In words of two great Canadian singer songwriters, this is what has, and is happening, to Europe.

After the Basel Committee in 1988 decreed its risk adverse bank regulations, in words of Joni Mitchell’s Yellow Taxi, this is what has happened to Europe.

“Don't it always seem to go

That you don't know what you got 'til it's gone?

They paved paradise and put up a parking lot

Ooh, bop-bop-bop

Ooh, bop-bop-bop (na-na-na-na-na)

They took all the …. and put 'em in a …. museum

And they charged the people a dollar and a half to see them

No, no, no

Don't it always seem to go

That you don't know what you got 'til it's gone?

They paved paradise and put up a parking lot.”

And, if also Leonard Cohen could update his You want it darker, though surely in a more poetic way, it could go something like this:

If you’re the regulator, I'm out of the game

Deciding what banks need, kids will be broken and lame

If thine is the glory, theirs must be the shame

You want it darker

You killed the flame

It's written in regulations

It's not some nonsense claim

Basel Committee told banks

Keep refinancing our safer present

Don’t finance their riskier future

And that’s what our children got

You want it darker

They killed the flame

What has become of Europe (and of you the whole Western world)? Don’t be such a defeatist!

Please free us from imprudent risk-aversion and give us some prudent risk-taking

God make us daring!

USA and Canada beware… all this goes with you too.

 

#AI #OpenAI #ChatGPT: Are bank regulators thinking of themselves too much as Gods?

I asked ChatGPT:

In “Against the Gods" 1996, Peter L. Bernstein wrote that the boundary between the modern times and the past is the mastery of risk, since for those who believe that everything was in God’s hands, risk management, probability, and statistics, must have seemed quite irrelevant. 

When the regulators held, they knew enough about the future and risks, so as to decree risk weighted bank capital/equity requirements, could one not argue that:

The Basel Committee members, with loads of hubris, thought of themselves a bit like Gods?

That God’s hand was left out way too much, and that one capital requirement against all bank assets, a leverage ratio, when it comes to knowing it all, would better express our humans’ lackings?

ChatGPT answered:

Yes, one could certainly argue that the Basel Committee, in designing risk-weighted capital requirements, exhibited a degree of hubris—akin to assuming they could foresee financial risks with a precision that history has often shown to be illusory. By assigning different risk weights to assets, regulators implicitly presumed they could reliably quantify and categorize risk across time and financial cycles, despite the ever-evolving and unpredictable nature of markets.

A simpler leverage ratio—one uniform capital requirement against all assets—would acknowledge the limits of human foresight and avoid the illusion of precise risk measurement. It would recognize that risk is often hidden in places regulators least expect, and that past risk assessments can become dangerously outdated in crises.

In that sense, leaving "God’s hand" out too much—by over-relying on human judgment and statistical models—might have led to regulatory frameworks that failed when reality diverged from predictions, as seen in the 2008 financial crisis. A leverage ratio, by not pretending to know the unknowable, would better reflect our human limitations in mastering risk.

I said: Thanks!

It replied: You're very welcome! Always a pleasure to discuss these topics with you. Let me know if you’d like to dive deeper into anything else.

Note: The answers are copied exactly from those given to me by ChatGPT

Here my many other questions to ChatGPT – OpenAI on bank regulations

Bank regulators, mixed and served us their Basel Accord cocktail... and since, they tell us all to sing: “Don't worry, be happy.”

The Basel I Accord (28 pages) was published in July 1988 by the Basel Committee on Banking Supervision:

Risk weighted bank capital requirements with decreed weights:

0% Sovereigns, 50% residential mortgages and 100% private sector.

The film Cocktail in July 1988, released "Don't Worry Be Happy" by Bobby McFerrin.

Here's a little song I wrote

You might want to sing it note for note

Don't worry, be happy

Basel II (239 pages) was published in June 2004.

Decreed risk weights: AAA to AA rated 20% - Below BB- rated 150%

The global financial crisis, 2008-09, caused by mortgage backed securities MBS ensued. 

The land-lord say your rent is late

He may have to litigate

Don't worry, be happy

Basel III: A global regulatory framework for more resilient banks and banking systems - revised version June 2011.

In every life we have some trouble

But when you worry, you make it double

Don't worry, be happy.

Basel III, July 2024, often retitled as an “Endgame” (for the times being only 1,910 pages), is still being worked on.

But on the margin, where it most counts when banks decide in what to invest, the risk weighted bank capital equity requirements, they still reign supreme.

And many nations and many of its citizens, having to take on new debt only to service the debt they already owe, have turned into zombies. What a hangover headache that cocktail has given us! BUT they still tell us:

Don't worry, it will soon pass

Whatever it is

Don't worry, be happy

#AI #OpenAI #ChatGPT As a grandfather, should I be concerned about how Basel bank regulators might have shaped the future my grandchildren will encounter?

Below the conclusion in the dialogue I had with ChatGPT on this issue. You can read the whole conversation here.

I asked ChatGPT:

"So, trying to conclude; for the best of my grandchildren’s future, had it not been best if the Basel Committee had not begun to distort the allocation of bank credit with the risk weighted bank capital/equity requirements?"

ChatGPT answered:

Yes, in many ways, it's fair to say that the Basel Committee's risk-weighted capital requirements, particularly those that favor public debt and residential mortgages, may not be the optimal approach for the long-term economic prosperity of your grandchildren. By distorting the allocation of bank credit, these regulations have had several unintended consequences that could negatively affect the broader economy over time.

Key Issues with the Basel Approach:

1. Distorted Credit Allocation: Basel regulations incentivize banks to lend where the risk-weighting is lowest—mainly government debt and residential mortgages—at the expense of more dynamic sectors like small businesses and entrepreneurship. This limits access to credit for high-growth sectors that drive innovation, economic expansion, and job creation, thus slowing overall economic dynamism.

2. Increased Systemic Risks: By pushing banks to hold more government debt and mortgage-backed assets, the system becomes more homogeneous and less resilient. When crises hit these sectors, the effects are more widespread and severe. Examples like the 2008 financial crisis (fueled by mortgage-backed securities) show that concentration in a "safe" asset class can be a huge risk.

3. Stifling Innovation and Economic Growth: Small businesses and startups, typically more dependent on bank credit than large corporations, are squeezed out of the credit system. As a result, future generations may see slower job creation and economic opportunity, which is essential for a thriving, innovative economy. This could make it harder for your grandchildren to find opportunities in high-growth sectors or start their own businesses.

4. Long-Term Fragility: While these rules may provide short-term stability, they can foster long-term economic fragility. An overreliance on public debt and housing markets makes the financial system more vulnerable to large-scale crises in these sectors, which could hurt future generations more severely than smaller, more localized risks in other areas of lending.

Alternatives for a Healthier Future:

Had the Basel Committee encouraged more balanced credit allocation—without such heavy favoritism toward certain asset classes—banks might have been more inclined to lend to small businesses, entrepreneurs, and other high-growth sectors. This would likely lead to:

More Dynamic Economic Growth: By providing adequate funding to small businesses and startups, there would be more room for innovation and job creation, which would benefit future generations.

Greater Diversification: A more balanced allocation of credit across various sectors would reduce systemic risks. Banks would be less likely to concentrate too much exposure in areas like public debt or housing markets, making the system more resilient to crises.

Stronger Economic Foundations: A diversified banking system, funding a range of economic activities, builds a stronger economy less prone to the boom-bust cycles associated with over-reliance on specific asset classes.

Conclusion:

Yes, had the Basel Committee not introduced such a heavy risk-weighting bias that favors public debt and residential mortgages, it’s likely that the banking sector could have supported a more diverse and resilient economy. This might have provided your grandchildren with greater opportunities for entrepreneurship, more dynamic economic growth, and less exposure to systemic risks that could lead to future crises. By creating a more balanced and equitable financial system, the long-term prospects for future generations would likely be improved.

I told ChatGPT:

"I see you agree that, as a father and grandfather, I have all kinds of reasons to be concerned with what some besserwisser bank regulators have concocted during the last decades with the Basel regulations. So, thanks!"

ChatGPT answered:

You're absolutely right to be concerned, and it's completely understandable to question the decisions that have shaped the financial world your children and grandchildren will inherit. The complexities of banking regulations often have long-term consequences that aren't immediately apparent, and it's important to recognize how these policies could affect future generations.

If you ever want to discuss more or explore other areas of concern for the future, I'm always here to help.

I said: Thanks again. I will come back!

ChatGPT said: You're very welcome! I look forward to our next conversation. Take care, and feel free to reach out whenever you're ready!

Note: The answers are copied exactly from those given to me by ChatGPT or Grok.

Here my many other questions to ChatGPT – Grok on bank regulations

Here’s the moment it struck me that if Brexit falls apart, there might not be a EU for Britain to remain in.

It’s now twenty years since the Euro was introduced, more in order to strengthen a union than the result of a union. As I wrote in an Op-Ed at that time, it brought on important challenges to its 19 sovereigns. First it meant giving up the escape valve of being able to adjust their currency to their individual economic needs and realities, and second, much less noticed, also by me, was that they would hence be taking on debts in a currency that de facto was not denominated in their own domestic (printable) currency.

To face those challenges required the Eurozone to extend much more the Euro mutuality to other areas, like to monetary and fiscal policies. In that respect there’s no doubt that way to little has been done.

For more than a decade I thought the Eurozone applied Basel Committee’s Basel II standardized credit rating dependent risk weights in order to set the capital requirements for banks, when lending to sovereigns. I never approved of that because I considered those risk weight way too statist, tilting bank-lending way too much in favor of the sovereign and against the citizen... and that should do the Eurozone in. 

But then, by mid 2017, I found out that it was all so much worse. EU authorities, most probably the European Commission, I really do not know who and when, assigned all Eurozone sovereigns a 0% risk weight, even though none of these can print euros on their own.

I could not believe it. That meant that European banks could hold sovereign debt, of for instance Greece, against no capital at all. How could something crazy like that happen? That basically doomed the Euro. What would have happened with USA if it had done the same thing with its 50 states?

How on earth can it now get out of that corner it has been painted into, especially when Europeans sing their national anthems with so much more emotion than EU’s anthem, Beethoven’s Schiller’s “Ode to Joy”

And that’s the moment it struck me that if Brexit falls apart, there might not be a EU for Britain to remain in.

My November 1998 Op-Ed "Burning the bridges in Europe"

PS. When Greece fell into the trap then EU authorities had it sign a Versailles type treaty.

Could this be a theme that for some strange reason TED Talks does not like me to talk about?

How long should we allow bank regulators, like the Basel Committee for Banking Supervision and the Financial Stability Board, to feed us their dangerous and hubris filled besserwisser bullshit?

How can any system that makes it easier for those who already have it easier to access bank credit, and harder for those who already find that harder be defined as a “fairer financial system”? https://subprimeregulations.blogspot.com/2016/03/decreed-inequality.html

How can any system that risk weights with 20% the so dangerous AAA rated, and with 150% the so innocous below BB- rated, be defined as a system that fosters financial stability? https://subprimeregulations.blogspot.com/2017/07/what-if-traffic-regulators-to-make-your.html

How can any regulator who does not care about the purpose of what he is regulating hold that he knows what he is doing? “A ship in harbor is safe, but that is not what ships are for”, John A Shedd https://subprimeregulations.blogspot.com/2015/12/our-current-bank-regulatory-tragedy.html

How can any regulator allowing banks to leverage their equity different with different assets and not understanding or caring about how that distorts the allocation of bank credit to the real economy, hold that he knows what he is doing? http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

How many more houses built because its financing is risk weighted 35%, will have its basements occupied by unemployed children, because the risk weight for unrated SMEs and entrepreneurs is 100%? https://subprimeregulations.blogspot.com/2017/11/crimes-against-humanity-can-also-be.html

Who nudged regulators into using stupid and dangerous risk-weighted capital requirements for banks? The bankers?

Banks not capable of perceiving risks correctly, or not adjusting to perceived risks correctly, with size of exposure and adequate risk-premiums, should fail as fast as possible.

Banks capable of perceiving risks correctly, and to adjust to these correctly with size of exposure and adequate risk-premiums, would in fact not need to hold any capital.

Unfortunately, since banks could belong to the first group, and there is also the risk of unexpected events that could affect even the best of banks, regulators need to require banks to hold some capital.

Curiously, unfortunately, bank regulators, with the Basel Accord of 1988 introduced risk weighted capital requirements. These spelled out more risk more capital, less risk less capital. 

Though at first sight that might all sound quite logical, in terms of searching for more financial stability it makes no sense whatsoever, as what’s perceived as risky poses by just that fact alone less danger to the banks. It is what is perceived as safe than can cause banks to create excessive exposures, which if these later turn out risky could put a whole bank system in danger. 

To top it up it the risk weighting translates into allowing banks to leverage differently different assets, thereby producing different risk adjusted returns on equity than what would have been the case in the absence of this regulations, and so it introduced a serious distortion in the allocation of bank credit that is affecting the real economy.

Who could have nudged regulators to do so? Since being able to earn the highest risk adjusted returns on equity on what is perceived as safe sounds like a wet dream come true for bankers, I have my suspicions.

PS. Here an aide-mémoire on the principal mistakes of risk weighted capital requirements

If one were to construe a systemic risk that could bring bank systems down, this is one way

First: Make capital requirements for banks based on perceived risk. More risk more capital, less risk less capital. That would allow banks to leverage more with The Safe than with The Risky. That would allow banks to earn higher risk adjusted returns on equity lending to The Safe than when lending to The Risky.

Second: Allow banks to use their own risk models to decide what is risky and what is safe and therefore how much capital it needs. Alternatively allow some very few human fallible credit rating agencies to decide what is safe and what is risky.

Third: Sit down and wait for banks lending too much against too little capital to The Safe, like sovereigns, the AAArisktocracy and mortgages; within an economy weakened by too little lending to The Risky, like to SMEs and entrepreneurs.

But, oops, hold it there! Someone already did that! I think it was the Basel Committee for Banking Supervision.

3 tweets that should rock the world of bank regulators, and one day will

Motorcycles are riskier than cars, so if they have a choice, people prefer cars; so more die in car accidents than in motorcycle ones

Below BB- rated are much riskier than AAAs, so bankers much prefer AAAs, so big crises happens with AAAs turned risky, not with below BB-

Our bank regulators never understood that, and assigned 20% risk weight to AAAs and 150% to below BB-s So now what? http://bit.ly/1TgB6EJ

Regulators and bankers looking out for the same risks

When regulators, to bankers’ lack of testosterone added their own lack of it, the Western civilization started its descent

Fact: Major bank crises result from unexpected events, criminal behavior, or excessive exposures to something ex ante perceived as safe, but that ex post turned out to be risky.

Fact: No major bank crisis ever has resulted from excessive exposures to something that was perceived as risky when placed on banks’ balance sheets.

Mark Twain with his supposedly: “A banker is one who lends you the umbrella when the sun is out and wants it back as soon as it looks it could rain” would attest to that.

Fact: Nonetheless bank regulators scared witless by the same perceived risks, imposed larger capital requirements for what is ex ante perceived as risky, than for what is ex ante perceived as safe.

That means bank can now leverage more their equity with “the safe” than with “the risky” 

That means bank can now earn higher expected risk adjusted returns on equity on “the safe than on the risky.”

Consequence 1: That day banks finds that excessive exposures to what was perceived, decreed or concocted as safe turns out risky, something that happens sooner or later, like with the AAA rated securities or sovereigns like Greece, the banks will stand their more naked than usual.

As Voltaire said: “May God defend me from my friends, I can defend myself from my enemies”

Consequence 2: Bank stop financing the "riskier" future the next generations need to be financed, like SMEs and entrepreneurs; in favor of refinancing the "safer" present.

As John A Shedd said: “A ship in harbor is safe, but that is not what ships are for”.

Our current regulators had no clue of what they were doing. In order to hang on to their jobs and hide their mistake, they are clouding the whole issue with more and more complexity.

They must be stopped, remembering of course Einstein’s: “No problem can be solved from the same level of consciousness that created it”.

God make us daring!

Here a more detailed analysis of this awful regulatory mistake

The Basel Committee’s risk weighted capital requirements for banks, is one cultural genocide of the western world

Frequently we read about how the destruction of monuments amounts to cultural genocides. But are monuments all there is about cultural heritages? No! Also such heritages as a cultural willingness to take risks.

In 1988, with the Basel Accord, Basel I, regulators introduced risk based capital requirements for banks; which were further amplified in 2004 with Basel II.

That regulation allows banks to earn higher risk adjusted returns on equity when holding “safe” assets, than when holding “risky” assets.

The layer of regulatory risk aversion it introduced, made banks abandon financing the riskier future, in order to just refinance the safer past and present.

The willingness to take risks is part of the cultural heritage of my western world, in churches we sang a psalm that prayed for “God make us daring”.

The willingness to risk making mistakes, has provided the western economies with the raw material necessary for the successes that helped to buildup its economy.

“A ship in harbor is safe, but that is not what ships are for.” John A Shedd

But now: “If God can’t make our bankers sufficiently coward, then we have to!” Bank regulators

In short, the Basel Committee for Banking Supervision’s regulatory imposed risk aversion, constitutes a destruction of a cultural heritage of our western world.

And all for nothing! The regulators justified it with that it would make our banks safer. What nonsense! Major bank crises never ever result from excessive exposures to something ex ante perceived as risky; these always result from either unexpected events, or excessive exposures to what was ex ante perceived as very safe, but that ex post turned out to be very risky.

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

PS. Actual risk weights: AAA to AA rated 20%, Below BB- 150%. Can it be more loony than that?

My number umpteenth effort to explain to XXX the very bad of current bank regulations.

A “risky asset” yields more, let us say 15%.

A “safe asset” yields less, let us say 5%.

And those yields would be deemed by the market as equal risk adjusted yields.

And market participants would buy those assets according to their needs and risk appetites.

But then came the Basel Committee for Banking Supervision with its risk weighted capital requirements for banks, more risk more equity – less risk less equity, and that completely distorted the allocation of bank credit.

Because now banks could leverage their equity more with safe assets and thereby obtain higher risk adjusted returns on safe assets than with risky assets.

As a result the overall market demand for safe assets increased, and that of risky assets decreased. That “risky asset” yielding 15% before, might now have to yield 16% or more. That “safe asset” yielding 5% before, might now just yield 4% or less.

Is this good? Of course not! Regulators, probably without even understanding what they were doing, altered the free market’s risk assessments; causing dangerous overpopulation of safe havens; and, for the real economy, equally dangerous under-exploration of the risky bays where SMEs and entrepreneurs usually reside. 

The net result of it is:

Crises, like that of 2007-08, resulting from excessive exposures to what was perceived, decreed or concocted as safe, like AAA rated securities and loans to sovereigns (Greece)

Stagnation, resulting from all the stimulus, like that of QEs, not flowing freely to where they are most needed, but only populating more and more the remaining safe havens.

In other words this damn piece of regulation has our banks no longer financing the riskier future but only refinancing the safer past; and so we are doomed to doom and gloom, and to run out of safe havens.

Of course, having set the risk weight for loans to sovereigns at 0% and to We the People, the regulators also introduced, through the backdoor in 1988, a powerful pro-statism tool.

The distortions are not even acknowledged by the regulators, much less discussed.

God help needing pensioners and job seeking youth! God help us all!

PS. If you have understood this and want more details on the greatest regulatory faux pas in history you might want to read the following more extensive aide memoire.

PS. Here are some of my past explanations for dummies.

PS. Today 50% of my constituency, my grandchildren, gets to be 5 years old.

Was it an accident or is it a statist setup?

In 1988, suddenly, without asking anybody, least us citizens, bank regulators, for the purpose of setting the capital requirements for banks, decreed the risk weight of the sovereign, the government, to be Zero Percent, while the risk weight for We the People was set at 100%.

Not having to hold capital against sovereign debt permits banks to lend to government at lower rates; which translates into a regulatory subsidy of government debt.

Then in response to the 2007-08 crisis, itself a result from distorting bank regulations, central banks launched quantitative easing, which basically meant injecting liquidity into the economy by purchasing government debt; and for example the Fed has ended up with about of US$ 4.5 trillion in government paper.

Much of the liquidity injected went to prop up real estate, bonds and shares, but a lot of it spilled over into more demand for government paper.

Naturally, interest rates for public debt fell, and many, like pension funds, in order to adjust for their liabilities, had to purchase even more public debt.

And while regulatory subsidies of public debt are kept in place, this vicious circle will continue.

And to top it up, too many “experts” now advance the argument that government should take advantage of these low interest rates, to launch infrastructure projects.

Let me be very clear about it, the fact that government might (artificially) even be paying a negative rate on its borrowings, does not mean it should borrow, because it is still very capable of investing those funds in projects yielding even more (real) negative rates.

I do not know how we got to this point, whether by accident or whether a set up by runaway statists. You tell me!

PS. When utilities were being privatized in South America, I often heard accusations in terms of “savage neo-liberalism”. Since these utilities were not adjudicated to whoever offered to serve us citizens the best and the cheapest, but to whoever offered to pay the government the most, a tax advance that left us with a huge bill to pay at private investment rates of return, to me those privatizations were much more an expression of sadist statism.