Wednesday, November 23, 2011

I accuse the bank regulators... they caused the crisis!

If risk models, credit ratings and market intuitions were perfect, then a bank would really not need any capital at all, since all risk considerations would have been correctly priced, in the interest rates, in the amounts and in the duration of the loans. But, since risk-models, credit ratings and market intuitions are often not perfect, the regulators needs to require the banks to hold some capital, to make sure that there is an adequate cushion provided by the shareholders who are profiting from the bank activity, before creditors and tax payers are called upon to help out. 

Unfortunately the current generation of bank regulators, stupidly, did not base their capital requirements for banks on the possibility of mistakes, but on precisely the same risk models, credit ratings and market intuitions… requiring for instance minimal equity when the perceived risk of default of a borrower seemed minimal.

And it is precisely there, where the perceived risks of default seem minimal, where the risks for a systemic bank crisis resides, as what is ex-ante perceived as “risky” does never grow into a dangerously sized exposure.

And so, instead of helping to cushion for the mistakes of the banks, the regulators, with their distortions, increased the probabilities of the mistakes being made, and their negative financial consequences. 

And that they did by allowing banks to hold only 1.6 percent in capital when investing in triple-A rated securities or lending to sovereigns like Greece, which implied an authorized leverage of 62.5 to 1, while at the same time requiring the banks to hold 8 percent in capital when lending to job creating small businesses and entrepreneurs, an authorized leverage of 12.5 to 1. And that they also did by allowing the banks to lend to the “infallible sovereigns” against no capital at all, where not even the sky was the limit on leverage. 

And that is why we got those monstrous large bank exposures to what was ex-ante officially perceived as not risky, and which have now, ex-post, exploded in the whole Western World. 

And that is why the “risky” small businesses and entrepreneurs find access to bank lending so curtailed and expensive.

The bank regulators need to be held fully accountable for what they did, because if we do not get to the bottom of this sad affair, neither won’t we get out of it.

Here´s a video that explains a fraction of the stupidity of our bank regulations, in an apolitical red and blue! http://bit.ly/mQIHoi

Thursday, November 17, 2011

Capital Inadequacies: The Dismal Failure of the Basel Bank Capital Standards

Thank you Mark Calabria for the invitation.

And thank you Kevin Dowd for the paper that inspired the conference.


My intervention begins on minute 20:30

Monday, November 14, 2011

The lunacy and the obscenity of current bank regulations

If risk models, credit ratings and market intuitions were perfect, then a bank would really not need any capital at all, since all risk considerations would have been correctly priced, in the interest rates, in the amounts and in the duration of the loans. But, since risk-models, credit ratings and market intuitions are often not perfect, the regulators should require the banks to hold some capital, to make sure that there is an adequate cushion provided by the shareholders who are profiting from the bank activity, before creditors and tax payers are called upon to help out.

Unfortunately the Basel Committee generation of bank regulators, did not base their capital requirements for banks on the possibility of mistakes, but on precisely the same risk models, credit ratings and market intuitions… requiring for instance minimal equity when the perceived risk of default of a borrower seemed minimal. In other words instead of helping to cushion for the mistakes the regulators, with their distortions, increased the probabilities of mistakes being made, and their financial consequences.

Also, the obscene bank bonuses, based on obscene bank profits, are more the product of some obscene low capital requirements, than the product of good banking. If you earn an expected margin of 1 percent lending to Greece, and leveraged that on your capital 62 times, as the banks were explicitly authorized to do, then your expected return on that bank equity would be 62 percent a year… who would not lend to Greece?

The bank regulators, who are the ones most responsible for causing the current financial crisis that is menacing the Western World, need to be paraded down Fifth Avenue and Champs-Élysées wearing cones of shame… and to be barred, for life, from all regulatory activity.

We urgently need regulators who also understand that risk-taking by the banks is like oxygen to our economies, and therefore understand the need for not rewarding any excessive risk-adverseness... so as to also avoid, the so dangerous overcrowding of the ex-ante safe havens.

Here´s a video that explains a fraction of the stupidity of our bank regulations, in an apolitical red and blue! http://bit.ly/mQIHoi

Friday, November 11, 2011

What Niall Ferguson left out

Niall Ferguson in “Civilization: The West and the Rest” argues that the west's ascendancy, is based on six "killer apps": competition, science, democracy, medicine, consumerism and the work ethic. Those are indeed ingredients, but unfortunately he misses the willingness to take risks... the oxygen of development. 

Perhaps he does not remember psalms calling out “God make us daring”… and that is why he fails to understand how the bank regulators, with their stupid nanny-scared capital requirements, based on doubling up the importance of ex-ante perceived credit risks, are now slowly but surely taking the Western World down. 

Ps. Here’s a link to… Who did the eurozone in? http://bit.ly/t3mQe0 and as you will read, it really was the butlers… and here´s also a video that explains a fraction of the stupidity of our bank regulations, in an apolitical red and blue! http://bit.ly/mQIHoi


And here a comment added December 28, 2015 

In 1988, Basel I halted the ascendancy of the Western civilization and, in 2004, Basel II provoked its fast descent.

In the preface of the book Ferguson writes:

"It was about the first decade of the twenty-first century, just as it was drawing to a close, that I really got the point: that we are living through the end of 500 years of Western ascendancy”

Not a bad estimate. The ascendance stopped in 1988, with the Basel Accord, Basel I, when regulators introduced risk weighted capital requirements for banks and decided that the risk weight for sovereigns was zero percent while for the private sector 100 percent; and then a truly fast descent began when in 2004, with Basel II, they split up the private sector with risk weights  that ranged from 20 to 150 percent, depended on the credit ratings.

That allowed banks to leverage more with “safe” assets than with risky assets; which meant they could earn higher risk-adjusted returns on safe assets than on risky; which meant they built up excessive exposures to what is perceived or deemed to be safe, and ignored what is perceived as risky, like lending to SMEs and entrepreneurs.

And anyone who understands that risk taking is required to keep the economy moving forward so as not to stall and fall, can understand the sad results of it all.

And that it affects primarily the western civilization, is explained by the fact that it possesses the largest amount of “safe” assets than banks can leverage up on, while holding on to the illusion that all is fine and dandy.

Thursday, November 10, 2011

Who did the eurozone in?

There are of course many suspicious characters to blame for the eurozone’s pains, not the least the fact that it was created without any strong fiscal root system.

In November 1998, in an Op-Ed titled “Burning the bridges in Europe”, and that had to do with the fact there was no escape-route for the euro I also wrote: “That the European countries will subordinate their political desires to the whims of a common Central Bank that may be theirs but really isn’t, is not a certainty. Exchange rates, while not perfect, are escape valves. By eliminating this valve, European countries must make their economic adjustments in real terms. This makes these adjustments much more explosive.”

But, there is one huge piece of evidence that is ignored by most of those trying to explain the current troubles. That evidence is the “risk-weights”, the smoking-gun which we find in the hands of the butlers in charge of regulating the banks, and who have their quarters in the Basel Committee for Banking Supervision. Yes, it was some butlers who did the eurozone in! 

The bank butlers, naturally concerned about the safety of the banks, imposed a basic bank capital requirement of 8 percent; applicable for instance when banks lent to European small unrated businesses. In this case that limited the leverage of bank equity to a reasonable 12.5 times to one. 

But, when banks lent to a sovereign, with credit ratings such as those Greece-Portugal-Italy-Spain had during the buildup of their huge mountains of debt, the bank butlers, because this lending seemed so safe to them, and perhaps because they also wanted to be extra friendly with the governments who appointed them, they applied a “risk-weight” of only 20 percent. And that translated into an amazingly meager capital requirement of 1.6 percent; and which allowed the banks to leverage their capital when lending to the infallible a mind-blowing 62.5 times. 

The result was that if a bank lent to a small business and made a risk-and-cost-adjusted-margin of 1 percent, it could earn 12.5 percent a year, not much to write home about. But, if instead it earned that same risk-and-cost-adjusted-margin lending to a Greece, it could then earn 62.5 percent on your bank equity… and that, as you can understand, is really the stuff of which huge bank bonuses are made of, and also the hormones that cause banks to grow into too-big-to-fail. 

And, as should have been expected, the banks went bananas lending to “safe” sovereigns. With such incentives, who wouldn’t? Just the same way they went bananas buying those AAA rated securities that were collateralized with lousily awarded mortgages to the subprime sector, and to which the bank-regulating-butlers also applied the risk-weight of 20 percent. And of course the governments also went the way of the banana-republics, and borrowed excessively. What politicians could have resisted such temptations? 

And it was these generous financing conditions, and all the ensuing loans, which helped to hide all the misalignments and disequilibrium within the eurozone… until it was too late. 

Now how could these bank-regulating-butlers do a criminally stupid thing like that? The main reasons were: the bank butlers only concerned themselves trying to make the banks safe, and did not care one iota about who the banks were lending to and for what purpose; they ignored that banks were already discriminating based on perceived risks so what they were doing was to impose an additional layer of risk-perception-discrimination; they completely forgot that no bank crisis in history has ever resulted from an excessive exposure to what was considered as “risky”, but that these have always been the consequence of excessive exposures to what, at the moment when the loans were placed on the banks balance sheet, was considered to be absolutely “not-risky”. 

Also, when the bank-regulating-butlers decided to outsource much of the risk-perception function to some few credit-risk-rating-butlers, two additional mistakes were made. First, they completely forgot that what they needed to concern themselves with was not with the credit ratings being right, but with the possibility of these being wrong; and second, that what they needed most needed to look at was not so much the significance of the credit ratings meant, but how the bankers would act and react to these. 

And the consequences of these regulatory failure in the eurozone, are worsening by the day, or by the nanosecond… because these bank capital requirements have the banks jumping from the last ex-ante-officially-perceived-no-risk-sovereign now turned risky, to the next ex-ante-officially-perceived-no-risk-sovereign about-to-turn risky … all while bank equity is going more and more into the red… and becoming more and more scarce. 

What could be done? One solution could be that of declaring a ten year new capital requirement moratorium on all current bank exposures; allowing the banks to run new lending with whatever new capital they can raise, while imposing an equal 8 percent capital requirement on any bank business, no risk-weighting. If there’s an exception, that should be on lending to small businesses and entrepreneurs, in which case they could require, for instance, only 6 percent of capital, because these borrowers do not pose any systemic risk, and also because of: when the going gets to be risky, all of us risk-adverse need the “risky” risk-takers to get going. 

But that requires of course a complete new set of bank-regulating-butlers… as the current should not even be issued any letters of recommendations. Let’s face it, after such a horrendous flop as Basel II, neither Hollywood nor Bollywood, would ever dream of allowing the same producers and directors to do a Basel III, and much less with only small script changes and the same actors.

The saddest part is that many of those in charge of helping Europe to get out of the current mess that they helped to create, might be busying themselves more with dusting off their own fingerprints.

If there is any place that deserves an occupation... that is Basel!

Monday, November 7, 2011

The G20 Cannes Action Plan for Growth and Jobs, is just the continuation of sheer bank regulatory lunacy

Basel I, II, II.5, III are almost exclusively based on stimulating the banks to lend to what is ex-ante perceived as “not-risky”, like triple-A rated securities and "infallible sovereigns", precisely the terrains where all systemic bank crisis like the current one occur; and which therefore creates disincentives for bank lending to what is ex-ante perceived as “risky”, like the small businesses and entrepreneurs… those who can provide us with the next generation of jobs. 

Therefore, to include in a statement titled “Action Plan for Growth and Jobs”, “We commit to the full and timely implementation of the financial sector reform agenda agreed up through Seoul, including: implementing Basel II, II.5 and III along the agreed timelines”, is just the continuation of sheer bank regulatory lunacy

What about capital requirements for banks based on job creation ratings?

Friday, November 4, 2011

Poor "systemic irrelevant financial institutions"

So now except for 29 banks all the rest have de-facto been qualified as systemic irrelevant financial institutions. Is this going to make the lucky few less too-big-to-fail? Against a requirement of only 1 to 2.5 percent in additional equity, to be paid in comfortable installments? They've got to be kidding! 

Please, someone, save us from these regulators who keep digging us deeper and deeper in the hole where they've placed us.

Tuesday, November 1, 2011

Greece, a great referendum… one more!

Of course the timing is lousy, but I believe the referendum proposed by Greek Prime Minister George Papandreou to be the absolutely correct thing to do… better late than never. The bail-out deal offered to Greece can only be successful if it can count with the legitimacy of the full approval of the Greeks, otherwise not even a 90 percent haircut could be enough. On the contrary, not doing the referendum would, de-facto, mean giving in to those who are opposing the current bail-out agreement. Should they vote yes or no? That is entirely for them to decide.

By the way, I would also like to see a referendum in Greece, and in the rest of Europe, regarding whether to keep in their posts, or fire without any sort of letter of recommendation, all those bank regulators in the Basel Committee who allowed the European banks to lend to a Greece, Italy, Portugal… against only 1.6 percent in capital, meaning authorizing the banks to leverage their equity over 60 times when lending to the politicians of these sovereigns…