The complaint I presented to the Consumer Financial Protection Bureau CFPB

Introduced by means of:

https://help.consumerfinance.gov/app/tellyourstory

I refer to the Equal Credit Opportunity Act (Regulation B) in order to present the following complaint: 

Banks consider credit risk information, like that contained in credit ratings, when setting interest rates, amount of loans and other contractual terms… this causes a natural market based discrimination of those perceived as risky. We all know well Mark Twain’s description of a banker: that as the one who lends you the umbrella when the sun shines, and wants it back, urgently, when it looks like it is going to rain. 

But when bank regulators use the same credit risk information, in order to also determine the capital requirements for the banks, then they produce artificial regulatory discrimination in favor (a subsidy) of those already favored by being perceived as not risky, and against (a tax) those already being disfavored by being perceived as risky. And I argue that this regulatory discrimination is contrary to the spirit of the Equal Opportunity for Credit. 

The discrimination occurs in the following way. If a bank is allowed to have less capital when lending to the not risky that signifies he can leverage its equity more and therefore obtain larger returns on equity when lending to the “not-risky”. If a bank is forced to have more capital when lending to the risky that signifies it can leverage less its equity and therefore obtains lesser returns on equity when lending to those perceived as “risky”. To make up for this regulation and present the banks with the same opportunity of returns on their equity, the “risky” need to pay an additional interest rate, and this additional is quite substantial. 

The capital requirement regulations are explained in terms of making the banks safer, but that is not the case, in fact it makes the banks more unsafe. There has never ever been a major bank crisis that has resulted from excessive exposures to what was perceived as risky, think of Mark Twain’s banker, they have all resulted from excessive exposures to what was ex ante considered not risky, but, ex post, turn out to be very risky. And in that respect it allows for excessive leverage buildup precisely in those areas that contain the greatest risk and consequences of bad surprises, namely the lending to what is perceived as “not-risky”. 

Let me just end by commenting on the great contradiction that the discrimination of those perceived as risky, like the small businesses and entrepreneurs, really signifies in “a land of the brave”. 

Please help stop that odious discrimination. To deny those perceived as risky fair access to bank credit, is an act of regulatory violence.

PS. https://subprimeregulations.blogspot.com/2013/11/have-risk-weights-of-current-bank.html

PS. Just in case, the returns on equity I speak of are of course the risk-adjusted ones.

PS. You doubt what I say? Ask regulators these questions.

A brief summary of my thoughts on banks and risks

Capital requirements for banks which are lower when the perceived risk of default of the borrower is low, and higher when the perceived risk is high, distort the economic resource allocation process. This is so because those perceptions of risk, have already been cleared for, by bankers and markets, by means of interest rates and amounts of exposures. 

All current dangerous and obese bank exposures, are to be found in areas recently considered as safe and which therefore required these banks to hold little capital. What was considered as “risky” is not, as usual, causing any problems. This is not a crisis caused by excessive risk taking by the banks, but by excessive regulatory interference by naïve and nanny type regulators. 

And, if that distortion is not urgently eliminated, all our banks are doomed to end up gasping for oxygen and capital on the last officially perceived safe beach… like the US Treasury or the Bundesbank.

Bank regulators have no business regulating based on perceptions of risks being right, their role is to prepare for when these perceptions turn out to be wrong. 

You do not regulate banks based on perceived risks but based on what banks might do with the perceived risks.

A nation that cares more for history, for what is has got, for the haves, for their baby-boomers, for "The Infallible", the AAA rated or sovereigns, than for the future, for what it can get, for their young, for the not-haves, for "The Risky", the small businesses or the entrepreneurs, is a nation on its way down.

With capital requirements for banks based on perceived risk interest rates were manipulated… where do the risky sue?

When regulators set the capital requirements for banks based on perceived risks, even though these perceived risks are already priced in by the bankers in the interest rates, they are effectively manipulating the interest rates. The direct consequence is that those officially perceived as not-risky, have to pay much less interest than what would be the case without this distortion, and those officially perceived as risky need to pay much more… and all for absolutely no good reason at all.

And so when I read that Barclays has been fined £290m ($450m) for trying to manipulate a key bank interest rate which influences the cost of loans and mortgages, my first thought was, where can the “risky” small businesses and entrepreneurs sue the regulators for all the monstrously excessive interests they paid?

My simple calculations, here, indicate that a not rated bank client, exclusively on account of this odious regulatory discrimination, has to pay about 270 bp (2.7%) more in interest rates when compared to an AAA rated bank client… or, like now, in times of extremely scarce bank capital, suffer the consequences of being excluded from access to bank credit.

On bankers and weathermen

Do you remember Mark Twain’s banker, he who wants to lend you the umbrella when the sun shines but wants to take it back as soon as it seems like it is going to rain? Well that banker would surely be taking some notice of what the weathermen opined, in order to set the interest rates, the amounts and the other terms of the loan. 

But what if the regulators also told this banker that if the weatherman spoke of sun, his bank was allowed to hold very little capital, which meant being able to leverage its equity much more, but, if he spoke of rain, it was then required to hold much more capital and leverage less? 

Obviously, since a banker must love returns on bank equity, since otherwise he would be booted, that would doom Twain’s banker to choke on sunny forecasts (like AAAs and infallible sovereigns), and avoid like the pest all possible rains (like small business and entrepreneurs)… only to find out, much too late, that weather reports are not always that accurate. 

And so shall we exclude using weather forecast from bank capital requirement calculations, or shall we regulate the weatherman… so that he gives our bankers absolutely accurate forecasts… so that our Mark Twain banker can trust these even more?

Ps. here a letter published by the Financial Times in January 2003.

A Wicked Question on Bank Regulations

If bankers do as Mark Twain says, namely “lend you the umbrella when the sun shines and wanting it back when it rains”, and all bank crisis ever have resulted from excessive lending to what was perceived as “not risky”, and any perceived risk has already been considered in the interest rates and the amounts of the loans, what is the logic behind allowing banks to hold less capital requirements when they engage in what is perceived as “not risky” as current bank regulators do?

My urgent proposal for the capital requirements for banks

I propose that regulators urgently calculate any individual bank´s capital to total assets ratio, and ask for it to apply a capital requirement that increases ever so slightly over a fairly long time on any new asset it acquires… until reaching some basic goal, like the original 8 percent of Basel II, but more real. 

That way we should be able to put our banks on a stronger footing to lend, with so much less distortion.

US bank regulators, please don’t salt an already too salted soup!

I just found a 200 page document where the Department of the Treasury, The FederalReserve System, and the Federal Deposit Insurance Corporation ask for opinions on the document referring to: RIN 3064-D97: Regulatory Capital Rules: AdvancedApproaches Risk-based Capital Rule; Market Risk Capital Rule 

And here is my plea: 

Bank regulators please don’t salt an already too salted soup! 

If regulators are going to regulate based on perceived risks, and consequently establish risk-weights, they need to be absolutely certain that those risks have not been already cleared for, since otherwise they will of course only be introducing dangerous distortions. 

Since bank loans and investments are already by means of interest rates, amounts of exposure and other contractual terms, risk-weighted for perceived risks it is therefore hard to understand what risk-weights are added in with the proposal, so as to come up with a correct net risk weight. 

From what we see the current proposal will only increase the possibilities that banks overdose on perceived risks, for no good purpose at all. 

Current regulations caused a crisis that can best be explained in terms of obese bank exposures to what was ex ante perceived as absolutely not risky, and that ex post turned out to be very risky; and anorexic bank exposures to what is perceived as risky, like small business and entrepreneurs, which makes it a crisis so hard to get out of. 

In cooking terms, you are proposing to put salt in the soup with no consideration to how much salt was put in by the chef… It can, and most probably will, turn into a nasty salty dish. In this context do not forget that Mark Twain, with his “a banker lend you the umbrella when the sun shines and wants it back when it looks like is going to rain”, already hinted at that the chefs salted too much. 

And so friends, do yourself and us a big favor. Before digging us deeper in the hole, ask the proponents of the new rules, what risks are they covering for that the banks are not already covering for. I expect that when you hear their answers you will determine that the safest route is to get rid of capital-requirement-determining risk-weights altogether.

Also, I see that the regulators put a lot of trust in the bankers own risk models. That is nice, quite decent of them, but is it not really their role to prepare for when the bankers get their risk models wrong?

Also, frankly, banking is something that should be accessible to the public, but here you are asking the public to comment on formulas that seem designed to launch a space ship to Jupiter, and that is just not right. Is this a public consultation on something you yourself don´t understand?

Finally, in the “land of the brave”, how can you discriminate so much against the “risky”? Don´t you know about the risk-taking it took to get you here? Do you really think the West was won with capital requirements for banks which discriminated against risk-taking?

The Western World, as we know it, is unintentionally being assassinated by Basel bank regulators

If a banker has two types of clients the absolutely not risky and the somewhat risky he will set the interest rates that makes it indifferent for him who he lends to. 

If then that indifference rate of the not-risky is allowed by the regulator by means of differentiating the capital requirements, to be much more leveraged than the indifference rate of the risky, three things will happen: 

First and foremost the banker will concentrate on lending to what is officially perceived as not risky and provides the highest expected risk adjusted return on equity. 

Second, he might even lower the interest rates when lending to the officially perceived as not risky, since he has room for doing that and still produce a risk-adjusted satisfactory return on equity. 

Third, he will ignore the officially perceived risky, that is unless these accept to pay an even higher interest rate. 

The final outcome of the system will be obese bank exposures to what has or is officially perceived as not risky and anorexic exposures to what is officially perceived as risky, like to small businesses or entrepreneurs… In other words… the current crisis.

I am not sure Professor Stiglitz is a valid spokesman for the de-equalized.

Professor Joseph E. Stiglitz has written "The Price of Inequality: How Today’s Divided Society Endangers Our Future". 

Now, if Professor Stiglitz is so worried about inequality, as he should rightfully be, how come he does not care about one of the most important inequality drivers of our time, namely that of the capital requirements for banks based exclusively on the perceived risks of a borrower´s default, and where, of course, the “not-risky” are closely correlated to the haves, and the risky” to the not-haves? 

Professor Stiglitz chaired the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System, which presented its final report in September 2009. In it we find no objection to this odious regulatory discrimination. 

I mean how can one not object a system which allows banks to lend to “infallible sovereigns”, those already obtaining the best conditions, against no capital at all, and at the same time require the banks to hold 8 percent in capital when lending, at high rates and low sums, to a sovereign rated BB+ or below? 

I mean how can one not object a system which allows banks to lend to the “infallible corporate”, those rated AAA to AA”, those already obtaining the best conditions, against only 1.6 percent in capital, and at the same time require the banks to hold 8 percent in capital when lending, at high interest rates and low amounts, to a corporate rated BBB+ or below, or to a small business or an entrepreneur? 

Is Stiglitz unaware that banks already discriminate for perceived risks by means of interest rates, amounts lend and other term, and so that this regulatory discrimination, placed on top of that, can only guarantee that banks overdose on perceived risks? 

Has Stiglitz never read Mark Twain describing bankers as those who lend you the umbrella when the sun shines but want it back, hurriedly, when it looks like it is going to rain? 

Can Stiglitz not understand the nature of the current crisis where our banks got saddled with obese bank exposures to what was, ex ante, officially perceived as absolutely not risky… like lousy securities disguised as splendid triple-A’s, loans to Icelandic banks, loans by the Spanish banks to the real estate sector in Spain, loans to an “infallible” Greek government, and other similar; and anorexic exposures to the “risky”, the small businesses and entrepreneurs, those we most need our banks to finance? 

And, because of all this, I am sorry, but for the time being, I am not sure Professor Stiglitz is a truly valid spokesman for the de-equalized.

The complaint I filed with the Federal Trade Commission.

Federal Trade Commission 

Reference: Discriminatory bank regulations. 

We refer to your stated mission of preventing business practices that are anticompetitive or deceptive or unfair to consumers; in this case to the consumers of bank credit. 

We are perfectly aware that banks are in their full right to discriminate their lending conditions, like the interest rates, the amounts lend and other terms, based on the risk of default they perceive. But, what we find to be extremely unfair, even outright immoral, is for the bank regulators to determine that the capital requirements of the banks should also be based on those same perceived risks. 

That makes the access to bank credit, for those officially deemed as absolutely not risky, much more abundant and cheaper than would have been the case without regulatory intervention, and the access to bank credit, for those officially deemed as risky, like small businesses and entrepreneurs, much more scarce and expensive than would again have been the case without any regulatory intervention. 

Or, in words of Mark Twain, it will make the banks much more prone than they already are to lend you the umbrella when the sun shines, and to take it away when it looks like it is going to rain. 

And, besides, it all serves no good regulatory purpose, since all it does is to guarantee that the officially perceived safe havens become dangerously overpopulated. 

And, besides, there is no factual reason for this type of regulatory discrimination against perceived risk, because there has never ever been a bank crisis because of excessive bank exposure to what was ex-ante considered as risky. 

Are bank regulators stupid, immoral, or both?

If free to do so, insurance companies charge more and insure for lesser amounts those who have a precondition, and that is as should be expected, or in other words, something normal. But suppose the insurance companies had to charge even more to insure someone with precondition, only because a regulator, in order to safeguard the insurance company, decided to impose a risk-tax on those with a precondition… would you consider that stupid or immoral? I myself would consider that to be both stupid and immoral. And so hear me out:

If a banker perceives a borrower to be risky he will charge him higher interest, lend him less and probably negotiate some harsher conditions to compensate for that… but that is all just again, normal and natural market discrimination. 

And, traditionally, bankers have proven to be almost too effective in adjusting to perceived risks; not only as noticed by Mark Twain, when describing them as those who lend you the umbrella when the sun is out and wanting it back when it looks like it is going to rain; but also by the fact that there never ever has been a bank crisis that has resulted from excessive lending to those ex ante perceived as risky. 

But, when the regulators, based on the same perceptions of risk that the banker see, decided to allow the banks to hold less equity when lending to those officially perceived as not-risky; we are effectively in the presence of an artificial regulatory discrimination against those perceived as risky… and that, as I see it, is both incredibly stupid and outright immoral.

The missing (perhaps prohibited) regression!

Run a regression for all the different serious problem loans of banks around the world, like lousy securities disguised as splendid triple-A’s, loans to Icelandic banks, loans to the real estate sector in Spain, loans to a Greek government, and other similar… on the risk-weight of 20 percent or less established in Basel II, and which allowed the banks to finance what´s mentioned above holding only 1.6 percent or less in capital, which means an authorized leverage of bank capital 62.5 to 1 … and then draw your conclusions.

Turning the bank capital thumbscrews in Europe!

According to Basel II, until January 13, 2012 European banks could hold sovereign debt of Spain against zero capital and then, until May 13, they were required to hold a modest 1.6 percent in capital; currently, with Spain rated BBB+, they need to hold 4 percent, and, if Spain would be downgraded 3 notches more, to BB+, then they would be required to have 8 percent of capital. 

Of course, the more capital you must hold against any asset, the higher must the interest rate be in order to produce the same return on bank equity… which is one of the torture instruments of that so cruel economic torture chamber the Basel Committee bank regulators unwittingly designed. 

Of course, if and when banks are required to hold 8 percent in capital when lending to Spain, the same capital they are required to hold when lending to ordinary small businesses or entrepreneurs, then that would be a more real market rate… since all those lower earlier rates where in fact regulatory subsidized rates. 

And Europe still has the same set of regulators using the same paradigm writing up Basel III! Go figure that out.

The Paper... the most current version

Excessive Regulatory Risk Adverseness Caused the Crisis 5912

Greece… even if expelled from the Eurozone, is free to use the Euro

Though it would obviously not enjoy any seigniorage benefits, Greece, if expelled from the Eurozone can very well keep on using the Euro… so at least not having to waste money changing vending machines or feeding the fx-changers. 

Yes, obviously, it would have to earn the Euros it needs, and not survive on some Drachmas it can print, if it finds buyers for them, but, having to earn ones livelihood seems like a reasonable point where to start the reconstruction.

Europe…what if?

What if European bank regulators had imposed their 8 percent capital requirement for banks on all their assets (12.5 to 1 leverage) like they did for instance on loans to small businesses and entrepreneurs, instead of allowing the banks to hold some ex ante perceived as no risk assets against a meager 1.6 percent or less (62.5 to 1 leverage)?

Just for starters, European banks would not have invested in triple-A rated securities backed by lousily awarded mortgages to the subprime sector in the USA; would not have lent the outrageous amounts they did to Icelandic banks or Greece; and Spanish banks would not have overexposed themselves to the real-estate sector. Do you want me to continue?

Thank God for timely capital flight!

Because of the regulatory incentives of only having to hold 1.6 percent in equity when lending to Greece, which meant being allowed to leverage their bank equity a mind-boggling 62.5 to 1, German and other European banks lent to Greece like crazy and at crazy low rates. What would you have liked the Greeks to do?... the same nonsense?... so that even more money had been lost down the same drain? 

No thank God there was some intelligent and timely capital flight, and private Greeks placed at least some or their funds out of harm´s way. 

Now it is up to these private Greeks, to see how, with their diminished resources they can best help their homeland, in times when helping it might actually produce some good results. 

But, whatever it does, Europe first needs to put the sparkplugs back into its economic engine.

Those sparkplugs, the risk-takers, the “risky” small business and entrepreneurs, were forcedly removed by the regulators when they decided to base the capital requirements for banks on the perceived risks of default, as if those perceptions were not already discriminated for sufficiently by the banks. 

What these regulations delivered, as should have been expected, are dangerous obese bank exposures to what is officially perceived as not-risky e.g., government debts, and, for us and economic growth, equally dangerous anorexic exposures to what is officially perceived as “risky”. 

But, unfortunately, what does Mario Draghi of FSB and ECB, and his fellow failed bank regulators of the Basel Commitee, know about sparkplugs?

A Nobel Prize recall

Frankly, any Nobel Prize winning economist, like Joseph Stiglitz, who is capable of defining over and over again a crisis resulting from excessive and obese bank exposures to what was officially perceived as absolutely not risky, as a demonstration of excessive risk-taking by the banks, should be asked to return his Nobel Prize.

Risk taking provides the financial system with the Lebensraum it needs to grow sturdy

The better the credit ratings are, and the better our risk models are, the better will we stack our financial system, for a while, but then also the higher¸ in Nassim Taleb´s terms, its fragility, or its brittleness will be. 

If we want a flexible, a sturdy, or in Nassim Taleb´s terms an anti-fragile system, then our financial system need risk-taking, a lot of it, of many varied kinds. Risk-taking is not only the oxygen of economic growth it is also what allows our financial system the Lebensraum it needs.. 

Risk-taking is “anti-fragility”, which is why in our churches we can hear the prayer of “God make us daring!” Our current problem is that our nanny bank regulators in the Basel Committee completely forgot all about it… or perhaps they never knew.

PS. What I spoke and wrote about fragility