Saturday, September 11, 2021

A much-needed and much overdue conference

John A. Shedd, in his 1928 “Salt from my attic” wrote: “A ship in harbor is safe, but that is not what ships are for”. 

Does that not apply to banks too?In his autobiography “Keeping at it”, penned together with Christine Harper in 2018, Paul Volcker, the Chair of the Federal Reserve from August 1979 to August 1987, with respect to the credit risk weighted bank capital requirements approved in 1988 and which are known as Basel I, valiantly confessed:

“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… 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."

Allowing banks to leverage much more with Treasuries and residential mortgages, which means it is easier for them to obtain satisfactory returns on equity with these assets, made it of course much harder for the “risky” e.g., small businesses and entrepreneurs to compete for credit. They now get less credit or pay higher interest rates than in absence of these regulations. Direct results? More government debt, higher house prices and less private sector jobs/incomes.

The harsh truth is that with the risk-weighting, the Fed decreed the less creditworthy to also be less worthy of credit, and that banks financing or refinancing the “safer” present would have priority over their financing the riskier future. 

An even harsher truth is that, in terms of financial stability, it’s all for nothing… even counterproductive. All the excessive exposures that could lead to major systemic bank crises, have always been built-up with what’s perceived as safe, never ever with what’s perceived as risky.

Who is going to pay by far the most for all the consequences? Our children and grandchildren.

“Where would America, the Home of the Brave be, if the credit risk averse bank regulations had not been introduced?”, is that not a question that merits a conference transmitted live on prime time? 

Why has it not taken place yet? Thirty-three years of silence clearly evidences this is not a red or blue issue and, sadly, violet is so out of fashion.

Why does your paper/organization sponsor such a conference?

Thursday, August 26, 2021

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

We urgently need our banks to be banks again

Current bank capital requirements, with capital meaning equity, meaning the skin in the game bank shareholders should have, are mostly based on perceived credit risks; not on misperceived risks, or the unexpected, like a Covid-19.

That would be less of a problem, if those capital requirements were based on risks conditioned to how credit risks are perceived.

But they’re not! What’s perceived more creditworthy, meaning what’s preferred by banks, have much lower capital requirements than what’s perceived less creditworthy.

And lower capital requirements mean higher leverages, making it therefore easier to earn risk adjusted returns on equity with what’s perceived (or decreed by regulators) as safe, than with what’s perceived as risky.

The consequence? A procyclicality that fosters higher and higher exposures to what’s safe, against less and less capital.

And what’s defined as “safe”? Loans to sovereigns, residential mortgages and assets with very high credit ratings?

And what’s risky? E.g., loans to small businesses and entrepreneurs.

So precisely like in 2007-08, when banks were caught with their pants down because of huge exposures to mortgage-backed securities with misperceived AAA ratings, they’re now standing there naked because of the unforeseen economic consequences of Covid-19; especially those derived from lockdowns.

The procyclicality of it all; when times are rosy banks can hold little capital but when times get hard banks have a hard time raising capital, sets us up to the fact 

And so, just when we now most need banks to help us out, it’s the hardest for them to raise the capital that would allow them to do so. What a mess!


So, what would I propose? In few words, the following: 

“Banks, you can now hold zero capital, but that comes with: zero dividends, zero buy-backs and zero bonuses until you have ten percent in capital against all assets; and until you’ve paid back, including a reasonable interest, all what central banks or taxpayers have assisted you with.”

To ease the transition one could allow all bank assets incorporated some months before the change, to be held, until its maturity, against the capital requirement valid when put on banks' balances.

And I would allow small investors to buy some of that bank equity that helps these meet that ten percent requirement on favorable conditions… so as to connect the banks with the citizens again

Fellow citizens, let’s rescue our banks from hands of those financial engineers concerned with “how much can we leverage this asset?”, so as to put these back into hands of loan officers whose first question to applicants is, “what are you going to use the money for?”

And let’s rescue banks from that statism/communism/fascism implied with risk weights of 0% the Government, 100% the citizens… all as if bureaucrats/politicians know better what to do with credit for which repayment they’re not personally responsible for, than e.g., entrepreneurs.

Let’s be clear. Risk taking is the oxygen of all development and so, in that vein, for the real economy what’s “safe” represents carbs, while what’s “risky”, proteins and vitamins.


And finally let’s stop putting financial instability on steroids. The large dangerous exposures that could become dangerous for our bank systems are always built up with what’s perceived as safe, never ever with what’s perceived risky. 


Give it a thought, the newspaper you read; would it dare to publish a Galileo-heliocentric opinion and risk being confronted by the Basel Inquisition?


Sunday, June 20, 2021

Could/would an Inquisition Tribunal nominate as a Nobel Prize winner in Physics, someone arguing a heliocentric world?

Why do I ask?

The Nobel Memorial Prize in Economic sciences is officially the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. The Governor of Sveriges Riksbank since 2006, is Stefan Ingves, and who, from 2011 to 2019 served as the Chairman of the Basel Committee on Banking Supervision. 

And the Church of the Basel Committee holds, as a dogma, with their credit risk weighted capital requirements, that even though never ever have those excessive exposures that caused bank crises been built up with what’s perceived as risky, but always with what was perceived as safe, that what is really dangerous to our bank systems, is what’s perceived as risky, or what has not been decreed by them as being very safe... like loans to governments.

So, could an economist who argues that what’s perceived as safe is much more dangerous to our bank systems than what's perceived as risky be nominated to such a Nobel Memorial Prize in Economic sciences?

You tell me.


Thursday, May 27, 2021

Where would the Home of the Brave be, if all its immigrants had been met by risk-adverse bank regulations?

In his Washington Post May 27 op-ed, “Subsidizing America’s most important product," George F. Will referred to “Joseph Schumpeter an immigrant from Austria” whose theory was that “the principal drivers of social dynamism are… innovators — inventors of new things and companies” and added that “The common denominator [of it] is the restless, risk-taking spirit of a talented few.”The de facto spirit of the risk weighted bank capital requirements in the United States can currently be summarized in the following way: 

“We regulators allow you banks to leverage your capital a lot, and therefore earn high risk adjusted returns on equity, with what’s safe, e.g., Treasuries and residential mortgages. But, as a quid pro quo, you need to stay away from what’s risky, e.g., small businesses and entrepreneurs”

So, let me ask: Where would the Home of the Brave be if all its immigrants had been met by such regulatory risk adverseness?


PS. John Kenneth Galbraith wrote: “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]. “Money: Whence it came where it went” 1975

PS. And at the World Bank I argued time and time again: “There’s a clear need for an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth.”


PS. And, to top it up, in The Land of the Free, that risk aversion came hand in hand with outright statism

Monday, May 24, 2021

On the morality of current banker's decisions

A banker confronts a choice:

On one hand, Alt. A, a number of not so creditworthy borrowers who are asking for small loans, accepting to pay what could rightly be deemed a bit higher interest rate than what the risk adjusted interest rate should be.

On the other hand, Alt. B, a very creditworthy borrower, that is asking for a very large loan, at a rate lower than what an adequate risk adjusted interest rate should be.

Years ago, the banker would gladly gone for Alt. A, but, after the introduction of risk weighted bank capital requirements, which mean banks can leverage much more with what’s more creditworthy than with what’s less so, means the bank would obtain a higher risk adjusted return on its equity with Alt. B.

A banker has to pick Alt B. or he’s toast… and so he picks it… (that is unless he would not want to be a banker any more… and instead, like George Banks, go and fly a kite)

In reference to Per Bylund’s twitter thread on “morality of actions”, how would you classify the banker’s action.

Monday, April 12, 2021

Bank regulators, please wake up, being more creditworthy, should not mean, as you have decreed, being also deemed more worthy of credit.

Anyone deemed more creditworthy in terms of representing less risk of default will, by definition, get more credit and on better terms (like lower risk adjusted interest rate) than anyone deemed to be less creditworthy.

But if banks are allowed to leverage their equity more with the more creditworthy, and can so easier earn higher risk adjusted returns on equity, that does also imply these borrowers to be more worthy of credit than the less creditworthy… and that’s as wrong and dangerous as can be, for the bank system and for the real economy... and in reality, that's even immoral.

The wealthy are usually creditworthy, but they not more worthy of credit than the “riskier” poor. The risk weighted bank capital requirements, wrongly and immorally, Decreed Inequality.

A government is (at least in the short run) quite often very creditworthy, but it is not more worthy of credit than its citizens, as the risk weighted bank capital requirements so wrongly decree.

A house buyer is often creditworthy, but he is not more worthy of credit than e.g., small businesses and entrepreneurs, as  the risk weighted bank capital requirements so wrongly decree.

A house buyer with a larger down-payment, a lower loan to value LTV, is more creditworthy, but he is not more worthy of credit than a riskier house buyer providing a smaller down-payment, a higher LTV, as the risk weighted bank capital requirements so wrongly decree.

A developed nation is (at least in the short run) quite often very creditworthy, but it is not more worthy of credit than riskier developing nations, as the risk weighted bank capital requirements so wrongly decree.

A federal government is (at least in the short run) quite often very creditworthy, but it is not more worthy of credit than riskier local governments, as the risk weighted bank capital requirements so wrongly decree.

An AAA rated corporation is credit creditworthy, but it is not more worthy of credit than a much riskier below BB- rated one, as the risk weighted bank capital requirements so wrongly decree.

And I could go on and on





 

Thursday, February 4, 2021

Do the risk weighted bank capital requirements make the risky more or less risky?

Basel III’s bank capital requirement’s risk weights (RW) for residential mortgages depending on Loan to Value (LTV); implied Allowed Leverage of capital/equity (AL) and expected Return On Equity (eROE), calculated with a Risk Adjusted 0.5% expected Return on Asset (eROE) 

LTV<50%: RW = 20%: AL = 62.5 to 1: eROE = 31%
50% < LTV ≤ 60%: RW = 25%: AL = 50 to 1: eROE = 25%
60% < LTV ≤ 80%: RW = 30%: AL = 41.7 to 1:  eROE = 21%
80% < LTV ≤ 90%: RW = 40%: AL 31.25 to 1: eROE = 16%
90% < LTV ≤ 100%: RW = 50%: AL 25 to 1: eROE = 12%
LTV > 100%: RW = 70%: AL 17.9 to 1: eROE = 9%

Those with higher LTV, because they are riskier, must naturally pay banks higher risk adjusted interest rates. But, since banks can hold less capital against lower LTVs, they must also compensate banks, so as to provide these with a competitive risk adjusted return on equity.

So, in order for those who have no money to put down (LTV) > 100%, and with which banks can leverage 17.9 times, in order to compete with those who put down LTV <50%, need to provide an expected Risk Adjusted Return on Asset of 1.73 (31%/17.9); meaning in this case a 1.23% higher interest rate than without this distortion.

And we ask: charging those who have no money to put down, and who should perhaps not even have access to a residential mortgage, a 1.23% higher interest rate than what their risk adjusted interest rate would otherwise be, does that make these more or less risky?

Conclusion: The risk weighted bank capital requirements have, de facto, 0% to do with credit risk reduction, and 100% to do with risk generating distortions.

If race can be correlated to higher LTV mortgages, does this not de facto imply regulators are engaged in discrimination based on race?

Basel Committee... Good Job!



And we must also ask, are the risk weighted bank capital requirements really in accordance with the spirit of the Equal Credit Opportunity Act (ECOA) or the Community Reinvestment Act (CRA)?



Saturday, January 30, 2021

And the Academia kept silence.

Note: The Basel Committee’s use of the term “capital” in “risk weighted bank capital requirements” has sowed loads of confusions. Its real significance is “risk weighted bank shareholders’ equity/skin-in-the-game requirements". It has nothing to do with in what bank assets it’s invested.


“A ship in harbor is safe, but that is not what ships are for”. John A. Shedd, 1928. Does that not apply for banks too?

For about 600 years banks allocated credit based on risk adjusted interest rates. After risk weighted capital requirements were introduced, they allocate it based on risk adjusted returns on regulatory equity (RORE). Huge distortions ensued! 
And the Academia kept silence.

The risk weighted bank capital requirements are based on perceived credit risks and not on risks conditioned to how bankers react to perceived risks. Clearly the regulators know nothing about conditional probabilities.
And the Academia kept silence.

To delegate so much of the determination of credit risk into the hands of some few human fallible credit rating agencies, had, almost by definition, to introduce into our banking systems, a dangerous systemic risk.
And the Academia kept silence.

Lower bank capital requirements when lending to the government than when lending to citizens, de facto implies bureaucrats know better what to do with credit they’re not personally responsible for than e.g. entrepreneurs
And the Academia kept silence.

Lower bank capital requirements for banks when financing the central government than when financing local governments, de facto implies federal bureaucrats know much better what to do with credit than local bureaucrats.
And the Academia kept silence.

Lower bank capital requirements for banks when financing residential mortgages, de facto implies that those buying a house are more important for the economy than, e.g. small businesses and entrepreneurs.
And the Academia kept silence.

Lower bank capital requirements for banks when refinancing the “safer” present than when financing the “riskier” future, de facto implies placing a reverse mortgage on the current economy and giving up on our grandchildren’s future.
And the Academia kept silence.

When outlook is rosy, investment grade abounds, banks can: hold little capital, leverage a lot, obtain high returns on equity, buy back lots of shares, pay lots of dividends and huge bonuses. When rain starts, junk grades appear… banks will stand naked.
And the Academia kept silence.

And the Academia kept silence.

Could it be that? “One has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” George Orwell

“Assets for which capital requirements were nonexistent, were what had most political support: sovereign credits. A simple ‘leverage ratio’ discouraged holdings of low-return government securities" Paul Volcker


On the Nobel Prize: The Economic Sciences Prize Committee of the Royal Swedish Academy of Sciences selects the Nobel prize winner in economic sciences. That prize was established by Sveriges Riksbank in 1968. The current Governor of said central bank, is Stefan Ingves who, from 2011 until 2019, served as the Chairman of the Basel Committee on Banking Supervision.

Could anyone arguing that what’s perceived as safe is much more dangerous to our bank system (heliocentric) than what’s perceived as risky (geocentric), be nominated for that prize by such a (Inquisition) committee? 
https://subprimeregulations.blogspot.com/2020/12/how-come-we-ended-up-with-stupid.html

PS: With the appearance ChatGPT – Grok, Academia will be asked much more on the why of its almost total silence on the outright dangerous bank regulations. Just wait until their peer reviewed papers get reviewed by #AI.


Since we know all about risks, to make your banks safe, we regulators, we the Basel Committee, we give you our risk weighted bank capital requirements. And the Academia (desperately wanting to be counted among the Pigs on Orwell’s farm) kept silence.

Thursday, January 28, 2021

Five sad musings on the current bank regulations autocratically dictated by central bankers.

It is so hard for me to muster enough interest about central bankers’ monetary policies, while they make these so ineffective by imposing regulations that dangerously distort the allocation of bank credit.

“Credit risk weighted bank capital (equity) requirements” 
translates as 
“Worthy of credit allowed bank capital (equity) leverages”

Their lower bank capital requirements when lending to the government than when lending to citizens, de facto implies bureaucrats know better what to do with credit they’re not personally responsible for than e.g. entrepreneurs... and so are more worthy of it.

Their lower bank capital requirements for banks when financing the central government than when financing local governments, de facto implies federal bureaucrats know much better what to do with credit than local bureaucrats... and so are more worthy of it.

Their lower bank capital requirements for banks when financing residential mortgages, de facto implies that those buying a house are more important for the economy than, e.g. small businesses and entrepreneurs... and so are more worthy of it.

Their lower bank capital requirements for banks when financing the “safer” present than when financing the “riskier” future, de facto implies placing a reverse mortgage on the current economy and giving up on our grandchildren’s future.

And all that for nothing. Those excessive bank exposures that could be dangerous to our bank systems are always built-up with assets perceived or decreed as safe, and never ever with assets perceived as risky.




Thursday, January 21, 2021

Might “availability heuristic” “availability bias” explain the loony risk weighted bank capital requirements?

"The availability heuristic, also known as availability bias, is a mental shortcut that relies on immediate examples that come to a given person's mind when evaluating a specific topic, concept, method or decision. 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.

The availability of consequences associated with an action is positively related to perceptions of the magnitude of the consequences of that action. In other words, the easier it is to recall the consequences of something, the greater those consequences are often perceived to be. Most notably, people often rely on the content of their recall if its implications are not called into question by the difficulty that they experience in bringing the relevant material to mind"

Could that explain why the world, so submissively, has accepted the regulators' bank capital requirements based on that those excessive exposures that could be dangerous to bank systems are built-up with assets perceived risky, and not with assets perceived as safe? 

Has the immediate example of the certainty of Monday Morning Quarterbacks, informing them about the awful consequences of what was very risky after the game, totally blocked regulators from even looking at what was considered as very safe before the game?

Richard Thaler
Cass Sunstein
Daniel Kahneman

Thursday, December 31, 2020

How come we ended up with stupid portfolio invariant risk weighted bank capital requirements?

Which are based on:

That those excessive exposures that can really be dangerous to our bank systems are build up with assets perceived as risky and not with assets perceived as safe.



That substituting risk adjusted returns on equity for risk adjusted interest rates, would not seriously distort the allocation of bank credit.



Though Paul A. Volcker, in his autography “Keeping at it”, valiantly confessed “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”


And here my explanations:

All bank regulators faced/face a furious attack mounted by dangerously creative capital minimizing / leverage maximizing financial engineers, who, getting rid of traditional loan officers, those with their “know your client” and their “what are you going to use the money for?”, managed to capture the banks. (And, since less capital means less dividends, they can also pay themselves larger bonuses.)

Hubris! “We regulators, we know so much about risks so we will impose risk weighted capital requirements on banks, something which will make our financial system safer” Yep, what’s risky is risky, what’s safe is safe. What is there not to like with such an offer? And the world, for the umpteenth time, again fell for demagogues, populists, Monday morning quarterbacks and those who find it so delightful to impress us rolling off their tongues sophisticated words like derivatives.

In a world full of mutual admiration clubs, like the Basel Committee and Academia in general, you do not ask questions that can imply criticism of any of your colleagues or superiors, “C’est pas comme il faut», nor, if you are a high shot financial journalist, do you risk not being invited to Davos or IMF meetings.

"It is difficult to get a man to understand something, when his salary depends upon his not understanding it!" Upton Sinclair

Clearly there are many more jobs with ever growing thousands of pages of regulations than with just a one liner: “Banks shall have one capital requirement (8%-15%) against all assets”. And so, instead of getting rid of the extremely procyclical credit risk weighted capital requirements, they designed new insufficient countercyclical ones.

“The time spent on any item of the agenda will be in inverse proportion to the sum involved." Parkinson’s law

Since bank regulators must have heard of (supposedly) Mark Twain’s “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it looks to rain” it is clear they all missed their lectures on conditional probabilities.


“There are some mistakes it takes a Ph.D. to make”, Daniel Moynihan.

“One has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool”, George Orwell, in Notes on Nationalism


And so now: 

“A ship in harbor is safe, but that is not what ships are for” John A. Shedd, something that should apply to banks too. Sadly, dangerously our bank systems, banks are overpopulating safe harbors and, equally dangerous for our economy, underexploring risky waters. 

“What gets us into trouble is not what we don't know. It's what we know for sure that just ain't so.” Mark Twain

And since current bank capital requirements are mostly based on the expected credit risks banks should clear for on their own; not on misperceived credit risks, like 2008’s AAA rated MBS, or unexpected dangers, like COVID-19, now banks stand there with their pants down.

Let us pray 2021 will not be too hurtful.

PS. Might “availability heuristic” “availability bias” help explain these loony risk weighted bank capital requirements?

Saturday, December 26, 2020

My very brief summary of Basel I, II, III history... and my hopes for a future Basel IV

1988 Basel I (30 pages) decreed risk weighted bank capital requirements with risk weights of 0% the sovereign and 100% citizens, which de facto indicates bureaucrats know better what to do with credit they’re not personally responsible for than citizens.


2004 Basel II (251 pages), (creative capital minimizing/leverage maximizing financial engineers, fooled regulators into believing that the buildup of those excessive exposures that could endanger our bank systems, is done with assets perceived as risky.

2010 Basel III (the current version has so many pieces it’s hard to say how many pages it contains but it's at least 1.600), some small gestures of rationality like a leverage ratio and countercyclical capital buffers BUT, on the margins of bank capital requirements, which is where it most counts, Basel I's and Basel II's distortions are alive and kicking.

202X Basel IV, lets pray they throw Basel I, II and III out, and set a fix bank capital requirement of 10%-15% on absolutely all assets. That would allow the so much needed traditional bank loan officers to return to the banks

Sunday, December 20, 2020

Small businesses (like restaurants) besides Covid-19 lockdowns, when it comes to bank credit, these have also for a long time suffered lockouts

Before Basel Committee’s risk weighted capital requirements, if a residential mortgages and loans small businesses produced the same risk adjusted expected net margin/return on asset (eROA), these would produce the same risk adjusted expected returns on equity (eROE)

That was then: Now, with Basel III a residential mortgage with e.g., a loan to value of 80% to 90%, has a risk weight of 40%; which times the basic 8% requirement, results in a capital requirement of 3.2%, which allows banks to leverage 31.25 times their capital (equity).

While a loan to small businesses have a risk weight of 100%; which results in a capital requirement of 8%, which allows banks to leverage 12.5 times their capital.

So, if the eROA for residential mortgages and loans to small businesses is 1%, then residential mortgages produce a eROE of 31.25%, while loans to small businesses only a eROE of 12.5%

And so, even if interest rates on residential mortgages were reduced by e.g. 0.5%, resulting in a lower risk adjusted expected ROA of 0.5%, residential mortgages, yielding banks a 15.625% risk adjusted eROE, would still be more interesting to banks than loans to small businesses

And therefore, small businesses, in order to access credit, must pay higher interest rates so as to increase the expected risk adjusted ROA, in order to produce banks a competitive risk adjusted eROE.

And so, though the less creditworthy (small businesses/entrepreneurs) always got smaller bank loans and paid higher interest rates but, with risk weighted bank capital requirements, the regulator also decreed them to be less worthy of credit.

What’s the net result of all this? Too much credit at too low interest rates for the purchase of houses, and too little credit to the small businesses/entrepreneurs who could generate the jobs/the incomes/the down-payments, for house buyers to service their mortgages and pay food and utilities.

Conclusion: The risk weighted bank capital requirements have, de facto, 0% to do with credit risk reduction, and 100% to do with risk generating distortions.


Basel Committee… Good Job!

PS. There has too be and adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth.

The Basel Committee for Banking Supervision’s dangerous distortion of the allocation of bank credit, all explained for dummies in just four tweets.

If a safe borrower’s 4% and a riskier borrower’s 6% provide banks the same 1% risk adjusted net margin then, before the introduction of BCBS’s credit risk weighted capital requirements, those would have been the rates charged by banks.

But now, because the “safer” can e.g. be leveraged 25 times while the riskier e.g. only 12.5 times, with those initial rates, the safer will provide banks a 25% risk adjusted return on equity, while the riskier only 12.5%.

So, now the safer could be offered less than a 4% rate, even down to 3.5% (new risk adjusted net margin of .5%) and still be competitive vs. the riskier when accessing bank credit, and/or be awarded too much credit… which could (will, sooner or later) turn him risky.

And the riskier will now have to pay 7% (new risk adjusted net margin of 2%) in order to remain competitive vs. the safer, which would make him even riskier, or not have access to credit at all, which could hurt the growth possibilities of the real economy



Saturday, December 12, 2020

Basel Committee’s members, when will they ever learn, when will they ever learn?

On their own, banks would naturally charge higher interest on residential mortgages to those with higher loan to value ratios (LTV) than to those with lower LTVs. 

But with Basel III, the first will be charged even higher rates, in order to compensate for the fact that banks are now allowed to leverage more with lower LTVs; which means it's easier for banks to obtain higher risk weighted returns on equity with “safer” lower LTVs.

That makes the riskier even more risky, and, by lowering the risk adjusted interest rate they would pay without this regulatory distortion, could even turn the “safer” into becoming very risky. 

When will the Basel Committee ever learn that any risk, even if perfectly perceived, will lead to the wrong responses, if excessively considered?

When will the Basel Committee ever learn that what’s dangerous to our bank system is not what’s perceived as risky, but what’s perceived as safe?

Thursday, December 3, 2020

About prices in kid’s lemonade stands and interest rates on sovereign debt

If a mother gives her children lemons for them to make lemonade to sell, and then their grandfather comes to their stand and buys lemonade at an extravagant price, would any economist refer to that as the market price of lemonade in lemonade stands? I hope not.

And if regulators allow banks much lower capital requirements when holding Treasuries/Gilts than when holding loans to citizens, and then Fed/BoE with their quantitative easing, QEs, buys up loads of Treasuries/Gilts, are the low interests on these, free market rates?


@PerKurowski

Thursday, October 8, 2020

Any risk, even if perfectly perceived, causes the wrong answer to it, if excessively considered.

Any risk, even if perfectly perceived, causes the wrong action, if excessively considered.

“A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it looks to rain” Mark Twain (supposedly)

And Mark Twain is right in that bankers, in general are risk adverse and, when they accept taking some, it is usually in small amounts and against high risk premiums.

And, for around 600 years, bank credit was allocated, usually with a view on the portfolio, based on risk adjusted net interest rates.

But then, in 1988 with Basel I, the Basel Committee introduced (I would say ‘concocted’ is a more precise term) the concept of risk weighted bank capital requirements, based on exactly the same credit risk aversion.

With that the regulators ignored that any risk, even if perfectly perceived, causes the wrong answer to it, if excessively considered.

If Twain was alive he could just as well be writing: “A bank regulator is a fellow that allow banks to hold little capital when the sun is shining, so that banks can pay lots of dividends and buy back lots of stock, but wants banks to hold much more capital, the moment it starts to rain”

And, since then, bank credit is allocated based on risk adjusted returns on equity and, of course, the higher the allowed leverage is the easier it is to obtain a higher return on equity.

John A. Shedd (1859 – 1928) wrote “A ship in harbor is safe, but that is not what ships are for”. And that should also apply to banks. Unfortunately, these capital requirements guarantee that banks stay in safe harbors, running the risk of dangerously overcrowding these, and stay away from the risky oceans, and most certainly not lending enough to those “risky” entrepreneurs and SMEs on which our real economies so much depend.

In his book “Money: Whence it came, where it went” (1975), John Kenneth Galbraith wrote “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”


And it’s all so much worse. With their much lower bank capital requirements on loans to governments than on loans to citizens, statist/communist/ fascist regulators de facto imply bureaucrats/politicians know better what to do with credit for which repayment they’re not personally responsible for, than e.g. entrepreneurs.

And it is all so stupid. There’s never ever been a major bank crisis caused by the buildup of excessive exposures to what’s perceived as risky, those exposures have always been built up with assets perceived as safe.

The regulators, by basing most of their pro-cyclical bank capital requirements on perceived credit risks; not on misperceived credit risks, or unexpected dangers, like a pandemic, guaranteed all banks now stand there with their pants down. Basel Committee, Good Job!



Wednesday, September 9, 2020

My #CatoFinReg tweets during “The Evolution of Banking: The 2020 Cato Summit on Financial Regulation”


Many of these tweet were retweeted and or liked by @CatoEvents and @CatoCMFA, something that I much appreciate. 
That said, I do believe the “risk weighted bank capital requirements”, merit a public discussion that is long overdue.


Why does the Emperor wear no clothes?
Why do regulators base their risk weighted bank capital requirements on that what’s perceived as risky is more dangerous to our bank system than what’s perceived as safe?


Should for instance Texas be happy with that banks in Texas have to hold much more capital (equity) when lending to Texan entrepreneurs than when lending to a AAA rated corporation elsewhere or to the Federal government?


Regulators based bank capital requirements mostly on perceived credit risk banks, not on misperceived credit risks, or unexpected dangers, like Covid-19… so now banks stand there with pants down, with no capital to support lending… when most needed


Lower bank capital requirements on loans to the government than on loans to entrepreneurs, de facto implies bureaucrats/politicians know better what to do with credit they’re not personally responsible for, than entrepreneurs. 
Do they really?


The risk weighted bank capital requirements improve opportunities of credit of… “those that have the most political support, sovereign credits and home mortgages” Paul Volcker, 2018. 
Have not federal regulators exceeded their authority when doing so?



Sunday, April 19, 2020

A letter in Washington Post: The capacity to borrow at reasonable interest rates is a strategic sovereign asset

In his April 12 op-ed, "How economists led us astray" Robert J. Samuelson wrote, "What we conveniently overlooked was the need to preserve our borrowing power for an unknown crisis that requires a huge infusion of federal cash."

Yes, the capacity to borrow at a reasonable interest rate (or the seigniorage when printing money) is a very valuable strategic sovereign asset, and it should not be squandered away by benefiting the members of the current generations or with some nonproductive investments. 

So, when public borrowings are authorized, that should require Congress being upfront that a part of that borrowing capacity is being consumed, which has a cost, and give an indication of who (children or grandchildren born what year) are expected to have to pay back that debt.

Mr. Samuelson also referred to "low dollar interest rates [that] will keep down the costs of servicing the debt." Sadly, those current "low dollar interest rates" are artificial rates, much subsidized in that since 1988, with Basel I regulations, banks are not required to hold any capital against Treasuries, and of course subsidized by the Federal Reserve purchasing huge quantities of Treasuries.

PS. A reverse mortgage on our children’s and grandchildren’s future

Friday, April 3, 2020

What if golf, roulette, horse-racing or tennis, had fallen into the hands of a Basel Committee?

What would have happened to golf, if its handicap system had fallen into hands as those of the Basel Committee who designed the risk weighted bank capital requirements?

What would have happened to casinos, if odds settings, like for roulette, had fallen into hands as those of the Basel Committee who designed the risk weighted bank capital requirements?

What would have happened to horse racing, if the handicapping of horses with weights had fallen into hands as those of the Basel Committee who designed the risk weighted bank capital requirements?

What would have happened to tennis, if the ranking of the players had fallen into hands of those of the Basel Committee who designed the risk weighted bank capital requirements?

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