Friday, February 5, 2016
The pillar of regulations designed to keep the banking system safe, is the risk weighted capital requirements for banks.
These, with Basel II, set the risk weight for ‘highly speculative’ below BB- rated assets to be 150%, while the corresponding risk weight, for ‘prime’ AAA rated assets, was set at 20%.
For a basic requirement of 8%, that meant banks needed to hold 12% in capital against ‘highly speculative’ below BB- rated assets, while only 1.6 percent for ‘prime’ AAA rated assets.
That meant banks could leverage their equity, and all the support they receive from society, 8.3 times to 1 when holding highly speculative’ below BB- rated assets; and a mind-boggling 62.5 times to 1 with ‘prime’ AAA rated assets.
That of course distorts the allocation of bank credit to the real economy and, by favoring the access to bank credit for "The Safe", odiously discriminates against that of "The Risky", like SMEs and entrepreneurs.
As is that has banks earning higher risk adjusted returns on what is perceived as safe than on what is perceived as risky, which means banks no longer finance sufficiently the riskier future but mostly stick to refinancing the safer past. ,
And by negating The Risky their fair access to productive bank credit opportunities, inequality can only increase.
But, what I really cannot understand is: How come mature men (and women) can believe that what is rated below BB-, meaning is perceived as ‘highly speculative’, and therefore very risky, can be more dangerous to the banking system, than what is rated AAA, meaning ‘prime’, and therefore perceived as absolutely safe?
No! There has to be something fundamentally wrong with the current mindset of the bank regulators.
Such crazy risk aversion to perceived credit risk should, in The Home of the Brave, be deemed unconstitutional.
Wednesday, February 3, 2016
Basel global bank regulations: What blocked timely warnings from even being heard and much less considered?
Charles Goodhart has written “The Basel Committee on Banking Supervision: A History of the Early Years 1974-1997, 2011” For someone like me who became slightly aware of the existence of the Basel Committee in 1997 and who as an Executive Director of the World Bank 2002-04 questioned much of what it was up to, it is an extraordinary interesting book and I will comment it frequently… jumping all over it.
Close to the end, page 578, Goodhart writes. “The regulatory process itself is likely to exacerbate internal self-reinforcing dynamics… by introducing a single set of international standards, it tends towards making more banks behave in the same way at the same time (Alexander, Eatwell, Persaud and Reoch 2007). Thus it adds to the likelihood of crowded trades forcing major and sudden price readjustments”.
Precisely, in April 2003, a time during which Basel II was discussed, when commenting on the World Bank’s Strategic Framework 2004-06, I formally warned:
“Ages ago, when information was less available and moved at a slower pace, the market consisted of a myriad of individual agents acting on limited information basis. Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market and we are already able to discern some of the victims, although they are just the tip of an iceberg. Once again, perhaps only the World Bank has the sufficient world standing to act in this issue.
A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind. Who could really defend the value of diversity, if not The World Bank?"
How do such comments become so totally ignored? Was it because I did not belong to any mutual admiration network of experts?
Monday, February 1, 2016
Is there anything more shortsighted short termism than credit risk weighted capital requirements for banks?
More ex ante perceived credit risk requires more capital – less ex ante perceived credit risk allows much less capital… that is the pillar of current bank regulations.
And that allows banks to leverage much more when lending to The Safe than when lending to The Risky; which means banks can earn much higher expected risk-adjusted returns on equity when lending to The Safe than when lending to The Risky.
And so banks do not any longer finance the riskier future, but keep to refinancing the safer past. If that is not short termism, what is?
Global Association of Risk Professionals (GARP) Have you no comments on bank regulators’ risk management?
One of the few and perhaps even only risks that banks clear for, with risk premiums and size of exposures, is the ex ante perceived credit risks, that quite often expressed in credit ratings.
But regulators did not find that sufficient and decided that banks should also clear for the same ex ante perceived credit risk, in their capital.
And as far as I understand any perceived risk, even if it is perfectly perceived leads to the wrong action if it is excessively considered. Would you agree GARP?
And if I was a bank regulator I would be much more interested in why banks fail than in why their borrowers fail. Wouldn’t you be too GARP?
And knowing that bank capital is to be there to cover for unexpected losses, then the last thing I would do would be to base the capital requirements on some expected losses… especially when we know that the safer something is perceived the larger its potential to deliver some truly nasty unexpected losses. Would you not agree with that GARP?
And, if I was a bank regulator, managing risks, the first thing I would do is to be certain about the purpose of banks. That would indicate me that probably the risk we least can afford banks to take, is that of not allocating bank credit efficiently to the real economy. And that is something that becomes impossible when allowing banks to leverage differently with different assets, and thereby earning different and not market based expected risk adjusted returns on equity. Would you not agree with that GARP?
Right now the world is becoming a sad place, especially for coming generations, since regulators having given banks the incentives to stop financing the riskier future, and to make their profits by concentrating on refinancing the safer past.
GARP do you not have a responsibility is speaking up against the Basel Committee’s and the Financial Stability Board’s particularly harmful and lousy way of managing risks?
I ask because your stated mission is: “As the leading professional association for risk managers, the Global Association of Risk Professional's mission is to advance the risk profession through education, training, and the promotion of best practices globally.”
And also because in “What we do” you state: “GARP enables the risk community to make better informed risk decisions through “creating a culture of risk awareness®”. We do this by educating and informing at all levels, from those beginning their careers in risk, to those leading risk programs at the largest financial institutions across the globe, as well as, the regulators that govern them.”
Saturday, January 30, 2016
Regulators have imposed credit risk weighted capital requirements for banks… more perceived risk, more capital – less perceived risk, less capital.
That allow banks to leverage more their equity and the support they receive from society like for instance deposit insurance guarantees when lending to The Safe than when lending to The Risky.
That means banks earn higher expected risk adjusted returns on equity when lending to The Safe than when lending to The Risky.
And so banks will lend more and on easier terms to The Safe, and less and on relatively harsher terms to The Risky.
And too much lending in too easy terms against too little capital to what is ex ante perceived as safe, but that ex post can turn out risky, is precisely the stuff major bank crises are made of.
And too little lending and on too harsh relative terms to what is ex ante perceived as risky, like to SMEs and entrepreneurs, is precisely the stuff that hinders sturdy economic growth.
Banks no longer finance the riskier future they only refinance the safer past... and our young are going to pay dearly for it.
Friday, January 29, 2016
“delta, vega and curvature risk” Basel Committee’s member understand less and less what they are doing, by the minute
To read the Basel Committee’s “Minimum capital requirements for market risk” of January 2016 is truly mindboggling. Do yourself a favor and just look at the index.
Do those really responsible for what is coming out of the Basel Committee truly understand what is said there?
I am sure that John Kenneth Galbraith’s “If one is pretending to knowledge one does not have, one cannot ask for explanations to support possible objections”, applies to most of them.
And it is not like the Basel Committee has shown itself to be a good regulatory body. It has actually been one of the most failed ones… so failed that they should have been prohibited from having anything to do with bank regulations… forever.
Do you really think its current Chair, Stefan Ingves, could provide you with a lucid explanation of it?
I know enough about finance to know when our banks are being dug even deeper in the hole in which they should not be.
The regulators wrote that the bank capital requirements are portfolio invariant because … otherwise it “would have been a too complex task for most banks and supervisors alike”... and now they come with "delta, vega and curvature risk"?
Credit ratings do not reflect timely possible severe drops in commodity prices or volatile monetary policies
What is happening with commodities, like oil, and with emerging countries should open the eyes of bank regulators… but probably it won’t.
Our bank nannies based their requirements of that capital that is to cover for unexpected losses on what they perceived as the one and only risk, namely the ex ante perceived expected credit risk… in much as it was reflected in the credit ratings.
And the credit rating agencies rate the companies based on what they currently see.
Where did the credit ratings reflect the possibility of a dramatic drop in the price of oil before it happened? Nowhere!
Where do credit ratings consider the consequences, like for emerging markets, of shocking volatile monetary policies before they hit the market? Nowhere!
And so now there is a lot of downgrading going on, and as a result lots of new capital is being required of banks, something that only accentuates the general downturn.
The truth is that banks should already have had the capital to cover for unexpected losses, when they placed the assets on their balance sheets.
Thursday, January 28, 2016
I refer to:
Attack of American Free Enterprise System
Date: August 23, 1971
To: Mr. Eugene B. Sydnor, Jr., Chairman, Education Committee, U.S. Chamber of Commerce
From: Lewis F. Powell, Jr.
It mentions "The Ideological War Against Western Society"
And I have a question for you all.
In 1988, by means of the Basel Accord, Basel I, for the purpose of setting the risk weights applicable to the credit risk weighted capital requirements for banks, the regulators defined a zero percent risk weight for the OECD sovereigns (governments) and a 100 percent risk weight for the citizen (the private sector)
That meant that governments would have more favorable access to bank credit than the citizens; which de facto implied that government bureaucrats use bank credit more efficiently than citizens.
There were protests from other sovereigns who also wanted to be awarded a zero percent risk weight… but how come no American citizens protested this in your face statist regulation?
Is not the strength of a sovereign solely the reflection of the strength of its citizens?
That distortion subsidizes government debt; with the subsidy paid for all those in the private sector who as a consequence will, in relative terms, have less and more expensive access to bank credit?
Is this of no interest to America?
If so then America is not what I had learned to believe and admire.
Monday, January 25, 2016
The role of journalists is to be curious. So why aren’t those who cover bank regulations? Are they scared?
Even though credit risks were already cleared for banks by means of interest rates and size of exposures, regulators introduced in the 1980s risk weighted capital requirements for banks. These indicated banks needed to hold more capital against assets perceived as risky than against assets perceived as safe. That allowed banks to leverage more with assets perceived as safe than with assets perceived as risky resulting in that banks earned higher expected risk adjusted returns on equity on assets perceived as safe than on assets perceived as risky.
Where not regulators aware of that this introduced serious distortions in the allocation of bank credit to the real economy? And if so, who authorized them to do such a thing?
In Basel I, for the purpose of calculating the risk weighted capital requirements for banks the risk-weight of the sovereigns was set at zero percent while the risk-weight of the private sector that provides the sovereign its strength was set at 100 percent.
How come? Would this not mean that the access of sovereigns to bank credit would be subsidized by the private sector's loss of access?
In 2004 Basel II set the risk in the private sector at 20 percent for what was rated ‘prime’ AAA to AA; 100 percent for what was unrated, and 150 percent for what was rated ‘highly speculative’ below BB- rated.
This meant that bank regulators considered ‘highly speculative’ below BB- rated to be much more dangerous to banks and the bank system than ‘prime’ AAA to AA rated.
How could expert regulators believe such a thing?
Bank capital is to cover for unexpected losses, and that the regulators acknowledge.
How then could regulators believe they could use ex-ante perceived expected credit losses to generate an estimate for the unexpected? And to top it up, by definition the safer something is perceived, the larger its potential to cause unexpected losses. And if so should not the capital requirements be 180 degrees in the opposite direction, higher for what is perceived as safe than for what is perceived as risky?
And there are many more questions on this issue a curious reporter should be able to make… but they don’t ask… why? Are they scared for something?
Thursday, January 21, 2016
I refer to Wall Street’s World Economic Forum “Outlook 2016”, January 20, 2016.
Like for instance when Lingling Wei and John Hilsenrath write “Global Economy Loses Steam” The Wall Street Journal, January 20, 2016.
How on earth could not the Global Economy lose steam with regulators who, in an effort to make banks safer, have decided banks should be allowed to earn much higher risk adjusted returns on equity when lending to what is ex ante perceived or deemed to be safe, like to “infallible sovereigns”, AAArisktocracy or housing, than when lending to “risky” SMEs and entrepreneurs. That is the direct result of the risk weighted capital requirements.
“The future is here. It just needs a big push”, writes Christopher Mims. Indeed but why not start by removing the hurdles? As is, with this regulatory credit risk aversion, banks are no longer financing the riskier future they are only refinancing the safer past.
And all that distortion for no good reason, since major bank crisis never result from excessive exposures to something ex ante perceived as risky, but always from too big exposure to what has turned out to be erroneously perceived as safe.
What a shame that, with so many good journalists present in Davos, no one makes THE QUESTION
PS. Another version of THE QUESTION
Tuesday, January 19, 2016
If banks are allowed to hold less capital against mortgages than against loans to SMEs and entrepreneurs… something that they are allowed now.
Then banks can leverage their equity, and the support they receive from society, by for instance deposit insurance schemes, much more with mortgages than with loans to SMEs and entrepreneurs.
And then banks will earn higher ex ante perceived risk adjusted returns on equity when lending to those buying houses than when lending to those who can generate the next generation of jobs.
And then banks will lend more to home buying than to job creation.
And then the citizens are doomed to end up sitting in expensive houses, with low salary jobs or no jobs at all to pay their utilities and their mortgages with.
Is this really what you want?
Thursday, January 14, 2016
How could a crisis resulting from statist interventions, morph into a backlash against banks, capitalism and markets?
1988 with the Basel Accord, Basel I, the regulators, for the purpose of determining the capital requirements for banks, set the risk weight of the Sovereign (the government) to be zero percent while that of the private sector was set at 100 percent. Have you ever seen something more statist than that?
And in 2004, with Basel II, regulators within the private sector, assigned risk weights that ranged from 20 to 150 percent.
Those risk weights translated into banks needing to hold much less capital (mostly equity) against the Sovereign and the Safe Privates (the AAArisktocracy and houses) than against the Risky Privates (SMEs and entrepreneurs).
That meant banks could leverage their equity much more with Sovereign and Safe Privates, than with Risky Privates.
And that meant banks could obtain much higher risk-adjusted returns on equity with Sovereign and Safe Privates, than with Risky Privates… have you ever heard of something that distorts the allocation of bank credit more than that?
And of course the world ended up with a typical bank crisis, one of those that always result from excessive exposures to something ex ante perceived (or deemed) as safe (AAA-rated securities – Greece), but in this case made so much worse by the banks having been allowed to hold especially little capital against “The Infallible”.
But yet this utterly faulty regulation has been framed in terms of “de-regulation”, which has placed the full blame for the crisis on banks, free markets and capitalism.
How did that happened… who are the responsible for that?
A question: Basel II required banks to hold 1.6 percent in capital against what is AAA rated and 12 percent against the below BB- rated. What do you think poses greater danger to the stability of the banking sector: what’s AAA or what’s below BB-?
Bank capital is to help cover for unexpected losses.
The safer something is perceived the greater the potential of unexpected losses.
No bank crisis ever has resulted from excessive exposures to something ex ante perceived as risky.
Current capital requirements for banks are much lower for what is perceived as risky than for what is perceived as safe.
So the current capital requirements for banks seem to be 180 degrees wrong... could that be?
Wednesday, January 13, 2016
Banks regulators believe what’s rated AAA, is more dangerous to the banking system than what’s rated below BB-… Really?
Bank regulators, when trying to make our banks safe, decided that the risk weight for AAA rated assets, a rating described as “prime”, was to be 20%. That, since the basic capital requirement in Basel II was 8 percent, meant that banks needed to hold 1.6 percent in capital (equity) against those assets; and could leverage their equity 62.5 times to 1 with these assets.
For assets rated below BB_ though, ratings described as moving from “highly speculative”, through “extremely speculative” and up to “default imminent”, the risk weight was set at 150 percent. And that, with Basel II’s basic 8 percent, meant that banks needed to hold 12 percent in capital against such assets, and which allowed banks to only leverage about 8.4 times to 1.
But let me ask all of you. What do you think can create those kind of excessive exposures that could endanger the stability of our banking system; exposures to what ex ante was thought to be AAA but that ex post surprised banks by being very risky, or exposures to what was rated below BB- and actually turned out to be very risky?
I hear you… so what did we do to deserve such bad bank regulators?
Tuesday, January 12, 2016
Optimism? No! Use of credit risk weighted capital requirements for banks reflects a severe pessimism about the future
Had banks not held excessive financial exposures related to AAA rated securities backed with mortgages to the subprime sector, or to loans to sovereigns like Greece, the greatest bank crisis of our times would not have happened… and there can be no doubt about that.
Those excessive financial exposures, to assets that were ex ante perceived or deemed as safe, should have been an expected consequence of allowing banks to earn much much higher risk adjusted returns on equity on these assets, than what they could earn for instance on “risky” loans to SMEs and entrepreneurs.
That resulted from regulators allowing banks to hold much much less capital (equity) against “The Safe” than against “The Risky”; by which banks could leverage their equity many many times more with supposedly safe assets than with supposedly risky ones.
And the cost of the greatest bank crisis of our times is still underestimated and is still growing, because it does not include the cost of all those growth opportunities the world, as a consequence, missed and misses by not lending to “risky” SMEs and entrepreneurs.
Favoring with regulations what’s safe over what’s risky, something that also promotes inequality can only be the result of a deeply ingrained risk adverse pessimism. Therefore, while these faulty regulations are still in place, referring to a feeling of optimism about the future is a contradiction in terms.
The economy is, by going for the “safe” carbohydrates, growing obese. A muscular growth requires the intake of “risky” proteins.
Banks are no longer financing the riskier future they are just refinancing the safer past.
How come the Home of the Brave (and Europe) that became what it is because of its willingness to take risks, has accepted this senseless regulatory risk aversion?
Bank capital should cover unexpected losses but what is perceived as safe, has always a greater potential of delivering these than what is perceived as risky and therefore avoided.
How come those most guilty for the greatest bank crisis of our times have not been named, much less held accountable?
Monday, January 11, 2016
The Basel Committee for Banking Supervision introduced credit risk weighted capital (equity) requirements for banks: more risk more capital – less risk less capital.
That allowed banks to leverage their equity much more when lending to that perceived or deemed safe, like to the AAArisktocracy or Infallible Sovereigns, than when lending to those perceived risky, like SMEs and entrepreneurs.
That allowed banks to earn much higher risk-adjusted returns on equity when lending to the safe than when lending to the risky… sort of realizing bankers' wet dreams.
And that means banks build up dangerous excessive financial exposures to what is perceived as safe, against very little capital, precisely the stuff major bank crises are made off.
And that means banks will mostly refinance the safer past than finance the riskier future, negating thereby the young the opportunities their elder benefitted from in the past.
And, in a nutshell, that guarantees growing inequalities and weakening economies.
Damn the Basel Committee, their associates and all other who maintain interested silence on this de facto regulatory crime against humanity, that I sincerely believe was committed unwittingly.
Where did this disaster, which could even be defined as an unwitting economic crime against humanity, originate? There are many factors, and here are some of those I feel are most relevant.
Regulators never defined the purpose of the banks and, if you regulate without doing that, then anything could happen.
Regulators though knowing that banks capital is to be there to help cover for unexpected losses, got confused and used the expected credit risks to estimate the unexpected.
Regulators simply ignored that what is perceived as safe has by definition a greater potential to deliver unexpected losses than what is perceived as risky.
Regulators concerned themselves with the perceived risks of bank assets, instead of with the risk of how bankers would manage those perceived risks.
Regulators simply did not do some empirical research on what causes major bank crises and where therefore not able to manage the differences between ex ante perceptions and ex post realities
Etc. etc. etc.
Shame on the Basel Committee, their associates and all other who keep mum on this.
Saturday, January 9, 2016
How come Nobel Prize winning economists do not understand how regulators distort the allocation of bank credit?
Capital is invested in banks by shareholders looking to obtain the best risk adjusted returns on their equity.
Before current regulators concocted the credit risk weighted capital requirements for banks, the banks, without any sort of discriminations, gave credit to whoever offered them the highest risk adjusted margins.
But now, because of those requirements, more credit risk more capital – less risk less capital, banks can leverage their equity much more with what is perceived as safe than with what is perceived as risky; and can thereby earn much higher risk adjusted returns on equity when lending to the perceived safe than when lending to what is perceived as risky.
And of course, favoring the AAA rated and sovereigns, negates the fair access to bank credit to those perceived as risky, like SMEs and entrepreneurs, and so helps to weaken the economies and to increase the existing inequalities.
Just look at this: Basel II of June 2004 set the risk weight for AAA rated at 20 percent and allowed banks to leverage their equity over 60 times. But for unrated corporations the risk weight was set at 100 percent and in this case banks could only leverage about 12 times.
And all distortion for nothing, since absolutely all major bank crisis result from excessive exposures to something that ex ante was perceived as safe but that ex post turned out to be very risky.
But you read the comments on the 2007-08 crises by Nobel Prize winning research economists, like those of Joseph Stiglitz and Paul Krugman, and it is clear they have no idea about how the regulatory incentives distorted the allocation of bank credit. Unless they shut up for other reasons, like ideological ones, it would seem clear they never had the benefits of a decent Econ 101.
As for me, I strongly feel the Nobel Prize Committee, when the winners use the Nobel Prize reputation to opine in areas totally strange to them, should have the right to revoke Nobel Prizes, and ask for the prize money to be repaid.
Friday, January 8, 2016
World Bank, the credit risk weighted capital requirements for banks promote financial instability and exclusion
May 9-13, 2016 the World Bank will hold “The 13th Overview Course on Financial Issues: Promoting Stable and Inclusive Financial Systems”
And I wonder if they are still going to ignore the distortions produced by the credit risk weighted capital requirements for banks; more risk, more capital – less risk less capital.
These capital requirements allow banks to leverage more with “the safe” than with “the risky”; which means banks will earn higher risk adjusted returns on equity lending to “the safe” than when lending to “the risky”; which means banks will lend too much to “the safe” and too little to “the risky”. And that will:
Promote financial instability since all major bank crisis have always resulted from excessive exposures to something ex ante perceived as safe but that ex post resulted risky.… in this case aggravated by the fact that banks against that hold especially little capital.
Promote exclusion, as it odiously discriminates against the risky… like SMEs and entrepreneurs.
I quote John Kenneth Galbraith from “Money: Whence it came where it went” 1975. “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.”
And when will the World Bank, the world’s premier development bank remind the world of that risk-taking is the oxygen of any development.
Again I quote John Kenneth Galbraith from “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]... 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.”
In March 2003, as an Executive Director of the World Bank I gave the following formal statement on this:
And soon 12 years later, I am still waiting L
Tuesday, January 5, 2016
The Basel Committee decided that in order to make banks safe, these need to hold more capital (equity) against assets perceived as safe from a credit risk point of view than against assets perceived as risky.
For instance in Basel II a private sector asset rated AAA to AA carried a 20 percent risk weight while an asset rated below BB- had a 150 percent risk weight. That meant banks needed to hold 7.5 times more capital against a below BB- rated asset than against a AAA to AA rated asset.
Allowing banks to leverage their equity differently based on credit risks obviously distorts the allocation of bank credit to the real economy, something that by itself could also be very dangerous for the safety of banks.
And so, the only way those risk weighted capital requirements for banks could be justified, would be if they really made banks safer.
But ask any bank regulator, like Stefan Ingves, the current Chair of the Basel Committee the following:
Sir, would you be so kind so as to provide us with one example of a major bank crisis that has resulted from excessive bank exposures to assets that were perceived as risky when placed on the balance sheet of banks.
If they cannot answer, should that not be a sufficient indication that they might have no idea about what they are doing?
I mean I can think of many instances were bankers were lulled into a false sense of security by good credit ratings, but I cannot for my life imagine bankers building up excessive exposures to something rated below BB-. Can you?
Monday, January 4, 2016
Joseph Stiglitz: Until the world rids itself of distortionary bank regulations, The Great Malaise will continue.
Professor Joseph Stiglitz, in Project Syndicate and Social Europe, January 2016 writes “Why The Great Malaise Of The World Economy Continues In 2016”
And in it Stiglitz states: “While our banks are back to a reasonable state of health, they have demonstrated that they are not fit to fulfill their purpose. They excel in exploitation and market manipulation; but they have failed in their essential function of intermediation. Between long-term savers (for example, sovereign wealth funds and those saving for retirement) and long-term investment in infrastructure stands our short-sighted and dysfunctional financial sector.
“Short-sighted and dysfunctional financial sector”? Of course, how could it not be, when regulators impose odiously discriminating capita requirements for banks based on credit risk.
That allows banks to leverage their equity more with what is perceived or deemed to be safe than with what is perceived as risky; and which means banks make higher risk adjusted returns on equity with “safe” assets than with “risky” assets. And of course that completely distorts the allocation of bank credit to the real economy.
Why can a Professor Stiglitz scream out against market manipulation of banks and simultaneously keep total silence on the so much worse bank credit manipulations by regulators?
Why can a Professor Stiglitz scream out against fiscal austerity and simultaneously keep total silence on the so much worse bank credit austerity that is hitting the “risky” borrowers in the market, like SMEs and entrepreneurs.
Why can a Professor Stiglitz scream out against inequality and simultaneously keep total silence on that inequality driver capital requirements for banks based on credit risk signify?
Why cannot a Professor Stiglitz understand that if you want banks to “match long-term savings to long term needs” you are better off with capital requirements based on long term needs and not on short-termish credit risks?
Professor Stiglitz then opines “The obstacles the global economy faces are not rooted in economics, but in politics and ideology.”
Absolutely! When Stiglitz wants government bureaucrats to take advantage of that ultra low interests that in much result from favoring bank regulations, in order to finance new projects, he shows he is clearly rooted in politics and ideology. His being “Long live the technocrats and their technocratic approaches! They can do no wrong!”
I guess Professor Stiglitz was thrilled with the Basel Accord of 1988 that, for purposes of bank capital requirements, set the risk weight of sovereigns at zero percent and the risk weight of the private sector at 100 percent.
I guess Professor Stiglitz was thrilled with the Basel Accord of 1988 that, for purposes of bank capital requirements, set the risk weight of sovereigns at zero percent and the risk weight of the private sector at 100 percent.
Sunday, January 3, 2016
The Big Short is short on the whole truth. There’s too much vested interest in “Bank regulators can’t be that wrong!”
Paul Krugman, in the New York Times of December 18, 2015 wrote: “You want to know whether the movie [The Big Short] got the underlying economic, financial and political story right. And the answer is yes, in all the ways that matter”
No! I now saw “The Big Short”. It is a very good movie that describes accurately many elements of the crisis that resulted from excessive exposures to AAA and AA rated securities; those that were backed with badly awarded mortgages to the subprime sector.
But, unfortunately, just as I suspected, it remains totally mum on what really propelled the crisis, namely outlandishly bad bank regulations.
In the over two hours movie, we do not hear a single word about that banks in Europe, and investments banks in the USA, thanks to the Basel Committee and the SEC, were allowed to hold these securities against only 1.6 percent in capital… meaning they could leverage their equity, and the support they received from society, a mind-blowing 62.5 times to 1.
The risk-adjusted returns on equity banks expected to make on AAA to AA rated securities by leveraging them over 60 times, blinded everyone. When in the movie it is mentioned that even though the default rate of the subprime mortgages was increasing dramatically, and yet the price of those securities was rising, they ignored among others the runaway European demand for these. These securities, CDO, MBS, ABS or what you want to call them were in fact thought to be the new gold to be found in California, and way over a trillion Euros pursued that gold during less than two years.
Want to read about it? Here is what happened to little Narvik of Norway in “And then the roof caved in”, page 114.
Anything that could be traced back to an AAA rated security allowed banks to finance any operation with it against almost no capital. For instance if AAA rated AIG sold you a credit default swap, that was enough… and so everyone bought CDS’s from AIG, who could not resist selling CDS’s on AAA rated securities.
Paul Krugman and others like Joseph Stiglitz, even though bank regulations odiously discriminate against “The Risky” and in doing so increases inequality, cannot find it in themselves, or in their agendas, to accept that technocratic regulators, regulating on behalf of governments, could be so wrong.
The Big Short mentions though a prime driver of the disaster. One broker confesses he would make immensely higher commissions supplying truly lousy adjustable rate mortgages to the packagers of AAA security, than sending them reasonable fix rate prime mortgage. The way the incentives worked, the worse the mortgage, the higher was the added value of the to AAA-ratings conversion process.
PS. And not only The Big Short is guilty of omission. In its 848 pages the Dodd Frank Act, though the US is a signatory, does not even mention the Basel Accord and the Basel Committee
PS. I just looked at the index of Michael Lewis’ “The Big Short again”. It does not mention Basel regulations, risk weighted capital requirements for banks, nor the meeting on April 28, 2004 when SEC decided that the investment banks in the US, would be able to play by Basel rules… and thereby open the way for the minimum capital requirements against anything AAA rated for these banks.