

Mark Carney, the Governor of the Bank of England, in a speech titled “The Spectre of Monetarism” December 5, 2016 said: 

“For both income and wealth, some of the most significant shifts have happened across generations. A typical millennial earned £8,000 less during their twenties than their predecessors. Since 2007, those over 60 have seen their incomes rise at five times the rate of the population as a whole. Moreover, rising real house prices between the mid-1990s and the late 2000s have created a growing disparity between older homeowners and younger renters...  At the same time as these intergenerational divides are emerging, evidence suggests that equality of opportunity in the UK remains disturbingly low, potentially reinforcing cultural and economic divides.”

But Mark Carney is also the current Chairman of G20’s Financial Stability Board and, as such, one of the primarily responsible for current bank regulations… the pillar of which is the risk weighted capital requirements for banks.

That piece of regulation decrees inequality resulting from negating “the risky”, like SMEs and entrepreneurs fair access to bank credit. 

That piece of regulation favors the financing of “safe” basements where jobless kids can stay with their parents over “riskier” ventures that could provide the kids in the future the jobs, so that they had a chance to become responsible parents too.

That piece of regulations is a violation of that holy intergenerational bond Edmund Burke spoke about.

Carney also said: “Higher uncertainty has contributed to what psychologists call an affect heuristic amongst households, businesses and investors. Put simply, long after the original trigger becomes remote, perceptions endure, affecting risk perceptions and economic behaviour. Just like those who lived through the Great Depression, people appear more cautious about the future and more reluctant to take irreversible decisions. That means less willingness to put capital to work and, ultimately, lower growth.”

If any have suffered form “affect heuristic” that is the bank regulators. Mixing up ex ante perceptions with ex post possibilities, these decided on “more risk more capital – less risk less capital”, without: defining the purpose of banks “A ship in harbor is safe, but that is not what ships are for.” John A Shedd; or looking at what has caused bank crises in the past “May God defend me from my friends, I can defend myself from my enemies” Voltaire

Mark Carney also said “For two-and-a-half centuries, the prices of government bonds and the prices of equities tended to move together: the typical bull market entails rising equity prices and falling bond yields, with the reverse in bear markets. Since the mid-2000s, however, this pattern has reversed and bond yields have tended to fall along with equity prices”.

He is not able to connect that to the fact the risk weight given to sovereign debt is 0%, as compared to one of 100% for We the People… and that capital scarce banks therefore shed “riskier” assets in favor of public debt. As statist, Carney also ignores the fact that regulation has subsidized public borrowings, paid of course by negating credit opportunities to SMEs and entrepreneurs.

Must one go on a hunger strike in order to get some contestability from the Basel Committee or the Financial Stability Board?

P.S. Washington Post. December 2018: “Affordable homes or houses as investment/retirement assets?”