Risk Off

I’ve suggested here before that we should declare Ireland a Basel III free zone. (Difficult I know given the IMF/EU/ECB deal, but given the fact that the ESRI is now suggesting we’re likely to get €3bn back from the banks recap – I say why not, because we don’t actually have functioning banks)

The evidence from this report suggests that Regulators have continued to fight the Regulatory wars when the soldiers in the field aka the banks are dying of starvation. The wars happened in 2002/2003/2004 but the Regulators were dining out at the time. Todays Regulatory battles are like war games – interesting but serve no economic purpose and cost a serious amount of scare cash.

Report:

‘..Chart 18 plots the path of the UK credit-to-GDP guide-path over recent years. Unsurprisingly, it suggests that UK banks’ capital ratios should have been tightened in the run-up to the crisis, with credit-to-GDP above its long-term trend by up to 10 percentage points. That disequilibrium has since been completely eliminated as credit growth has collapsed. Currently, the guide-path is close to cycle-neutral. Any further fall would put credit below its cycle-neutral level, implying a loosening to support risk-taking.

Setting regulation to boost risk-taking may feel like a new and radical departure from the past. But in fact it is neither as radical nor as new as it might first appear. In 1938, the US was facing a double-dip recession. Criticism of banks’ unwillingness to lend to the real economy was rampant. Fear in financial markets was mounting. The situation was eerily reminiscent of today.

At that point, Roosevelt turned macro-prudential. In the Uniform Agreement on Bank Supervisory Procedures, a relaxation of prudential and valuation standards was announced for US banks. This aimed explicitly to support lending and activity in the real economy, “the activist goal of liberalizing bank examinations to make them dynamically adjustable to current economic policies”.8 It worked. Lending and growth resumed…’

Tim Geitner has recently been quoted as the only thing that really matters in banking today is capital, capital and more capital. His close cousin Mathew Elderfield has been ploughing a similar furrow.

If the evidence on what we’re reading here and seeing on the gound is to be believed then messrs Geitner and Elderfield are wrong, wrong, and more wrong by the passing hour. It’s not the future we should be looking to in this case but the history books. Ongoing implementation of the Basel III death list is working.

@DB

Indeed it does allow leeway but in Ireland we’re working toward a 10.5% Core Tier Ratio when in reality someting akin to 1% is probably more appropriate.

In any event capital ratios are a dire method to use to establish the safety of banks balance sheet – longer term the only metric that actually stands the test of time is a conservative Loan to Deposit ratio at c100% or below. It’s the most natural risk hedge in banking – if you got it you have to be careful with it and without it, well you don’t play the credit creation game. Relatively easy to administer and Regulate and doesn’t require teams of lawyers to stand in waiting on either side.

@Yields or Bust
If credit has become a Dodo why is our money still in credit deposits ? – I see no reason for credit in this economy to be honest – the Central bankers if truely acting altruistically are in cloud cuckoo land.
Of course the simple explanation is that they are acting selfishly to save their doomed credit empires.
The save debt destroy infrastructure, save debt destroy human capital save debt save your ass stratergy is near a Malthusian end point as interest / wealth extraction is nearly finished with.
JCT outburst about price stability which was only acheived through wage deflation in the face of massive credit inflation perhaps gives us some hope this banking pox is coming to a end.
But they will not go quietly me thinks – they will try to bring the entire economic ecosystem down with them.

Excellent analysis, but it leaves me cold. The ultimate ‘risk averse’ decision makers are small in number. They had no difficulty being risk on, if that’s the expression, when their computer models convinced them that nothing could go wrong.

To my mind, this paper fails to address the underlying irrationality of the ‘market’, instead portraying it as some sort of rational process in which individuals veer between being ‘risk on’ or ‘risk off’. I don’t know much about this stuff, but I suspect that there are people whose jobs are on the line if they make the wrong call so they follow the ‘herd’, or the calculations of whatever computer model they are hooked into at the time, to hedge their bets on an hourly basis. In teh real world and that of politics too, there’s no such thing as the instant solution.

The authors are right that at the end of the day it’s going to be a political decision – and a very brave one – that will break the impasse.

I find it somewhat depressing, that this rather good paper has a mere 9 comments. The current crisis was caused by insufficient information about risk. neither regulators, investors, nor other market participants had adequate information.

this paper should be a lot more important.

The bank of England and the U.K. was at the centre of the cause of the financial crisis through lowering regulation to attrat business to London from Frankfurt and New York. The U.K. economy and the city of London is so dependent on finance. They are footdraggers on implementing regualtion so I am not at all surprised by this kind of article.

Paper is neat. Easy to read, good undergrad stuff. Does not ref. Koo or any of the 12 Apostles of Doom (the ones who DID see the debt Ponzi scheme developing).

Hazard: the potential to cause harm.

Risk: the probability of harm.

Bit tongue-in-cheek defs, but you get the drift.

Debt is a virtual , on-biological, pathogenic virion. Its a hazard; it can cause harm. So also, a biological pathogenic virion, but in this case the pathogenicity of the virion usually attenuates as the infection spreads out into a susceptible population. The 1919 – 1921 Influenza Pandemic is a good example.

But debt? Now debt can (without any nutrient or substrate) grow exponentially; its victims neither develop immunity nor die-off, and its pathogenicity does not attenuate. The debt virion only ‘dies off’ with deflation or inflation (of money). Choose your medicine.

Our stupid financial gobshites have not only ‘genetically engineered’ the pathogenicity of debt to obscene levels, but have mandated that more and more folk need to be infected (no die-off). In order to ensure this outcome they have mandated ‘growth’. Growth is a good incubator for debt virions. But, and herein lies the predicament. Growth is a ‘natural’ process: it IS subject to chemical, physical, mathematical and technological attenuation.

The prognosis for debt: not good.

Brian Snr.

@ All,

I haven’t read the paper, but I always like to see Tversky, A, and Kahneman, D, 1974 work at the end in the references list. Some of the authors I most admire have used that original work quite a bit, to build some good new stuff around. I listened to a George Soros recent interview, in which he remarked the best way to offer stimulus into an economy, may be to relax the capital ratio requirement down from 8% to 6% at some stage, and to release that money into the economy to support business. There was a lot more to his version of a plan than that, and I’m sure it’s published out there in print somewhere. I only got the podcast interview, but his plan sounded of interest. BoH.