Five comments on Patrick Jenkins “Failure to learn lessons of 2008 caused LDI pension blow-up”

Five comments on Patrick Jenkins “Failure to learn lessons of 2008 caused LDI pension blow-up”. Not sent by a letter to the Financial Times.

“There’s no such thing as risk-free” 

Especially if you take into account that e.g., major bank crises always result from the build-up of dangerously excessive exposures with assets perceived or decreed by regulators as especially safe.

“Ultra-low interest rates have obscure side-effects”

Indeed, especially when those ultra-low interest rates are the result of manipulations. The current risk-free rate has nothing to do with the risk-free rate before risk weighted bank capital requirements and QEs.

“A leveraged bet — to ‘juice’ otherwise low returns”

“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

“In the UK, the government wants to make it easier for pension funds and life insurers to invest in riskier assets”

And it should be done, but only by removing the artificialities that have pension funds, life insurers and banks investing excessively in “safe” assets.

“Amateurish governance is dangerous. One of the lessons of bank failures in 2007-8 was that expertise matters”

No! Trusting too much the expertise, e.g., credit rating agencies, introduces a much more dangerous systemic risk.

And I could make many more similar comments.

Britannia, to have a chance to become its former self, needs to free its financial systems from its mis-regulators.

Sir, Martin Wolf asks: “Britannia is not ‘unchained’. It is instead sailing in perilous waters. Can the new captain and first mate even see the rocks that lie ahead?” “The economic consequences of Truss” FT September 21.

Wolf writes: “Thatcher and those who followed her allowed the search for safety in corporate pensions to shift portfolios away from the supply of risk capital to business to ownership of government bonds. This in effect turned the plans into state-backed pay-as-you-go schemes.”. 

Sir, more than three decades late Martin Wolf seems to notice that huge rock of Basel I that, for its risk weighted bank capital requirements, decreed weights of 0% government, 30% residential mortgages and 100% citizens. Better late than never… but really?

These bank capital requirements are based on that what’s perceived as risky, e.g., loans to small businesses and entrepreneurs are more dangerous to bank systems than what’s perceived as safe, e.g., government debt and residential mortgages.

That de facto translates into it being much more important for banks to hold government debt and residential mortgages than loans to small businesses and entrepreneurs. Something which, with Solvency II, applies to its insurance companies too. Really, is that how Britannia got to be strong?

Sir, the Western world’s banks were taken from the hands of savvy loan officers who knew their first duty was to know their clients and understand what their loans were going to be used for and placed into the hands bank own capital minimizing/leverage maximizing dangerously creative financial engineers.

“UK has a deregulated economy… in which the successful are well rewarded, but those who do less well are penalised. Such Thatcherite aims then are now a reality” No! Bank regulators reward those ex-antes perceived or decreed as safe over those perceived as risky. That has zero to do with their ex-post success. Has the UK's public debt been well employed?

Let’s hope someone like Liz Truss dares to set aside whatever mandates she might have, no matter how worthy these might be, in order to tackle a real financial regulatory reform.

Sir, what would Edmund Burke with his intergenerational social contract have opined about prioritizing the refinancing of the “safer” present over the financing of the riskier future?   

 

Why does the world ignore regulations that totally disrupt the allocation of bank credit?

Sir, I refer to Martin Wolf’s “Shocks from war in Ukraine are many-sided. - The conflict is a multiplier of disruption in an already disrupted world” FT April 27.

The concentration of human fallible regulatory power in the Basel Committee has, since 1988, resulted in bank capital requirements mostly based on that what’s perceived as risky e.g., loans to small businesses and entrepreneurs, is more dangerous to our bank systems than what’s perceived or decreed as safe e.g., government debt and residential mortgages; and not on misperceived risks or unexpected events, like a pandemic or a war. 

What can go wrong? I tell you Sir.

When times are good and perceived risks low, these pro-cyclical capital requirements allow banks to hold little capital, pay big dividends & bonuses, do stock buybacks; and so, when times get rough, banks stand there naked, just when we need them the most.

And of course, meanwhile, these capital requirements, by much favoring the refinancing of the safer present over the financing of the riskier future, have much disrupted the allocation of credit

Why has the world for decades ignored this amazing regulatory mistake?

Sir, perhaps you could ask Martin Wolf to explain that to us.

PS. Two tweets today on bank regulators’ credit risk weighted bank capital requirements.

What kind of banks do we want?

Banks who allocate credit based on risk adjusted interest rates?

Or banks who allocate credit based on risk adjusted returns on the equity that besserwisser regulators have decreed should be held against that specific asset?

https://subprimeregulations.blogspot.com/2021/01/and-academia-kept-silence.html

Bank events' matrix

What’s perceived risky turns out safe

What’s perceived risky turns out risky

What’s perceived safe turns out safe

What’s perceived safe turns out risky

Which quadrangle is really dangerous?

Covered by current capital requirements?

NO!

https://youtu.be/TUdKhm6_a8Y

FT, on banking and finance who are you to believe, Francis Fukuyama or Paul Volcker?

Sir, Francis Fukuyama in “The war on liberalism” FT March 5, writes:

“Liberals understand the importance of free markets — but under the influence of economists such as Milton Friedman and the “Chicago School”, the market was worshipped and the state increasingly demonised as the enemy of economic growth and individual freedom. Advanced democracies under the spell of neoliberal ideas trimmed back welfare states and regulation, and advised developing countries to do the same under the “Washington Consensus”. Cuts to social spending and state sectors removed the buffers that protected individuals from market vagaries, leading to big increases in inequality over the past two generations.

While some of this retrenchment was justified, it was carried to extremes and led, for example, to deregulation of US financial markets in the 1980s and 1990s that destabilised them and brought on financial crises such as the subprime meltdown in 2008.”

Paul A. Volcker in his autobiography “Keeping at it” of 2018, penned together with Christine Harper, with respect to the risk weighted bank capital requirements he helped to promote and which were approved in 1988 under the name of Basel I 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."

Sir, in reference to advising developing countries with the “Washington Consensus”, in November 2004 you kindly published a letter in which I wrote:

“Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it 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.”

So, there are two completely different bank systems:

Before 1988, one in which banks needed to hold the same capital against all assets, credit was allocated based on risk adjusted interest rates and the market considering the bank’s portfolio, accurately or not, values its capital.

After 1988, one risk weighted capital requirement banks where credit is allocated based on risk adjusted returns on equity, something which clearly depends on how much regulators have allowed their capital to be leveraged with each asset... clearly favoring government credit, which de facto implies bureaucrats know better what to do with (taxpayers') credit than e.g., small businesses and entrepreneurs. Communism!

Sir, I am of course just small fry, not even a PhD, but, if you have to choose between describing what has happened in the financial markets since 1988 as a “deregulation”, as Fukuyama opines, or an absolute statist and politically influenced misregulation, as Volcker valiantly confesses, who do you believe?

Sir, is this topic taboo… or just a too hot potato for the “Without fear and without favour” Financial Times?

PS. In Steven Solomon’s “The Confidence Game” 1995 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…”

@PerKurowski

How can you hold governments accountable, while their borrowings are being non-transparently subsidized?

Sir, Aveek Bhattacharya discusses various options to improve the productivity and effectiveness of public spending. “A future case for the ‘retro’ policy of public sector reform” FT February 18, 2022.

He fails to mention: Current bank capital requirements are much lower for loans to the government than for other assets. This translates into banks being able leverage much more their capital – and so making it easier for them to earn higher risk adjusted returns on equity when lending to the government than when lending to the citizens. That, which de facto implies bureaucrats know better what to do with credit they’re not personally responsible for than e.g., small businesses, turns into a subsidy of the interest rates government has to pay on its debts. Top it up with that the quantitative easing carried out by central banks is almost all through purchases of sovereign debt, and then dare think of what sovereign rates would be in the absence of such distortions.

Sir, if you really want to make your government more accountable, have them at least know what their real borrowing costs are.

Sir, in a letter you published in 2004, soon two decades ago I asked “How many Basel propositions will it take before regulators start realizing the damage, they are doing by favoring so much bank lending to the public sector?” Do you think this only applied to developing nations? If so, please open your eyes.

@PerKurowski

The Basel Committee blocks development

I refer to Aleksandr V Gevorkyan’s “Small economies require new development model” November 5.

What would FT opine on a development model that include bank regulations based on:

1.- Bureaucrats know better what to do with credit than entrepreneurs; 

2.- It is better to refinance the safer present than financing the riskier future, and 

3.- Residential mortgages are more important than small business loans?

I ask because that’s precisely what the credit risk weighted bank capital requirements ordain, those globally marketed by the Basel Committee and capital minimizing/leverage maximizing financial engineers.

Do you really think the developed world would have been able to develop as much with those regulations? Is not risk-taking the oxygen of all development?

On another topic Gevorkyan mentions “involving the entrepreneurial and investment potential of the large expatriate community (diaspora) that is now a feature of most small economies.” Absolutely but, let us not ignore the sad fact that in many countries it is the family remittances that help to keep in power the governments that caused the diaspora to have to emigrate.

PS. At the High-level Dialogue on Financing for Developing at the United Nations, New York, October 2007, I presented a document titled “Are the Basel bank regulations good for development?” Fourteen years later, that question is still not discussed

The history I’ll tell my grandchildren has little to do with Philip Stephens’ history.

Sir, Philip Stephens writes: “Twenty-five years ago… the world belonged to liberalism. Soviet communism had collapsed. Historians will record the 2008 global financial crash as… the moment western democracies suffered a potentially lethal blow. The failure of laissez-faire economics was visible before the collapse of Lehman Brothers.” “The west is the author of its own weakness” Financial Times, October 1, 2021.

The history I will be telling my grandchildren is quite different.

Thirty-three years ago, the world belonged to liberalism and Soviet communism was collapsing. Historians will record how in 1988, one year before the Berlin Wall fell, the western world’s bank regulators introduced risk weighted bank capital requirements that distorted the allocation of credit. That put an end to any laissez-faire economics. With risk weights of 0% the government and 100% citizens, as if bureaucrats know better what to do with credit than e.g., entrepreneurs, communism took over. 

The 2008 global financial crash resulted from banks being allowed to leverage their capital/equity/skin-in-the game a mind-boggling 62.5 times, with assets that human fallible credit rating agencies had assigned a AAA to AA rating.

Yes, the west is the author of its own weakness… it much renounced to the willingness to take risks that had made it great. 

Sadly though, there are way too many interested in not disclosing what really happened… and therefore our banks are still in hand of insane risk aversion. “Insane”? Yes, because those excessive exposures that could become dangerous to our bank systems, are always built-up with assets perceived as safe, never ever with assets perceived as risky.

PS. My 2019 letter to the Financial Stability Board

Spurn bank regulators' false promises.

Sir, Martin Wolf makes a good case for “We should not throw liberal trade away for the wrong reasons and in the wrong way”, “Spurn the false promise of protectionism” FT June 16.

Yet, when regulators, decades ago, decided to throw liberal access to bank credit, by imposing credit risk weighted bank capital requirements, something which completely distorted the access to bank credit, Wolf and 99.99 percent of those who should have spoken up, kept mum.

Though I’ve no idea whether they read it, in a 2019 letter I wrote to the Executive Directors and Staff of the International Monetary Fund, I argued that these risk weights are to access to credit, precisely what tariffs are to trade, adding “only more pernicious” 

Wolf writes that “the US economy has suffered from high and rising inequality and a poor labour force performance” and includes among other explanations the “rent-extracting behaviour throughout the economy”

But anyone who reads “Keeping at it” 2018 in which Paul Volcker’s 2018 valiantly confessed: “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”, should be able to understand that rent-extraction also occurs by means of cheaper and more abundant access to credit.

And boy did regulators throw away unencumbered access to credit in “the wrong way”

Here follows four examples: 

To establish their risk weights, they used the perceived credit risks, what’s seen “under the street light” while, of course, they should have used the risks for banks conditioned on how credit risks were perceived. 

By allowing banks, when the outlook was rosy, to hold little capital, meaning paying high dividends, lots of share buy backs, and huge bonuses, they placed business cycles on steroids.

Very little of their capital requirements cover misperceived credit risks or unexpected events. Therefore, just as in 2008 with the collapse of AAA rated mortgage back securities, and now with a pandemic, banks were doomed to stand there with their pants down.

With risk weights of 0% the sovereign and 100% the citizens, which de facto imply bureaucrats know better what to do with credit they’re not personally responsible for than e.g., entrepreneurs, they smuggled communism/statism/fascism into our banking system.

“We will make your bank systems safe with our credit risk weighted bank capital requirements” Sir, what amount of wishful thinking must have existed for the world, its Academia included, to so naively have fallen for the hubristic promises of some technocrats.

@PerKurowski

Central banks and regulators cancelled the creative part of destruction.

I refer to Martin Wolf’s comments on Philippe Aghion, Céline Antonin and Simon Bunel’s “The Power of Creative Destruction”, “The innovation game” FT June 11, 2021 

John Kenneth Galbraith in “Money: Whence it came where it went” of 1975 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]” That’s creative destruction in action.

The current risk weighted bank capital requirements allow banks to earn much higher risk adjusted returns on equity when financing what’s perceived (or decreed) as safe e.g., loans to the government and residential mortgages, than when lending to the “risky” small businesses and entrepreneurs. That’s creative destruction inaction. 

Would the development Galbraith describes have been possible with these regulations? No! Such risk-averse regulations do not help promote innovations.

Sir, in august 2006, in reference to an FT editorial mentioning the possibilities and impact of a “global housing slowdown”, you published a letter I wrote in which I referred to “The long-term benefits of a hard landing.” When the global financial crisis erupted in 2008, there was too much interest in trying to avoid collecting any of these benefits, and the crisis-can was kicked forward... and then much upward with QEs. 

The result? Way too little creative destruction and way too many surviving zombies… and here we are, on a much higher mountain of public and private debt. That will cause pure destruction.

“Risk weighted bank capital requirements”. Sir, if that’s not sophisticated technocratic demagoguery, what is?

Bank regulators never considered the unexpected, like a pandemic

Sir, Angela Merkel, Justin Trudeau and Erna Solberg opine: “The Covid-19 pandemic has taught us that the costs of prevention and early response are small compared with the consequences of under-investment.” “G7 should pay lion’s share of costs to help end the pandemic” FT June 10.

That’s correct but it should not have taken a pandemic to understand that banks need also to have sufficient capital so as to be able to respond to unexpected events. Unfortunately, instead of basing their bank capital requirements on such possibilities, or on that of misperceived credit risks e.g., 2008’s AAA rated mortgage-backed securities, bank regulators, the Basel Committee, doubled down on perceived credit risks, those which were already being cleared for by banks. 

The result? Though so many don’t want the innocent child to be heard, the banks now stand there naked.

Sir, again, if what’s perceived as safe is safe, and what’s perceived as risky is risky, would banks need capital. Not much. 

Bank regulations need a complete overhaul, meaning going back to the humbling reality of risks being hard to measure; instead of digging us down even deeper in the hole with Basel IV, Basel V and so on.

PS. July 12, 2012 Martin Wolf wrote: “Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk.” Martin Wolf clearly heard me, but he did not listen.

@PerKurowski

It’s sad when we need to remind regulators to prepare for the unexpected

“The time to prepare for the next threat is now”, that’s how Bill Emmott ends his “How to build global resilience after the pandemic” FT, May 25.

Sir, Mark Twain, supposedly, said: “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”

Today, if alive, with respect to Basel Committee’s risk weighted bank capital requirements, Mark Twain would have opined: “A bank regulator is a fellow who allows banks to hold little capital when the sun shines, so these can pay lots of bonuses and dividends and buy back lots of stock, but wants banks to hold much more capital, the moment the rain starts”

PS. Emmott writes “But there must be an international accord on debt restructuring, akin to the Brady Plan in the early 1990s.” I lived through that restructuring. It was made feasible by developing countries being able, because US$ interest rates were high, to very inexpensively purchase US$ 30 years zero coupon bonds issued by the US, in order to guarantee the repayment of the principal of their debts. In a world of ultra-low, even negative interest rates, what’s the price of such bonds?

@PerKurowski

Should the Louvre, a homage to inequality, have to be culturally cancelled?

Sir, I refer to Ruchir Sharma’s “The billionaire boom” FT Weekend, May 15.

In this case, as so often happens in articles about the wealthy, it is illustrated with yachts.

As likewise always happens, the fact that the wealthy froze their earned in “good or bad industries” money, or their outright ill-gotten money, by handing it over to those building or selling the yachts, and most probably committing to employing a yacht crew, is an issue of no interest. 

Just as with respect to taxes on wealth the question of what assets and to whom are the wealthy to sell these in order to raise the money to pay for the taxes on wealth it, is scrupulously avoided by the tax proponents.

Where the wealthy’s money flows, should be an integral part of the overall analysis. Then we would be more alert to the possibility that taxing it, and handing over the money to bureaucrats, for them to decide on its use, could lead to the most unproductive use of wealth.

Sir, a personal anecdote. Walking around the museum Louvre in Paris I suddenly saw an 1560 by Pierre Reddon for King Charles IX. I then asked myself who in his sane mind would request this type of absolutely useless shield? Clearly it had to be someone extremely wealthy and powerful, someone who did not care one iota about his own security being threatened on a close range, or about its enormous costs.

https://collections.louvre.fr/en/ark:/53355/cl010117233

In that moment it suddenly dawned on me that basically nothing of what I was seeing at the museum would exist, if it had to be produced by a society where income and wealth was equally distributed. In other words, all this art around me, to have become a reality, has actually required a very unequal society. 

In other words, Shhh... just between you and me Sir... since the museum of Louvre is, unwittingly, a homage to inequality, should it be cancelled?

PS. Sharma writes “Sweden has long abandoned central elements of the social democratic agenda, including wealth and inheritance taxes, as impractical.” There might indeed have been certain policy intermezzos, but legend holds that when Otelo Saraiva de Carvalho, chief strategist of the 1974’s Carnation Revolution in Lisbon, told Sweden’s social democrat leader Olof Palme: “In Portugal we want to get rid of the rich”, Palme replied, “how curious, in Sweden we only aspire to get rid of the poor”

PS. And, as I have written to you soon 3.000 times, those “subprime banking regulations”, with their risk weighted capital requirements, impede that much of that money the wealthy are sloshing around, is efficiently allocated to the real economy. Now, whose fault is that?

@PerKurowski

The “Parable of talents” is currently quite inapplicable to any wealth tax.

Sir, I refer to “Why the toughest capitalists should root for a wealth tax” Martin Sandbu, FT, May 10.

Much of the current wealth is the direct result of huge liquidity injections, and which are distorted by risk weighted bank capital requirements that, among other, so much favors the debts of the government over debts to the citizens… all as if bureaucrats/politicians know better what to do with credit for which repayment they are not personally responsible for, than e.g., small businesses and entrepreneurs.

To favor such wealth tax, besides removing such distortions, I would also like to know what assets, and to whom, the wealthy should sell in order to raise the money to pay such taxes… and what would be the resulting overall productivity of such resource transfer. I believe a full review of the current productivity of all government spending is long overdue.

So, in this respect, taxing wealth with its revenues seemingly not being sufficiently productive, an understatement, sort of reminds me of a Harry Belafonte & Odetta song titled A hole in the Bucket

Sandbu also writes that “a net wealth tax…is the tax version of the New Testament’s parable of the talents” I’m not at all sure that’s currently really so.

I extract the following from Matthew 25: 24-27: 24 “Master,’ 25 I was afraid and went out and hid your gold in the ground. 26 “His master replied, ‘You wicked, lazy servant! So, you knew that I harvest where I have not sown and gather where I have not scattered seed? 27 Well then, you should have put my money on deposit with the bankers, so that when I returned, I would have received it back with interest.”

First, we now have regulators who, with bank capital requirements, tell banks that when they scatter and sow, they should be risk averse, guarding it all in safe gold, e.g., loans to governments and residential mortgages; staying away from what’s risky, e.g., entrepreneurs and small businesses.

Second, to top that up, with QEs central banks are injecting money thereby keeping interest rates ultra-low.

So, are we allowing bankers to exploit their talents? No! 

Will that produce good interest rates for the depositors? No! 

And if inflation takes off, will they receive their real money back? No!

Sir, with respect to risk taking, and even though I am a protestant, let me finally quote Pope John Paul II: Our hearts ring out with the words of Jesus when one day, after speaking to the crowds from Simon's boat, he invited the Apostle to "put out into the deep" for a catch: "Duc in altum" (Lk 5:4). Peter and his first companions trusted Christ's words, and cast the nets. "When they had done this, they caught a great number of fish" (Lk 5:6).

About Italy, there are serious questions that FT, and others, should not silence.

Sir, I refer to “Draghi plots €221bn rebuilding of Italy’s recession ravaged economy” Miles Johnson and Sam Fleming, and to “Europe’s future hinges on Italy’s recovery fund reforms”, Andrea Lorenzo Capusella, FT April 22, and to so many other articles that touch upon the issue of Italy’s future, in order to ask some direct questions.

Do you think Italy’s chances of a bright future lies more in the hands of Italy’s government and its bureaucrats, than in hands of e.g., Italian small businesses and entrepreneurs?

I ask this because, with current risk weighted bank capital requirements, regulators, like Mario Draghi a former chairman of the Financial Stability Board, arguably arguing Italy’s government represents less credit risk, do de facto also state it is more worthy of credit. I firmly reject such a notion.

Yes, Italy clearly shows a stagnant productivity, but could that be improved by in any way increasing its government revenues?

Italy, before Covid-19, showed figures around 150% of public debt to GDP and government spending of close to 50% of GDP. I am among the last to condone tax evasion… but if Italian had paid all their taxes… would its government represent a lower share of GDP spending, and do you believe its debt to GDP would be lower?

One final question: Sir, given how Italy is governed, excluding from it any illegal activities such as drug trafficking, where do you think it would be without its shadow eeconomy, its economia sommersa? A lot better? Hmm!

PS. As you know (but seemingly turn a blind eye to), Italy’s debt, even though it cannot print euros on its own, has, independent of credit ratings, been assigned by EU regulators, a 0% risk weight.

If our pied-à-terre falls into the hands of a Climate Stability Board, we’re toast.

Climate change dangers require:

Spending fighting it, trying to hinder it 

Spending adapting to it, to avoid its worst consequences

Saving, in order to be able to mitigate its worst effects

How should we budget for that to best avoid ending up toast?

Sir, let me begin with a very brief take on the last three decades of bank regulations.

“A ship in harbor is safe, but that is not what ships are for” John A. Shedd. 

And neither are the banks, but that was ignored.

Before Basel Committee’s risk weighted bank capital requirements, everyone, whether perceived as a risky or as a safe credit, paid risk adjusted interest rates. After these were introduced, bank credit is allocated based on risk adjusted returns on equity.

The “safe”, meaning e.g., governments (bureaucrats/politicians), assets with high credit ratings and residential mortgages, pay relatively lower rates, because banks can leverage their capital/equity many times more with the net margin they provide. The “risky”, meaning e.g., small businesses and entrepreneurs, must pay comparatively higher rates, in order to compensate for the fact that banks must leverage less capital/equity with their net margins.

That has caused banks to overpopulate the safe harbors of the past and present, and to explore the riskier oceans much less than the future of our children and grandchildren needed.

Of course, all for nothing, since those excessive exposures that can become dangerous to our bank systems, are always built up with assets perceived as safe, never ever with assets perceived as risky.

And since current bank capital requirements are mostly based on expected credit risks banks should clear on their own; not on misperceived credit risks, 2008’s AAA MBS, or the unexpected, COVID-19, banks now stand there naked, though few dares to call out the Emperor on that.

So, how did we end up with all this? There are many reasons but, if I must pick one, that would be, “mutual admiration clubs”.

Sir, in November 2004 you published a letter in which I wrote: “The Basel Committee is just a mutual admiration club of firefighters seeking to avoid bank crisis at any cost - even at the cost of growth. Unwittingly it controls the capital flows in the world, and I wonder when will it realize the damage they’re doing, by favoring so much bank lending to the public sector.”

In “A new dawn for globalization” FT, Life & Arts, March 20, Mark Carney is allowed to write: “As chairs of the Financial Stability Board, Mario Draghi and I were at the forefront of efforts to reform the global financial system. Our aim was a system that once again valued the future, financed innovation and was prepared to take action in the event of failure. As its performance during the Covid-19 crisis has demonstrated, although far from perfect, the financial system is now safer, simpler and fairer”

If that’s not spoken as a member of a club that will not call him out on anything, what is?

And now Carney wants “a set of networks that can turn the existential threat of climate change into the greatest commercial opportunity of our time… and the Institute of International Finance’s Taskforce on Scaling Voluntary Carbon Markets is developing a large-scale, high-integrity carbon offset market.”

A new powerful mutual admiration club, backed enthusiastically by all climate-change fight profiteers. Scary indeed!

PS. As I read it, Pope Francis, when nailing his “Encyclical Letter LAUDATO SI’” to the web, denounced carbon credits to be just like the indulgences Martin Luther protested, when he nailed his “95 Thesis” to the church door.

PS. Why do you not ask Mark Carney to comment on Chris Watling’s “Now is the time to devise a new monetary order”, FT, March 19.

@PerKurowski

A new monetary order requires the old regulatory order.

I refer to Chris Watling’s “Now is the time to devise a new monetary order” March 19.

Sir, it is hard for me to understand how Watling, correctly pointing out so many distortions in the allocation credit and liquidity, can do so without specifically referencing the role of the risk weighted bank capital requirements.

For “the world economy [to] move closer to a cleaner capitalist model where financial markets return to their primary role of price discovery and capital allocation is based on perceived fundamentals”, getting rid of Basel Committee’s regulations is a must.

For such thing to happen, discussing and understanding how distorted these are, is where it must start.

E.g., Paul Volcker, in his 2018 “Keeping at it” penned together with Christine Harper valiantly confessed: “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”.

Sir, why is that opinion of Volcker rarely or perhaps even never quoted? Could it be because in a mutual admiration club it’s not comme-il-faut for a member to remark “We’re not wearing any clothes?

Volcker mentions “The US practice had been to assess capital adequacy by using a simple ‘leverage ratio’- capital available to absorb losses on the bank’s total assets”

Going back there, would return banks to loan officers; and send all those dangerously capital minimizing/leverage maximizing creative financial engineers packing.

My 2019 letter to the Financial Stability Board

My 2019 letter to the IMF

@PerKurowski

 

Bank capital requirements or bank leverage allowances?

Martin Wolf referring to Windows of Opportunity by David Sainsbury writes that growth is “exploiting new opportunities that generate enduring advantages in high-productivity sectors and so high wages… developing something fundamentally new is often costly and risky” “Why once successful countries get left behind” February 22.

Indeed, but as Pope John Paul II, in his Apostolic Letter "Novo Millennio Ineunte" reminded us of the words of Jesus when one day, he invited the Apostles to "put out into the deep" for a catch: "Duc in altum" [and] "When they had done this, they caught a great number of fish".

Sir, “risk weighted bank capital requirements” reads like a very sophisticated tool that, when it comes to keeping our bank systems safe, is expected to assure great prudence. For instance, a 20% risk weight assigned to AAA rated asset and 100% to loans to unrated entrepreneurs and using Basel Committee’s basic 8% capital requirement, translates into 1.6% in capital for AAA rated assets and 8% for loans to unrated entrepreneurs. At first sight, that seems quite reasonable, because of course AAA rated could be five times riskier than what’s not rated.

But there is another side of that coin, that of a very costly risk-taking avoidance. It becomes much clearer if we label the former as “risk weighted bank leverage allowances”. 

Doing so we observe banks are allowed to leverage 62.5 times to one with assets rated AAA, but only 12.5 times with loans to unrated entrepreneurs. The question then is: if banks are allowed to leverage 50 times more their capital with AAA rated assets, why would any bank lend to unrated entrepreneurs, that is unless these pay much more in interest rates would in order to make up for that regulatory discrimination?

Sir, John A. Shedd wrote “A ship in harbor is safe, but that is not what ships are for” and I am sure FT agrees that applies to banks too. Unfortunately, current regulations have banks dangerously overpopulating “safe” harbors, e.g. residential mortgages, while leaving those deep waters that need to be explored in order for once successful countries not ending up left behind.

PS. Much as I already wrote 2009 in Martin Wolf's Economic Forum. 

Basel Committee’s risk weighted bank capital requirements is fodder for our wishful thinking hopes.

I refer to Tim Harford’s “From forgeries to Covid-denial" On how we fool ourselves: Whether believing implausible statistics or falling for frauds, humans are addicted to wishful thinking” FT, January 30, 2021.

Sir, I ask, the Basel Committee’s risk weighted bank capital requirements, could that just be a forgery made to satisfy our deep wishes of our banks always being safe?

Now why so little objections? Edward Dolnick explained it with: “Experts have little choice but to put enormous faith in their own opinions. Inevitably, that opens the way to error, sometimes to spectacular error.”

By the way. Where has Academia been on all the regulatory distortion of the allocation of bank credit?

Macroeconomic theory stands no chance while autocratic regulators distort the allocation of bank credit.

Sir, in reference to Martin Sandbu’s “The revolutions under way in macroeconomics”, January 28, I must ask: What macroeconomic theory stands a chance against the Basel Committee’s risk weighted bank capital requirements? 

Lower bank capital requirements when lending onto 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. 

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.

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.

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.

https://subprimeregulations.blogspot.com/2019/07/risk-weights-are-to-access-to-credit.html

@PerKurowski

What America (and much of the rest of the world) needs is to free itself from the clutches of statist/communist bank regulators.

Sir, Martin Wolf, opines that “Joe Biden may be a last chance for US democracy” “Competency is Biden’s best strategy” January 27. 

Oh, if only all was that easy and in Biden’s hands. When compared to what some dark hands through bank regulations are doing to America (and to much of the world), both Donald Trump and Joe Biden are small fry.

Paul Volcker in his 2018 autography “Keeping at it” 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”. Volcker continued with “Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011”. That compared to all other that has been said about and quoted from Paul Volcker, has been totally ignored, or outright censored. 

But what does it really mean?

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. 

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.

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.

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.

Sir, I just ask, would America have even remotely become the great land it is, if that kind of risk adverse bank regulations had welcomed the immigrants when arriving at Ellis Island / Liberty Island... to the Home of the Brave?

Wolf also uses new-confirmed Treasury secretary, Janet Yellen, to endorse what he himself have argued so many times namely: “With interest rates at historic lows, the smartest thing we can do is act big” Again, where would those historic low rated be without the Fed’s QEs and without the regulatory favors mentioned? Really? Historic lows or historical communist subsidies?

PS. Not the first time (nor probably the last) I've written to Martin Wolf on this.

@PerKurowski