On the Basel III framework:
“The new regulatory arrangements rely heavily on a Risk Weighted Assets regime which is too complex and a leverage ratio which permits gearing that is too great. Basel III is a busted flush. The banking lobby would be only too happy to settle for these ‘tough, new rules.’ The taxpayer should not.”
On whether Basel III leverage limits will be adequate:
“No. Basel III will permit banks to fund 97 percent of their risk taking with debt. In other words, only 3 percent of loss absorbing equity funding will stand between a bank’s risk-taking prowess and recourse to the taxpayer. And we know all about bankers’ risk-taking prowess. Going forward bond holders will take the hit before the taxpayer. But how long do you suppose a bank’s creditors are going to hang around as that tiny sliver of loss-absorbing equity erodes? Bank funding will flee. No funding -- no lending. For that matter no bank -- absent bailout or life support.”
On the British Bankers’ Association’s argument that a leverage ratio is a blunt instrument with potential unintended consequences:
“It is blunt in that it is more difficult for banks to evade than the flawed alternative of Risk Weights. Basel II, the failed predecessor to Basel III, established the concept of Risk Weighted Assets. The idea is that some risks are riskier than others and therefore equity funding should vary with the particular type of risk run by banks. It is an appealing concept. Now it is certainly true that risks vary but it is also certain that bankers and regulators will misjudge those risks. How much loss-absorbing capital did the boys in Basel require of investments in Greek government bonds? Answer: Zero. How much loss absorbing capital did they require in support of CDOs squared? Forty pence for every 100 pounds of the stuff. How much do the new improved Basel III rules require of these same securities that neither banker, investors, rating agency or regulator was able to judge? Answer -- less than 1.4 percent of the notional exposure.
‘‘Bankers prefer the RwA approach because they can currently choose whether to use their own models to calculate the risks or instead, select the weightings set by Basel -- whichever approach permits more leverage. Studies by the Financial Services Authority, International Monetary Fund and Bank for International Settlements all confirm that different banks calculate the same risks in widely different ways. It is an increasingly discredited system. But it is the one preferred by the banking lobby. Perhaps they know best -- but is that the way to bet?
On U.K. regulation exceeding Basel requirements:
‘‘In one sense, the U.K. has done so with its ring-fencing initiative. But much of bank risk-taking will remain outside the ring-fence and so we come back to the key question of leverage. And here government remains wedded to Basel despite non-partisan advice to the contrary. As you know, the Independent Commission on Banking led by Sir John Vickers recommended a leverage ratio of 4 percent (i.e. a limit to gearing of 25 times). Government rejected it. The Parliamentary Commission on Banking Standards has recommended the same. Government remains reluctant. The interim FPC of the Bank of England asked for the power to vary leverage. This key tool has been withheld by government.
‘‘In other words, three independent bodies made recommendations which might reduce leverage levels relative to those permitted by Basel. Government has ignored all three. This is both tragic and sad.
‘‘It is tragic because it means that some of the banks of the world’s largest financial center may be among the most fragile. It is sad because in the first years of the new government, the U.K. was at the forefront of financial reform. It has now been left behind by the Swiss, the Swedes and, if recent reports of Federal Reserve thinking are accurate -- by the U.S. as well. Given that the assets of the U.K.’s banks exceed four times U.K. GDP you would think Her Majesty’s Treasury would err on the size of caution.’’
On the influence of bank lobbying on government policy:
‘‘Given the above, you be the judge. I fear that the banks have bamboozled government into believing that society must choose between safety and growth; between safer banks and bank shareholder value; and between a safer financial framework and a competitive City of London. These are all false choices. Lower leverage is compatible with economic growth; it is compatible with attractive risk-adjusted shareholder returns, and it compatible with the success of the U.K. as a global financial center. Higher capital and lower leverage are just not compatible with past levels of banker pay. And there’s the rub.’’
On U.S. proposals to raise equity funding requirements to 5 or 6 percent:
‘‘I would go much further. But the proposals sound like a step in the right direction. How big a step depends on the degree to which derivatives are included in the denominator of the equity-to-asset ratio. I also want to study Thomas Hoenig’s reaction and testimony. The vice chairman of the U.S. Federal Deposit Insurance Corporation is a smart cookie and doesn’t duck the issues. One thing is for sure: these developments undercut the argument that more restrictions on leverage here in the U.K. will cause Britain’s banks to decamp to New York. It is one of several guns that bankers have held to the government’s head. The gun is filled with blanks.”
“Barclays is the poster child for excess leverage. Its balance sheet is roughly the size of the U.K.’s GDP. It funds 1.5 trillion pounds of risk-taking with 97.5 percent debt and 2.5 percent loss-absorbing equity. The average hedge fund trades with less than 3 times leverage. Barclays has chosen to operate with 45 times leverage.
‘‘So Barclays deploys gearing 15 times that of most hedge funds. If the bank’s assets eroded in value by a mere 1.5 percent, it would be 100 times leveraged. How confidence inspiring is that? How long would its creditors stick around to find out? Antony Jenkins has been happy to take the risk. His board is happy to let him do so.
‘‘His regulator is a bit less enthusiastic. The Prudential Regulatory Authority has asked Barclays to get to the Basel III minimum of 3 percent equity sooner rather than later. That will still leave the largest bank in the land leveraged 33 times.
‘‘In his first public comments on the regulator’s request, the new chief executive officer of the ‘new’ Barclays appeared to threaten to cut back lending if he were forced to become a tiny bit safer a tiny bit sooner than he had planned. In a published letter I pointed out half a dozen other ways that the bank could reach the ratio without hurting the economy. I then simply asked if the CEO’s statement constituted a threat, hubris, reflex or just plain stupidity. Whatever you want to call it, it sure sounded like the old Barclays.
On the European Union cap on bonuses, and whether bankers bought it on themselves:
‘‘They brought it on themselves but it won’t solve the problem. As a member of the FPC, my main concern was that the structure of pay should not undermine financial stability. ‘Heads I win/tails the taxpayer loses’ is a recipe for recklessness. Add to the mix a level of leverage of 33 times or more. Now multiply by trillion pound balance sheets and systemic shock is assured.
‘‘More capital can limit the public damage from reckless risk-taking. More accountability can reduce the recklessness to begin with. Investment-banking partnerships would never have dreamed of taking the magnitude of risks with their own money that they now happily take with the capital of others. So you either reintroduce a liability-like partnership structure or you withhold the rewards for risk-taking until the risks taken mature and the results are known.’’
On the financial-stability impact of unwinding monetary stimulus:
‘‘The recent bond market episode constitutes an early rehearsal for reversal. Market participants now realize that the great unwind is going to be a rocky road indeed. But they should also try to understand why that is.
‘‘Central banks worry about four things: 1) inflation; 2) economic growth; 3) financial stability; and 4) political pressure. On the way down and on the way into these extraordinary policies all four factors favored monetary ease and liquidity largesse. Inflation was not a concern; economic depression loomed; financial panic warranted any and all measures to restore liquidity and confidence; and politicians were supportive of every intervention that might support the economy.
‘‘Now, however, these same four factors threaten to pull in different directions and to different degrees. And this will make clarity of policy communication even more difficult on the way out than it was on the way in.
‘‘This has implications for the effectiveness of forward guidance. In short, volatility is likely. More importantly there is the danger that many of these factors will conspire to lead policy makers to do too little too late rather than too much too soon.’’
On his practice of speaking frequently about leverage:
‘‘We are working our way through the biggest credit bubble in history. Now bubbles are not new. They are always the same and always a little bit different. They inevitably involve heavy doses of greed, stupidity and leverage. What distinguishes our most recent episode is the extent and magnitude of leverage. We cannot outlaw greed and we will not abolish stupidity. But we can and must address the issue of leverage.’’
On his time on the FPC:
‘‘It was a privilege to serve and enormously satisfying to do so. I am very grateful to have had the opportunity.
On why he wasn’t appointed to a second term:
‘‘Her Majesty’s Treasury found more suitable candidates.’’
On the skill set at the FPC:
‘‘Given the committee’s remit, it would be helpful to include people expert in insurance and investment management. When liquidity crises strike, it is useful to understand the people who have the money as well as the ones who need it.’’
On the government’s Help to Buy program and whether the FPC was consulted:
‘‘We were not consulted and I am not sure that we should have been. But the FPC must monitor the policy’s impact on housing prices and the potential it or other policies might have for creating bubbles.’’
On concerns about the independence of the FPC:
‘‘The FPC was a bold initiative. Government is to be congratulated on its establishment. To be effective it will need the appropriate tools and the courage to use them. It is understandable that government might want to reserve to itself as many economic levers as possible; understandable but not easily reconcilable with the objective of the committee to take unpopular decisions where necessary.’’
On his biggest surprise during his tenure on the FPC:
‘‘Where is the banker-statesman? I am surprised and disheartened by the complete absence amongst serving CEOs of statesman-like qualities. Now there are CEOs of large banks who are smart and capable. There are chief executives who have the ear of politicians and influence their thinking. And there are a few who have been willing to stand up in public and voice a view.
‘‘But please name one who has acknowledged the industry’s failings, embraced the need for reform and then got out and worked with wisdom, humility, selflessness and objectivity to structure a sound, stable and fair financial system. Most have fought the regulatory agenda. None has got out in front of it -- much less set it. Society deserves better of the financial leaders who claim to be serving Society. I am surprised that none of the current crop has seized the opportunity.
‘‘The high point was progress in debunking the banking lobby’s self-serving propaganda. The low point was the realization that many still swallow it.’’
Advice to future FPC members, some of whom will serve part-time, as he did:
‘‘Be prepared to devote a full three days a week. Take advantage of the central bank’s enormous and available resources in order to examine in an unbiased way the issues at hand. Then, stand up and speak out. We sit at one of the most interesting and challenging junctures in financial history. A seat at the FPC should not be seen as a resume builder. It is an opportunity to contribute. Members can make a difference -- first and foremost to the lives of the ordinary citizen.
To contact the editor responsible for this story: Craig Stirling at firstname.lastname@example.org