Tuesday, May 16, 2017

Why are excessive bank exposures to what’s perceived safe considered as excessive risk-taking when disaster strikes?

In terms of risk perceptions there are four basic possible outcomes:

1. What was perceived as safe and that turned out safe.

2. What was perceived as safe but that turned out risky. 

3. What was perceived as risky and that turned out risky.

4. What was perceived as risky but that turned out safe.

Of these outcomes only number 2 is truly dangerous for the bank systems, as it is only with assets perceived as safe that banks in general build up those large exposures that could spell disaster if they turn out to be risky.

So any sensible bank regulator should care more about what the banks ex ante perceive as safe than with what they perceive as risky.

That they did not! With their risk weighted capital requirements, more perceived risk more capital – less risk less capital, the regulators guaranteed that when crisis broke out bank would be standing there especially naked in terms of capital. 

One problem is that when exposures to something considered as safe turn out risky, which indicates a mistake has been made, too many have incentives to erase from everyones memory that fact of it having been perceived as safe.

Just look at the last 2007/08 crisis. Even though it was 100% the result of excessive exposures to something perceived as very safe (AAA rated MBS), or to something decreed by regulators as very safe (sovereigns, Greece) 99.99% of all explanations for that crisis put it down to excessive risk-taking.

For Europe that miss-definition of the origin of the crisis, impedes it to find the way out of it. That only opens up ample room for northern and southern Europe to blame each other instead.

The truth is that Europe could disintegrate because of bank regulators doing all they can to avoid being blamed for their mistakes.

Sunday, May 7, 2017

The insidious credit distorting risk weighted bank capital requirements’ tax, crosses the Laffer Curve at point zero

The Laffer Curve indicates at what rate, a tax will produce less tax revenues for the government.

For purposes of setting the capital requirements for banks in 1988 (Basel Accord) the regulators introduced the risk weighing of banks’ assets. And they decided that loans to the sovereign carried a 0% risk weight, while loans to the citizens (SMEs and entrepreneurs) 100%. 

That means banks need to hold less capital (meaning equity) against loans to the sovereign (meaning government) than against loans to citizens.

That means banks can leverage more their equity with the market risk adjusted interest rates for loans to the sovereign than with the market risk adjusted interest rates for loans to the citizens; which means sovereign will have more and cheaper access to bank loans, a regulatory subsidy, paid by lesser and more expensive access to bank credit for the private sector, a regulatory tax.

That de facto signifies that regulators believe government bureaucrats can make better use of bank credit than the private sector, something that is not true. 

As a consequence of this regulatory distortion, bank credit will not be allocated efficiently to the economy; and so the economy will grow less; and so the tax intake will be smaller; and so the Laffer curve has immediately been crossed. 

Of course, if the current generation does not care about falling tax revenues being compensated with higher debts to be repaid by grandchildren, then this is a moot issue.

PS. Of course all other favoring, like a 20% risk weight for the AAA-risktocracy and 35% for residential housing also to misallocate credit... and thereby cause less ordinary tax revenues. 

PS. Of course, sadly, nothing is gained in term of stability, as never ever do major bank crisis result from excessive exposures to something perceived risky. These results from excessive exposures to something perceived safe, like sovereigns like Greece, like AAA rated securities.

Sunday, April 30, 2017

IMF does still not understand how the risk weighted capital requirements for banks distort. Why? Groupthink?

IMF’s Global Financial Stability Report 2017 on page 43 and 44 Box 1.2. “Regulatory Reform at a Crossroads” states:

Finalization of the Basel III package of reforms— the revision of the “standardized” approach to the calculation of risk-weighted assets and limits on the use of internal models to assess risks—appears to have faltered… The outstanding challenge is to reconcile views on the weight to attach to each element, particularly to the balance between reliance on internal models and constraint through the calibration of the floor [based on a standardized approach]”

So regulators wants to reconcile between:

Use of internal risk models, which is basically similar to allowing Volkswagen to calculate their own carbon emissions. 

Using the standardized approach designed by regulators and which included, for instance risk weights of only 20% for what is perceived very safe, like what’s AAA rated, and which precisely because of that perception can lead banks to build up dangerously large exposures; and a 150% risk weight for what is rated below BB-, something to which banks would never dream to expose their balance sheets much to.

We all know that minus times minus leads to a positive number but does reconciling one craziness with another craziness lead to a sane regulation. NO!

Box 1.2 also includes: “countries outside the central standards-setting bodies [in particular emerging markets]…rely heavily on a strong global standard to level the playing field and support financial stability”

Question: Does allowing the safe to have better access than usual and the risky less than usual really signify to “level the playing field”?

Box 1.2 concluding states: “Completion of the reforms is vital to address previously identified fault lines and thus ensure that the global financial system is safe and can promote economic activity and growth.”

Congratulations! I believe this is the first time I have read from somebody close to the regulators, as IMF is, that besides “safe and resilient”, the banking system needs also to “promote economic activity and growth.”

It is truly sad this comes at such a late stage. Anyone wanting banks to promote economic activity and growth, would never have accepted the risk weighted capital requirements for banks, as these dangerously distorts the allocation of credit to the real economy. 

So clearly, IMF still has much internal analysis to do before they get there. I hope its groupthink allows it.

3 questions on IMF’s Global Financial Stability Report’s, “Where Are the U.S. Corporate Sector’s Vulnerabilities?”

That section, on page 9 states:

“The corporate sector has tended to favor debt financing, with $7.8 trillion in debt and other liabilities added since 2010. Bank lending to the corporate sector has continued to recover and could well rise further in response to more favorable market valuations. In contrast, equity finance has traditionally been outstripped by share buybacks and has recently leveled off. A drop in the cost of equity capital may stimulate equity financing, but it could coincide with higher corporate debt—particularly if additional share buybacks are financed through debt.” 

That begs three questions: 

First: How much of the recent increase in the stock markets is the result of buybacks; that which helps earnings per share to get a sort of artificial boost; that which results in less equity controlling the corporations? 

Second: Do the recent stock-market prices increases duly reflect the increase riskiness derived from much higher corporate debts? 

Third: Have Central Banks therefore, with their low interests rate policies, de facto, dangerously lowered the capital (equity) requirements of corporations? 

On the first two questions I have no answers, though just having to ask them should suffice to at least raise some eyebrows. 

On the third the IMF clearly seems to respond, “Yes!” when on that same page, under the subtitle “High Leverage Combined with Tighter Borrowing Conditions Could Affect Financial Stability” it writes: 

“As leverage has risen, so too has the proportion of income devoted to debt servicing, notwithstanding low benchmark borrowing costs. Although the absolute level of debt servicing as a proportion of income is low relative to what it was during the global financial crisis, the 4 percentage point rise has brought it to its highest level since 2010, which leaves firms vulnerable to tighter borrowing conditions. The average interest coverage ratio—a measure of the ability for current earnings to cover interest expenses— has fallen sharply over the past two years. Earnings have dropped to less than six times interest expense, close to the weakest multiple since the onset of the global financial crisis.” 

Holy Moly! And interest rates have not yet returned to something more "normal"; and the Fed's balance sheet is still so huge it leaves little space for any future QE assistance...and not to speak of the already too large public debts. 

My intuition tells me that if we do not develop something along the lines of a Universal Basic Income, fast, we will not be able to counter sufficiently upcoming recessions and huge unemployment so as to keep truly horrendous populists away.

Really, how on earth can we have left so much power in so few so intellectually incestuous hands?

Tuesday, April 25, 2017

IMF, "cash" what cash? Have you any idea how the $2.2 trillion in retained foreign earnings is invested?

“Is the U.S. Corporate Sector Ready to Accelerate Expansion—Safely?

The potential for a one-off repatriation of retained foreign earnings, including liquid funds held abroad.

Repatriating liquid assets held abroad by U.S. companies would also benefit the information technology and health care sectors, where 60 percent of the $2.2 trillion in unremitted foreign earnings held abroad is concentrated.

Cash windfalls from repatriation would likely accrue to cash abundant sectors”

In order to analyze the effects of any repatriation of retained foreign earnings, one would need to know how that money is invested… because you can be absolutely sure it is not in cash under corporate treasurers’ mattresses.

That is why I ask IMF whether they know. If they don’t then they better find out before they speculate on what the repatriation of these retained foreign earnings would signify. 

What if the $2.2 trillion is all invested in treasuries? J

This is somewhat similar to all those divisive statements that reference that the wealth of the 62 richest equals that of 3.6 billion poorest, without the slightest thought given to how that wealth could be transferred.

IMF: The “I scratch your back if you scratch my back” crony statism deal between sovereigns and banks, must stop.

In 1988, with the Basel Accord, Basel I, for the purpose of capital requirements for banks, regulators assigned to the sovereigns a risk weight of 0%, while citizens got one of 100%.

That meant banks would be able to leverage more their capital when lending to sovereigns than when lending to citizens. 

That meant banks would be able to earn higher expected risk adjusted returns on equity when lending to sovereigns than when lending to citizens. 

That meant that banks would lend more and at lower rates than usual to sovereigns and in relative terms less and at higher rates than usual to citizens.

That de facto established the Sovereign-Bank Nexus. I Sovereign help to guarantee you banks, and you help to finance me abundantly and cheap.

IMF, in its Global Financial Stability Report 2017, page 36 and 37 have a section titled “The Sovereign-Bank Nexus could reemerge”. It correctly spells out how banks can be affected by difficulties of sovereigns and how sovereigns can be affected by difficulties of banks. 

But it makes absolutely no reference to the regulatory support of the Sovereign-Bank Nexus previously described. Why?

IMF, Basel Committee for Banking Supervision: Don’t tell me you do not know who did the Eurozone in?

Saturday, April 22, 2017

Should not science matter to bank regulators, at least a little?

I ask because though I am no scientist, far from it, have never really understood Einstein’s relativity theory, I know that if I were asked to regulate banks there would be two basic questions I would have to ask:

First, what is the purpose of our banks? Quite early someone would have mentioned John A Shedd’s “A ship in harbor is safe, but that is not what ships are for” and I would have ascertained that purpose to be, to allocate credit to the real economy, carefully but efficiently. 

Second, what has caused major bank crises? a. Unexpected events, like devaluations, b. criminal behavior, like lending to affiliates; and c. dangerously large exposures to something ex ante perceived as very safe but that ex post turned out to be very risky. Surely someone would have also cited Voltaire’s “May God defend me from my friends, I can defend myself from my enemies” as a reminder that what is perceived as risky is, precisely because of that perception, quite innocuous.

After that initial mini research, the last thing I would have come up with is the current risk weighted capital requirements, more risk more capital – less risk less capital, that which distorts the allocation of bank credit, for no stability purpose at all... much the contrary.

So again… should not science matter to bank regulators, at least a little?

Thursday, April 20, 2017

Regulatory risk aversion distorts credit and causes dangerous bank exposures to what is perceived, decreed or concocted as safe.

Mark Carney, Governor of the Bank of England, and the Chair of the Financial Stability Board, on April 7, 2017 gave a speech titled: “The high road to a responsible, open financial system”. 

Carney said: “The pillars of responsible financial globalisation eroded prior to the global financial crisis. Regulation became light touch and ineffective…. few participants were exposed to the full consequences of their actions as governance and compensation arrangements focused on the short term.”

But to call regulations that as a pillar has risk weighted capital requirements for banks, which allow banks to leverage assets differently because of perceived or decreed risk, “light touch”, is pure nonsense. And if there is anything as focused on the short term, that must be regulations that give banks incentives not to lend to the “riskier” future, but to take refuge in refinancing the “safer” past and present.

Carney bragged: “The system is safer because banks are now much more resilient, with capital requirements for the largest global banks that are ten times higher than before the crisis and a new leverage ratio that guards against risks that may seem low but prove not.” 

Since that “ten times higher” refers to capital in relation to risk weighted assets, and he has no way to ascertain the ex ante risk perceptions will coincide with the ex post realities, that number may or may not be true. The improvement might come from banks shedding a lot of safe “risky” assets and taking on more exposures to potentially risky “safe” assets. Finally, mentioning “a new leverage ratio that guards against risks that may seem low but prove not”, amounts to admitting they had no idea what they were doing before.

Carney opined: “The financial system is simpler. As banks have become less complex and more focused, they are lending more to households and businesses and less to each other. A series of measures are eliminating toxic and fragile forms of shadow banking while reinforcing the best of resilient market-based finance. And more durable market infrastructure is simplifying the previously complex – and dangerous – web of exposures in derivative markets.”

He wishes!

But when I object the strongest is when Carney states “The financial system is fairer because of reforms that are ending the era of “too big to fail” banks and addressing the root causes of a torrent of misconduct.”

Fairer? With regulators favoring those who perceived as safe were already favored with easier access to bank credit, and increasing the obstacles for those who perceived as risky already found it harder to access bank credit, has nothing to do with fairness. It is just odious regulatory discrimination.

Tuesday, April 18, 2017

IMF and World Bank, have you really thought about what bank regulators are doing to our grandchildren?

Beginning 1988, with the Basel Accord, and much expanded in 2004, with Basel II, the Basel Committee for Banking Supervision, imposed on banks risk weighted capital (equity) requirements. Less perceived risk less capital - more perceived risks more capital.

The regulators also decreed that the sovereign would carry less risk weight than their subjects, which de facto implies they believe government bureaucrats use bank credit more efficiently than the private sector.

That means!

Banks can leverage more their equity with assets perceived as safe than with assets perceived as risky. 

Banks can earn higher risk adjusted returns on equity with assets perceived as safe than with assets perceived as risky. 

So sovereigns (the government), the AAA-risktocracy and those buying houses will have ampler and cheaper access than usual to bank credit.

So the “risky” SMEs and entrepreneurs, no matter how useful they might be for moving the economy forward, will find it harder and more expensive than usual to access bank credit.

So banks will be financing insufficiently the “riskier” future of our grandchildren, keeping busy refinancing the “safer” past and present of parents and grandparents. 

Grandfathers or grandfathers to be, I ask you,do you believe this is to act responsibly with respect to our grandchildren’s future?

I don’t! 

It is pure statism!

It distorts the allocation of credit in such way that it guarantees our real economies to stall and fall. As John A Shedd said: “A ship in harbor is safe, but that is not what ships are for

It means our banks, and we all, are sooner or later going to end up gasping for oxygen in some dangerously overpopulated safe-havens. As Voltaire said: “May God defend me from my friends, I can defend myself from my enemies”. 

Saturday, April 15, 2017

When banks play it too safe - putting inequality on steroids - the McKinsey silence

In his April 9 Outlook essay, “Public Policy, Inc.,” Daniel W. Drezner, writing about how consultancies such as McKinsey have started to act like policy knowledge brokers, mentioned that these “have their own biases.” Indeed.

Bankers love to hold assets perceived as safe against very little capital. It helps them earn great risk-adjusted returns on equity.

But we citizens have no reason for loving that:

By going too much for the safe, banks will not lend sufficiently to the riskier entrepreneurs who are the prime builders of our grandchildren’s future. Sooner or later, banks will get caught with little capital holding dangerously large exposures to something that was perceived safe but that turned out risky. Depositors and taxpayers will suffer.

There is no question that banks are more important clients for consultant companies such as McKinsey than citizens are. That must be why financial consultants have not denounced how the Basel Committee on Banking Supervision’s risk-weighted capital requirements for banks dangerously distort the allocation of bank credit to the real economy.

Millions of entrepreneurs around the world have, as a direct consequence of these capital requirements, been denied the opportunity of bank credit. Talk about putting inequality on steroids. 

Per Kurowski, Rockville
The writer was an executive director at the World Bank from 2002 to 2004.

Wednesday, April 12, 2017

Mme Lagarde. I don’t agree with that IMF is “Building a More Resilient and Inclusive Global Economy”.

On April 12, Christine Lagarde, Managing Director of IMF gave a speech titled “Building a More Resilient and Inclusive Global Economy

Mme Lagarde stated: “We have found that technology has been the major factor behind the relative decline of lower- and middle-skilled workers’ incomes in recent years, with trade contributing to a much lesser extent” So where was IMF with this argument during the recent walls against foreign workers debate? Jobs are of course important but is it not also time to start thinking about the need for decent and worthy unemployments?

Mme Lagarde also stated: “Financial stability requires that we complete the reform of global financial regulations. These rules—especially on bank capital, liquidity, and leverage” Hah! With capital requirements for banks that are especially low for what can cause bank crises, namely what’s perceived as safe? Like the ultra low risk weighted assets of the AAA rated securities and a sovereign like Greece? IMF has to be joking.

Mme Lagarde spoke about IMF’s efforts for “avoiding protectionist measures as well as distortive policies that give rise to competitive advantage.” So why then does IMF keep silence on capital requirements for banks that make it harder than it already is for those perceived as risky, to access bank credit, like the SMEs and entrepreneurs?

Mme Lagarde holds that “today’s policies should not disadvantage future generations, who would be left to pay for the imprudent actions of today’s generation.” Hold it there! The current imprudent risk adverse bank regulations that give banks incentives to stay away from financing the riskier future and just keep to refinancing the safer present, does precisely disadvantage future generations.

Mme Lagarde, let me assure you that the current Basel Committee’s bank regulations do not live up to any of the three principles proposed by the great Roman architect Vitruvius:

Durability: No! “May God defend me from my friends, I can defend myself from my enemies” Voltaire”.

Utility: No! “A ship in harbor is safe, but that is not what ships are for” John A Shedd.

Beauty: No! Besides perhaps delighting some anxious nannies that regulation raises no one’s spirits. God make us daring!


Friday, March 31, 2017

The Basel Committee for Banking Supervision has doomed our banking system to fail in its purpose, and to crash.

The Basel Committee (and national bank regulators) allows banks to hold less capital against assets perceived or decreed as safe, like loans to sovereigns, to what has an AAA rating or residential mortgages, than against assets perceived as risky, like loans to SMEs and entrepreneurs. 

That means banks can leverage more their equity with “safe” assets than with “risky” assets.

That means banks can earn higher risk adjusted returns on equity on “safe” assets than on “risky” assets.

That means banks will acquire too many safe assets and too little risky assets.

But, you might ask, is that not great? The answer is, NO! 

It guarantees that the real economy will be negated the risk-taking necessary for it to keep on moving forward so as not to stall and fall. 

A ship in harbor is safe, but that is not what ships are for.” John A Shedd (1850-1926)

And it guarantees that, sooner or later, (like in 2007-08 with AAA rated securities and Greece) banks will end up holding, against too little capital, too much of an asset ex ante perceived as safe, but that ex-post turns out to be very risky. 

May God defend me from my friends, I can defend myself from my enemies” Voltaire

And of course that meant that bank regulators decreed inequality.

Thursday, March 30, 2017

BoE: Regulations make banks value what’s “risky” riskier than what it is, and what’s “safe” safer than what it is.

I refer to “The art of the deal: what can Nobel-winning contract theory teach us about regulating banks?” by Caterina Lepore, Caspar Siegert, Quynh-Anh Vo published on BoE’s Bank Underground blog.

It states “Capital Structure: Banks can finance their assets via debt, equity, hybrid securities or a mix of them. Changes in banks’ capital structure may have big impacts on their market capitalisation and are usually under close watch of regulators.”

As many do, that recognizes that differences in capital structure impacts market capitalization and profits. But again, as most can’t, the authors cannot take that intellectual step to understand that different capital structures, ordained for different assets, by means of risk weighted capital requirements for banks, distort the allocation of credit to the real economy.

Since banks do look at perceived risks when deciding on size of exposures and risk premiums, to have regulators also make these ex ante perceived risks influence the capital requirements, one is effectively doubling down on whatever ‘information asymmetries’ might exist in the perception of risks.

That de facto means that current regulations make banks value what’s “risky” riskier than what it is, and what’s “safe” safer than what it is… and seemingly no one, not even BoE, cares a damn.

The author’s also write: “Because banks are better informed about their own risks, institutions allowed to determine risks using their own models, under the internal ratings-based (IRB) approach, may have incentives to under-estimate risks.”

Of course they have incentives to under-estimate risks, as that would generate lower capital requirements, as that would allow for higher leverage of equity, as that would increase the expected risk adjusted returns on equity. 

To understand how naïve regulators have behaved, let us just indicate that it is similar to allowing Volkswagen to do their own carbon emission testing in their own laboratories.

But, don’t get me wrong, this does not mean for a second bank regulators do it better with their standard risk weights. Just as an example those private sector assets rated AAA to AA and that could because of their perceived safety really cause a major bank crisis if those perceptions turn out to be wrong ex-post were assigned in Basel II a risk weight of 20%, while the totally innocuous below BB- rated carry a risk weight of 150%. 

The authors suggest: “In the real world where banks can both undertake excessive risks and underreport such risks, as recognized by the current capital framework, a combination of risk-weighted capital requirement and a non-risk-based leverage ratio might indeed be optimal.”

The fact is that the higher a “non-risk-based leverage ratio” might be, the more can the “risk-weighted capital requirement” distort on the margin. I invite you to think of the movie “The drowning pool”

Professors Oliver Hart’s and Bengt Holmström’s contributions to contract theory can indeed be “helpful in regulating banks!” But, let us not kid ourselves, current bank regulatory mistakes are so basic, these need no new theories in order to be corrected, just pure common sense.

Here are my most urgent questions on bank regulations. These seemingly belong to those that should not be asked, much less answered.

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?