Monday, March 20, 2017

How many YYYs at XXX believe the below BB- rated more dangerous to a bank system than the AAA rated?

I ask because the bank regulators in the Basel Committee clearly do believe that.

In 2004, with Basel II they assigned a 150% risk weight to what is rated below BB-, something to which banks would never ever create dangerous exposures to; and a meager 20% to what is AAA rated, something which, if wrong ex-post, is precisely the stuff bank crises are made of.

And I am a bit concerned seeing that no one is out questioning the regulators about this.

I have tried to ask them questions, but I am not a University, an important media or a sufficiently important personality

Would they answer me if I were ZZZ?

Here is a question to all of you who have read Charles P. Kindleberger’s emblematic “Manias, Panics and Crashes”

In that book, a History of Financial Crises, (6 editions!) did you find something whatsoever that would in the least indicate to you, that current risk-weighted capital requirements for banks could bring stability to our banking system?

I haven’t, much the contrary!

This non-portfolio adjusted risk weighted regulation would only seem to feed more into speculative bubbles… when times are good, a lot seems good, and so a lot gets bank credit… until something gets too much bank credit... and is not so good any longer. 

And if so many crises were caused by unexpected events... how can you settle on regulating based on expected risks?

Could it be that current bank regulators never ever read this book? 

Could it be that regulators never even looked for what has caused bank crises before regulating these? 

Yes, apparently, amazingly, that’s how it seems.

If in doubt just reflect that in Basel II of 2004, the regulators awarded a risk weight of only 20% to that so dangerous for the banking system as what’s rated AAAs, and slammed a 150% risk weight on the so really innocuous below BB- rated, that which would never ever attract excessive bank exposures.

If you happen upon a bank regulator ask him these questions and see him cringe

Sunday, March 19, 2017

Banks, regulators and sovereigns, colluded to introduce, statism, risk aversion and complacency.

It's hard to pinpoint the exact meaning of complacency, especially as that sentiment could have different origins. I am not really sure what it means to Tyler Cowen, but to me, complacency, is quite often only a more comfortable and somewhat hypocritical expression of a “Please don’t rock the boat” wish.

I now quote extensively from Tyler Cowen’s “The complacent class” (page 13)

One thing most Americans agree on it politics–for all the complaining about the bank bailouts–is that there should be more guaranteed and very safe assets. The Federal Reserve Bank of Richmond has estimated that 61 percent of all private-sector financial liabilities are guaranteed by the federal government, either explicitly or implicitly. As recently as 1999, this figure was below 50 percent. We’re also more and more willing to hold government-supplied, risk free assets, even if they offer very small or zero yields… Plenty of commentators suggest that something about this isn’t right, but again the push to fix it is extraordinarily weak, especially since that would mean someone somewhere would have to take significant financial losses.


There is a Zeitgeist and a cultural shift well under way, so far under way in fact that it probably needs to play itself out before we can be cured of it. The America economy is less productivity and dynamic, Americans challenge fundamental ideas less, we move around less and change our lives less, and we are all the more determined to hold on to what we have, dig in, and hope (in vain) that, in this growing stagnation, nothing possibly can disturb our sense of calm.”



Is it really so as Cowen seems to argue, that the Home of the Brave, that which has developed based on considerable doses of risk-taking by risk-takers, now comes to this complacency on its own... or was it entrapped?

I argue the latter. One way or another, regulators managed to sell to a financially naïve political sector the concept that it was possible for bank regulators, or for the more sophisticated banks’ risk models to determine real-risks, and so introduced risk-weighted capital requirements… topping it up by putting aside all considerations as to whether this could distort the allocation of credit to the real economy.

In 1988 America induced and signed up on the Basel Accord, Basel I. That ruled that for the capital requirements banks needed to hold, the risk weight of the sovereign was to be zero percent, 0%; for mortgages to the residential housing 55%; and for loans to We the People 100%.

In 2004, with Basel II, the risk-weight for residential mortgages was reduced to 35%; We the People were also split up in “the safe”, the AAA rated, the AAArisktocracy with a risk weight of 20%; passing through a risk-weight of 100% for those not rated ordinary citizens; and topping it out at 150% for those rated below BB-.

What did this mean? First that regulating technocrats, sent out the falsely tranquilizing message to the market of “Don’t worry, banks are now risk-weighted”. Second, that statists told banks: “We scratch your back and you scratch ours… the State guarantees you, and you lend to the State as cheap as possible”. 

Of course that immediately resulted in that banks would search out any assets that were decreed, perceived or concocted as safe; as with these banks could leverage more and therefore obtain higher risk adjusted returns on equity… which much explains the much increased appetite for “safe assets”, in America and Europe.

Of course that meant that the sovereign would by artifice receive much more bank credit, at much lower rates than usual; making a joke of that “risk-free-rate” used in finance. 

Of course that immediately resulted in that banks would avoid all assets officially perceived as “risky”, like loans to SMEs and entrepreneurs, as with these banks could leverage much less and therefore obtain lower expected risk adjusted returns on equity… which of course affected the productivity and the dynamism of the real economy, in America and Europe.

Of course that meant banks would prefer financing the construction of the “safe” basements were young unemployed can live with their parents than the riskier future that could create the jobs they need… which reduces mobility as more and more get to be chained to houses with artificially high prices.

And a truly sad part of all these induced statism and risk aversion is that it does not lead to any more bank stability, much the contrary. Major bank crises are caused by unexpected events (e.g. devaluations), criminal behavior (e.g. loans to affiliate) and excessive exposures to what was ex ante perceived as very safe but that ex post turns out to be very risky, among others because being perceived as very safe often causes it to receive too much bank credit.

What caused the 2007-08 crisis? Excessive exposures to what was perceived or decreed as safe as AAA rated securities and sovereigns like Greece.

What has caused stagnation thereafter? Lack of lending to SMEs and entrepreneurs, those best equipped to open up new paths.

Where banks in on this? Answer would banks like being able to earn the highest risk adjusted returns on equity when holding what they perceived as the safest? Of course they would, that sounds like bankers’ wet dreams come true.

I find “The Complacent Class” to be a fun and very useful book, and it could help get very important and needed debates going. That said I would like to see Tyler Cowen substantially updating the second edition of it, by including that dangerous risk aversion and complacency imposed on banks and on America (and Europe) by its regulators.

Thursday, March 16, 2017

If Basel’s capital requirements for banks were gender or race weighted, would the world have been so silent?

We now have risk weighted capital requirements for banks, more risk more capital, which clearly discriminates against the access to bank credit of those perceived as risky. That even when what is perceived as risky has never ever caused a major bank crisis; in terms of risk perceptions, that dishonor has always fallen on those ex ante perceived as very safe.

And so SMEs and entrepreneurs have much less access to bank credit, that is unless they are willing to pay much higher risk premiums. And so our economies are provided with much less of that oxygen that risk-taking signifies to its development.

And yet the world keeps mum on it.

I wonder what hullaballoo it would raise if instead those capital requirements were gender or race based?

I ask because when it comes down to odious discrimination it all seems the same. 

Dr Andreas Dombret your Basel I, II and III will be discovered as a truly ugly piece of Ramsey statue.

I will quote from Dr Andreas Dombret speech “Basel III - goal within sigh” delivered at the Bundesbank symposium on "Banking supervision in dialogue", Frankfurt am Main, 15 March 2017. 

The Member of the Executive Board of the Deutsche Bundesbank stated:

“The statue of Ramses is not only a work of art; it is also testament to the highest quality of craftsmanship, which is one major reason it has survived for three thousand years. Figuratively speaking, this is how we, too, must approach the Basel reform package. It’s not just about developing uniform, consistent rules – risk sensitivity is another of our guiding principles. During the negotiations, we will therefore call for higher risk to go hand in hand with higher capital requirements.”

Dr. Dombret if you and your regulatory technocrat buddies keep on insisting that what is perceived as risky is the stuff major bank crises are made of, your Basel regulations will doom the banks and the real economy.

You state “The equity ratio of German banks and savings banks has risen by more than half a percentage point to currently 16.2% since September last year, which was due primarily to the reduction in risk-weighted assets”, and I ask: How do you know that the reduction in risk-weighted assets did not affect those assets your banks most need to hold for your real economy not to stall and fall? 

Dr. Dombret, if you read this comment please answer these following questions, if you dare!

If bank regulations had been privatized, how much would a Basel Committee Ltd have paid in fines for 2007-08 crisis?

I ask, because in courts it would have been quite easy to demonstrate that the banking sectors excessive exposures, to for instance AAA rated securities backed with mortgages to the subprime sector in the US, or in loans to a sovereign like Greece, those which caused the crisis, were the direct result of the risk weighted capital requirements for banks.

By strangely awarding lower risk weights to what was perceived as safe, which translated into lower capital requirements, the banks could leverage their equity with exposures to the “safe” many times more than with exposures to what was perceived as risky, like loans to SMEs.

As an example the risk weight for the AAAs was 20%, for sovereigns it hovered between 0 and 20% (Greece) and for SMEs 100%. That meant banks could leverage their equity 62.5 times with AAAs, unlimited to 62.5 times with sovereigns, but only 12.5 times with SMEs. That meant banks would earn much higher expected risk adjusted returns on equity on AAAs and sovereigns than on SMEs. 

I mentioned above, “strangely awarding”, because any regulator who knows what he is doing, would have gone back to analyze what causes bank crisis. Doing so he would have discovered that excessive exposures to what were ex ante perceived as risky never ever occur, (ask Mark Twain). All crises result from either unexpected events (devaluations), criminal behavior (loans to affiliates) or excessive exposures to something ex ante perceived very safe but that ex post turned out to be very risky.

So if society had brought this in front of a court, how much would Basel Committee Ltd have been fined? Clearly so much that it would have been out of business; so much more than what happened to Arthur Andersen when it was brought down for failing in its auditing of Enron.

And all that before all those “risky” SMEs, those who as a result of these regulations had their access to bank credit impaired, would have sued Basel Committee Ltd for the loss of their lifetime opportunities. 

But what has happened to the regulators responsible for the Basel Committee for Banking Supervision? Nothing, zilch, zero, nada, in fact many of them have been promoted.

And anyone knows what has happened to those emission controllers that were cheated by Volkswagen? Nothing? Perhaps there is a real case for privatizing regulations and controls, that way we could at least have some accountability.

PS. In the case of the larger more “sophisticated” banks the Basel Committee even went as far as allowing these to use their own models to calculate capital requirements, something like allowing Volkswagen to calculate their own carbon emissions.


Wednesday, March 8, 2017

“You’re crazy!” That’s what John K. Galbraith would have said; about Basel’s risk weighted capital requirements for banks

I quote from John Kenneth Galbraith’s “Money: Whence it came where it went” 1975.

“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] 

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.”

[But that] 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.”

So, on behalf of "the men of wisdom", in came the Basel Committee for Banking Supervision. With Basel I 1988, and Basel II 2004, it told bankers that even when they already consider perceived risk when setting interest rates and deciding on the amount of exposures, they also had to consider the perceived risks for how much capital their banks needed to hold.

In other words bank regulators ordered the banking system to double down on ex ante perceived, (decreed or concocted) risks.

For a while, while bankers were exploiting all the opportunities of being able to mind-boggling leverage their equity with what was thought safe (a banker’s wet dream come true) all seemed fine and dandy. 

The immense growth of bank credit (later followed up with QEs) injected tremendous amount of liquidity into the economy… all until some safe havens, like AAA rated securities and Greece, in 2007/08 became dangerously overpopulated and burst.

One should think the “men of wisdom” would have updated their wisdom, but no!

“The risky”, like SMEs and entrepreneurs, still have to compete with “The Safe” for access to bank credit while carrying the burden of generating larger capital requirements for the banks… while “the safe” havens run the risk of being dangerously overpopulated.

I have no doubt John Kenneth Galbraith, if alive, would say: “You’re crazy!”

Sunday, March 5, 2017

Here is one mystery in current bank regulations that regulators refuse to reveal to us.

That which has an AAA rating, meaning it is perceived as very safe, will of course have much access to bank credit, and be required to pay very low risk premiums. If those ratings then turn out to be wrong, sometimes precisely because since it was considered very safe too much credit was given to it, individual banks, and the bank system, face a very serious problem.

That which has a below a BB- rating, meaning it is perceived as extremely risky, has access to much less credit and, when it gets it, will be by paying much higher risk premiums. If those ratings turn out to be even worse, some individual bank might have a smaller problem, but the bank system as such, would face no problems at all.

But, an here is the mystery, bank regulators, with their Basel II, in June 2004, for the purpose of setting the capital requirements for banks, set a 20% risk weight for the AAA rated and 150% for what is below BB-.

Why so? If "safe" could be dangerous and "risky" is innocuous, could it not really be the other way around?

And that, since regulators refuse to explain it, is now, soon 13 years later, still a mystery to us


Sunday, February 26, 2017

The Basel Committee, FSB and other bank regulators know dangerously little about risks. Why? Here it is!

What many perceive as very safe can lead to the build up of very large exposures that could threaten the bank system.

What many perceive as very risky never leads to the build up such large exposures that it could threaten the bank system.

Yet the Basel Committee, in Basel II of 2004, assigned a risk weight of only 20% to what rated AAA to AA and therefore so dangerous to the banking system, and one of 150% to what is rated below BB- and therefore so innocuous to the banking system.

The Basel Committee has refused to explain why they did so, and the only document purported to explain it, is pure GroupThink mumbo jumbo.

Additionally, risk weighted capital requirements for banks allow banks to leverage their equity differently with different assets, which produces quite different expected risk adjusted returns on equity than would have been the case in the absence of such regulations, and therefore this dramatically distorts the allocation of bank credit to the real economy. It introduced rampant risk aversion that have our banks no longer financing the riskier future, only refinancing the safer past.

Additionally, without obtaining due permission, the Basel Committee assigned a risk weight of 0% to a set of friendly sovereigns and 100% for the We the People of such sovereigns. This introduced rampant statism. As if government bureaucrats could use bank credit better than the private sector.

I have tried by all means possible to get explanations from the Basel Committee, even by using their formal consultation procedures, but all to no avail.

Please, you in the media who have more access to bank regulators ask them: Why do you think the below BB- rated are more dangerous to the bank system than the AAA rated?

Have you never heard of Voltaire’s “May God defend me from my friends, I can defend myself from my enemies”?

We also have John A Shedd (1850-1926) with his: “A ship in harbor is safe, but that is not what ships are for.”

With respect to that the Basel Committee is not only not allowing our banks to sail to explore riskier but perhaps more profitable bays, but it is also assuring to turn safe havens into overpopulated death traps. 

For our children and grandchildren’s case, help me to get rid of those dangerously incapable regulators.

P.S. Like during the Oscar it seems that at the Basel Committee there was also a mix-up of envelopes, in this case of those containing the names of what is the most and the least risky for our bank system. The saddest fact is that at the Oscar they got it fast, 2 minutes and 30 seconds, but in Basel they have yet to discover it after more than a decade.

Monday, February 20, 2017

A pre-reading it comment on Mercatus Center’s Tyler Cowen’s “The Complacent Class”

Note: I have not read Tyler Cowen’s “The Complacent Class: The Self-Defeating Quest for the American Dream” yet, as it is still not available. If it contains something that would contradict the following comment that would be great welcomed news. 

In Foreign Affairs we can read: “Tyler Cowen’s timely and well-written book points to a central feature of contemporary American life: since the 1980s, U.S. society has become less dynamic and more risk averse. The quest for safety and predictability has made the country both more and less comfortable than before. Although many (perhaps even most) Americans enjoy the stability and security that the status quo provides, increasing numbers feel thwarted by the lack of opportunity and slow economic growth that characterize their increasingly static society.” 

And I ask, how could that not be when bank regulators introduced risk weighted capital requirements for banks? That primarily happened in 1988 with Basel I and in 2004 with Basel II. 

And the risk weights imposed were such as: Sovereign 0%, AAA-risktocracy 20%, residential houses 35%, We the People, like unrated SMEs and entrepreneurs 100%, and below BB-rated 150%.

That clearly gives banks all the incentives (higher allowed leverages) to finance and refinance much more what is ex ante perceived, decreed or concocted as safe, most often what derives from something that already is known and exists; and to stop financing the unknown riskier future. In other words those regulations imposed risk aversion on the Home of the Brave. 

That, in the short term, not only guarantees a static society, but worse, medium and long term, it causes a falling society. 

It is perfectly understandable that those with Statist inclinations, and who in the 0% risk weight for the sovereign must see their wet dreams come true, don’t say a word about the distortions in the allocation of bank credit those regulations cause… and this even though this regulation actually decrees that inequality they so much tell us they abhor. 

But, that professors from a Mercatus Center at George Mason University that presents itself as “the world’s premier university source for market-oriented ideas”, keeps hush about this all, really makes me sad. 

But, that professors from a Mercatus Center at George Mason University that presents itself as “the world’s premier university source for market-oriented ideas”, keeps hush about this all, really blows my mind. What keeps them from seeing the problem? A peculiar confirmation bias?

PS. In 2011 I already commented about this to Tyler Cowen, when sending him by email what I wrote to Martin Wolf with respect to his "The Great Stagnation"


PS. And there is enough evidence on the web about how I have commented on this issue, time after time, on blogs run by Professors of the Mercatus Center.

Friday, January 27, 2017

Dear Mr Kurowski, here is our answer to your doubts. Sincerely, the experts in Basel Committee, FSB and affiliates

(I dreamt I got this letter from our bank regulators in response to my questions.)

Dear Mr Kurowski

It does not matter whether the risky already get less credit and pay higher interest rates, they must get even less credit and pay even higher interests… because they are risky. Don’t you get that!

It does not matter whether the safe already get more credit and pay lower interest rates, they must get even more credit and pay even lower interests… because they are safe. Don’t you get that!

It does not matter that the risky have never caused a major bank crisis. Risky is risky and that’s that! 

It does not matter that there could be too large exposures to what’s perceived safe but could in act not be; which could cause a huge crisis. Safe is safe and that’s that.

Yes, yes we understand, (we think) that our risk weighted capital requirements might introduce some serious credit austerity for the risky, like SMEs and entrepreneurs, and that this could affect the economic growth of the real economy. But that’s not our problem. Our sole concern is to keep banks safe. 

For economic growth there are infrastructure projects, like bridges, to be undertaken by the Sovereign taking advantage of the exceptionally low rates it is awarded, because it is really and truly safe. If we can’t trust the Sovereign who are we to trust? The citizens?

Oh, that the 2007-08 crisis was caused primarily because of too much investment in securities rated AAA that was supposed to be super-safe? Yes, but now we are imposing huge fines on those credit rating agencies, so they should have learned their lessons, and all will be fine and dandy. Trust us Mr Kurowski. We are after all, as you know, the experts. 

PS. For your own good stop writing those letters about us to the Financial Times. How many now, around 2500? You’re crazy! Don’t you see FT doesn’t care?

Yours sincerely,

Names withheld (by me)… out of delicacy

PS. Friends, as you can see, our bank regulators remain as captured as ever in their cognitive bias, poor us.

Monday, January 23, 2017

Has history known a worse and more dangerous case of confirmation bias than that of current bank regulators?


Confirmation bias, also called confirmatory bias or myside bias,[is the tendency to search for, interpret, favor, and recall information in a way that confirms one's preexisting beliefs or hypotheses, while giving disproportionately less consideration to alternative possibilities. It is a type of cognitive bias and a systematic error of inductive reasoning. People display this bias when they gather or remember information selectively, or when they interpret it in a biased way. The effect is stronger for emotionally charged issues and for deeply entrenched beliefs. People also tend to interpret ambiguous evidence as supporting their existing position. Biased search, interpretation and memory have been invoked to explain attitude polarization (when a disagreement becomes more extreme even though the different parties are exposed to the same evidence), belief perseverance (when beliefs persist after the evidence for them is shown to be false), the irrational primacy effect (a greater reliance on information encountered early in a series) and illusory correlation (when people falsely perceive an association between two events or situations).

A series of experiments in the 1960s suggested that people are biased toward confirming their existing beliefs. Later work reinterpreted these results as a tendency to test ideas in a one-sided way, focusing on one possibility and ignoring alternatives. In certain situations, this tendency can bias people's conclusions. Explanations for the observed biases include wishful thinking and the limited human capacity to process information. Another explanation is that people show confirmation bias because they are weighing up the costs of being wrong, rather than investigating in a neutral, scientific way.

Confirmation biases contribute to overconfidence in personal beliefs and can maintain or strengthen beliefs in the face of contrary evidence. Poor decisions due to these biases have been found in political and organizational contexts:


The Basel Committee for Banking Supervision's and other bank regulator's confirmation bias. 


Regulators think, as they should, as it is, that what is rated below BB- is much more riskier than what is rated AAA. 

But when deciding on the risk weights to be used for the capital requirements of banks in Basel II of 2004, the regulators directly extrapolated from these beliefs and assigned 20% to the AAA rated and 150% to the below BB-. That is probably one of the most dangerous cases of confirmation bias in history.  Regulator should not have looked at the risk of the assets but at the risk of the assets to the banks, which is not the same thing.

The truth is that precisely because the below BB- is perceived as very risky, that makes it much less risky for the banks; while the AAA rated which is perceived as very safe, precisely because of such perceptions, is what could lead to those dangerously high bank exposures that can cause a huge bank crisis if the ex-post reality turns out to be different.

We are in 2017 and the regulators, because of "belief perseverance", have still not discovered their own confirmation bias… and that even after the mother of all evidences, represented by the AAA rated securities backed with mortgages to the subprime sector turning out to be so very risky.

That this was the fault of credit rating agencies is hugely irrelevant. The better the ratings are, the more confidence is deposited in these, and so the worse do the doomsday scenarios become.

Does anyone know a worse case of confirmation bias?

The dangers? First of course that banks will get caught with their pants down, little capital, precisely when one big exposure might get hit. But second, it introduced a senseless risk aversion that have banks no longer financing the riskier future but only refinancing the “safer” past and present… so our economies are stalling and falling.

PS. Are you still unsure of this? Then try to get the regulators to answer you these questions

PS. In this case it is not only regulators who suffer from “belief perseverance”. Prestigious and influential economists like Martin Wolf, even when being told that the safer is riskier and the riskier is safer, can’t get a grip on the issue.

Saturday, January 14, 2017

Reflections on Terracotta Warriors, credit ratings, and capital requirements for banks

I read in Latin American Herald Tribune of January 14, 2017: “A Chinese state-run newspaper reported that armed with clubs authorities destroyed a museum with 40 fake Terracotta Warriors that tricked numerous tourists and prompted some complaints”

Oh I can already hear it! “Tom, you see, I told you those terracotta soldier boys they took us to see seemed fake. Why did you not listen to me? Why did we have to show those photos to Nancy and George? Do you think we could now sue the Chinese tourism authorities for those terra-whatever being fakes, or at least for disclosing those as fakes after the fact?



My head started to spin too. Some years ago I bought some small Terracotta Warriors in China. Because of their size and pricing, I always thought these to be absolute fakes. No problema! But are these now exposed to being crushed by some Chinese regulator? Might someone over there have a copyright on these that has been infringed?

Come to think of it, do we not need some Chinese Terracotta Authenticity rating agencies? 

Perhaps, but, if those rating agency fall for the temptations to be most certainly offered to them by shady Terracotta Warrior suppliers, hey we’re talking China here, could we ask our government to sue these agencies? 

I mean like the US has done with Moody’s and S&P with respect to their worse than lousy rating processes that produced totally unworthy AAAs for some of the securities backed with mortgages to the subprime sector in the US.

But then again, if these terracotta rating agencies mislead us, would we see some of the money from the fines, or would that only go to those who, to begin with, excessively empowered the rating agencies? 

And should then regulators in China request the vendors of Terracota Warriors to hold more capital, against the risk of being sued, the faker the rating shows its product to be; somewhat like what is being done with banks and their risk weighted capital requirements?

I would not think so. I would have bought my Terracota Warriors even if rated very fake; since the price was right.

Of course, the real problem, like in the case of the AAA rated securities, would be an AAA rated Terracota Warrior, and for which partly because of that rating, billions had been paid for at an auction, if it then later proves to be fake.

Does this mean that the better a Terracota Warrior would be rated, the more capital should the suppliers hold? Yes! Precisely! That’s what fundamentally current bank regulators got wrong.

The safer an asset is ex ante perceived, decreed concocted or rated, the riskier it could be ex post. They completely ignored Voltaire’s “May God defend me from my friends, I can defend myself from my enemies


Thursday, January 12, 2017

The SEC Regulatory Accountability Act is even more needed for the case of Fed / FDIC bank regulations

The SEC Regulatory Accountability Act, sponsored by Financial Services Committee member Rep. Ann Wagner (R-MO), passed 243-184.

Jeb Hensarling (R-TX), the Chairman of the Financial Services Committee explained it: 

“Ill-advised laws like the Dodd-Frank Act empower unelected, unaccountable bureaucrats to callously hand down crushing regulations without adequately considering what impact those regulations have on jobs…The true cost of Washington red tape includes the jobs not created, the small businesses not started and the dreams of our children not fulfilled.”

Now under the bill, before issuing a regulation the SEC will be required to:
identify the nature and source of the problem its proposed regulation is meant to address;
utilize the SEC’s Chief Economist to assess the costs and benefits of a proposed regulation to ensure the benefits justify the costs;
identify and assess available alternatives; and
ensure that any regulations are consistent and written in plain language.

Further, the legislation requires the SEC to engage in a retrospective review of its regulations every five years and conduct post-adoption impact assessments of major rules.

What great news! Not a moment too soon. Now the Financial Services Committee needs to, as fast as possible, issue a similar bill with respect to the regulations applied by the Fed and FDIC to the banks… because in their case they never even defined the purpose of banks before regulating these.

The current risk weighted capital requirements for banks are totally senseless.

Not only has regulators no business regulating based on perceived risks already cleared for by banks, as they should primarily require some capital reserves to face uncertainties, but these regulations also cause banks to no longer finance the “riskier” future but mainly refinance the “safer” present and past, at great costs for the real economy and for future generations.

Here are some questions I have not been able to have regulators to answer; perhaps the Financial Service Committee needs not to go on a hunger strike to manage that.



Bank regulators should be forced to see “Hell on Wheels” and read John Kenneth Galbraith’s “Money: Whence It Came, Where It Went”

In the TV series Hell on Wheels, its main character, Cullen Bohannon, when asked to testify before the US Senate about all the obvious corruption of Thomas ‘Doc’ Durant, someone absolutely not Bohannon’s friend, someone absolutely not one having been sanctimonious or behaved according to any social norms, repeats, over and over again, to the great chagrin of his interrogators: “The Transcontinental railroad could not have been built without Thomas Durant

And John Kenneth Galbraith wrote in his “Money: Whence it came where it went” 1975 the following: “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.”

And Galbraith also opined in his book that: “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.”

Therefore I cannot but conclude in that bank regulators should be forced to see “Hell on Wheels” and read John Kenneth Galbraith’s “Money: Whence It Came, Where It Went”. That in order to, hopefully, be able realize that with their risk weighted capital requirements for banks, these will not finance the risky future, but only refinance the safer past and present and, as a result, the economy will stall and fall. 

To add insult to the injury, bank regulators are doing all this in the belief that bank crises result from excessive exposures to what is perceived as risky, which is utter nonsense. Bank crises have always, and will always, result from uncertainties; that which includes unexpected events, like devaluations earthquakes and regulators not knowing what they are doing, criminal behavior and excessive exposures to something ex ante perceived as safe but that ex post turned out to be very risky.

“If you see something, say something”. Someone should run to the Homeland Security of the Home of the Brave and denounce that, most probably, unwittingly; some serious terrorism is taking place by means of dangerously risk adverse faulty bank regulations.

Do bank regulators, now with “output floor” based on their standardized risk weights, keep on making fun of us?

A 75-percent output floor signifies that no matter which outcome the bank’s internal calculation yields, the risk weight that determines the capital required, can’t be more than 25 percent lower than the standardized risk weighting method designed by the regulators.

So let’s see what that really means. 

For the standard method’s 0% risk weighted sovereign, unless some bank’s internal calculation comes up with a negative risk, it will still mean 0%.

For the standard method’s 20% risk weighted private asset, it means the weight cannot be less than 15%.

For the standard method’s 35% risk weighted residential mortgage, it means that weight cannot be less than 26.25%.

For the standard method’s 100% risk weighted private asset without a credit rating, like loans to SMEs, it means that the risk weight cannot be less than 75%.

Really? Are bank’s internal models worse than your standardized weights? Do you really think the Medici’s would have assigned a risk weight of 0% to the Sovereign?

There’s absolutely nothing wrong with allowing banks to use their own risk models in order to try to minimize their cost of capital, but that regulators concoct a set of ex ante perceived standardized risk weights in order to determine how much capital banks should have in order to be able to confront, not perceived risks, but uncertainty, is just as crazy as it gets.

Here some questions bank regulators refuse to answer, something that should make us all nervous. They really might not have a clue about what they are doing.

Sunday, January 8, 2017

Economist Andrew Haldane. At least when acting as a bank regulator, you are admitting the wrong error you committed

Chief economist of Bank of England Andrew Haldane says “his profession must adapt to regain the trust of the public, claiming narrow models ignored ‘irrational behaviour’” “Chief economist of Bank of England admits errors in Brexit forecasting” The Guardian, January 5, 2017.

Hold it Mr Haldane! What you and other economists ignored. when acting as regulators, was that banks would, as always, behave perfectly rational, and lend to what they expected would yield them the highest risk adjusted returns on equity.

That is what you failed to understand when allowing banks to hold less capital against what was perceived, decreed or concocted as safe. That meant banks could leverage more, and so earn higher expected risk adjusted returns on equity, when lending to the “safe”. 

That distortion in the allocation of bank credit to the real economy, resulted in that banks end up lending too much at too low interest rates to the “safe”… which could be risky for the banks; and to little and too expensive to “risky” SMEs and entrepreneurs which is very dangerous for the economy.

Friday, December 30, 2016

Mercatus Center, in order to reframe financial regulations, you must dig in much deeper into the current mistakes.

I refer to “Reframing Financial Regulation: Enhancing Stability  and Protecting Consumers” 2016, by the Mercatus Center at George Mason University, and edited by Hester Peirce & Benjamin Klutskey.

The book includes many wise suggestions but, since it does not seem to capture how incredibly faulty current regulations really are, it has gaps that make it more difficult to understand how sensitive the financial system, primarily banks, and the real economy as such, is to the process of implementing a “reframing”.

For brevity and because my main reservations with current financial regulations have to do with the issue therein discussed, I will limit my comments to Chapter 1: Risk-Based Capital Rules by Arnold Kling.

The author writes: “Risk-based capital rules dramatically affect the rate of return banks earn from holding different type of assets. Regardless of the intent of these rules they strongly influence capital allocation in the economy.”

That is correct, although referring to the ex-ante expected risk adjusted returns on equity would be more precise.

Then the author states: “They substitute even crude regulatory judgment for individual bank discretion and market mechanism”. 

That is not entirely correct. The real problem is that since banks already clear for ex ante perceived risks, when setting interest rates and the amount of their exposures, that regulators also use basically the same ex ante risk perceptions for determining the capital requirements, means that “ex-ante perceived risks”, will be doubly considered. What regulators missed entirely, is that any risk, even if perfectly perceived, will cause the wrong actions, if excessively considered.

The book identifies partly what the distortion in the allocation of bank credit could do to the safety of banks, but what it most misses to comment on, is what the risk weights actually calculated and used, really meant and mean to the allocation of bank credit to the real economy. 

For instance Basel I, 1988, applied to the United States, set the risk weight of 0 percent for US Treasuries; 20 percent for claims to for instance local governments; 50 percent when financing residential properties and revenue bonds; and 100 percent all other claims on private obligors.

0% risk weight for the sovereign? If that’s not in runaway statism what is? De facto it implies that regulators consider government bureaucrats will give better use to bank credit than the private sector.

In 2001 the Federal Reserve Board, the Office of the Comptroller of the Currency and the FDIC set the following risk weight depending on credit rating; AAA to AA 20 percent; A 50%; BBB (the lowest investment grade) 100 percent; and BB (below investment grade) 200%.

If that’s not runaway stupidity what is? The regulators really seem to have thought (and think) that assets perceived as extremely risky, are more dangerous to the bank system than assets perceived as safe. As if they never heard of Mark Twain’s “A banker lends you the umbrella when the sun shines and wants it back when it looks it could rain”; as if they never heard of Voltaire’s “May God defend me from my friends, I can defend myself from my enemies”. 

Worse though, they never gave any consideration to the possibility that millions of “risky” 100% weighted SMEs and entrepreneurs, so vital to the sturdy growth of the real economy, would see their credit applications negated only because of this. 

Mercatus Center, any reframing of current financial regulations that is not based on a full understanding of how statists and stupid current regulations are, will not be able to adequately deliver what we, especially the young, so urgently need.

For instance all those propositions of increasing the capital requirements for banks with higher leverage ratios but that would keep of the risk weighting in place fail to understand that the bigger the capital squeeze the more will the risk weighing distort the allocation of bank credit to the real economy. (Think of “The Drowning Pool”)

For instance to avoid imposing on the real economy the bank credit austerity that would result in the initial stages of capital increases the grandfathering of old capital requirements for existing assets until these are disposed would be a must.

Mercatus Center, you have clout that I as a citizen have not! Do all us a favor and request straight answers from the regulators on some very basic questions.

Sunday, December 25, 2016

Harvard Law School. I hope you did not believe Bill Coen with that the Basel Committee knows what it’s doing.

Bill Coen, the Secretary General of the Basel Committee on Banking Supervision, spoke at the Harvard Law School on December 12, 2016. In: “The global financial crisis and the future of international standard setting: lessons from the Basel Committee” Coen had this to say about the metric of the risk-weighted ratio:

“Its strength is that it sets capital requirements according to the perceived riskiness of a bank’s assets.” 

Comment: It is sheer lunacy to set capital requirements according to ex ante perceived risks, when you should set them according to the risk that banks might not adequately perceive the riskiness of their assets. In fact all bank crises have occurred from unforeseen events (like devaluations), criminal behaviors or excessive exposures to what ex ante was perceived as safe but that ex post turned out to be risky. No bank crisis has ever resulted from excessive bank exposures to something ex ante believed risky.

“Its weakness is that it is susceptible to setting too low capital requirements, either unintentionally (model risk), or intentionally (gaming).”

Comment: This evidences mindboggling naiveté. For banks to earn the highest possible risk adjusted returns on equity, they will automatically look to hold as little equity as possible. So it is like placing some delicious cookies in front of children, and expecting them to reach out for the spinach.

Students and professors at Harvard Law School, do us all a big favor. Send Bill Coen the following questions, and ask him formally to respond. At least that would save me from having to go on a hunger strike or other similar extremes in order to get some answers.

PS. You could also ask the Harvard Business School about why they have kept such silence on the monumental mistakes of current bank regulations.