Basel III: The Fatal Flaw

By Simon Johnson

The international discussion among government officials regarding bank reform is, at an informal level, going better than you might think.  Top people in the “official sector” are increasingly willing to confront the banking lobby and even refute its more egregious claims, particularly the completely erroneous notion that making banks safer – by requiring them to hold more capital – would actually hurt the broader economy and undermine growth.

Unfortunately, the structured intergovernmental process that actually changes the rules around banks – known as Basel III (or “Basel 3”) – was rushed to an unsatisfactory conclusion last weekend.  The US and other countries with major financial centers will need to add substantial additional capital requirements at national levels if these new rules are to be at all effective.

The heart of the substantive discussion regards whether tightening “capital requirements” – the buffers against losses that banks are required to hold – will have a negative impact on the economy.  The banks insist that requiring them to hold more capital would slow lending and therefore slow the real economy.  The global banks’ Institute for International Finance issued a paper in June that insisted on this point, but there is really no substance to their claims.

The most readable counter arguments come from a paper by Sam Hanson, Anil Kashyap, and Jeremy Stein (reviewed here recently).  The fact that three leading academics would take on the banks’ arguments is not news, but in recent months it has become clear that – behind the scenes and off-the-record – a growing number of important officials agree broadly with this view.  The Bank for International Settlements itself has produced two serious assessments which, if you look at them carefully (and this is not light reading) argue strongly that longer-term growth would benefit from higher capital requirements because we would experience fewer mega-crises, and that the transition to such arrangements would be much smoother than the industry claims.

Running parallel with this nascent intellectual renaissance among officials, there has been pressure on the Basel Committee on Banking Supervision – comprising 27 countries with substantial financial sectors – to produce an agreement on capital requirements ahead of the Seoul G20 summit in November.  The rush to reach agreement in this time frame undermined those arguing for a broader rethink – as the consensus among officials only shifts slowly.  The result – the framework agreement announced this weekend – increases capital requirements only modestly and phases those increases in only gradually.

The key conceptual breakdown is this: While pushing back against the banks’ claims that higher capital requirements would be harmful, the officials have still allowed the banks to frame the discussion – implicitly conceding that moving to higher requirements quickly could reduce lending and damage growth.

But again the best thinking from independent analysts demonstrates that this view is completely at odds with the reality.  David Scharfstein and Jeremy Stein, summarizing experience on this issue, point out that there is a world of difference between requiring banks to reach a certain capital-asset ratio (which they are likely to do by shrinking assets, i.e., making fewer loans among other things) and requiring them to raise specific dollar amounts of capital.

You can say what you want about the bank stress tests implemented in the US in spring 2009 (e.g., that they were not tough enough, in terms of considering potential future losses – and therefore how much capital the banks needed), but in terms forcing banks to raise specific dollar amounts of capital subsequently, this is the approach to follow.

Banks do not like to raise capital; they will generally only do it when forced.  The fair way to do this is through tough and transparent stress tests; these should be repeated in the US and on a comparable basis in other financial center countries every year.  Agreeing to move in this direction should be a major goal of the G20, but alas it is currently nowhere near being on the agenda.

The Hanson-Kashyap-Stein view, which is completely mainstream financial economics (not any kind of radical or political view) is that banks should be required to hold enough capital at the peak of the cycle so that when they suffer losses (and, 2007-2010, US banks lost about 7 percent of their “risk-weighted” assets, which is the denominator here), they still have enough capital so that the markets do not think they will fail – and therefore there is no need to dump assets in a desperate bid to survive.  (It’s the forced asset sales of this nature that turn financial distress at particular institutions into broader asset price declines and that can trigger panics.)

The logic here points towards at least 15 percent Tier 1 capital being required in good times; the most forward looking officials in G20 countries start to mention aiming for closer to 20 percent (Tier 1 is a good headline measure of loss-absorbing capital, i.e., what stands between the bank and insolvency; the discussion sometimes slips into other related measures).  This is what would really help make banks much safer (i.e., thus making banks’ stock a much less risky investment and reducing the required rate of return for all involved).

Treasury Secretary Tim Geithner is fond of saying that the appropriate response to the crisis – and the way to prevent any kind of recurrence – is with “capital, capital, capital.”  The Dodd-Frank financial reform act did not raise capital requirements – as Treasury insisted on deferring to the Basel III process.  Basel III, we learned this weekend, is on course to raise capital requirements – but to a level below what US banks have held on average in recent decades (for Tier 1 capital, Basel III posits 8.5 percent at the end of the day; US banks fluctuate roughly around 10 percent).

The best – and perhaps only remaining chance – is for the US to insist on stronger capital requirements for domestic financial institutions, as permitted or even encouraged in Basel III under the heading of “countercyclical buffer”.   And systemically important financial institutions, for which the Basel process appears to have completely dropped the ball, should be subject to even higher requirements.  This should be coordinated with the UK (where there is already thinking in the right direction), Switzerland (again, forward thinking officials hold sway), and anyone else who can be brought on board.

An edited version of this post appeared this morning on the’s Economix blog; it is used here with permission.  If you would like to reproduce the entire post, please contact the New York Times.

97 thoughts on “Basel III: The Fatal Flaw

  1. There isn’t enough capital in the universe to support the derivative casino. Basel III is Faulty. It is merely rearranging the Titanic deck chairs. One could only imagine what Keynes would say about all this. Right now he must be regretting that he saved capitalism. Possibilities for our grandchildren, my a**!

  2. There are 3 problems with the banking sector and Basel III. First, RWA is fatally flawed, as correlation is 1 in a crisis. Second, as you mention, tier 1 capital needs to be raised and leverage reduced. (As an aside, the notion that reducing leverage won’t reduce loan availability is simply laughable. Of course it will. And loans will become more expensive, which will reduce demand.) Finally, tier 1 capital needs to be real capital. Cash reserves deposited with a central bank. Not deferred tax assets, or hybrid capital, or home country sovereign bonds. Capital needs to be capital.

    Of course the effect of instituting all three much needed reforms will bring about a veritable ice age for the economy, which may paradoxically
    Bring about a new crisis-this time at the sovereign level as tax receipts plunge.

  3. Great post. I really appreciate the academic paper links as well.

    I guess pay close attention to bank balance sheets and credit markets and be ready to yank your money out when the next crisis is eminent. (that’s assuming you’re foolhardy enough to think markets are safe now). I hope anyone on the executive board of the 5 big American banks currently lose their shirt and are forced to wear a dunce cap while being shot at by BB guns. They could make it into a time-passing game at state unemployment offices.

    I would include current investors in the 5 big American banks as well as running targets in this BB gun game, but I have decided to allow for the minute chance of “white knight investors” that want to clean the SOBs out.

  4. “……the capital ratio requirements are going to be relatively meaningless if the assets they’re measured against get overvalued. This means ensuring proper accounting methods, which the Financial Accounting Standards Board has been grappling with, but failed to get right during the crisis. (Though who wants to keep debating mark-to-market rules?)

    we have the past decade as a good example for what happens when regulators are put behind the wheel while they’re asleep. As the housing bubble built up, the Fed, FDIC, SEC, and Treasury all had the authority needed to identify the systemic risks building up in the system.

    But not only did their analysis miss the canyon they were driving into, but when alerted to the possibility of an abyss ahead, their response — at least from the Federal Reserve — was to say they would only mop up after a car crash, not prevent one.

    But to believe that bankers won’t find their ways around the new laws or manipulate them for gain while putting the taxpayers at risk, is cognitive dissonance at best.”

  5. The MAG group consists of central bank modelers, which becomes obvious if you look at their thinking process and assumptions. Consider:

    “When it is assumed that the central bank RESPONDS to the incipient aggregate demand fall and reduced inflationary pressures precipitated by the regulatory changes, the central estimate of the maximum output loss shrinks significantly.”

    That’s a heroic assumption, given the utter incompetence (or, alternatively, conspiratorial brilliance) of the FED and ECB at managing the previous liquidity crisis. Even then, their assumptions seem to imply the central banks will RESPOND AFTER EVIDENCE OF AGGREGATE DEMAND DROP APPEARS, rather than pro-actively.

    Read them – “responds to incipient demand fall”. Depressing. If they think they can delay policy initiatives by 3 months until every lagging indicator in existence tells them we’re dropping into recession, then I assure you that the hit to GDP will be more than the 0.17% they are estimating.

    If they want to restrain the drop to 0.17%, they are going to need to pro-actively inject (or, at least, COMMIT to inject) hundreds of billions of dollars into the economy before they start seeing clear evidence of an aggregate demand drop.

    Not going to happen – the Fed and ECB are run by ideologue hawks and cowardly doves.

    The models they are running are not that different from the models that told them the Fed could respond in October 2008 with modest (and sterilized) liquidity injections, and the markets would respond with nice continuous adjustments even as the DOW was zig-zagging 600 points a day.

    Moreover, this is the same attitude and overconfidence that caused otherwise sharp people like Christina Romer to claim that “everyone” was caught by surprise at the intensity of the economic implosion in early 2009. “Everyone” must be a small circle of her friends who are well insulated from the equity markets and the 17% of americans who are unemployed or underemployed.

    But there are always silver linings… Obama will suffer a crushing (and well deserved) defeat in the midterm. Christina Romer will have plenty of time to return to Berkely and re-run her flawed regressions comparing inflation trends and poverty rates.

    “The nation’s poverty rate jumped to 14.3% in 2009, its highest level since 1994, and the 43.6 million Americans in need is the highest number in 51 years of record-keeping, the government said Thursday.”

    I wonder if THAT could be related to THIS:

  6. For a year this blog has been the biggest supporter and champion of Elizabeth Warren’s nomination to head a consumer protection agency. Obama has now named her to do just that, and if she is what we hope she is, many of the shortcomings of the FinReg bill can be overcome with the flexability written into the bill for the organizations themselves to set up rules and regulations. This is a great victory for all those who were hoping the middle class would once again get a seat at the table in this country’s financial system.

    So I turn to Baseline this morning ready to share my happiness with you both – and nothing? Have you so bought into the view that everything is still terrible and nothing is being fixed that any evidence counter to that view is just ignored? I hope that’s not the case, I come to this blog for honesty, not for the constant reaffirmation of a particular viewpoint most other blogs advance.

  7. This administration reminds me of Winston Churchill’s quip about America – you can count on it to do the right thing when it has exhausted all other options.

  8. Well, if you want honesty, here’s my take on the situation. There are strong reasons to believe that this appointment is an advisor is a confirmation that Prof. Warren will never lead the new agency. Time will tell, but if the President is not willing to nominate her at this point in time, when are we to believe that he eventually would? Maybe she’ll surprise people and be able to implant a strong vision of consumer protection within this nascent organization. Let’s hope so, but this appears to be an admission that her detractors are too strong for even the President to cross.

  9. Your assessment can’t be faulted. BHO could have made this advisory appointment months ago. This guy takes endless time to make decisions and likes to study situations to death, but even so, Warren has too many POWERFUL detractors. Really, there is no point to elections other than political theater. The Business Roundtable trumps everything.

  10. Puhleese. There simply is no redemption for the administration or democrats at this stage. Americans need to cancel their subscription to partisan charades. We’re all still licking our wounds from being left holding the bag from “financial reform.” If you still support BHO, it will be difficult finding a blog to fit the crime.

  11. I do want to point out that I understand her appointment doesn’t make everything hunky dory and all the problems are over. But you’d think Simon or James would say something about it.

  12. A recent post at Naked Capitalism by Yves Smith suggests the appointment of Warren is advisory and probably temporary, and is aimed at keeping her as a “team player” on the inside as opposed to having her become even more of a vocal critic from the outside.

  13. A layman’s view: Am I not right that Basel 2 is going to work fine until VaRs based on given 2 years of historical data pass recent crisis’ volatility? Is it not just this technical problem and are not all those money sitting in FED waiting for that? Correct me if I am terribly mistaken

  14. There are several inadequacies within Basel III:

    1) Increasing Tier 1 capital requirements in the short run does more harm than good to the economy as a whole, particularly in a slow economy where credit has been strictly limited. And it does not directly address weaknesses #2 & #3.

    2) Derivative risk remains an undisclosed contingent liability, and is treated as a state secret. Part of the failure is attributable to lax accounting standards and poor regulatory reporting requirements. Increasing Tier 1 capital will not save the banking system from widespread failure and subsequent bailout.

    3) Interest rate risk management remains unaddressed, which is curious given that these financial institutions are glorified financial instruments themselves with undisclosed duration gaps.

  15. Simon Johnson writes: “the completely erroneous notion that making banks safer – by requiring them to hold more capital – would actually hurt the broader economy and undermine growth”

    He is absolutely wrong! Requiring the banks to hold more capital under the actual system where those who are perceived as having more risk, and that therefore can never even constitute a systemic risk, does indeed hurt the broader economy and undermine growth.

    Today, for the first time the Financial Times in the Lex Column accepted what I have been saying for ages namely that “Historically, true crisis are caused by assets perceived as low-risk that aren´t.”

    Realizing the above makes of course the current bank regulations coming out from Basel completely nonsensical. I am following with interest how long it is going to take for Simon Johnson to realize this… and what he is going to say thereafter.

    The higher the capital requirements are using the current risk-weights the higher is the regressive discrimination imbedded in the system.

    Assume you raise the capital requirements to 100%

    Then loans to sovereign rated triple-A would still not generate a capital requirement because being risk-weighted at zero means that zero on 100 is still zero.

    Investments in securities rated triple-A, like those securities collateralized by lousily awarded mortgages to the subprime sector, and loans to triple-A rated client like AIG was; and who are risk-weighted at only 20% will generate a capital requirement of only 20%.

    But all those small businesses and entrepreneurs on whom we so much depend on for our next generation of jobs, because they are perceived as risky they are risk-weighted at 100% and so they will have to bear and pay for the full load of a 100% capital requirements.

    With regulators like these of the Basel Committee and Simon Johnson, our chances of getting out of this crisis are meager indeed.

    In due time financial history books will regard the Basel Accord and the perceived risk-phobia it brought on, as something absolute mindless from a financial regulatory aspect… but meanwhile what are we to do being stuck with the same growing-bigger-to-fail-bank, the same regulators and the same faulty paradigm.

    I invite you all to a Kindergarten class on financial regulators that will make it easier for you to understand the disaster of having bank regulators that are fixated on seeing the gorilla in the room and have completely lost track of the ball.

  16. I would immediately reduce the capital requirements for what is “perceived as more risky” which is primarily all small and that will not pose any systemic risk precisely because it is perceived as risky and then I would, little by little, for instance over three years, rebuild the capital requirements to where perhaps Basel III indicates… but, the same for all type of assets and no risk weights-based on perceived risks that only confuse the market.

    Let the credit ratings state what they want but do not force or incentivize the markets to follow their opinions.

  17. Re: @ StatsGuy____Winston Churchill was an arrogant bully…born unto fabulous wealth with a propensity of ignorance, suchly flavored with a sprinkled feign thusly reaking distain for the masses, period! His claim to fame came only from FDR whose mother couldn’t take anymore of the great pretenders ego…a slogging wetshod – ladlied by his neo-fascist latent inhabitions cradled within his maternal instincts. He was in real life a compassionate failure, but rather a usefull tool vis-a-vis vaudeville transvestite, parading ones paraffin vanity. I’m sorry but “No Quotes” from this fethered quipper indulge my wonted curiousity.:-(

  18. The Basel Committee’s lousy Maginot line

    It is impossible not to see now that the financial regulators in the Basel Committee, trying to fend off a bank and a financial crisis, constructed an incredibly faulty Maginot line.

    It was built with lousy materials, like arbitrary risk-weights and humanly fallible credit rating opinions.

    And it was built on the absolutely wrong frontier, for two reasons:

    First, it was build where the risk are perceived high, and where therefore no bank or financial crisis has ever occurred, because all those who make a living there, precisely because they are risky, can never grow into a systemic risk. Is being perceived as risky not more than a sufficient risk-weight?

    Second it was built where it fends of precisely those clients whose financial needs we most expect our banks to attend, namely those of small businesses and entrepreneurs, those who could provide us our next generation of decent jobs and who have no alternative access to capital markets.

    Now with their Basel III the Basel Committee insists on rebuilding with the same faulty materials on the same wrong place and it would seem that we are allowing them to do so.

    I am trying to stop them… are you going to help me or do you prefer to swim in the tranquil waters of automatic solidarity with those who are supposed to know better?

    The implicit stupidity of the Basel regulations could, seeing the damage these are provoking, represent an economic crime against humanity!

  19. IIRC, demand for loans in the US has been on a downward trend for about 25 quarters. Before that, demand for loans was artificially elevated due over-valued assets.

    Foreign inflows were also feeding excess liquidity into the US at least during the 2003 to 2005 period.

    Bubbles are essentially the result of excessive amounts of investment capital in the economy. The simple laws of supply and demand suggest that a bubble is not possible unless the total amount of investment capital exceeds the actual value of all available assets.

    So, if there is still excess capital in the economy, it would seem that higher reserve requirements would simply absorb excess liquidity. The more solvent banks would lend more as the less solvent banks would be forced to lend less.

    I don’t fully understand any of this, but I’m not sure that anyone else does either, it seems though that higher reserve requirements do not absolutely cause less lending as some commenters here have claimed that they do?

  20. Several more years of disaster, with the opportunity to try again to elect a real change agent in 2016. That may be the best one can hope for at this stage.

  21. Another French General heard from as Dr. Johnson continues to fight the symptoms of the last war. How do you reconcile higher capital standards with TBTF as this becomes a prscription for oligopoly. Better to focus on “randomness” as in Too-random-to-regulate (TRTR) than risk management. It was “uncertainty” (no positive cash flow and mark-to-model valuations) in the form of MBS no-money-down, liar loans that was the snow flake that caused the financial avalanche. Basel III’s one-size-fits-all deterministic metrics lack the robustness to address randomness and are therefore toxic (another can of paint on a dilapidated structure).

  22. Wow this probability-theoretic critique is really starting to resemble its notional targets, i.e., the {tired, corrupt, hopeless, naive, self-serving, dilapidated,etc.} “one-size fits all” approaches that allegedly reduce all regulatory/rule-making efforts to exercises in futility… Funny how one mans principled crusade can be anothers irrational OSFA fixation…

  23. Re: @ Per Kurowski___Churchill was a mix and match “plagarizing puzzle amateaur” – always espousing heartfelt slurs of empty mediocracies – a shogun’s sword never to part its sheath…where only flailing words mantled his courage! Quotes #1/2 : Politicians and War (1932) vol.2; ch6___”Churchill on top of the wave has in him the stuff of which tyrants are made.” end quote ____Quote #2/2 : George Orwell (Eric Blair) 1903-1950/ {(‘The Lion and the Unicorn’) (1941) pt.1 “England your England”}____”England is not the jewelled isle of Shakespeare’s much-quoted passage, nor is it the inferno depicted by Dr. Goebbels. More than either it resembles a family, a rather stuffy Victorian family, with not many black sheep in it but with all its cupboards bursting with skeletons…A family with the wrong members in control – that, perhaps, is as near as one can come to describing England in a phrase.” end quote…thus is how I grade “Winston the Great thy England Cometh”

  24. The “TBTF’s Worldwide” will always keep “Their” reserves at the lowest common denominator, period! It is innate – their call-to-arms mantra – their thesis for a perpetually wealthy, and anti-proactive quasi-emancipation…and that’s all there is to it, or what it has been from the (evolves, thus getting only better) beginning. Thanks Simon and James :-)

  25. This standard ideal of orchestrated “capital controls” is simply a stopgap not a complete resolution or solution to decades old foundation to perverse incentives and almost compulsive abuses. Until mandates are defined in the context of real time community and social accountability (a good transparancy gold standard) these “regulatory constraints” merely serve to preserve a system that should be exposed to social and cultural scrutiny instead of the limelight of multi-million dollar successions where the ends justify the means, and the cost is never paid by the benefactors…ALL are part of an international financial system that is, in reality, a small group of special interest groups preserving the system that serves them so well. Meanwhile, intelligent universal appeals which from region to region ends in corruptive collapse and socially destructive collusion and contagion until the corrosive bubbles once again end in public crisis and no one accountable.

    Speak to mandates of social responsibility and accountability and your “capital controls” might be credible. Until then it is suspect to “more of the same under another branded name”.

  26. Stephan,

    Perhaps I am not privy to some prior argument of yours, but, this comment is not much more than unsupported claims with pseudo-axioms as a smokescreen. What is this: “prescription for oligopoly”, for instance. And your “snowflake” is only axiomatic if it is assumed that snow has not been falling for the past 30 years or so. Where is the ‘why’? Convince me of something other than the notion that our national debate is mostly just pointless polemics.

  27. “While pushing back against the banks’ claims that higher capital requirements would be harmful, the officials have still allowed the banks to frame the discussion – implicitly conceding that moving to higher requirements quickly could reduce lending and damage growth.”

    Typically we call that practice “paying lip service”.

    The unwashed masses just need to be told the leaders care. The almighty elites, on the other hand, must be genuinely appeased. World leaders know exactly what they’re up to. Don’t listen to their words. Evaluate them strictly on their actions and their true intentions are completely clear.

  28. @ rayllove

    The legacy governance system for the US capital market is broke.

    If there is complexity, there is uncertainty. To achieve real regulatory reform, policymakers have to move beyond risk management to randomness governance of both determinate and indeterminate underlying economic conditions. Unfortunately, the degree of reform undertaken tactically addresses the symptomatic problems rather than strategically trying to fix the causal market flaw by segmenting randomness in terms of predictable, probable, and uncertain governance regimes.

    Trying to govern both risk and uncertainty with the legacy, one-size-fits-all deterministic regime is analogous to having one set of driving instructions for both the U.S. and U.K. The result is larger and more frequent boom-bust cycles.

    See: Mr. Volker is wrong!

  29. Stephen,

    Respectfully, I will try to help you understand what it means to support your claims… it is imperative to meaningful argumentation:

    The legacy governance system for the US capital market is broke. [because…]

    If there is complexity, there is uncertainty.[why, or, how is it possible to have a banking system without complexities?]. To achieve real regulatory reform, policymakers have to move beyond risk management to randomness governance of both determinate and indeterminate underlying economic conditions.[why?]. Unfortunately, the degree of reform undertaken tactically addresses the symptomatic problems rather than strategically trying to fix the causal market flaw by segmenting randomness in terms of predictable, probable, and uncertain governance regimes.[had you supported your claim regarding ‘uncertainty’ in the second sentence, along with more support along the way this may have been a good sentence. as it stands though you seem to be taking credit for a claim on “the causal market flaw” without establishing what that is. this is what similar to what I said above regarding pseudo-axioms. or, perhaps the cause here is widely accepted and I am ‘out of the loop’ so to speak].

    Trying to govern both risk and uncertainty with the legacy, one-size-fits-all deterministic regime is analogous to having one set of driving instructions for both the U.S. and U.K.[why? do you think that you have established the ‘why’ with your preceding argument? unsupported claims do not add support] The result is larger and more frequent boom-bust cycles.[why?]

    Support does not necessarily need to follow your claims but it does need to be somewhere. An easy way to write well is to begin with a claim and then just explain ‘why’ with each sentence in secession until something comes up that requires another paragraph. Some English teachers recommend using an imaginary ‘because’ after each declaration. The key to good writing though is just being honest about what you know.

    Again, respectfully, Ray.

  30. The predatorclass den of vipers and thieves on Wall Street will RESIST this effort to the death, because it would ultimately result in their death, or insolvency, or bankruptcy, and possibly, prison sentences for certain predatorclass olympians.

    That said, simple logic proves the necessity of these kind of requirements for there to be any hope of stability in the markets.

    The more critical issue is best framed here:

    (“The key conceptual breakdown is this: While pushing back against the banks’ claims that higher capital requirements would be harmful, the officials have still allowed the banks to frame the discussion – implicitly conceding that moving to higher requirements quickly could reduce lending and damage growth.

    But again the best thinking from independent analysts demonstrates that this view is completely at odds with the reality. David Scharfstein and Jeremy Stein, summarizing experience on this issue, point out that there is a world of difference between requiring banks to reach a certain capital-asset ratio (which they are likely to do by shrinking assets, i.e., making fewer loans among other things) and requiring them to raise specific dollar amounts of capital.”

    The unspoken reality here is that – 13 Bankers march into the President’s, or King’s or Prime Minister’ office and threaten to tank the markets if the government proceeds with these demands, – and why? because it would result in very significant haircuts for these individual predatorclass hobgobblins, and for some of them – jail.

    Call these evil conniving, manipulative, sociopathic monsters’ bluff, and force these 15-20% capital requirements. Let’s see who is left standing. Governments are already fund defacto finance systems, so government will have to step in and pickup the slack, when the banks fail.

    For two years the single solution to redressing the “Great Recession” has been government funneling trillions of taxpayer dollars to the offshore accounts of the predatorclass den of vipers and thieves in the finance sector.

    Any modicum of redistribution of government largess from the predatorclass, to the people will stimulate economies globally.

    Real change will NOT come easily – or from my personal perspective – bloodlessly – (the opposing forces are too deeply entrenched) – but it will come if good leaders make sound decisions that benefit the greater society, if the people unite and collase to DEMAND necessary changes, and if the predatorclass den of vipers and thieves in the finance sector are forcefully put back in the keep.

    Change is a process. It doesn’t happen overnight. But affecting Change is necessary and possible if we all abide by the rule of law, and make good decisions that benefit the people, and NOT the predatorclass.

  31. And what about the Small Businesses Financial Protection Bureau?

    For some insane reason when the banks lend to small businesses they need to have 8 percent in capital or 100% of whatever capital Basel III prescribes; but when banks lend to some who have been able to hustle up some AAA ratings then the banks need only 1.6 percent or 20% of whatever Basel III prescribes, or when banks lend to a AAA rated Sovereign like the US. they no capital at all… and of course the small businesses have to make up for the difference.

    Since this inequity has been of no major concern to Simon Johnson, I guess it fits perfectly his political agenda that the government can take up loans from the banks in this subsidized way.

  32. Per, “I am trying to stop them… are you going to help me or do you prefer to swim in the tranquil waters of automatic solidarity with those who are supposed to know better?

    The implicit stupidity of the Basel regulations could, seeing the damage these are provoking, represent an economic crime against humanity!”

    Of course many want to help! The paradox is that completely irrational, illogical and self-serving men

    (and I care not to go deeper into their “religious” beliefs – too crazy, but does explain the irrational part)

    are using a neutral tool for managing supply and demand of life-maintenance – MATH – in a most un-neutral way!

    YOUR math is clear – who can even argue it?!

    But here’s the noise and the focus – back to “hate they neighbor” – the neighbor who sucked in his neighbor to a sub-prime scheme

    the PREDATOR

    is taking the higher MORAL ground leading up to the “elections”

    and saying that the neighbor who walked away from the LIAR’S LOAN is the LIAR – bible quotes follow as proof.

    Math can go terribly wrong, no? Sure you can crunch the numbers to suck up all money in circulation

    no matter where you trickle it into (Idea?)

    and then yank it out.

    What an epic being written in USA regarding “architecture”, no? Make no mistake why single family homes were targeted – every individual home was a micro economy and we were starting to build the new industries from the ground up with our SAVINGS!

    They yanked out our SAVINGS before we could get it up and running – aborted the organic enterprise, so to speak.

  33. Basel III ignors the circumventions of Basil ll (2), and may well be parallel to and right in line with the decades old process of hostile takeover by private equity interests and a global system of concentrically controlled financial domination.
    Ellen Brown

    “Punishing Your Local Bank for Wall Street’s Misdeeds

    What precipitated the credit crisis and bank bailout of 2008 was not that the existing Basel II capital requirements were too low. It was that banks found a way around the rules by purchasing unregulated “insurance contracts” known as credit default swaps (CDS). The Basel II rules based capital requirements on how risky a bank’s loan book was, and banks could make their books look less risky by buying CDS. This “insurance,” however, proved to be a fraud when AIG (AIG), the major seller of CDS, went bankrupt on September 15, 2008. The bailout of the Wall Street banks caught in this derivative scheme followed.

    The smaller local banks neither triggered the crisis nor got the bailout money. Yet it is they that will be affected by the new rules, and that effect could cripple local lending. Raising the capital requirements on the smaller banks seems so counterproductive that suspicious observers might wonder if something else is going on. Professor Carroll Quigley, an insider groomed by the international bankers, wrote in Tragedy and Hope in 1966 of the pivotal role played by the BIS in the grand scheme of his mentors:

    [T]he powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent private meetings and conferences. The apex of the system was to be the Bank for International Settlements in Basel, Switzerland, a private bank owned and controlled by the world’s central banks which were themselves private corporations.

    The BIS has now become the apex of the system as Dr. Quigley foresaw, dictating rules that strengthen an international banking empire at the expense of smaller rivals and of economies generally. The big global bankers are one step closer to global dominance, steered by the invisible hand of their captains at the BIS. In a game that has been played by bankers for centuries, tightening credit in the ebbs of the “business cycle” creates waves of bankruptcies and foreclosures, allowing property to be snatched up at fire sale prices by financiers who not only saw the wave coming but actually precipitated it.”
    Ellen Brown

    Ellen Brown developed her research skills as an attorney practicing civil litigation in Los Angeles. In Web of Debt, her latest book, she turns those skills to an analysis of the Federal Reserve and “the money trust.” She shows how this private cartel has usurped the power to create money… More

    * Blog: Web of Debt
    * Book: Web of Debt: The Shocking Truth About Our Money System and How We Can Break Free

  34. But one can also build bridges to bridge the divide and cause a more unison reaction, because also:

    A visitor from outer space looking at the current financial regulations which require a bank to hold 100% of the standard Basel II or Basel III capital requirement when lending to a small business or entrepreneur, but allows it to hold zero percent of that same Basel II or Basel III capital requirement when lending to a triple-a rated sovereign, like that of the USA, would most likely have to conclude that planet earth is communistic.

  35. LOL – that and add this to the report alien files:

    “architecture” considered a risky “investment”

  36. Simon:
    While Basil III is buying time for International vested interests in the TBTF system of colonial finance (Felonialism), new ideas are not even being considered or advanced.
    Aside from the idea of some limited Domestic Money supply, and perhaps a “PUBLIC OPTION” TO THE FINACIAL monopolies there are no new discoveries or disclosures being offered for authentic reconciliation, and this “correction” is useless since they can’t predict the next 6 months of changes in the system let alone the time allotted to circumvent these “regulatory constraints.” No new work evaluates the corruption, and appeasement is at the core of blinding the system back to its new corrupt normal.

    Meanwhile, a new paper from… (no prejudgments)…the IMF which is (in my opinion) clearly worth studying:

    * Working Paper No. 10/214: Monetary Transmission of Global Imbalances in
    Asian Countries

    Author/Editor: Choi, Woon Gyu; Lee, Il Houng

    Summary: The paper explores the linkages between the global and domestic
    monetary gaps, and estimates the effects of monetary gaps on output growth,
    inflation, and net saving rates using panel data for 20 Asian countries for
    1980-2008. We find a significant pass-through of the global monetary gap to
    domestic monetary gaps, which in turn affect output growth and inflation, in
    individual emerging market and developing countries in Asia. Notably, we provide
    evidence that the global monetary condition is partly responsible for the
    current account surplus in Asia. We also draw implications for monetary policy
    coordination for global rebalancing.

  37. Re: @ Per Kurowski____Your passion, and courage to speak out is inspiring my consciousness to levitate and pique my involvement – accelerating this domicile crucible of past enertia – righting this rudderless shipwreak “You” call Basel III…now gravitating too the pinnacle of yours truly priority list. Simon should show his hand to be fair, and reexamine his thesis clearly of what seems, “a great deal of ambiguility”.

  38. @ Earle, Florida. I thank you for the support. My issue is that the current regulatory paradigm brought upon us by one of the first global regulatory experiments, the Basel Committee, turned out so utterly mistaken that almost all other discussions in this matter pale. And that is a problem that PhDs and regulators just do not know how to handle… they are stunned and lost for words.

    And that is why they hang around and discuss issues like the appointment or not of Elizabeth Warren, and that though a meritorious issue indeed, you should only take up when you have fixed the disaster that is happening in real time really on the main-streets, namely that all those who were never rated as having a low risk of default and who had absolutely nothing to do with creating this crisis, and who are weaker, are now being asked to bear the brunt of the readjustments.

    I have been pounding about this here in Baseline for about a year; and even longer in many other forums, and even though many participants have agreed with me, my concerns have always been ignored by those responsible for the site. I welcome you to go to the IMF blog where you will be able to see it is happening there too.

    They and the others do not answer me because they do not know what to answer me! Frightening! And now the G20 will go off to Korea and re-discuss the issue with exactly with the same discussants that all have a vested interest in the world not finding out what they really did.

    Bernard Lietaer
    From Wikipedia, the free encyclopedia

    Bernard Lietaer (born in 1942 in Lauwe, Belgium) is an economist and author and professor. He studies monetary systems and promotes the idea that communities can benefit from creating their own local or Complementary currency, which circulate parallel with national currencies.
    Bernard Lietaer, the author of “The Future of Money: Beyond Greed and Scarcity” (London: Random House, 2001) and the forthcoming “Of Human Wealth,” has been active in the realm of money systems for close to 40 years in a wide variety of functions. With the publication of his post-graduate thesis at MIT in 1971[1] (which included a description of “floating exchanges”) and the Nixon Shock of that same year which eradicated the Bretton Woods system by unhinging the US dollar value from its gold standard and inaugurated the new era of universal floating exchanges (previous to that time the only “floating exchanges” involved some exotic currencies in Latin America), the fledgling management consultant suddenly found himself to be at the center of the financial world’s attention. The techniques that he had developed for those marginal Latin American currencies were overnight the only systematic research which could be used to deal with all of the major currencies of the world.
    Within his books he describes and draws from the perceptions of Freiwirtschaft. He is the originator of a complementary currency called the terra.

    * The Future of Money
    * Of Human Wealth (forthcoming)

    * Interview with Dr. Bernard Lietaer
    * Interview with monetary specialist Bernard Lietaer on banks, the crisis and creative solutions 1/4/2009
    * Economic Insights from Bernard Lietaer 2/10/2009
    * Bernard Lietaer teleseminar on “New Money for a New World”
    * The Money Fix Podcast #02: Bernard Lietaer
    * Bernard Lietaer’s lecture
    * Bernard Lietaer’s blog at Reality Sandwich
    * A World in Balance?
    * “From the real economy to the speculative” (excerpts) by Bernard Lietaer
    * An interview with Bernard Lietaer
    * Community Currencies: A New Tool for the 21st Century
    * Another interview with Bernard Lietaer
    * A discussion about these interviews
    * Excerpts from his book, “The Future of Money: Creating New Wealth, Work, and a Wiser World”
    * (video) Bernard Lietaer for an NHK Japan documentary on complementary currency systems and Silvio Gesell
    * Short biography
    * Bernard Lietaer’s Homepage

  40. You are focused on the minutiae! The entire system is flawed, toxic, cancerous, unstable, and doomed to collapse. The focus should be on building a NEW system and structure. The old system and structure FAILED!!! Miserably!!! Catastrophic, nightmarish FAILURE!!! All the existing structures, systems, managements, and governments FAILED!!! Horribly!!! Terrible losses!!! Manifold pain and suffering!!!

    Your perfidious days are numbered biiiiaaatches!

    It is long past time for a new paradigm and real change!!!

    The gop, the predatorclass den of vipers and thieves on Wall Street, the parrots in the socalled MSM, and the cowardly spaniels in the socalled government speak with forked tongues, and have no eyes, no ears, and no hearts>

    In a world where there are no laws – there are no laws laws for anyone predatorclass biiiiaaatches!!!

  41. I argue, I believe convincingly, that the primary blame for this financial crisis lies with the Basel Committee, for having designed bank regulations based on an entirely faulty paradigm. Basel I was bad, Basel II was the height of stupidity and Basel III frighteningly evidences that even after the crisis they still don´t get what they did wrong.

    BP was grilled by Congress but who has grilled the BC publicly? Who are this cadre of invisible and untouchable global public servants? Why aren´t they questioned? Do we need to call upon the services of a James Bond?

  42. Fund the micro-economy….

    It’s OBVIOUS that “someone” was doing the exact opposite to micro economies – they were “de-funding” LIFE MAINTENANCE commerce one way or another – payroll taxes, CASH accumulation through meth and other “illegal” drugs that use the same “chemicals” as big pharma for production, weapons, — ALL “currency” flow has been diverted to MAXIMUM damage against humans and the planet so that a handful of psychos can claim to own it ALL on paper – or these days it’s “e-paper”.

    Go eat and drink your gold…

  43. Can’t get link on last Ref:____must Google @ “The Gentlemanley Market: the Culture of the London Gold Fix authored … (Page 16 of 20)” – Please realize that all the people referenced were instrumental/input in the U.S. Federal Reserve Act of 1913! PS. Sidenote: “The Balfour Declaration” also finds their fingerprints all over the language? Thanks Simon and James :-)) Go Rays!!!

  44. Yes we need a “James or Jane Bond”…

    CNBC was a virtual parade of whirling dervish commentators today spinning around Basel III, including tying “toxic” disposal into the mix – yikes.

    Instead of continuing with the plan to steal everything that human labor produced/produces/will produce in the past, the present and infinitely into the future as proof that it’s no longer “toxic”,

    why not just trickle “toxic” assets back into everyone’s personal accounts – creative accounting anyone?

    The solution to pollution is dilution…

    I’ll take a billion “derivatives” in the commercial real estate sector for 200, Alex…


  45. example – people who carry a mortgage greater than what the home will ever sell for again,

    give those mortgage holders the PAPER that was generated off of their home – were they Credit Default swaps or what were they? –

    so that the mortgage holder also holds the PAPER

    and can use that PAPER to pay down the principle…

  46. Treasury Bulls Bet On Deflation And A Ride On QE2

    September 22 2010 – Financial Times – excerpt

    “After months of debate, the US Federal Reserve is preparing to open the door to a dose of super-sized Treasury bond buying. That, at least, was the view in financial markets on Wednesday as the dollar tumbled, yields on sovereign debt fell and gold jumped to another record high.

    The statement issued by Fed policymakers on Tuesday, after the central bank left interest rates unchanged, went further than many investors had expected. To the surprise of bond market investors, the Fed formally expressed concern that inflation was too low for the central bank to fulfil its mandate of promoting price stability and full employment. It was “prepared to provide additional accommodation if needed to support the economic recovery.”

    That bias towards monetary easing, absent from its last policy statement, triggered speculation that the Fed would embark on another round of asset purchases to pump money into the economy – a policy known as quantitative easing – were inflation to keep falling. There were big implications for US government bonds, the dollar and gold, strategists said….

    Gold’s rise to a new record suggests there is “growing market discomfort with the idea of additional QE,” say economists at RDQ Economics.

    Were the Fed to succeed in heading off deflation only at the cost of stoking prices, that would be bad news for Treasuries. Investors buying long-term bonds at their current low yields would find their real returns eroded as inflation rose. Believe that scenario and the Treasury market may well be in bubble territory.”

    * Surprize – the rock & the hard place.

  47. Thanks for the links earle,florida. Interesting reading. Saudi Arabia may be “good friends” with the fascist warmongers and profiteers in what Indira Singh aptly names the bushcrimefamilycabals, but those jihadi funding royals are NO FRIEND of Americans. Mind you 15 Saudi’s and Saudi financing are the root and culmination of the horrorshow of 9/11!!! The fact are irrefutable!!! The predatorclass alone, and select bushcrimefamilycabals benefit from Amerika’s unholy alliance with Saudi Arabia. The rest of us pay a terrible price in blood and treasure for bowing to, and cowtowing to the house of Saud.

    The future stability of America and the entire world is implementing green technologies. The sooner we as a people globally remove ourselves from dependence on oil as an energy source – the better. Oil is a critical element in many manufacturing processes, so this necessary transition will not be easy or swift, – but oil is a finite, toxic, and politically and economically unsavory commodity. It is far past time to enter into the 21st Century with green, or clean technologies, and minimize our dependence on oil. That dependence will demand unendingwars and occupations and the feeding of a military machine dependent on that oil. Any cursory examination of history proves this point. Do you own google and get back to me.

    America must move toward green and clean technologies for national security interests, for the future of our children, and for the frayed and tattered remains of the more perfect union that was America.

    Back on point – the government simply printing money, and funneling it unrestrained into the offshore accounts of the predatorclass den of vipers and thieves on Wall Street – is a recipe for disaster!!!

    Real Change demands curbing, punishing, and dissolving the FAILED managements, and FAILED institutions, pimping and bruting FAILED products who are singularly and exclusively responsible for piloting the entire globe to the brink of economic collapse, -and hoisting terrible suffering and hardship on the shoulders of the people.

    Unless and until someone or some group demands real changes, and the forceful constraining of the predatorclass – we are all doomed to continued hardship, loss of bargaining power, and economic collapse.

    Math is incontrovertible, and the Truth will truly set you free – people might want to start looking into it.

  48. Thanks.

    I am sorry to inform that the article you refer to ignores that Basel III does not tackle the real problem with Basel II, namely the risk weights. Even if you increase the basic capital requirement to 100% but then apply a risk-weight of zero, as is the case when lending to triple-A rated sovereigns, then the capital required is still going to be zero.

    Of course those who are risk-weighted at 100%, like the small businesses and entrepreneurs, those who never caused this or any other crisis, they are going to bear, again, all the brunt of the regulations applied by a regulator who wants to be seen as stricter.

  49. @Rene: Who would do such a thing?

    Regulators who do not understand that their role is not stopping a bank from failing (besides who would like to live in a world where no banks failed) but that their job is to stop a systemic failure. And all the systemic failures and crisis in the world have occurred by lending or investing where the risk is perceived ex-ante as low which is the only areas that can grow into systemic dangerous volumes. The lending or investments to what is risky, though it might produce individual fatalities, will never grow into a systemic risk.

    Just being perceived as risky is more than weight enough!

    On the nakedcapitalism article? Yes they are waking up. The morning after you break out of a paradigm you completely forget why you held it, and of course you believe you have said so from the very beginning, most specially when Mr. Kurowski is not a PhD and does therefore not have the same rights of being cited Like for example:

  50. The naked variants of derivatives allow unmanageable losses, but the more traditional variants are more limited. Non-naked derivatives could be properly managed with capital requirements.

    For example, you can only borrow up to the total number of outstanding shares for short sells. ( and practically many fewer than that.) If the price goes up(they lose the short sell bet), the maximum any company could lose on non-naked short sells for that stock would be the change in price times the number of outstanding shares.

    IMO, Options contracts without underlying collateral should be banned.

  51. I think most of the comments are missing the mark, and that’s because there’s a distinct lack of understanding how banks operate.

    1) Credit rating agencies did a poor job with ABS. That isn’t the case with credit ratings on larger corporations, though there are notable exceptions which I’ll address later.

    2) Small businesses are VERY risky, as evidenced by the high rate of failure. Not only are loans risky due to the less stable nature of a smaller business, they are also more vulnerable during economic decline. Small business loans that are not diversified can even destroy a larger commercial bank by introducing system-wide failure. This is the type of counter-party risk that the Basel I, II & III attempt to address.

    3) The cost to originate and monitor loans for a portfolio of small businesses is far greater than a loan to a mid-sized to large business.

    The real problem is the failure of financial statement disclosure. Large businesses and banks are allowed to abstract their asset holdings in very vague categories, or in the case of Enron, not make any asset and liability disclosers. In the case of corporate and banking finance, it doesn’t matter what regulations you place on the table; if there is no information to monitor then there is nothing to regulate.

    That’s the essence of Basel III in a nutshell. It was designed to keep financial assets, liabilities and operations in the murky light of bank self-interest. Instead of opening the books, the banks are allowed to keep their operations obscure to REGULATORS as well as to each other. Counter-party risk is addressed not by analytic review of the financial standing of the bank, but rather the keeping a percentage of assets of book value (not fair market value) in a highly liquid asset class. From a regulatory perspective, it is akin to “We all know you’re cheats, liars or inept; let’s just discount what you say is true by X%”.

  52. @Edvard “Small businesses are VERY risky, as evidenced by the high rate of failure. Not only are loans risky due to the less stable nature of a smaller business, they are also more vulnerable during economic decline”

    That is precisely why they never grow into systemic risk exposure. Only what is perceived as not being risky can do that. And that is what the Basel Committee in their pursuit of saving individual banks never saw and still does not see. That they are more vulnerable during economic decline is also caused by the fact that they receive much less assistance than the too-big GMs or AIGs.

  53. @Per Kurowski

    You may wish to revisit the collapse of Continental Illinois National Bank and Trust Company.

  54. Re: @ Edward___The total aggregate sum (annum $$$ ~= +/-)of SME’s bankruptcies are actually miniscule in proportion too…let’s say the collapse of one such TBTF as Lehman Brothers? If you sum the totals…the rationale figures are quite alarming, being that ten (10) years of SME’s failures equal one massive failure. Where’s the logic? Note: FAQ’s #5; #6; #36 Ref:

  55. @Edvard The role of the regulators is not to stop one bank from making mistakes and failing on the contrary I want banks to fail now and again… just the thought of a world without failing banks should make everyone shiver… especially those who do not like the too-big-to fail banks. No I am talking about a regulator that thinks of the whole system and is aware that any of his regulations can turn itself into a dangerous systemic risk. And that type of regulators knows very well that the largest risks dwell in safe waters as few dare to go into the deep shark-infested waters.

  56. I’m afraid you’re changing the subject at tad, Per. We were discussing small business lending, and small lending practices can indeed bring down a large bank. The large bank needn’t even be the loan originator to the small businesses.

    To address your second point, there was nothing in Basel III that attempts to prevent banks from making mistakes. The purpose of Basel III is to limit the frequency and severity of bank failure. In very isolated cases, a bank can be allowed to fail if it doesn’t drastically impact the banking system. Yet banks have paper-thin equity margins coupled with significant holdings with other banks. The failure of a single bank cannot always be easily contained to that one bank. Once again, a tiny wart of a bank headquartered in a shopping mall can destroy the equity layer of the 7th largest bank in the USA (Continental Illinois). If Continental Illinois was allowed to fail, the ripple effect would have been to wipe out the equity layers of many other banks in the USA.

    This is digression from my point though. The equity layer itself is built on an accounting fiction. Without full disclosure, banks, regulators, industry watchdogs, rating agencies, taxpayers, etc. cannot assess the risk of individual banks and by extension, the risk the individual bank is imposing on the entire banking system.

  57. @ Per Kurowski
    @ Edward
    @ earle,florida

    I think defining your terms would go a long way to resolving your differences to this constructive converation.

    For example I have argued that like the World War II French Generals who built the Maginot Line’s fixed fortifications in reaction to World War I tactics, Dodd and Frank proposed legislation in response to the most recent crash. Their response focuses on scale, Too-Big-To-Fail (“TBTF”), rather than the economic randomness of predictable, probabilistic, and uncertain valuations for TBTF portfolio holdings which are Too-Random-To-Regulate (“TRTR”). Our “financial generals” have unfortunately conflated risk and uncertainty in deterministic, one-size-fits-all governance metric that almost certainly will result in a dysfunctional price discovery mechanism leading to increasingly more frequent and larger economic dislocations.

    Negative cash flow, mark-to-model CDSs are uncertain instruments that did/do not respon well to risk management techniques.

    See: Dodd-Frank: A fine alphabet soup appetizer, but where’s the beef?

  58. Re: @ Edward___Nor was I aware that GM, Chyrsler (Private Entity?), AIG, *GS, ML/BAC, GE, all became impregnated by “Holding Companies” to borrow at the FED’s (* denotes holding co. as one example) Window or were bailed out by “TARP”?

  59. Mr.Johnson, and Mr. Kwak have explained quite throughly that TBTF’s should be let go, period! The redundancy of arguing apples, and pineapples is a waste of my time – we go in circles when the evident answer was/is in the very near (never mind the complications of todays financial system…its a ruse) past. Here’s a very “Simple,~75’s Old, but Tried and True”….Ref:

  60. @Steven,

    With all due respect, mark-to-market does encompass my financial disclosure proposal. Further, your comment about negative cash flow is correct, but without meaningful financial statement disclosure by the banks how would you (or a bank, regulator, rating agency, etc.) ever discern a negative cash flow?

    Of course that’s negative cash flow from the previous quarter operations. The real problem in bank cash flow isn’t necessarily from ongoing operations; it is from the fire sale of less liquid assets in order to meet cash obligations during a financial crisis.

    There is a solution, but I wouldn’t expect the banking community to agree to it.

  61. The bright line that demarcates determinate from indeterminate randomness consists of negative cash flow and Mark-to-MODEL (not market) valuation.

    Absent randomness segmentation, indeterminate information cannot be processed effectively and efficiently by determinate, one-size-fits-all metrics due to a lack of correlation (similar to having one driving manual for the US and UK).

    See: “We’re All Screwed: How Toxic Regulation Will Crush the Free Market System”

  62. @Stephen:

    My bad, I scanned your post. Mark to model is nice in theory, though mark to market is vastly superior when there is a market. The problem with mark to model is arriving at a consensus as the the model, the availability of data for the model, substitutions or proxies for data values when timely data may not be available, and whether the model can be gamed by financial market participants for profit at the expense of the model’s integrity… and those are the questions just from the top of my head.

    Please expand on your mark to model disclosure requirements vis a vis Basel III.

  63. “There’s also an urgent need for the elimination of market institutions and trading practices that promote excess volatility. The stock index futures market should be regulated out of existence. The futures market circumvents margin requirements by enabling investors to have effective ownership of more than $150,000 of stock while putting down only $6,500. It makes possible trading strategies like portfolio insurance that increase market volatility by creating huge selling pressure after market declines. At the same time, the futures market offers no new opportunities to stable investors seeking to invest for the long term.”

    LAWRENCE SUMMERS, October 21, 1987

  64. To help you get beyond “scanning,” reference previous Baseline blog-posts on capital market governance or:

    1. Dodd-Frank: A fine alphabet soup appetizer, but where’s the beef?

    2. Mr. Volcker is wrong!

    3. We’re All Screwed: How Toxic Regulation Will Crush the Free Market System

    since most of your questions were previously addressed.

    In essence, Kurowski and I have similar view points but different priorities to achieve this goal. Kurowski’s independent variable is capital adequacy while I seek a structural revision to the legacy, one-size-fits-all deterministic governance to manage randomness via predictable, probabilistic, and uncertain regimes. Unless policymakers address the problem of non-correlative information, larger and more frequent economic dislocations.

  65. @ Earle

    Could you provide a reference for:

    “Mr.Johnson, and Mr. Kwak have explained quite throughly that TBTF’s should be let go, period!”

    Since I advocate Too-random-to-regulate (TRTR), critics of TBTF are the next best thing and I will glady give Messrs Johnson and Kwak attribution in the furtherance of capital market efficiency and effectiveness.


  66. Re: @ Edward___”The Basel Trinity” is all but one – nothings changed, period! All is relevant to one’s body function ie.)___CDO’s; CDS’s; MBS’s: ABS’s; R-C/MBS’s;…and then their came Sub-Prime; No-Doc; Alt-A; Tier 3 (tranches?), and the list goes on with TBTF’s Repos’s #105 and having the…”Three Rating Agencies” in their pocket…this was/(?) wasn’t perpetrated by the “Diabolical Lab Work of Basel (Frankenstein) Methodology”? Please note…as “Per” says all is “Basel” – only the “TBTF’s” indulged in this chicanery, goaded by their Basel Herdsman? For Shame!!!

  67. @ Earle

    My recolllection was that Messrs Johnson and Kwak were in the TBTF camp (would welcome refernce to the contrary). This, unfortunately, perpetuates the deterministic status quo and enables the oligarchs to become financial cyborgs.

    TRTR is the conceptual TERMINATOR

  68. @ Earle

    I have read 13 Bankers. Johnson and Kwak’s positions are well stated. That explains my earlier question to you re TBTF as it was inconsistent with what they wrote on p 202.

    While I can question re 13 Bankers, I can explain what I have written. How else do you attain transparency if you do not accurately cite your references?

    My value-added contribution comes from the 50+ articles written and the book that can be supported (and detracted) by practitioner (both regulatory and industry) experience.

  69. Are you ok with a 71.4 to 1 leverage for banks?

    Basel III now tells us that the basic capital requirement for banks is not any longer going to be the 8 percent of wishy-washy made up capital of Basel II, but a more real and solid 7 percent. This is good news!

    But, unfortunately, Basel III completely ignores mentioning the risk-weights, though these were the real source of the problems with Basel II.

    And so now with Basel III, as the risk-weight for operations with triple-A rated securities remains 20%, the “more real and solid” equity required is 1.4 percent; the new authorized leverage for banks when investing in exactly the same type of securities that set of the current crisis, is 71.4 to 1.

    Are you really ok with this?

  70. I’ve said this before, but I’m going to keep saying it. It’s time to dump the idea of “risk” completely. In an environment driven by high-speed computerized trading, it’s less than useless, it’s dangerous.

    The cycles of destruction will be coming faster and faster. Instead of 30-40 years between major blowouts, we’re seeing catastrophic collapse re-emerge in less than ten years. Networked computing power has completely changed the world around us, yet we pretend that the landscape is still the same one we’ve always lived in. There will be no more recouping over a 10-20 year period as happened after the crash of the 30s. Those days are gone. Technology has swept them away. We’re already seeing the return of bubbles, in the bond market, in Asian real estate, in garlic for heaven’s sake:

    The risk equations are predicated on the existence of individual probability distributions for different events based on the presumed rating for a given financial instrument. Those probability distributions don’t exist. Time series for the behavior of the market have the hallmarks of brownian motion but that’s misleading. The selling and buying, the hedges on exotic derived instruments, all of this constitutes an iterated discrete non-linear dynamical system.

    All the risk estimates in the world will not keep this from happening again. It’s built into the market system, and always has been. It wasn’t obvious when the dynamic unfolded slowly over decades. It should be very clear now.

    There may be answers to this. Lots of work has been done to determine how you can stabilize systems like this. But tagging capital with arbitrary risk estimates isn’t going to work in my opinion.

  71. Mr. Cimon:

    Agree with some minor exceptions

    If there is complexity, there is uncertainty. To achieve real regulatory reform, policymakers have to move beyond risk management to randomness governance of both determinate and indeterminate underlying economic conditions. Unfortunately, the degree of reform undertaken tactically addresses the symptomatic problems rather than strategically trying to fix the causal market flaw by segmenting randomness in terms of predictable, probable, and uncertain governance regimes. Trying to govern both risk and uncertainty with the legacy, one-size-fits-all deterministic regime is analogous to having one set of driving instructions for both the U.S. and U.K. The result is larger and more frequent boom-bust cycles.

    The conflation error of risk and uncertainty leading to financial chaos is the prmise of “We’re All Screwed: How Toxic Regulation Will Crush the Free Market System.”

    Along the same line

    1. Dodd-Frank: A fine alphabet soup appetizer, but where’s the beef?

    2. Mr. Volcker is wrong!

Comments are closed.