Bailouts, which could carry significant costs to taxpayers, to be justified, must have a great purpose.

Note: I’m simultaneously sending out this type of "J'accuse" letter to Financial Times, Washington Post, New York Times, Wall Street Journal, The Globe and Mail, and The Economist.

SVB was holding a high number of Treasury and other government bonds — amounting to more than half of its assets. When will one dare ask regulators: How much capital/equity/skin-in-the game, were SVB's shareholders required to hold against that?

Bailouts, which could carry significant costs to taxpayers, to be justified, must have a great purpose.

We do not need “tougher” rules for our banks, we need better rules. Risk weighted bank capital/equity requirements based on what’s perceived as risky being more dangerous to bank systems than what’s perceived as risky, make absolutely no sense. 

Not only, by feeding the creation of excessive exposures to what’s “safe”, these put the dangers to bank systems on steroids but also, by distorting the allocation of credit, make it much harder for the economy to reach its true potential.

By incentivizing banks to refinance much more the "safer present" than to finance the "riskier future" it effectively imposes a reverse mortgage on the economy that will be very costly for future generations.

 

Additionally, by de-facto declaring the more creditworthy more worthy of credit, and as a consequence the less creditworthy to be less worthy of credit, they hinder equality of opportunities.

And since banks are one if not the most important channel to transmit central banks’ monetary policies, these regulations impede those to work as expected. Just think about how these distort the risk-free interest rate.

To top it up, with decreed risk weights of 0% governments – 100% citizens, as if bureaucrats/apparatchiks know better what to do with credit, for which repayment they’re not personally responsible for than e.g., small businesses, that’s communism or fascism, that has empowered a Bureaucracy Autocracy.

And I could go on and on.

Therefore, assisting the banks in need during a conversion from risk weighted bank equity requirements to solely a strong leverage ratio, 10% equity against all assets, has a great purpose. Especially if it stimulates and democratizes new bank equity.

A Chilean styled bailout could do. Zero bonuses, dividends and buy-backs, until the bank’s shareholders have 10% of equity in it against all assets, and until all the financial assistance provided has been repaid with some interest.

In short: The world needs to rescue its banks from the hands of equity minimizing / leverage maximizing creative financial engineers, much empowered by regulators, and return these to old style “know your client” bank loan officers. Welcome back George Banks.

PS. I might not be a PhD, and I have never been a regulator, but I'm not a newcomer to these issues.

@PerKurowski

Bank regulators were contaminated by the virus of totalitarianism

Mario Vargas Llosa in “The Call of the Tribe”, 2023, has a chapter titled Friedrich August von Hayek (1859-1992). It mentions Hayek, in “The Road to Serfdom” 1946, opining “that centralized planning of the economy inevitable undermines the bases of democracy, and that fascism and communism were therefore two expressions of the same phenomenon of totalitarianism. By the same token, all regimes, even those appearing to be free, would be contaminated by the virus of totalitarianism if they sought to control the functioning of the market.”

Paul Volcker in his “Keeping at it” 2018 (valiantly) confessed: “Assets assigned the lowest risk, [1988] for which bank capital [equity] requirements were therefore nonexistent or low, were what had the most political support: sovereign credits & home mortgages… A ‘leverage ratio’ discouraged holdings of low-return government securities”

Bank capital requirements with decreed risk weights 0% Federal Government and 100% We the People; could that have been a "spontaneous evolution of institutions"? NO!

Tell me, is that not about the greatest example of regimes appearing to be free, having been contaminated by the virus of totalitarianism, bringing fascism and communism by stealth?  (What would the Founding Fathers have opined)

All those declaring themselves followers, admirers and promoters of Hayek, how can they have ignored all this, for more than three decades?

On three side issues: 

Regulators allow banks to hold much less capital/equity when financing what’s perceived (or decreed) as “safe” e.g., public debt, residential mortgages and AAA rated, than when financing what’s perceived as “risky” e.g., loans to small businesses and entrepreneurs. I’m sure Hayek would have known, as any economist should have known, that such incentives had to cause dangerously much lending to the “safe”, and weakening too little lending to the “risky”

I’m sure Hayek would also have objected assigning some few human fallible credit rating agencies so much power when determining how much capital/equity banks had to hold against assets.

If asked about bank capital/equity requirements based on what’s perceived as risky being more dangerous to bank systems than what’s perceived as safe, Hayek could have probably asked: What were the large exposures that detonated bank crises built-up with, with assets perceived as risky or with assets perceived as safe?

The risk weighted bank capital requirements had a real purpose... quite different from making our banks safe

"I have been sitting here for most of these five days without being able to detect a single formula or word indicating that growth and credits are also a function of bank regulations"

I've often complained about the lack of purpose of the current bank regulations… until I finally understood that the risk weighted bank capital requirements decreed weights of 0% government - 100% citizens, revealed their real purpose, the empowerment of Bureaucracy Autocracies.

And don't take my word for it. Paul Volcker valiantly confessed: “Assets for which bank capital requirements were nonexistent, were what had the most political support; sovereign credits. A ‘leverage ratio’ discouraged holdings of low-return government securities”

What would America’s Founding Fathers opine about bank capital/equity requirements with decreed risk weights: 0% Federal Government and 100% We the People?

Financial Communism

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.

My What Ifs on risk weighted bank capital requirements

“Assets assigned the lowest risk, for which bank capital requirements were therefore nonexistent or low, were what had the most political support: sovereign credits & home mortgages… A ‘leverage ratio’ discouraged holdings of low-return government securities” Paul Volcker

"What If"... on risk weighted bank capital requirements

What if Basel Committee’s “Risk weighted bank capital requirements” had been labeled “Risk weighted bank equity/shareholders’-skin-in-the-game requirements”? Would the world have better understood the distortions caused?

What if one single Business School had questioned Basel Committee’s risk weighted bank capital requirements which imply bureaucrats know better what to do with credit, they’re not personally responsible for, than e.g., small businesses and entrepreneurs?

What if one single School of Economics had questioned Basel Committee’s risk weighted bank capital requirements which imply that residential mortgages are more important than e.g., small businesses and entrepreneurs?

What if one single statistician had explained to the Basel Committee that they might improve their risk weighted bank capital requirements by taking some lectures on conditional probabilities?

What if one single Nobel Prize winner in Economics had explained the dangerous procyclicality of the Basel Committee’s risk weighted bank capital requirements?

What if one Judge of the US Supreme court had questioned the constitutionality of risk weighted bank capital requirements with decreed weights: 0% Federal Government – 100% We the People? 

What if one renowned PhD had warned about the systemic risk introduced when, for purposes of risk weighted bank capital requirements, too much decision power was allocated to some few human fallible credit rating agencies?

What if one single renowned historian had reminded the Basel Committee that all major bank crises had resulted from excessive exposures built-up with assets perceived as safe, never with assets perceived as risky?

What if classifying government debt and residential mortgages as demand carbs; and loans to small businesses and entrepreneurs as supply proteins, would that have made a difference when deciding with what seeds our economies should be sowed?

What if instead of risk weighted bank capital requirements, we had purpose weighted bank capital requirements? Oops, what if the risk weighted bank capital requirements already concealed a purpose?

What if instead of besserwisser hubristic risk weighted bank capital requirements, we had a humble one single bank capital requirement against all assets?

Academia has kept total silence

PS. On this issue I’m not a newcomer.

PS. What to do? Here's a suggestion inspired by Chile.

Before the debt ceiling is lifted, which it must be, Congress must dare to at least pose a question.

Note 1988: "Assets for which bank capital [equity] requirements were nonexistent, were what had the most political support; sovereign credits. A ‘leverage ratio’ discouraged holdings of low-return government securities” Paul Volcker

A letter in the Washington Post

Before the debt ceiling is lifted, which it must be, Congress must dare to at least pose a question.

In much of Peter Orszag’s Nov. 22 op-ed, “GOP threats to weaponize the debt limit are dangerous,” one can agree with his conclusion, but when he mentioned, “The evolution of debt is also influenced by the economy, market interest rates and other factors, but those are mostly outside the control of policymakers,” he omitted vital aspects. Let me explain it with a question:

What would the United States’ public debt be in the absence of regulatory subsidies, such as bank capital requirements with decreed risk weights of zero percent against federal government debts and 100 percent against citizens’ debts; copious amounts of Treasury purchases by the Fed with quantitative easing programs; and the preaching by modern monetary theory fans that has definitely promoted a dangerous lackadaisical attitude when discussing the limits of public debt?

Yes, Congress must approve increasing the debt level. It’s too late to do otherwise, but to do so without even trying to answer that question would be to irresponsibly kick the debt can forward and upward with disastrous consequences.

And, by the way, the Supreme Court should look at what the Founding Fathers might have thought about the aforementioned risk weights.

PS. The links displayed above are the ones placed on the web by the Washington Post

PS. Here’s a dialogue with ChatGPT about the moral hazard easy public debt causes. 

PS. The decreed risk weights 0% Federal Government - 100% We the People, seem clearly un-American. Have these been discussed and approved by the US Congress in accordance to the Constitution?

PS. Here’s a dialogue with ChatGPT about zombie nations.

In short: Regulatory subsidies, QEs and MMT preaching, allowed governments the very Easy Debt that generated the Easy Money which, for decades, has kept bureaucrats/politicians/apparatchiks living on Easy Street 

Déjà vu! Not the first time I warn about a crisis can being kicked forward. The 2007-2008 was.

My other letters published in the Washington Post related to this issue:

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 18, 2020: The capacity to borrow at reasonable rates is a strategic sovereign asset

Unbeknownst to it, the world has begun unruly bankruptcy proceedings

(An Op-Ed that shall seemingly not be published)

“The assets assigned the lowest risk, for which capital requirements were therefore nonexistent or low, were those that had the most political support: sovereign credits and home mortgages… The “overall leverage” approach had a disadvantage as well in the eyes of shareholders and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return government securities." That is Paul Volcker valiantly explaining 1988’s Basel I.

Though risk-taking is the oxygen of all development, it introduced serious credit risk-aversion. Paraphrasing Mark Twain: “A banker is a fellow that should lend the umbrella when the sun shines and should urgently take it back when it rains”.

By much favoring banks holding “safe” government debt and residential mortgages (demand-carbs) than loans to “risky” small businesses and entrepreneurs (supply-proteins), way too much debt has been generated against a weakly obese not muscular economy. Of course, in the process, bureaucracy autocracies were empowered, and houses transformed from home into valuable investment assets. 

Naturally, that completely distorted the transmission of central banks’ monetary policy and those interest rates set in free markets that had been used as references e.g., the risk-free interest rate.

And since these capital requirements are mostly based on perceived credit risks, not misperceived risks or unexpected events, e.g., pandemic or war, our banks stand there naked, just when we surely need them the most.

More than three decades of this has now come home to roost. Sadly, three major obstacles stand in our way of finding the least painful ways out.

First, those who have benefitted from an empowered Bureaucracy Autocracy don’t want to let go until its last breath.

Second, those who abundantly profit financially, politically or just narcissistically from polarization will not let go while they can still breath.

Third, frontline defenses, like the academy and the press, have kept complicit silence. When all explodes, they will blame other events that “no one in their sane mind could foresee” … or, as usual, neoliberalism. In their defense, they will probably point to the fact that Ben Bernanke, who defends these regulations, won the 2022 Nobel Prize in Economics. 

What’s now going on in Britain, is the canary in a coal mine.

The Easy Debt governments have counted with the last decades, kept bureaucrats, politicians and their dependent on Easy Street. We will all pay dearly for that. God help us.

PS. What can be done? Not a full plan, but here's a start:

1. Zero dividends, buy-backs and big bonuses, before banks have ten percent in capital against ALL assets.

2. Debt to equity conversion should be one of the most important resolution tool

PS. I quote from a letter I wrote published in 2004 by Financial Times: “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. We wonder how many Basel propositions it will take before they start realizing the damage, they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

PS. My 2019 letter to the Inquisitional Financial Stability Board. 

In America, in the Home of the Brave, in democracy, how can this have been going on, for over three decades?

“Assets assigned the lowest risk [in 1988], for which bank capital requirements were therefore nonexistent or low, were what had the most political support: sovereign credits & home mortgages… A ‘leverage ratio’ discouraged holdings of low-return government securities” Paul Volcker “Keeping at It” 2018.

That de facto means banks can leverage more their capital/equity with government debt and residential mortgages than with loans to small businesses and entrepreneurs. 

That de facto means banks can easier earn risk adjusted returns on capital/equity with government debt and residential mortgages than with loans to small businesses and entrepreneurs.

That de facto means banks have been given incentives to hold more government debt and residential mortgages than when holding loans to small businesses and entrepreneurs.

That de facto means banks will hold government debt and residential mortgages against much lower risk adjusted interest rates than those charged on loans to small businesses and entrepreneurs.

That de facto implies bureaucrats know better what to do with bank credit for which repayment they’re not personally responsible for than small businesses and entrepreneurs with theirs.

That de facto implies residential mortgages are more important than loans to those who can create the jobs and incomes, by which make down-payments, repay mortgages, service utilities & live.

In America, in the Home of the Brave, in democracy, how can this have been happening, for over three decades, and no one objects?

What would its Founding Fathers have said?

If you want your nation to prosper and become strong, what bank capital (equity) requirements would you prefer?

The current risk weighted ones, which have banks allocating their credit based on risk adjusted return on required equity (ROrE)? 

These imply e.g.:

Bureaucrats knowing better what to do with credit for which repayment they’re not personally responsible, for than small businesses and entrepreneurs.

Financing the purchase of houses with residential mortgages has priority over financing those who can create the jobs, the incomes, by which repay mortgages and service utilities. (Which makes houses become more investment assets than affordable homes)

Or, just one single capital requirement against ALL assets, a leverage ratio, which will have everyone compete for credit with risk adjusted interest rates, and banks allocating their assets based on maximizing their risk adjusted return on one single equity (ROE)?

Or, would you argue: “But, the risk weighted makes our bank system safer”  Sorry, No! It’s just another dangerous Maginot Line

The first nation to kick out Basel Committee regulations and return to one single bank capital requirement against all assets, has the best chance of getting back on the right track. How to transition from here to there? Not easy, but here’s one route.

PS. Why do those who with so much emotions argue against trade protectionism, with such ease ignore to argue against credit allocation protectionism?

A tweet to @imfcapdev April 5 2021

"Excess of carbs e.g., government loans, residential mortgages; insufficient proteins e.g., bank loans to entrepreneurs and lack of exercise e.g., no creative destruction/zombification, causes GDP obesity. Can IMF/WBG develop a Body Mass Index for GDP?"

If you go into that dark forest that looks horrible to you... then we will force you to eat broccoli and spinach.

But if you stay out on the fields where everything looks safe and beautiful... then we will allow you to eat as much chocolate cake and ice cream you want.

Here my dialogues with #AI ChatGPT - OpenAI about current bank capital/equity requirements.

Two questions to America’s economists, and one for its lawyers.

Bear with me.

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

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

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

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

Then, in Steven Solomon's “The Confidence Game” we read:

“On September 2, 1986, the fine cutlery was laid once again at the Bank of England governor’s official residence at New Change… The occasion was an impromptu visit from Paul Volcker… When the Fed chairman sat down with Governor Robin Leigh-Pemberton and three senior BoE officials, the topic he raised was bank capital…” 

Finally in his autobiography “Keeping at it” of 2018, penned together with Christine Harper, Paul Volcker wrote:

“The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages. Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011. The American “overall leverage” approach had a disadvantage as well in the eyes of shareholders and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return US government securities."

Thanks!

So, now let me ask America’s economists two questions:

If since its Founding Fathers’ days America’s banks had been regulated so as to finance much more the government and residential mortgages than loans to its small businesses and entrepreneurs, would America be where it is now? 

Knowing that all those excessive bank exposures that have set on major bank crises were always built-up with what was ex ante perceived as very safe, what true precautionary purpose do these regulations serve?

And one question to America’s lawyers:

The risk weighted bank capital requirements with decreed weights of 0% Federal Government 100% - We the People, do they really conform with what 's wanted in the U.S. Constitution?

Where do I come from? 

At the World Bank “Let us not forget that the other side of the Basel [Committee’s regulatory risk weighted capital requirements] coin might be many, many developing opportunities in credit foregone”

As one of the Christian Western World? God make us daring!

As one having a strong opinion? My letter to the Financial Stability Board.

25 years on the issue. My first Op-Ed ever, began with what this post does.

The (Odious) Bank Credit Redistribution Act: The Great Financialization

1988 Basel I: Risk weighted bank capital requirements with decreed weights: 0% government, 50% residential mortgages and 100% the rest, e.g., small businesses and entrepreneurs; all as if bureaucrats know better what to with credit, for which repayment they’re not personally responsible for than e.g., small businesses and entrepreneurs; all as if financing the purchase of a house is more important than financing those who can create the jobs, the incomes, by which repay mortgages and service utilities.

Why? “Assets assigned the lowest risk, for which bank capital requirements were therefore nonexistent or low, were what had the most political support: sovereign credits & home mortgages” Paul Volcker

2004 Basel II: The introduction of the systemic risk of bank capital requirements depending hugely on human fallible credit rating agencies. To top it up the decreed weights e.g., 20% AAA to AA fated – 150% below BB- rated, continued to ignore the fact that all dangerous large bank exposures have always been built up with assets perceived as safe.

2007-2009 A global financial crisis (GFC) caused by excessive exposures to AAA rated mortgage-backed-securities (MBS).

2010 Basel III: Kicking the can forward so as not t be blamed the regulators, trying to mend regulatory blackholes concocted a mishmash of hundreds or regulations. Sadly, these all still leave intact, on the margin, which is where it most counts, the distortion in the allocation of credit produced by the risk weighted capital requirements.

2009… 2022: Job possibilities for bank supervisors and bank supervision responders keeps on booming… and just you wait for the ESG based capital requirements based on ESG ratings.

In short:

Bank capital requirements that so much favor government debts, has empowered Bureaucracy Autocracies all around the world. Central banks’ later Quantitative Easing (QEs), put that assistance on steroids

Before risk weighted bank capital requirements, bank credit was allocated based on risk adjusted interest rates. After, based on risk adjusted returns on required capital/equity (ROrE). That distorts even central banks’ monetary policy.

Bank capital requirements mostly based on perceived credit risks, not on misperceived risks or unexpected events, e.g., pandemic/war, guarantees banks will, sooner or later, stand there naked, just when we need them the most.

Favoring with much lower capital requirements banks holding “safe” government debt and residential mortgages (the present-demand-carbs), than loans to “risky” businesses (the future-supply-proteins), inflates inflation and causes obese - not muscular economic growth.

The Great Financialization, supported by low bank capital requirements, central banks’ QEs, and MMT preaching, produced way too much easy money... manna from heaven. That emptied many churches. Coming Minsky moments will fill these up again.

Extremely short:

These  risk weighted bank capital requirements have put Minsky moments on steroids.

PS. I have now, one way or another, been on this theme for twenty-five years

Should risk weighted bank capital requirements be based on perceived risks, or conditioned-on the risks perceived?

The Basel Committee, and co-regulators all base it on perceived risks. Mark Twain would have gone for the conditioned-on risks perceived. Why? “A banker is a fellow who wants to lend you the umbrella when the sun shines and wants it back when it rains”. (Supposedly)

Twain understood that bankers, conditioned upon them perceiving risks as low, will gladly hand out loads of loans which, when conditioned on them perceiving the risks as high, they would want to collect, as fast as they could.

Sadly, all current bank regulators clearly missed their lectures on conditional probabilities, and therein lies the problem.

Now, when credit risks are perceived as low, their risk weighted bank capital requirements allow banks to lend profusely against little capital, meaning being able to pay high bonuses and dividends and do plenty of stock-buy-backs. When risks are or become perceived as high, e.g., in a recession, then banks must hold more capital, just when it is the hardest for them to raise it, just when we probably need banks the most.

To understand the point, an on the scene live reportage the morning after a bank crisis interviewing all those Monday Morning Quarterbacks that beg to be interviewed all mornings after, would satiate us with the mention of some huge specific loads of very risky assets. And those suffering the availability heuristic a.k.a. the availability bias, would nod their heads in agreement. 

From Wikipedia we read: “The availability heuristic operates on the notion that if something can be recalled, it must be important, or at least more important than alternative solutions which are not as readily recalled. Subsequently, under the availability heuristic, people tend to heavily weigh their judgments toward more recent information, making new opinions biased toward that latest news.”

But, if a documentary was produced on what years/moths lead up to that crisis, it would certainly retell how those huge dangerous bank exposures were built up with assets deemed very safe. That documentary would seriously contradict the live reportage and the Basel Committee, and strongly agree with Mark Twain.

The problem with data is that when they are taken/registered also matters a lot.

Sadly, the safety of our bank systems is not only what’s endangered. Also the health of our economies. These risk averse bank capital requirements cause too large exposures to what’s “safe”, e.g., government debt and residential mortgages, think of it as demand pushing carbs; and too small exposures to what’s “risky” e.g., loans to small businesses and entrepreneurs, think of these as supply producing proteins. The result? Dangerous economic obesity.

Edmund Burke would have required the current bank regulations to be totally reformed

In a letter published by Washington Post 2015 titled “Reverse mortgaging the future” I wrote that the current risk weighted bank capital requirements implied that “we refused those coming after us the risk-taking that brought us here and, in such a way, we baby boomers — or at least our elite — allowed the intergenerational holy bond that Edmund Burke wrote about to be violated.”

Days ago, I began reading the introduction to “Edmund Burke and the Perennial Battle, 1789-1797” written by Daniel B. Klein and Dominic Pino. I got to page 9 and there found Edmund Burke mentioning “four hurdles that an abuse must clear in order to be worthy of reform.”

So here I go.

First. “The object affected by the abuse should be great and important.”

I submit that banks and their allocation of credit to the real economy is of utmost importance.

Second. “The abuse affecting this great object ought to be a great abuse.”

I submit that imposing how much capital/equity/skin in the game banks should hold against different assets will much determine to what/whom, how much and at what interest rates banks are willing to lend. 

Third. “It ought to be habitual, and not accidental.

I am sure the risk weighted bank capital requirements concocted by the Basel Committee for Banking Supervision and implemented for more than three decades by bank regulators all around the world meet perfectly both these criteria.

Fourth. “It ought to be utterly incurable in the body as it now stands constituted”.

Regulators who for decades have been unable to even acknowledge, much less discuss the existence of serious problems with their rulings, has sufficiently demonstrated a total incapacity to change and reform on its own.

And to what regulatory abuse am I referring to?

1.- Even though ALL bank crises ever have resulted from the build-up of excessive exposures with assets ex-ante perceived as safe but that ex-post turned out risky, regulators based their risk weighted bank capital requirements on that what’s perceived risky is more dangerous to bank systems than what’s perceived safe.

2.- Banks mostly subject to capital requirements based on perceived credit risks, not on the certainty of misperceived risks or unexpected events, e.g., a pandemic or a war, will stand there naked, just when we surely need them the most.

3.- When outlook seems rosy and risks are perceived low, banks will be allowed to pay large bonuses, large dividends and carry out share buy backs so, when times turn bad, banks will stand there naked, just when we might need them the most, just when it is harder for them to raise capital.

4.- By decreeing risk weights of 0% governments and 100% citizens the regulators indicate their belief bureaucrats know better what to do with (taxpayer’s) credit than e.g., small businesses and entrepreneurs with their own; something which has strongly empowered the Bureaucracy Autocracies around the world

5.- Risk weighted bank capital requirements much favor banks holding “safe” government debt & residential mortgages (demand-carbs-the present) over loans to “risky” businesses (supply-proteins-the future). The result: economic obesity that morphs into stagnation.

6.- Allowing banks to leverage more their capital/equity/skin-in-the-game when financing the safer present than when financing the riskier future, clearly violates that holy intergenerational bond Edmund Burke wrote about.

7.- And so on… and on and on.

PS. Here’s a reference to a more recent violation of that holy intergenerational social contract Edmund Burke spoke about. The response to Covid.

PS. And the elder will also be hurt since social security will be failing too.

Your Honor, can I sue the bank regulators?

Your Honor, 

My small riskier less creditworthy business always got less credit and paid higher interest rates than the more creditworthy, and that was ok. 

But the regulators, with their risk weighted bank capital requirements, also decreed it to be less worthy of credit and, since it now has to compensate the banks for these not being able to leverage as much their capital/equity as much as they can with other “safer” assets, they made it get even less credit and pay even higher interests. 

Can I sue them?