Current central bankers are just as lost as Greenspan and friends were lost before 2008, for exactly the same reason

Sir, Sebastian Mallaby when discussing the “alarming froth” in asset prices like shares, bonds and houses, due to “extraordinarily loose monetary policy”, but yet producing “low growth and low inflation” writes: “A … troubling echo concerns the role of regulation. If financiers seem to be taking too much risk, today’s doctrine holds that regulation should restrain them.” “Bubbly finance and low inflation cause alarm” October 8.

NO! NO! NO! Today’s regulations hold that banks should be taking on too much safety. Banks are not allowed to build up dangerous exposures to what is perceived as “risky”, like for example the below BB- rated, which has been assigned a risk weight of 150%; but banks are sure allowed to leverage immensely their capital, and the support they receive from society, with assets rated AAA to AA, risk weighted a mere 20%.

And, if the banks are big and “sophisticated” enough, then they are even allowed to use their own risk models even if, by definition, banks are always interested in minimizing their capital requirements so as to allow them to maximize their expected returns on equity.

There must be something in the air that stops expert central bankers from reaching out to their inner common sense and be able to understand how loony current bank regulations are.

The risk-weighting completely distort the allocation of bank credit to the real economy, making banks ignore their vital role in financing the “riskier” future, and having them to concentrate solely in refinancing the “safer” past. That dooms the world to gloom and doom or as they prefer to call it, to secular stagnation.

And all for nothing! Major bank crises never ever result from excessive exposures to what is ex ante perceived as risky; these always result from unexpected events or from excessive exposures to what was ex ante erroneously thought to be very safe.

@PerKurowski ©