December 30, 2008

Erroneous credit ratings were the ignored Black-Swans.

Sir in your “A straitened future for troubled banks” December 30 you rightly lay forward the many of the difficulties in deleveraging. But your analysis would have been more complete if you had acknowledged the fundamental role that financial regulators played in the leveraging process. The Basel Committee set up a system based on the presumption that risks could be measured accurately, always, and allowed some very highly leveraged balance sheets when the risks, among other as measured by the credit agencies, were deemed to be low risks.

The risk that was never accounted for, in other words the real Black-Swan event, was the risk that the credit rating agencies would be mistaken, a risk the regulators should never have ignored.