More on the lunacy of the Basel Accords

I was looking at the preferred asset classes under the Basel Accords in my previous post on why central banks are so determined to stave off a government default, and realised that every single asset class that is given less than a 100 percent credit risk weighting is now tainted by widespread default, scandals or bailouts.

The credit risk weightings mean that instead of reserving the standard 8 percent of capital in respect of a debt, the bank can cut that by the weighting applied to the asset class. Effectively, the reduction in credit risk weighting operates as a powerful subsidy to the borrowers and equally powerful incentive to over-leveraging the lenders.

As a baseline, all financial, consumer and corporate debt must be reserved at a credit rating of 100 percent of 8 percent, unless explicitly discounted. A weighting of 50 percent, for example, means that instead of holding $8 reserves on a loan of $100, the bank only needs to hold $4 of reserves. A zero weighting means they lend $100, but hold no reserves at all.

Mortgages get a credit risk weighting of 50 percent, and we all know how well the mortgage market is performing. Mortgages and mortgage backed securities became the largest asset classes globally in a matter of years thanks to the credit weighting subsidy and securitisation. If I recall correctly, our present long crisis started with the collapse of the sub-prime market and now all categories of US mortgages are impaired by the ongoing mess with MERS and fraudulent or missing documentation. Borrowing short to lend long brought down Northern Rock in the UK and many other over-leveraged mortgage banks.

Interbank debt gets a credit risk weighting of 20 percent. We've seen from the collapse of interbank lending that banks do not trust each other. At the same time, inter-bank exposures and credit derivatives mean that financial institutions are massively dependent on each other, such that bailouts are justified as essential to prevent systemic collapse. If Too-Big-To-Fail is predicated on the systemic impact of a bank's failure on other banks, it would seem that the 20 percent inter-bank risk weighting was and is unsound.

Government agency debt gets a risk weighting of 10 percent. Looking at Fannie and Freddie, and the serial scandals and bailouts they have occasioned over the past decade, it is hard to see how such a subsidy can be justified.

Finally, sovereign debt of Zone A states is zero weighted - no reserves required at all. Zone A includes any country in the EEA, full members of the OECD, or states that have concluded special lending arrangements with the IMF except that any state that reschedules its debt is excluded from Zone A status for five years.

So the current financial crisis started with bad mortgage debt, spread to bad bank debt, carried over into bad agency debt, and now encompasses bad sovereign debt. Each of these categories was given preferential capital weighting under the Basel Accords, and now all are open sores on the financial system and the stability of excessively indebted governments.

Not only did the Basel weightings encourage poor risk assessment, they directly contributed to the inadequate capitalisation of banks for the risks they assumed.

And yet, have you heard any regulator take responsibility for regulatory failures yet? I haven't. In fact, I've seen no historic analysis of capital requirements, deregulation of credit markets, securitisation, derivatives, demutualisation, or any of the other regulatory policy innovations which should reasonably be matters for review in assessing the causes of the current crisis.

As the bankers and regulators do not seem keen to be reflective about their own policies and conduct, it's hard to imagine that they can craft constructive reforms to make the system safer or more efficient in future.

I've downloaded the draft Basel Accord III, released this week, for leisure reading. Sadly, I'm trending to the view that all harmonised regulation is likely to end in disaster as it precludes independent judgement and sensible challenge to orthodoxy. Once something has been agreed by a big enough committee, it becomes impossible to question whether it makes sense. Ultimately the unintended consequences of incentives and distortions mean it won't make sense, but by then it's far too late to change course and break from the herd.

Basel Faulty: Sovereign Defaults and Bank Capital*

A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines. - Ralph Waldo Emerson

When historians of the future look objectively at the era preceeding this long financial crisis, they might well conclude that failure of the globalised capital system is traceable to the Basel Accords.** The unreasonable assumptions and myriad distortions introduced in this one-size-fits-all paradigm of bank capital adequacy fatally undermined the practice of independent judgement in assessing credit risk and prudential supervision of banks.

Bankers of the past had to assess the creditworthiness of a debtor or counterparty based on balance sheet, revenue potential and management reputation for competence. They husbanded their scarce capital, aware that each dollar lent remained at risk until repaid, with cash reserves proportional to the bank's assets usually 8 to 10 percent.

A primary fallacy of the Basel Accord is that OECD government debt is risk free and requires no bank reserves. Better yet, the banks can count the government debt they hold as Tier 1 capital, reserving against other debt assets. The Basel Accords assume all OECD government debt is a cash proxy, being liquid in all market conditions.

Walter Wriston's 1970s dictum that "sovereigns can't default" was disproved in the Third World Debt Crisis of the 1980s, but somehow the BIS Committee on Bank Supervision still embraced it when applied to OECD state debts.

Roughly, the risk weights of the main asset classes under Basel I were:
- zero for Zone A (EEA and OECD) government debt of all maturities and Zone B (non-OECD) government debt of less than one year;
- 20 percent for Zone A inter-bank obligations and public sector entity debt (e.g. Fannie Mae, Freddie Mac, et al.);
- 50 percent for fully secured mortgage debt;
- 100 percent for all corporate debt.

The post-Basel bank supervisors applied their prudential supervision models unthinkingly, to rubberstamp the bankers' leveraging of their balance sheets toward ever greater excess. No one bothered to ask whether Basel Accord assumptions made sense. They were the harmonised norm for prudential supervision and too deeply embedded in the fabric of international finance to adjust, except to allow more and greater leverage in Basel II through liberal recognition of derivatives. Basel II allowed the banks to offset even more risk exposure with even less capital through collateral, securitisation, credit default swaps, and recognition of the validity of internal asset valuation models.

Global harmonisation of prudential supervision around the Basel Accord meant that the hobgoblin of excess leverage became systemically entrenched in all markets, in all nations. The foolish consistency of harmonised capital adequacy was adored by little minds of global bankers and central bankers worldwide.

The zero weight for OECD government debt must have appeared a harmless subsidy to OECD governments in 1988, promoting liquid government debt markets and enhancing the competitive positioning of OECD-based global banks who stood to gain most from the harmonisation of global bank regulation and capital rules.

Leveraging their balance sheets to work every dollar of capital harder became the obsessive preoccupation of two generations of bank executives once the Basel Accords were adopted. Risk management departments were less about controlling exposure to adverse credit events than about identifying deal structures which would minimise the amount of regulatory capital allocated to any exposure.

Fannie Mae, Freddie Mac, and their ilk were an early mechanism to reduce the reserves required from 50 percent on an individual mortgage to twenty percent or even zero, allowing the banks to write more and more mortgages with less and less capital. When these entities proved inadequate in the go-go 1990s, asset back securities allowed banks to get sub-prime mortgages - and thereby the capital requirement - off their books entirely, passing the risks to yield-hungry investors. With Basel II they could reduce capital even further by writing each other a daisy chain of credit default swaps for all categories of exposure. Who could have known that it would end badly?

OECD government debt is zero risk weighted and accounts for a disproportionate bulk of Tier 1 capital of major banks. A default by any EEA or OECD government will force banks and central banks to recognise that government debt has inherent risk like all other debt. This would force recognition of a positive risk weighting, and bring into question the assumption that government debt can be counted as a cash-proxy in Tier 1 reserves. The illiquidity of impaired or defaulted government debt would undermine its role as a Tier 1 reserve asset in bank capital models.

At this writing the OECD governments at risk of default are Greece, Portugal, Spain and Ireland, with other states queuing up in the wings. Already the ECB is the only buyer in the market for much of the impaired government debt.

If any OECD state were to default there would be very serious implications:
- The Basel Accord zero risk weight of government debt would be proved fanciful;
- The assumption of government debt as a liquid asset suitable for bank Tier 1 reserves to meet unanticipated and sudden cash demands will become unsustainable;
- Banks would be forced to recapitalise at much higher levels, forcing even sharper deleveraging and contraction of lending;
- Governments would lose the captive, uncritical investor base they have relied on to finance excess public expenditure for the past 30 years;
- Central banks could be forced to suddenly monetise even more government debt if required to meet the cash demands of a run on their undercapitalised banks.

Looked at this way, you should be able to understand why the ECB keeps repeating that there can be no Eurozone sovereign default, and why the UK and US are staunchly behind them in preserving the illusion of state solvency for all Eurozone states.

It will likely prove impossible to reform the bankers and central bankers dependent on the Basel Accords for their business models and careers. Harmonisation of global standards was supposed to make the world safer. A foolish consistency on bad policy and bad practice led instead to a world on the edge of financial implosion.

This hobgoblin haunts us all.
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* Hat tip to Tracy Alloway at FTAlphaville for suggesting a revision to the title for this post.
** Several commenters questioned my spelling of Basle Accords in the original post. I prefer the British/French Basle which was standard in my youth on Basle Accord documents, to the German/American Basel more common and current today. Nonetheless, I yield to the customs and usage current today in changing the spelling to Basel.

The Return of London Banker?

I am back in the City that I love, at my pleasantly cluttered desk, after an adventure of nearly two years. I hope I did some good.

Looking back at what I published here and on Roubini.com in 2007 and 2008, I am proud of the passion and fluency I wrote with as we shared the experience of the financial crisis in its early stages. Some things I got right, some I got wrong, but that is to be expected when observing events honestly and with imperfect information as they unfold. I have not written with such passion since. I am not sure how or whether to start again.

Does anyone remember that I used to write? Does anyone care if I write again?

Let me know in the comments below.

Repost from 06/06/08: Reagan and Obama - Reforming the Welfare State

In Britain a national election lasts just three weeks and spending by each candidate is strictly capped. Campaigning between elections is not permitted. Accepting so much as a hotel stay from a lobbyist is a resigning offence. As a result, our news is full of the American campaigns to make up for the deficit in newsworthy political conflict locally. I follow the American election, as does most of the world given the potential for good and ill that proceeds from it. Please indulge me in ruminating on one aspect of the Obama candidacy that intrigues me.

Ronald Reagan came to power on a popular backlash against the welfare state. It appears that Barack Obama may come to power on a similar backlash against the welfare state. The difference is the identity of the welfare claimants.

Ronald Reagan inflamed the public’s righteous anger against a stereotyped ghetto “welfare queen” who raised a brood of illegitimate, proto-criminal children on public funds. Barack Obama will inflame the public’s righteous anger against the corporate welfare queens who have raised a brood of profiteering executives and lobbyists in the generation since. Under Reagan and succeeding presidents, including Clinton, the K Street lobbying machine transformed Washington DC into a government by the lobbyists, of the lobbyists and for the lobbyists. Subsidies, market distortions, tax breaks, earmarks, selective protectionism, regulatory forbearance, cost-plus government contracts, relaxed accounting oversight, criminal and civil immunity, war profiteering and other policy depredations promoted a corporate welfare state beyond the dreams of ghetto avarice.

Ronald Reagan partisans demonised citizens who paid no taxes but claimed public housing, medical care and food stamps as their right. Barack Obama appears prepared to challenge corporations who pay no or nominal taxes (worth clicking through just for the graph) but claim government subsidies, earmarks and tax breaks as their right. Corporations have further stripped the US tax base by outsourcing or relocating jobs abroad, leveraged speculation rather than productive capital investment, and transfer pricing to avoid US tax. If Obama does parallel Reagan, both campaigns will tap a deep well of public anger against the perceived injustice of those who degrade the nation’s future prosperity while claiming too much from its taxpayers.

The bankers of Wall Street now toasting the Fed’s recent largesse from their Hamptons beach houses and yachts are the latest in a long line of American corporate welfare queens who have lobbied for and secured generous federal contracts, subsidies and regulatory forbearance. As noted two weeks ago in Looting the Vaults, more has now been lent to banks by the Fed under opaque new facilities than has been appropriated for the war in Iraq. Both the Fed’s new facilities and the war appropriations arguably benefit corporate welfare queens rather than serve the public interest.

The contrast between McCain and Obama on lobbyists alone is striking. Obama has banned contributions from lobbyists to his presidential campaign, even returning $500 donated by Thurgood Marshall, Jr. Instead, Obama has built a novel fundraising machine that reaches out to millions of working class Americans. McCain’s campaign relies almost entirely on wealthy contributors and lobbyists for finance. He has recently suffered a series of staff purges as high-ranking campaign officials - all of them lobbyists - were linked to large corporations and dictatorial regimes. Obama has committed to opening his fundraising events to the press pool. McCain insists on holding his fundraisers behind closed doors, no press allowed.

Obama as the presumptive Democratic nominee and party leader is preparing to drive the contrast home. Yesterday Obama enforced his opposition to special interest money on the wider party. Obama announced that from now on the Democratic National Committee will return cheques from lobbyists and political action committees, mirroring the Obama presidential campaign. This is a significant initiative in positioning the Democrats as the party to reclaim government from the corporate welfare queens.

The media pundits will use the reliable rhetoric of identity politics, religious strife, class war, patriotism and national security, but they are merely masking the fundamental policy conflict that divides the presidential candidates: Should government serve the people or the corporate elite? When Obama invokes Reagan, as he does very effectively in his elegantly crafted speeches, he is tapping the same vein of public outrage against a government promoting the comfort of those who contribute too little to the nation’s wellbeing.

A recession would clarify the public policy choices. When the economic pie is shrinking, fairness becomes a surer focus. The eyes of the hungry are watchful as the slices served get smaller.

Can Obama successfully challenge the K Street machine? He encourages us to hope, but we should be realistic. The K Street machine will not sit idly by as their unfettered control of the corporate welfare state is threatened by the upstart junior senator from Illinois who would not “wait his turn”.

Ghetto welfare queens were powerless to forestall the legislative and regulatory reforms that cut their subsidies. Corporate welfare queens are very far from powerless. We see new evidence of their power to claim public funds and direct public policy every day as the credit crisis closes off private finance options and squeezes profits. Whether the American public can elect enough reform-minded representatives to successfully challenge the corporate welfare queens may be the political test of this generation and may well determine whether the American economy recovers its powerhouse status.

Also on Thursday, Obama introduced legislation on the floor of the Senate to expose the corporate welfare queens hiding in the federal budget: The Strengthening Transparency and Accountability in Federal Spending Act of 2008 (pdf).

Is JP Morgan a welfare queen for the Fed subsidised Bear Stearns buy-out? Discuss.

Next week I promise to stick to economic and regulatory policy.

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Post Script on 22/12/08: JPM's paltry $37 billion subsidy from the Fed back in the Spring seems like chicken feed compared to the over $5 trillion the corporate welfare queens have looted from the Fed and Treasury since then. Worse, I am now sceptical that Obama will be any different to Bush in terms of restraining taxpayer largesse to corporate elites. He seems to endorse every bailout and stimulus, regardless of merit. We shall just have to wait and see what happens, but so far Obama is looking only marginally more fiscally sound than Bush.

Robert Paterson's Boyd 2008 Summary - Hope!

From Robert Paterson's blog on Boyd 2008:

* The goal for us all to work to is clear - that we have to build back into the system Resiliency. This means that each region has to work to become largely energy, food and financially self sustaining and that each region needs to network into the others. In effect we shift from an efficient machine to a resilient network

* That the leadership model is no longer the dominant hero but the ego-less servant

* That we cannot wait to be saved. We have to all do our part to make our place "Home"

Many are desperate that somehow President Obama save us and importantly turn the clock back. Take us back to consumer heaven of 2006. Even if he could, would this be the right thing to do? To take us back to a world that is a fantasy?

What got us to this place?

The Dark Side of a Mindset. The Machine/Institutional/Newtonian/Engineering Mindset that created most of the wealth of the 19th and 20th century tipped over into the dark side. Where not only did we give up all our power to institutions but gave the few that ran them the license to use these institutions for their own benefit.

So we spend nearly a trillion on defense but not on what the troops really need. We spend billions of health and America is on a par with Cuba. We spend billions on education and more than 50% of Americans are functionally illiterate. We spend billions on food and we eat crap. We see that the leadership of these institutions live in a bubble. The gap between the rich and poor has never been greater. The middle class is being squeezed. We don't make anything anymore. We make no progress toward energy independence.

Re-Post from 30/05/08: Famine Futures: Deregulated Markets and Food Insecurity

Originally published at RGE Monitor on 30 May 2008.

In a week when Hormel celebrates another surge in Spam sales, my preferred indicator of US food insecurity, it is appropriate to raise the market and regulatory failures that are driving global food insecurity.

Like so much that we have observed in the past eight years of the Bush administration, the origins of the current food crisis can be traced to the recycled policies of the Nixon White House. Henry Kissinger stated the premise succinctly in 1970: "Control oil and you control nations; control food and you control the people."

With credit, oil and food markets spiralling out of reach of the poor and straining the middle-class, it is worth exploring whether similar policies underpin similar problems. In each industry, a small handful of global companies control supply and a massive increase in ill-transparent speculation acting on pricing in exchange markets forces prices up regardless of the fundamentals of supply and demand. The risks for famine and political instability are huge. One doesn’t need to be a conspiracy theorist invoking the Trilateral Commission to feel that something is very wrong with policies leading to simultaneous crises in credit, oil and food that threaten not just the wealth but the wellbeing of most of the world’s population.

Two or three generations ago, most of us would have been directly involved in food production as a hedge against food insecurity. My parents’ generation kept a garden in the back yard, putting to me to work each summer to raise corn, tomatoes, cucumbers and other fresh foods for the table, sending me to pick berries and fruits in season from our own and the neighbours’ bushes and trees. My grandparents’ generation kept chickens as well as a garden behind their house in the middle of a large industrial city. The garden and chickens helped my mother survive the Great Depression at a time when my father suffered stunted growth from rickets. My great-grandparents’ generation were almost entirely farmers working the land.

Today global agriculture is dominated by eight multi-national corporations. The policies promoted by successive governments and international institutions including the IMF, World Bank and WTO have aimed at undermining local production, distributed commercial networks, and diverse local markets in favour of mass production, streamlined supply chains and concentrated global market pricing.

As with other areas of our lives, the policies of “free market fundamentalism”, as George Soros styles it, have not diminished risks but increased them. My children are hostages to food insecurity, as are yours and billions of others. A disruption in global food supplies or surge in prices that puts food staples beyond the reach of many low income or middle-class families cannot be offset from the back garden. The exposure of food to pricing in markets open to manipulation and excess speculation puts the lives of millions at risk.

Mack Frankfurter at Seeking Alpha has written a compelling review of how we got where we are.

The Commodity Conundrum: Securitization and Systemic Concerns (Part I)

The Commodity Conundrum: Securitization and Systemic Concerns (Part II)

The Commodity Conundrum: Securitization and Systemic Concerns (Part III)

Mr Frankfurter reviews the history of “securitized commodity products” and the development of commodities as speculative investments, distinct from their role in production and consumption within the economy. He suggests that something “systemic and possibly more insidious” has altered the benign role of speculators as providers of market liquidity and ties this change to the ill transparency of OTC derivatives arising from The Enron Loophole. I recommend reading the whole series.

We begin to see a pattern emerging. Free market policies and liberalised regulatory regimes promoted rapid concentration of a sector into a global oligopoly which could control supply. Free market doctrines and trade liberalisation enabled predatory targeting of markets to undercut domestic production and smaller producers, reinforcing the concentration of the market and the pricing control of the oligarchs. Free market ideologies and innovative financial derivatives promoted domination of market pricing mechanisms by speculative investors able to accelerate steep price gains regardless of supply and demand fundamentals.

Whether it is credit, oil or food, we are all going to suffer from bad policies which promoted free markets as risk reducing rather than risk enhancing. In the US and the UK we may hope that our food insecurity does not worsen to the point of riots, looting, political instability and the starvation of children, but many parts of the world will not be so fortunate. If there is a backlash against free trade, against free market doctrines, against the domination of big banks, big oil and big food, perhaps it will not be unenlightened but enlightened. Perhaps it is overdue.

We can live without credit. We can live without oil. We cannot live without food.

Credit and oil prices are also feeding the food price bubble. The Kansas City Fed highlighted risks confronting the agricutural sector from higher credit costs for infrastructure, fuel and margin calls on hedged exposures in its report Survey of Tenth District Agricultural Credit Conditions.

The role of market mechanisms and deregulation in fuelling the commodity price rises is coming under increasing scrutiny as the markets themselves now fail to meet their basic function of matching buyers and sellers of commodities.

Bloomberg News:

The divergence between CBOT futures and the underlying commodity is so great that some grain merchants have stopped bidding for new crops, said Niemeyer, a member of the National Corn Growers Association board. Others won't guarantee a price for more than 60 days. ''We have a fundamental problem with the markets,'' said Kevin McNew, president of researcher Cash Grain Bids Inc. in Bozeman, Mont., and a former Montana State University economist. ''It is very difficult to operate a grain business when the cash prices are below the futures'' by such a wide margin, he said. The price gap should converge when futures contracts expire and deliveries are settled. Instead, the average premium for CBOT wheat has quadrupled in two years to 40 cents a bushel, compared with 10 cents the prior five years, McNew said. For James McReynolds, who farms 2,000 acres of wheat outside Woodston, Kan., futures aren't worth the risk. ''The differential of what the market should be and what you can actually sell is so far out of line that you aren't willing to do it,'' McReynolds said. ''This is a tough situation. Agriculture is not as healthy as we'd like to think it is.''

One of the drivers of the Commodity Exchange Act of 1936 was a desire to have regulators responsible for ensuring that commodity markets serve the legitimate hedging needs of producers and consumers in the economy and not merely speculators. The Enron Loophole devastated regulation of commodity markets. Once again, legislators and regulators have failed to protect the public by discharging their mandate in favour of protecting the speculators who bid higher for influence.

Re-Post from 15/05/08: Looting the Vaults of the Central Banks

Originally published on RGE Monitor.


When I was a young central banker, we often spent our lunchtimes debating how best to rob our employer. Tempted by the thought of great mounds of gold ingots far beneath us in the third sub-basement, nestling deep in bedrock, we would speculate on the viability of various plans for plundering our nation’s store of wealth. The presence of sufficient security forces to defend a medium size city and enough steel around the vault for a battle cruiser only spurred our youthful imaginations. After some months of fantasy gold robbery, I began to assert to my colleagues that stealing the gold would be foolish as it would be impossible to get away with enough gold in city traffic to make the attempt worthwhile, and selling it in any sizeable amount would lead to instant detection. I argued instead in favour of stealing the wheelie bins of cash conveniently lining the hallway to the loading ramp. Cash would be faster and easier to steal and more liquid to spend than gold.

I see now that I was a central banker of very little brain – and lacking ambition. The way to rob a central bank efficiently is to be a bank executive so skilled in financial engineering that I take my bank to the edge of extinction. I can then swap all my unpriceable, illiquid, engineered credit instruments for good central bank cash and Treasuries. That’s larceny without risk, making the central bank a complicit partner in the looting of its vaults, and earning gratitude and bonuses instead of audits and indictments.

Since the credit crisis was first diagnosed last fall, the Federal Reserve has advanced more cash and Treasuries than the entire five year cost of the Iraq war – over $400 billion. It has plundered more than half its holdings of US Treasuries, taking impaired asset-backed securities collateral in their place. It has overseen the devaluation of the dollar to third world levels of instability and inflation. And all of this debasement has as its objective the re-financing of those bank and shadow-bank executives who have so looted their own institutions that they hold the global financial system hostage to their incompetence, malpractice and greed. Without consultation or review, the Federal Reserve was able to chuck out decades of transparency and accountability in favour of secret facilities, secret loans favouring secret beneficiaries of secret largesse.

The Term Auction Facility (TAF), the Primary Dealer Credit Facility (PDCF) and the Treasury Securities Lending Facility (TSLF) are all ill-transparent conduits funnelling central bank cash to bankers in the private sector free of oversight, audit or scrutiny. The recent liberalisation of collateral by the Fed means that it is now officially the market maker of last resort for securities which are unmarketable in the private sector.

And the creepy thing is that most of the establishment thinks the Fed is doing a great job. Because there will never be an independent investigation or audit, we will never know whether they are policy geniuses or criminally complicit accomplices. Perhaps it makes no real difference to either motivation or outcome.

Now the Fed wants powers to enable it to create even more credit to finance failure. It is said to be seeking Congressional authority to pay interest on bank reserves (via Forbes with a hat tip to Steve Waldman). While this might sound benign, especially in a modern era when American banks hold no non-borrowed reserves, the expanded powers are potentially very dangerous. Paying interest on reserves would permit the central bank to extend hundreds of billions more in TAF, PDCF and TSLF credit without the inconvenience of having to sterilise the monetary expansion through further sales of its increasingly meagre inventory of Treasuries.

Spies and weapons, whether real or imaginary, are asserted by the military-intelligence complex as justifying more spies and weapons. If no attack occurs it is because they are so efficient at protecting us and pre-empting many unpublished threats. If an attack occurs, it was because they were under-funded or over-constrained. In the same way, financial excess and bad credit have been used by the banking system to justify more financial excess and bad credit in a self-reinforcing loop of financial and supervisory indulgence and forbearance. If no crisis occurs, it is because there is a new paradigm and risk management models are more reliable. If a crisis occurs, it is because banks lacked access to adequate liquidity and were over-regulated. For too long the cycle has reinforced monetary laxity, permissive deregulation and regulatory forbearance on accounting and capital adequacy, with all accountability and market discipline excused by the need to forestall contagion and systemic failure.

Any crisis now accelerates the trend toward greater public laxity, private excess and central bank secrecy. A crisis, real or manufactured, is most useful to increase the amount of public money clandestinely extended and diminish public oversight and administrative review of outcomes. This has been the pattern for at least 25 years, and may continue for some time to come before a taxpayer or creditor revolt ends the American spiral downwards towards bankruptcy and corporate tyranny.

It used to be the realm of conspiracy theorists to assert that policy makers in Washington were aligned with the military-intelligence complex in promoting international conflicts for profit or that the Federal Reserve was the tool of Wall Street banks in promoting irresponsible bubbles. Now it is accepted policy, defended openly in the media as right and inevitable, as providing an efficient means for America to meet the “threats” to security and financial stability in a changing world.

The danger of embracing the spin is that the productive economy shrinks from underinvestment and distortions as an increasing share of a slower growing pie gets diverted to government and the cronies who direct government policies.

The thrift failures in the 1980s were followed by financial deregulation and increased mortgage subsidies, enabling the massive misallocation of credit and leveraging of balance sheets on an even greater scale. Further deregulation, forbearance, subsidies and bailouts can only lead to more frightening misallocation of scarce capital in zero-savings America and more fragile over-leveraged banks, but now presenting a danger of contagion to the rest of the world. It is the savings of the world’s productive economies funding American misallocation and excess, and the world’s poor that suffer the contagion of inflation from a devalued dollar.

Already the ECB and Bank of England have followed the Fed in extending good central bank funds against questionable collateral under rapidly liberalising lending facilities. While they appear slightly more resolute on prudential supervision and inflation-fighting, they are nonetheless compromised and constrained by the policies and practices of bankers and central bankers across the Atlantic. As American banks receive forbearance and largesse, the European banks shout, “Me too!”

Globalisation of banking and regulatory “best practice” was once seen as raising standards, but may be at risk now of lowering them. Just as Japanese zero-interest rate policy flooded the world with cheap liquidity from the carry trade, fuelling speculative bubbles and providing cover for low rates elsewhere, Federal Reserve forbearance and credit accommodation may flood the world with warped management incentives and credit distortions which pervert the banking sector and financial markets, undermining rationales for savings and productive investment.

Without transparency of central bank facilities and policies, there can be no accountability for misuse of public resources and abuse of the public trust. Transparency provides an essential check on bank mismanagement, even for central bankers.

When Bloomberg revealed this week that Ben Bernanke lunched with [JPM's Matt] Dimon at the New York Fed on March 11 with key Wall Street bankers just three days before the emergency $14 billion financing for Bear Stearns and five days before the sweetheart $30 billion financing of JPMorgan’s acquisition of Bear (again, the acquired assets the Fed received for the cash are secret), it made me very uneasy. Suspicious minds might think the public interest and integrity of market mechanisms, including the corrective of the occasional failure, weren't foremost in their discussions.

Whether cock-up or conspiracy, recent reforms set the scene for looting of the central banks on a scale never imagined by my younger self.

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As some regulars to Professor Roubini’s blog will know already, I am a mere commenter on the blog who has been elevated to posting by invitation of the Professor. Having seen the list of new posters who will be joining us here, I can assure you that I am deeply honoured to be among them.

London Banker will continue to post anonymously. It permits me to be more forthright than I could be otherwise.

Despite being a poster, my commitment to this site is as a commenter, and I hope to see many comments from my blog buddies below so that we can continue the dialogue I have enjoyed on this site for so long.

Being new at this, I will also welcome ideas and guidance at londonbanker ( at ) btinternet.com.