Sir, Martin Wolf writes “financial regulation is procyclical: it is loosened when it should be tightened and tightened when it should be loosened. We do, in fact, learn from history — and then we forget”“
Why further financial crises are inevitable” March 19.
Yes and no!
Yes, it is procyclical especially when allowing banks to leverage more with those who, thanks to good times are perceived as safer, and much less in bad times with all those that then are perceived as risky, which of course includes many former very safe.
No, we have not learned from history, because there is too many interested in putting a veil on the mistake with the risk weighted capital requirements. And there is too many who do not want to admit they fell for the populist that told them to relax, because they have weighted the risks.
Even though a leverage ratio has been introduced, the following Basel II risk weights that which evidences an absolute lack of understanding of the concept of conditional probabilities have not been changed, and this even after a crisis that exploded in AAA rated territory.
AAA to AA rated = 20%; allowed leverage 62.5 times to 1.
Below BB- rated = 150%; allowed leverage 8.3 times to 1
Also, the distortion the risk weighting creates in the allocation of credit to the real economy is mindboggling. Just consider the following tail risks:
The best, that which perceived as very risky turning out to be very safe.
The worst, that which perceived as very safe turning out to be very risky.
And so the risk weighted capital requirements kills the best and puts the worst on steroids… dooming us to suffer from a weakened economy as well as an especially severe bank crisis, resulting from especially large exposures, to what was especially perceived as safe, against especially little capital.
Wolf writes: “The bigger the disaster, the longer stiff regulation is likely to last. [But] Over time, regulation degrades, as the forces against it strengthen and those in its favour corrode.” I agree, but I would have to add something to it, namely, the bigger the disaster the more the running away from responsibilities… and accountability.
@PerKurowski
Source:
http://teawithft.blogspot.com/2019/03/as-long-mistake-that-caused-crisis-gets.html
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