Tuesday, June 13, 2017

What causes the “motivated reasoning” that keeps Basel bank regulators from admitting their mother of all mistakes?

The Basel Committee for Banking Supervision developed, as a pillar of their regulations, the risk-weighted capital requirements for banks. 

They should never have done that because that completely ignored the fact that these would distort the allocation of credit to the real economy. 

But, when doing so, they also committed the mother of all regulatory mistakes, namely the following:

They set the risk weights based on the risk of the assets and not on the risks the assets represented for the bank system.

That for instance is why, in their standardized risk weights of Basel II, regulators assigned a meager 20% risk weight to what is AAA to AA rated, something which precisely because of such good rating, could lead to the build-up of dangerously large exposures; and a whopping 150% risk weight, to what is rated below BB-, and which is therefore of course rarely touched by bankers, not even with a ten-feet pole.

In other words regulators took the ex-ante risks to be the ex-post risks.

But it has been absolutely impossible to get anyone related to those regulations to admit such thing. And many of those who should have no reason to not divulge that mistake, like specialized journalists and finance professors, have also kept mum on it.

The Economist, June 10, 2017 writes on: “How to be wrong: To err is human. Society is suffering from an inability to acknowledge as much”. It refers there to a “framework for thinking about…[why] people frequently disregard information that conflicts with their view of the world”, elaborated by Roland Benabou and Jean Tirole.

The framework holds that: “Because beliefs… are treasured in their own right, new information that challenges them is unwelcome. People often engage in “motivated reasoning”. [This can be caused by]: “‘Strategic ignorance’… when a believer avoids information offering conflicting evidence.” or “In ‘reality denial’ troubling evidence is rationalized away”, or “in ‘self-signaling’, the believer creates his own tools to interpret the facts in the way he wants”

So Mr Roland Benabou and Mr Jean Tirole, I here ask you. Was, is, any of the three causes for “motivated ignorance” you mention, absent in this case of the Basel Committee’s so mistaken risk-weighted capital requirements for banks?

And also when illustrious Martin Wolf publicly acknowledges, without doubting the correctness of it, that “As 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", Why is Wolf still not capable to understand how 180 degrees-off the risk weighted capital requirements are?

And about that society is suffering from this mistake there can be no doubt.

If you want even a more detailed explanation on The Mistake go here.

And if Econ Journal Watch wants to attract some confessions then help me ask these questions