Writing in the Wall Street Journal on Saturday (behind the paywall), Peter Wallison provides a helpful reminder of how regulation incentivized banks to load up with dodgy sovereign debt:
“Under the Basel rules [broadly speaking, the global regulatory system for banks], sovereign debt—even the debt of countries with weak economies such as Greece and Italy—is accorded a zero risk-weight. Holding sovereign debt provides banks with interest-earning investments that do not require them to raise any additional capital.
Accordingly, when banks in Europe and elsewhere were pressured by supervisors to raise their capital positions, many chose to sell other assets and increase their commitment to sovereign debt, especially the debt of weak governments offering high yields…”
Incentives work. Even perverse ones.
"sovereign debt—even the debt of countries with weak economies such as Greece and Italy—is accorded a zero risk-weight"
This is the moral equivalent of placing unconditional trust in governments, two trick ponies that can only run printing presses or offer blank checks on the future earnings of taxpayers in their respective jurisdictions. The first trick is government's method of stealing from the past. The second trick is government's method of stealing from the future. Ignoring the monumental weight of historical evidence that governments are the among the least trustworthy of institutions is suicidal.
Reply to this commentLinkReport AbuseGenerally sovereign debt aka bonds are very safe (apart from a handful of European govt bonds at this time ) that still leaves plenty of other countries sovereign debt/bonds including US treasuries. So to argue that this basel regulation is wrong or bad is laughably ridiculous- like saying seat belts are bad because 2 kids per year die through strangulation on seat belts while playing in cars.
Reply to this commentLinkReport AbuseIf the principality in question provides and maintains honest money, your assertion is generally valid. However, fiat currencies invite and facilitate government abuse of its debt holders and its citizens.
Reply to this commentLinkReport Abusethere are only a handful of Governments that issue debt ... so the fact that only "a few" are going under doesn't help your argument ...
Reply to this commentLinkReport AbuseI heard very similar arguments a few years ago about mortgage backed securities. It was claimed that only a small percentage of the mortgage holders would default so those securities were actually quite safe. Strange how it didn't work out so well in the end.
Reply to this commentLinkReport AbuseThat's fine, as long as it's equally laughable that the parents of those 2 strangled children should be blamed for making them wear those seatbelts. Assuming, of course that laughter is ever an acceptable response to death or default.
Reply to this commentLinkReport AbuseYes but if the seat belts are encrusted with candy in such a way that the children slip them like nooses around their necks, all the while getting winks and nods from their insider playmates that should a spot of bother arise, they will take care of it with taxpayer money, then when they get the noose good and snug, the regulators try to raise alarm bells and the children scream and whine for the regulators to shut up until they have had just a bit more candy, then perhaps you have an issue, no?
Which leads you to the real tipping point for a world wide crash, when the insider elites no longer trust each other to do what is best to maintain the systemic status quo, and is either being duplicitous or merely vague about which direction they will go with decisions so the others cannot front run them, then you will see the markets seize up and the economies crash. imo.
Reply to this commentLinkReport AbuseYes but if the seat belts are encrusted with candy in such a way that the children slip them like nooses around their necks, all the while getting winks and nods from their insider playmates that should a spot of bother arise, they will take care of it with taxpayer money, then when they get the noose good and snug, the regulators try to raise alarm bells and the children scream and whine for the regulators to shut up until they have had just a bit more candy, then perhaps you have an issue, no?
Which leads you to the real tipping point for a world wide crash, when the insider elites no longer trust each other to do what is best to maintain the systemic status quo, and is either being duplicitous or merely vague about which direction they will go with decisions so the others cannot front run them, then you will see the markets seize up and the economies crash. imo.
Reply to this commentLinkReport AbuseThe trouble with economics is that supply and demand work: if everyone is tricked or legislated into thinking X is risk-free, then the supply increases, the quantity increases past what can be maintained with little risk, and the risk grows. Everybody wearing seatbelts doesn't make seatbelts any more dangerous, but everybody believing "housing prices never go down" leads to overvalued housing prices which leads to housing prices falling back down.
Likewise, people like you who naively think US treasuries are risk-free are one of the factors which has kept interest rates on federal debt down, which is one of the factors which has lured the government into taking on an exponentially increasing multi-trillion dollar debt, which is suddenly going to become very risky once the supply of naive money finally runs short and the remaining untapped investors start worrying about how or if they're ever going to be paid back. Note that "they can just issue an even bigger debt to someone else" is not a long-term repayment scheme, it's just the same "bigger sucker" thinking as "someone else will buy my house/dot-com-stock/tulips" was.
Reply to this commentLinkReport AbuseThere is a difference in kind between zero risk and low risk. There is no such thing as zero risk debt. It just does not exist. If nothing else, there is invasion risk. Things are zero risk if several variables are treated as constants. But variables vary and treating them like constants makes you fat, complacent, and lazy, never a good thing for managing investment risk.
This was the same sort of impulse that led to a reduction of insurance premiums for the FDIC. We sure could use that premium money we didn't collect during those fat years today
Reply to this commentLinkReport AbuseIf regulators allow you to jump off a bridge, it does not make your death their fault if you choose to do so.
The problem I had with Wallison's article was that he seemed to blame the lending mistakes completely on the regulators, and absolve the bankers of any responsibility for mispricing the risks they voluntarily took on. Of course the regulations were faulty, and there are plenty of examples of regulators failing to do their jobs even when the regulations were correct; but bad regulating does not absolve lenders or borrowers from their responsibilities to independently assess the choices they make.
Reply to this commentLinkReport AbuseThe prtoblem is that banks have to compete just like every other industry.
Reply to this commentLinkReport AbuseIt's well and good to declare that the banks should have stayed away from soveriegn debt, or internally managed it as not being risk free. The problem is that such banks would have had lower rates of returns compared to other banks that did do what the regulators allowed.
The result of this lower rate of return is that the stockholders can and will remove the officers and replace them with others.
Once the regulators put in place rules that are ruinous, the rest follows as surely as night follows day.
Why can't the sovereign debt have a "risk rating" to the banks holding it? We could create some independent ratings agencies that look at individual country's budgets, incomes, economy, etc and come up with formulas to rate them. Use letter designations to make "good" debt look good (maybe an "A") and bad debt look worse (maybe a "B"). Then we could differentiate the "good" debt further by giving them pluses and minuses and perhaps multiple letters ("AA", "AAA", "BB", etc). This could all be done by independent companies that understand the financial markets. Maybe they could report quarterly (unless something really big happens).
Oh wait, all of this already exists. We just don't want to use it. Perhaps there are more countries with cr*ppy debt and, because they had an input into the international rules, all sovereign debt is "good", risk free debt. Of course, you can usually judge the risk by the level of the return but, that might be too easy!
Reply to this commentLinkReport Abuse