Should our nannie state tax all risk-taking at higher rates, as current bank regulators do?

Motorcycles, in terms of deaths per miles driven, are much riskier than cars. Should society therefore levy a special risk tax to compensate it for the unnecessary early death of its members? (Even though we know more people die in car than motorcycle accidents) 

Since sport injuries have a cost for the society should we tax sports based on their injury rates? For instance, applying a ten percent risk tax on cricket and only one percent on croquet (to cover for the pesky squirrels).

If one assumes that the risks involved with any activity are not adequately perceived or considered, one could of course construe a case for those taxes. But, should we dare to assume risks are not already perceived and cleared for if we therefore could end up with a very risky too risk adverse society?

And I ask all this because taxing risk-taking is exactly what current regulators do with their risk weighted capital requirements for banks.

They now require banks to hold more capital against what is already perceived as riskier (motorcycles) than against what is perceived as safe (cars). This translates into banks having much higher possibility of maximizing their returns on equity with what is “safe” than with what is “risky”; which de facto is a tax on “the risky”.

Consequences? Banks build up dangerously large exposures to what is perceived, decreed, or concocted as safe, like sovereigns, AAArisktocracy and mortgages; and to small exposures, or even no exposure at all to what is perceived as risky, like SMEs and entrepreneurs.

Clearly if the risks are already perceived and considered by bankers, in the size of the exposure and the interest rates charged, to then also have the capital reflect the perceived risks, cause these risks to be excessively considered; resulting in an excessively risk-adverse banking system.

Just consider that already, partly because of the higher risk perceptions, many more people die in car than in motorcycle accidents. 

Think of a society where no one drives motorcycles or plays cricket because the risk-taxes are too high, and all keep to cars and crocket. Is that the kind of society that will be strong enough to survive? Is that what we want?

I am sorry but there is no more figurative way to express it. The Basel Committee for Banking Regulations and their affiliated regulators have effectively castrated our banking system. Will that make us safer? Of course not! 

Our banks will dangerously overpopulate safe-havens; in which they will die from lack of oxygen.

Our economies are going to dwindle into nothing, when denied the oxygen of risk-taking necessary for all development.

Friends, we must urgently get rid of these dangerously inept bank nannies.

Stefan Ingves, years after Basel Committee’s failure, you all have still no idea about how to regulate banks.

On December 2, 2016 Stefan Ingves, the Chairman of the Basel Committee gave a Keynote speech at the second Conference on Banking Development, Stability and Sustainability, titled “Finalising Basel III: Coherence, calibration and complexity” 

In it Ingves stated: “an area of further research which would be welcome relates to how we should think about the capital benefits of allowing banks to use internally modelled approaches, and therefore the appropriate calibration of capital floors to such models. What are the pre-conditions for such models to produce better outcomes than, say, simpler standardised approaches? And to whom do the benefits of improved modelling accrue? If a bank using a model can lower its capital requirements by, say, 30%, what are the financial stability and real economy benefits of such an approach? To what extent do the benefits of modelling accrue to lower-risk borrowers as opposed to the parties being compensated for developing and using the models?”

That is clear evidence that the Basel Committee still, soon ten years after the crisis, their failure, has no idea about what it is doing. It should concern us all. 

Here’s one example on of how the Basel Committee’s has totally confused ex ante risks with ex post risks. In their Basel II standardized risk weights the weight assigned to AAA assets is 20% while the weight of a highly speculative below BB- rated assets was set at 150%. 

I ask: What has much greater chance of taking the banking system down, excessive exposures to something ex ante believed very safe or excessive exposures to something believed very risky? The answer should be clear. Never ever have bank crises resulted from excessive exposures to something believe risky when placed on the balance sheet; these have always resulted from unexpected events (like devaluations), criminal behavior or excessive exposures to something perceived ex ante as very safe but that ex post turned out to be very risky. 

The truth is that the Basel Committee told banks: “Go out and leverage your capital more than with assets that are safe”. And so when disaster happens, like with AAA rated securities, banks stand there more naked than ever.

Of course, the other side of that coin is, “Do not go and lend to what is risky”. So banks dangerously for the real economy stopped lending to SMEs and entrepreneurs… something that is never considered when stress testing.

To top it up, like vulgar statist activists, they set a risk weight of 0% for the Sovereign and one of 100% for We the People; which translates into a belief that government bureaucrats can use bank credit more efficiently than the private sector… something which of course created the excessive indebtedness of Greece and other.

One final comment, the regulators naivety is boundless: “to whom do the benefits of improved modeling accrue? asks Ingves” Clearly there is no understanding of that bankers will, as is almost their duty, always look to minimize capital if so allowed, in order to obtain the highest expected risk adjusted returns on equity. 

When fake regulators supervise banks; totally unsupervised banks is much better.

PS. Must one go on a hunger strike to have the Basel Committee on Banking Supervision answer some very basic questions? 

Dr Raghuram Rajan the color of the credit risk weighted capital requirement for banks policy is INTENSE RED

Dr Raghuram Rajan: in “Towards rules of the monetary game” a speech delivered in New Delhi March 12, 2016 during the conference" Advancing Asia: Investing for the Future" said: 

“To use a driving analogy, polices that are generally seen to have few adverse spillovers, and are even to be encouraged by the global community should be rated Green, policies that should be used temporarily and with care could be rated Orange, and policies that should be avoided at all times could be rated Red.” 

And I have a simple question for Dr Rajan: 

What color, Green, Orange or Red would he give the policy of the risk weighted capital requirements for banks? 

That which allows banks to hold much less capital against what is perceived ex ante as safe than against what is perceived as risky. 

That which therefore allows banks to leverage more their equity with what is perceived ex ante as safe than with what is perceived as risky.

That which therefore allows banks to earn higher risk adjusted returns on equity on what is perceived ex ante as safe than on what is perceived as risky.

That which therefore cause banks to create excessive and dangerous exposures to what is ex ante perceived as safe and insufficient exposures to what is perceived as risky. 

That which in real terms means causing the banks to extract the most refinancing much more the safer past abandoning their social responsibility of assisting in the financing of the riskier future. 

That which “has led to the debt overhang” that which makes it more difficult for “new technologies and new markets [to] come to the rescue” 

Dr Rajan asks and answers: 

“Why is there so much of a political need for growth in industrial countries? 

One reason is the need to fulfill government commitments such as debt and social security entitlements. 

Another reason is that growth is necessary for inter-generational equity, especially because the young, who are most benefited from job creation, are the generations that will be working to pay off commitments to older generations. 

A third reason is that, within country, long periods of below par growth can lead the unemployed to become unemployable.” 

Dr Raghuram Rajan, using your driving analogy the color of the policy of risk weighted capital requirement for banks is INTENSE RED, especially for developing countries like India.

PS. Here is the document I presented at the High-level Dialogue on Financing for Developing at the United Nations, New York, October 2007, and titled “Are the bank regulations coming from Basle good for development?” It was also reproduced in The Icfai University Journal of Banking Law Vol. VI No.4, India, October 2008

Basel Committee and you other scheming dumb regulators, “Thanks, Great Job! Next time please keep out of our banks.”

A bank would ordinarily require lower risk premiums for the purchase of a house by someone willing to make an important down payment, and who showed sufficient income to be able to service the mortgage, than the risk premium the bank would require for riskier ventures, like that of lending to SMEs or entrepreneurs... those who though risky, could best help us to create the next generation of decent jobs.

But now, ever since regulators allowed banks to leverage more their equity with “safe” housing loans than with loans to The Risky, that meant the risk premiums offered in the market for housing loans suddenly got to be worth much more in terms of risk adjusted returns on bank equity, than those offered by The Risky. 

The consequence? More loans to housing, and much less loans to SMEs and entrepreneurs than would ordinarily have been the case without this distortion. 

And so now we are doomed to live unsafely in our safe houses, because of the lack of jobs we need in order to repay mortgages and utility bills.

Thanks regulators! Great Job! Next time please keep out of our banks.

Governments, your prime responsibility is to profoundly distrust your own technocrats, and to block these from dangerously meddling with our real economies.

http://subprimeregulations.blogspot.com/2016/02/the-governments-must-stop-their.html

Who is willing to rein in the bank regulatory abuses on Basel Committee Street?

The Basel Committee for Banking Supervision introduced credit risk weighted capital (equity) requirements for banks: more risk more capital – less risk less capital.

That allowed banks to leverage their equity much more when lending to that perceived or deemed safe, like to the AAArisktocracy or Infallible Sovereigns, than when lending to those perceived risky, like SMEs and entrepreneurs.

That allowed banks to earn much higher risk-adjusted returns on equity when lending to the safe than when lending to the risky… sort of realizing bankers' wet dreams.

And that means banks build up dangerous excessive financial exposures to what is perceived as safe, against very little capital, precisely the stuff major bank crises are made off.

And that means banks will mostly refinance the safer past than finance the riskier future, negating thereby the young the opportunities their elder benefitted from in the past.

And, in a nutshell, that guarantees growing inequalities and weakening economies.

Damn the Basel Committee, their associates and all other who maintain interested silence on this de facto regulatory crime against humanity, that I sincerely believe was committed unwittingly.

Where did this disaster, which could even be defined as an unwitting economic crime against humanity, originate? There are many factors, and here are some of those I feel are most relevant. 

Regulators never defined the purpose of the banks and, if you regulate without doing that, then anything could happen. 

Regulators though knowing that banks capital is to be there to help cover for unexpected losses, got confused and used the expected credit risks to estimate the unexpected. 

Regulators simply ignored that what is perceived as safe has by definition a greater potential to deliver unexpected losses than what is perceived as risky. 

Regulators concerned themselves with the perceived risks of bank assets, instead of with the risk of how bankers would manage those perceived risks. 

Regulators simply did not do some empirical research on what causes major bank crises and where therefore not able to manage the differences between ex ante perceptions and ex post realities 

Etc. etc. etc.

Shame on the Basel Committee, their associates and all other who keep mum on this.

The Big Short is short on the whole truth. There’s too much vested interest in “Bank regulators can’t be that wrong!”

Paul Krugman, in the New York Times of December 18, 2015 wrote: “You want to know whether the movie [The Big Short] got the underlying economic, financial and political story right. And the answer is yes, in all the ways that matter”

No! I now saw “The Big Short”. It is a very good movie that describes accurately many elements of the crisis that resulted from excessive exposures to AAA and AA rated securities; those that were backed with badly awarded mortgages to the subprime sector.

But, unfortunately, just as I suspected, it remains totally mum on what really propelled the crisis, namely outlandishly bad bank regulations.

In the over two hours movie, we do not hear a single word about that banks in Europe, and investments banks in the USA, thanks to the Basel Committee and the SEC, were allowed to hold these securities against only 1.6 percent in capital… meaning they could leverage their equity, and the support they received from society, a mind-blowing 62.5 times to 1.

The risk-adjusted returns on equity banks expected to make on AAA to AA rated securities by leveraging them over 60 times, blinded everyone. When in the movie it is mentioned that even though the default rate of the subprime mortgages was increasing dramatically, and yet the price of those securities was rising, they ignored among others the runaway European demand for these. These securities, CDO, MBS, ABS or what you want to call them were in fact thought to be the new gold to be found in California, and way over a trillion Euros pursued that gold during less than two years. 

Want to read about it? Here is what happened to little Narvik of Norway in “And then the roof caved in”, page 114. 

Anything that could be traced back to an AAA rated security allowed banks to finance any operation with it against almost no capital. For instance if AAA rated AIG sold you a credit default swap, that was enough… and so everyone bought CDS’s from AIG, who could not resist selling CDS’s on AAA rated securities.

Paul Krugman and others like Joseph Stiglitz, even though bank regulations odiously discriminate against “The Risky” and in doing so increases inequality, cannot find it in themselves, or in their agendas, to accept that technocratic regulators, regulating on behalf of governments, could be so wrong.

The Big Short mentions though a prime driver of the disaster. One broker confesses he would make immensely higher commissions supplying truly lousy adjustable rate mortgages to the packagers of AAA security, than sending them reasonable fix rate prime mortgage. The way the incentives worked, the worse the mortgage, the higher was the added value of the to AAA-ratings conversion process.

PS. And not only The Big Short is guilty of omission. In its 848 pages the Dodd Frank Act, though the US is a signatory, does not even mention the Basel Accord and the Basel Committee

PS. I just looked at the index of Michael Lewis’ “The Big Short again”. It does not mention Basel regulations, risk weighted capital requirements for banks, nor the meeting on April 28, 2004 when SEC decided that the investment banks in the US, would be able to play by Basel rules… and thereby open the way for the minimum capital requirements against anything AAA rated for these banks.

Who allowed some Homo tímidus ignarus to substitute for the Homo sapiens as bank regulators in the Basel Committee?

Credit risk is the natural risk most cleared for by banks. Not only does it define the size of their exposures, but also, because the riskier they can argue something to be, the higher will the risk premiums they can negotiate for themselves be.

But for timid, faint hearted, sheepish and outright fearful regulators, that was not enough. They had to make sure banks were really scared of credit risk, and so they doubled up on it by designing capital requirements that were also based on the same risk.

And so banks are now allowed to leverage their equity and the support they receive from society more with assets perceived as safe than with assets perceived as risky.

And consequentially banks can earn higher risk-adjusted returns on equity on assets perceived as safe, than on assets perceived as risky.

Someone might opine that if that makes our banks safer, that might not be such a bad idea. Nothing is further from the truth.

First, all major bank crisis have resulted from excessive exposures to something wrongly perceived as safe and never ever from something ex ante correctly perceived as risky. And so banks when the crisis happens are now guaranteed to stand with especially little capital to cover them up with. 

Second, by distorting the allocation of bank credit to the real economy, causing for instance insufficient lending to “risky” SMEs and entrepreneurs, it will weaken the economy; and a weak economy is of course also dangerous to banks.

Risk taking is the oxygen of any development. Risk taking is what brought us the Homo sapiens of the Western Civilization to were we are… and so I must ask: who allowed some Homo timidus to act as bank regulators? 

Without the natural and sturdy risk taking by our banks, our economies are now stalling and falling, and we are all beginning to gasp for oxygen in dangerously overpopulated safe havens.

But perhaps the term Homo tímidus ignarus is more appropriate. Bank capital should foremost help to cover for unexpected losses, so using expected credit risk to determine something unexpected is as dumb as can be; especially since the safer something is perceived to be, the larger is its potential to deliver unexpected losses.

PS. A question to Yuval Noah Harari: How does the willingness of Sapiens to take risks play out in the History of Humankind?

PS. Just in case, my Latin is almost non existent.

Understand what originated the bank crisis and what stops the economies from recovering in 157 words

Bank regulators told our credit risk adverse banks: 

“If you take on Safe assets, we will allow you to leverage your equity and the support you receive from the society more than 60 to 1 times but, if Risky assets then you cannot leverage more than 12 to 1.” 

And that of course meant banks would be earning much higher risk adjusted returns on equity on assets perceived or made out to be Safe, than on “Risky” assets. 

It was like telling children: “If you eat up your ice cream then you can have chocolate cake too but, if you eat spinach, then you must eat broccoli too. 

And so banks built up excessive dangerous financial exposures to “Safe” assets, like AAA rated securities and loans to Greece, which detonated the crisis. 

And so banks are reluctant to hold Risky assets, like loans to SMEs and entrepreneurs, which makes it impossible to get out of the crisis.” 

And, amazingly, most describe what happened and is happening with our banks in terms of deregulated entities and failed markets.