Bank regulators behave like the scarer employed at the energy-producing factory Monsters, Inc.

The idea of requiring banks to hold less capital (equity) against what is perceived, decreed or concocted as safe, like sovereigns, the AAArisktocracy and residential houses, than against what is perceived as risky, like SMEs and entrepreneurs, is absolutely cuckoo.

That means that when banks try to maximize their risk adjusted return on equity they can multiply (leverage) many times more the perceived net risk adjusted margins received from “the safe” than those received from “the risky”. As a result clearly, sooner or later, the safe are going to get too much bank credit (causing financial instability) and the risky have, immediately, less access to it (causing a weakening of the real economy). 

Anyone who can as regulators did in Basel II, assign a 20% risk weight to what is AAA rated, and to which therefore dangerously excessive exposures could be created, and 150% to what is made so innocuous to our banking systems by being rated below BB-, always reminds me of those in Monsters, Inc. who run scared of the children. I wish they stopped finding energy in the screams of SMEs and start using their laughter instead.

“We need a people’s Fed”. Yes, we sure do! Assigning 0% risk weight to the sovereign and 100% to any unrated citizen is pure statist ideology driven discrimination in favor of government bureaucrats and against the people. But perhaps the activists depicted are not into that kind of arguments. 

PS. Those in Monsters Inc. finally figured it out. Our bank regulators in the Basel Committee and the Financial Stability Board have yet to do so, even 10 years after that 2008 crisis, which was caused exclusively by excessive exposures to what was perceived, decreed of concocted as safe, like AAA rated securities and loans to sovereigns like Greece 😩

Fiscal waste's decades out

Some want tax cuts.

Some wants tax increases

But no one want tax spending cuts

So its the fiscal waste's decades out

But why worry when it is so easy to finance it with QEs, low interest rates and regulatory subsidies.

Regulatory subsidies? 

1988, Basel I's risk weighted bank capital requirements that decree 0% risk-weight for sovereigns and 100% entrepreneurs. 

That we suffer under the thumb of neoliberalism is mostly a self-serving myth created by statism fans.

In its simplest form neoliberalism represents a belief in that free markets will do better for all, or at least for most, than government with its central planning. 

So many failures have been attributed to neoliberalism and its bad intents that it takes too long to explain them all. In this respect I will here refer briefly to only two aspects that have been sold as neoliberalism, but that in reality are quite far from it, namely financial deregulation and privatizations.

Bank regulations: In 1988 the Basel Committee for Banking Supervision, for the purpose of setting the capital requirements for banks, decided that the risk weight of the Sovereign, meaning the central government was 0%, while that of We the People was 100%. That meant banks would be allowed to leverage more their equity when lending to the public sector than when lending to the private sector; which meant banks could earn higher expected risk adjusted returns on equity when lending to the public sector than when lending to the private sector; which meant banks would lend more to the public sector than to the private sector; which de facto meant that regulators believed the public sector could make better use of bank credit than the private sector. 

That principle is still well and alive today. How it has anything to do with neoliberalism, with financial deregulation and not with financial missregulation, is beyond my comprehension.

For instance those who attribute the financial meltdown of 2007‑8 to neoliberalism must ignore completely the decisive role that bank regulations played in distorting the allocation of credit to the real economy. It suffices to understand the definite role regulations played in the subprime mess and in the excessive lending for instance to Greece. Those regulations basically decreed inequality.

Privatization: Many or perhaps most of the privatizations of public services were allocated, not to those who offered to provide those services in the cheapest and best way, but to those who offered to pay the government the most for the rights. That in all essence signified the government collecting taxes in advance, leaving the citizens to repay these by mean of higher tariffs. How that has anything to do with neoliberalism, is beyond my comprehension.

Why have so many swallowed the myth of neoliberalism? One reason is that the world has too uncritically accepted using the term of crony capitalism, when most of the deviations it suffers are the direct consequence of crony statism.

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.

The Basel Committee for Banking Supervision successfully staged a cloaked global statist coup

Supposedly to make our banks safer, in 1988, with the Basel Accord, Basel I, the Basel Committee for the purpose of setting the capital requirements for banks, declared the risk weight of the “safe” sovereign to be zero percent, and that of “risky” not-rated citizens, We the People, to be 100 percent.

That meant banks needed to hold much less or no capital at all, when lending to the sovereign than when lending to citizens; which meant banks could leverage their equity and the support they received from society (taxpayers) much more when lending to the sovereign than when lending to citizens; which meant banks would earn higher risk adjusted returns on equity when lending to sovereigns than when lending to citizens; and which meant banks would favor more and more lending to the sovereign over lending to the citizen. And the SMEs and the entrepreneurs basically here represent the “not-rated citizens”.

There could be some discussion on whether lending to sovereigns represent less risk than lending to SMEs and entrepreneurs. I do not believe so. Banks do not create dangerous not diversified excessive exposures to SMEs and entrepreneurs; and, at the end of the day, the sovereign derives all its strength from its citizens. 

But what cannot be discussed is that implicit in these regulations, is the belief that government bureaucrats use bank credit more efficiently than SMEs and entrepreneurs, and that is pure and unabridged dumb runaway statist ideology to me.

For a starter, without this kind of regulatory subsidy, the Greek sovereign would not have been able to obtain so much credit. 

And then, without this kind of regulatory tax on private initiative, Greece will never be able to work itself out of its current predicament.

And the world keeps mum on this!

We must allow our banks to be banks again.

Basel risk-weights: Sovereign (Monarch) 0%, AAArisktocracy 20% and citizens 100%: And the world said nothing!

With the Basel Accord of 1988 (signed one year before the Berlin wall fall) regulators, for the purpose of setting the capital requirements for banks, assigned a 0% risk weight for loans to the sovereign and 100% to the private sector. Some years later, 2004, with Basel II, they reduced the risk-weight for loans to those in the private sector rated AAA to AA to 20%, and left the unrated citizens with their 100%.

That has introduced a considerable regulatory subsidy for the bank borrowings of the infallible sovereign (government bureaucrats) and of those of the private sector deemed almost infallible. And that has severely taxed the access to bank credit, of those deemed as risky, like SMEs and entrepreneurs.

That de facto means that bank regulators believe that government bureaucrats know better what to do with bank credit than citizens.

And the world said nothing! What's wrong? Have all gone statist?

Did you know the banks are regulated by means of an ideology?

In 2004 I wrote in the Financial Times: "Bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector (sovereigns)?

In May 2014, in the Brookings Institute in Washington, while discussing the book by Jean Pisani-Ferry "The euro crisis and its consequences", Jörg Decressin, the deputy director of the European Department of the International Monetary Fund (IMF), dared to put forward an explanation...finally! ... God bless him.

My question: “In Sweden there is a psalm that prays ‘God make us daring’. And risk-taking risks has been critical to get Europe to where it is. However, in June 2004, the Basel Committee introduced bank capital requirements based on perceived risks, which subsidizes risk-aversion and taxes risk-taking.

For example, a German bank, when lending to a German businessman should keep 8 percent of shareholders’ capital (equity) but, if lending to its government, or to Greece, it could do so without having to hold any capital. That distorts allocation of bank credit in Europe. The book does not mention that problem. Do you have any comments?"

His response: "You raise a very good question and an answer to this revolves around: 

Do you believe that governments have a stabilizing function in the economy?

Do you believe that government is fundamentally something good to have around?

If that is what you believe then it does not make sense necessarily to ask for capital requirements on purchases of government debt, because you believe that the government in the end has to have the ability to act as a stabilizer, when the private sector is taking flight from risk, that is when the government has to be able to step in and the last thing we want is then for people also to dump government debt and basically I do not know what they would do, basically like buy gold. 

If on the other hand your view is that the government is the problem then you would want a capital requirement, so it depends on where you stand [ideologically]. 

I think the issue of the governments being the problem was very much a story of the 1970s, and to some extent of the 1980s. The problems we are dealing with now are more problems in the private sector, we are dealing with excesses in private lending and borrowing and it proves very hard for us to get a handle on this. We have hopes for macro prudential instruments but they are untested, and only the future will show how we deal with them when new credit booms evolve.” End of quote

Jean Pisanny-Ferry… said he agreed and left it at that. 

No Decressin! It is not about the government or the private, it is about the balance between the two, that which is broken.

And I had no chance to ask: Are you arguing that we should support the government’s borrowing ex ante, so that the government can help us better ex post? Would that not result in that when the government is truly needed it might not be able to help because it would already be too indebted… like Greece?

Who authorize regulators to regulate the banks with THEIR ideology?

And what about those who argue that the IMF is a bastion of neoliberalism?... Is it just a Potemkin facade?

Europeans, the structural reform most necessary for Europe to grow, is to get rid of its current bank regulators with their foolish risk aversion and their pro-government and anti-citizen ideology.

Translated from El Universal

Pension funds - not yet!

For over ten years I have been enthusiastic about the implementation of pension funds such as those developed in Chile. I have assisted numerous related seminars, both in Chile as well as in Venezuela. We have finally come to the point where there is general acceptance in the country of the basic concepts involved and legal and political blessing seems just around the corner. Why, then, do I not feel satisfied? 

We have often seen the elderly treated in a very humane and civilized manner in poor and underdeveloped societies. We have also seen horrifying situations in countries with immense wealth and development. There seems to be, then, no real direct link between the wealth of a country and the quality of care it supplies for its elders. Obviously, the existence of economic resources facilitates care while the absence of the same can render even the best of intentions totally useless. 

In Chile, Peru and other countries in which pension funds have been established, these are only part of a series of measures and instruments aimed at returning economic rationality to their respective economies. In each of them, the fact that they have achieved strong and healthy growth, thereby allowing pension funds to obtain excellent returns, has undoubtedly contributed to the latter’s popularity. I doubt that any pension fund, no matter how well regulated, managed with utmost responsibility and subjected to the most efficient supervision, would have had the slightest chance of surviving and becoming an example for other countries should they have been developed in an economy managed by Salvador Allende or Alan Garcia. 

In order to guarantee the future of young, adults and elders alike in Venezuela, it is more important to achieve the reforms that insure that oil income such as that we have garnered in the last twenty years does not continue to go down the drain, than it is to simply introduce pension fund schemes. On the contrary, the development of pension funds in actual circumstances before the country has had the chance to find its way forward, could simply result in the disparaging of an excellent idea. 

This must necessarily be taken into account by all those that, in their search for business opportunities, are falling all over each other to assert their rights to administer the funds. The day a new generation of elderly accuses a fund administrator of bad management, it will be useless for the latter to argue that the State (synonym for politicians thirsty for fiscal resources required to complement reduced oil income) obliged them to invest in public securities. It will also be useless to look for absolution using the argument that they are not at fault that new devaluations have severely eroded the value of their patrimony. 

To assume responsibility of a pension fund is serious business. Even though I am certain that the private sector would be more efficient than the public sector, I believe that under present circumstances results would not be sufficiently satisfactory. If the country’s thinking population is satisfied with the mere introduction of pension funds, they are simply supplying politicians with the next generation of scapegoats. 

I would be ready to sacrifice for all time to come, the existence of pension funds managed by the private sector and even to accept the creation of a new Seguro Social in the hands of CorpoMercadeo professionals in exchange for fundamental reforms. I would even be ready to do so against a simple constitutional reform that would prohibit future contracting of external and internal debt by the public sector. I’m certain this trade off would be of great value to our future population of retirees. 

Finally, let us not forget that living in a society implies the continuous allocation and reallocation of resources. Should all our elders (myself included) become millionaires (in real terms) as a result of their investments in pension funds while the rest of the country lags behind and is not able to participate in this well being, let me assure you that future generations, in all their right, will certainly not allow us to peacefully enjoy our old age. 

For God’s sake, until when will we have to listen to siren songs about possible real returns in an unreal country.

Published in The Daily Journal of Caracas

Banking - between mirrors and piglets

Although I have never worked in the banking sector, I do remember, during the latter part of the seventies, being proud about the development of Venezuelan banks. I thoroughly enjoyed listening to anecdotes such as the fact that the most popular software application (i.e. SAFE) for the management of on-line banking operations had been developed in Venezuela. 

I was also aware of the fact that on-line banking in the country was being applied to a much greater degree than in the United States. I loved to read in the press about the participation of Venezuelan financial institutions in international loan syndications, although while doing so I pondered about the sanity of this participation and had the same ambiguous love-hate feeling as when I flew overseas with VIASA, our flagship airline. 

Finally, the fact that Venezuelan banks routinely appeared in “The Banker” magazine’s listing of largest banks, made reading this publication in London waiting rooms quite agreeable.

Twenty years later, I cannot but feel somewhat humiliated when I am asked to feel respectful and thankful that we are now to be the beneficiaries of new banking technology that in my humble opinion for the moment merely seems to imply substituting the small mirrors used by the Conquistadores to seduce the continent’s Indians with little plastic piglets.

Let me make it clear that my possible observations as a Patriot about the strategies established by financial Neo-Royalists are certainly not based on the rejection of the presence of foreign banks in general, much less of Spanish financial institutions, which due to their high profile will undoubtedly bear the brunt of humoristic expressions so proper of the Venezuelan populace. 

On the contrary, I am certain that there is an important place for foreign banks in Venezuela, although I would have liked to see an early aperture of the financial system aimed more at strengthening than at the reconstruction, in the style of the mythical Phoenix, of a system in ruins.

What motivates me is that an excessive praise heaped on the newly arrived foreign bankers, in addition to possibly causing unnecessary damage to the egos of our local bankers (that famous patriotic cry, “Vuelvan Caras”, is already audible in banking circles), clearly tends to confuse the issues and principal causes of the collapse of our financial system.

History can be written in a few words. A series of devaluations, the breach of exchange guarantee contracts, restrictions on offshore positions, obligatory preferential treatment for certain sectors of the economy, minimized participation in the financing of petroleum industry projects and surprising macroeconomic policy decisions such as the application of exorbitantly high real interest rates. 

All these factors caused a drastic decline in the quality of bank loan portfolios and an erosion of their respective net worth values to a minimum. Responsibility for all these ills lies principally with the Central Government and their main cause is again the fundamental failing of our society, i.e. the excessive concentration of national wealth in the hands of the State.

Each case must by analyzed separately but in general terms, I’m certain that should the United States, the United Kingdom and even Spain have had to suffer through similar catastrophes, the mortality rate would have been the same or higher. Likewise, I’m sure that the future productivity of Venezuelan banks will depend more on the rectification of the State’s actions than on the masterly lessons in banking we may receive from, with all due respect, the Casa Cándido strategists (Casa Cándido is a restaurant in Segovia famous for its servings of roasted piglet).

A better supervision of the banking sector by a professional Superintendency; reasonable norms that regulate the banking activities without strangling it; development of management capabilities that would insure the proper handling of banking crises without multiplying their initial cost; and responsible, professional bankers. 

All the above certainly must exist in order to head off another financial tragedy in the future, but they are certainly not enough to avoid such disasters.

As long as the size of Venezuelan State is not reduced in proportion to the private sector and the State continues to impose its omnipresent influence over all aspects of national life, the possibility of creating and environment of economic rationality is remote. Without economic rationality there is no way to avoid another financial crisis. Today’s generation of local bankers hopefully has already learned its lesson and I sincerely hope our newly arrived visitors will not have to do so as well.