Recently there has been a lot of discussion about the need to decrease the onerous capital requirements on securitisations as proscribed by Basel 2.5. Of course it must be said that the voices clamouring for the loosening of the restrictions are the banks and their lobbyists. That banks and their minions would be working behind the scenes, and in front of them, to try and push through changes which would decrease capital requirements is not in and of itself worrisome. Lower requirements mean increased leverage means, theoretically, increased profits.
Until something goes wrong.
But that is a topic for another day.
What I am interested in is why the Swedish central banker, Stefan Ingves, who is head of the Basel Committee on Banking Supervision, is speaking up on the topic in such august forums as the Financial Times, and even more importantly why is he suggesting softening the rules.
A bank is required to hold a capital reserve of 8% against its "standard risk-weighted" assets. This means, essentially that a bank by definition is
The Basel committee of which Mr Ingves is head has requested that the world's largest banks actually hold 9.5% capital versus their risk assets which gets the leverage down to 10%.
This is because Basel is already a bit disturbed by the fact that banks, as is their wont, are constantly redesigning their risk models to achieve the lowest possible capital requirement for their assets, regardless of their riskiness. Thus, depending on the bank, its national regulators, and the aggressiveness of its management the same portfolio of assets can have quite different capital requirements.
There is even a movement, championed in the editorial pages of the FT on July 10, 2013 suggesting that the somewhat blunt instrument of leverage ratios be instituted regardless of the risk weighting of the assets. The number being bandied about is 3% which equates to a leverage bordering on 35 times.
Given that banks, through their use of clever models, and pressure on their regulators have been able to carve out a niche where at the extreme they can avoid all capital requirements a minimum of 3% looks promising from a regulatory and bank solvency point of view relatively speaking.
The editorial goes on to suggest that leverage ratios are not perfect because they encourage lenders to focus on the riskiest assets available thus achieving the highest returns for a set amount of capital. Hmmm. Isn't that what banks always do? It's certainly what they are doing, and, more importantly, what they are being allowed to do, perhaps even encouraged to do, by the Basel Committee in that they are allowed to use their "approved" models.
So, back to my original question, given that the Basel committee is responsible for the security/solvency of the global banking system, why is Mr Ingves opening the door even wider for increased leverage rather than being the bulwark of the system I would hope the Head of the Basel Committee on Banking Supervision.
I don't know.
.
Monday, 30 September 2013
Friday, 27 September 2013
Quantative Easing to Infinity and Beyond?
Last week, to the total dismay of many in the market the Federal Reserve "surprised" the market by not initiating a reduction in their great stimulus program know as Quantitative Easing (QE). Among the reasons for the market to presume that a "taper" would begin was that in their Federal Open Market Committee (FOMC) minutes from previous meetings they mentioned that they had discussed the idea of a taper.
The market's reaction to this suggestion that they might start to taper QE was to drive mortgage rates from approximately 3.5% to 4.5%-still low-but a large jump relatively speaking, and to make the 30 year treasury trade off quite sharply.
Now to taper or not to taper was a 50/50 bet from the outset. The economic news in the US is constructive, but certainly not creating any stresses in the system. Unemployment is down, but I would draw your attention to the fact that many people seemed to have stopped seeking employment and so fall out of the pool, plus temporary as opposed to permanent employment growth seems to be the flavour of the recovery.
Add to this an almost pathological fear of deflation by the current Bernanke Fed, which will most likely be continued by a Yellen Fed, and I believe the market seriously got ahead of itself and fell into that most dangerous of traps-believing your own hopes to be facts.
So is the long end of the treasury curve artificially low? A resounding Yes!
Is there the potential that if the Fed were to continue to purchase the long end in their QE quest that they would be creating serious inflationary pressures? Again a resounding Yes!
But did I believe that the economic recovery has shown any real inherent strength strong enough to warrant essentially putting a break on economic potential? A resounding No!
Do I believe the inflationary pressures are such in the US that the Fed has no choice but to start to taper QE? You guessed it. Another resounding No!
At some time the Fed will start to taper. There is no way that they can continue ad infinitum in their QE washing machine. But before they start they must coordinate with the Treasury. In order to help stimulate the economy which is run by two ends of the yield curve- Fed Funds and 30 year Treasury yields, the Fed instituted a "twist" which essentially extended the maturity of the Fed's portfolio thus driving down yields at the long end while Fed Funds have been held excessively low in the front end.
In this case the artificially low yields in the long end must be kept somewhat low, again through artificial means. The Fed has to get the Treasury to agree to stop issuing long dated debt. The Fed will stop it's purchases in the long end, moving down the yields curve thus keeping the front end low and allowing/forcing all the index driven investors to purchase long dated securities from the Fed's balance sheet.
Once this reverse "twist" has taken place, the Fed can start to taper it's purchases of the front end of the curve and thereby ease the transition into higher yields without panicking the market or crushing the recovery.
I know, the question is why did all those prop traders really think the Fed would taper? Why did they make blatantly 50/50 bets? Believing your own rhetoric is truly dangerous!
The market's reaction to this suggestion that they might start to taper QE was to drive mortgage rates from approximately 3.5% to 4.5%-still low-but a large jump relatively speaking, and to make the 30 year treasury trade off quite sharply.
Now to taper or not to taper was a 50/50 bet from the outset. The economic news in the US is constructive, but certainly not creating any stresses in the system. Unemployment is down, but I would draw your attention to the fact that many people seemed to have stopped seeking employment and so fall out of the pool, plus temporary as opposed to permanent employment growth seems to be the flavour of the recovery.
Add to this an almost pathological fear of deflation by the current Bernanke Fed, which will most likely be continued by a Yellen Fed, and I believe the market seriously got ahead of itself and fell into that most dangerous of traps-believing your own hopes to be facts.
So is the long end of the treasury curve artificially low? A resounding Yes!
Is there the potential that if the Fed were to continue to purchase the long end in their QE quest that they would be creating serious inflationary pressures? Again a resounding Yes!
But did I believe that the economic recovery has shown any real inherent strength strong enough to warrant essentially putting a break on economic potential? A resounding No!
Do I believe the inflationary pressures are such in the US that the Fed has no choice but to start to taper QE? You guessed it. Another resounding No!
At some time the Fed will start to taper. There is no way that they can continue ad infinitum in their QE washing machine. But before they start they must coordinate with the Treasury. In order to help stimulate the economy which is run by two ends of the yield curve- Fed Funds and 30 year Treasury yields, the Fed instituted a "twist" which essentially extended the maturity of the Fed's portfolio thus driving down yields at the long end while Fed Funds have been held excessively low in the front end.
In this case the artificially low yields in the long end must be kept somewhat low, again through artificial means. The Fed has to get the Treasury to agree to stop issuing long dated debt. The Fed will stop it's purchases in the long end, moving down the yields curve thus keeping the front end low and allowing/forcing all the index driven investors to purchase long dated securities from the Fed's balance sheet.
Once this reverse "twist" has taken place, the Fed can start to taper it's purchases of the front end of the curve and thereby ease the transition into higher yields without panicking the market or crushing the recovery.
I know, the question is why did all those prop traders really think the Fed would taper? Why did they make blatantly 50/50 bets? Believing your own rhetoric is truly dangerous!
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