April 12, 2009

There is nothing so risky than what is seen as risk-free

The basic capital requirement for the banks established by the Basel Committee is 8% which results in a 12.5 to leverage. But since assets are then risk weighted, for instance at 20% in the case of loans to corporations rated AAA or AA-, the officially permitted bank leverage can increase to 62.5 to 1.

AIG’s whole business model was based on exploiting its supposedly risks free AAA rating which was precisely what led it to take on unimaginable risks. Since most investors in fact abhor risk and naturally go for anything perceived as having less risk we now, courtesy of the Basel Committee are seeing how the losses incurred in supposedly risk free investments are many times the losses incurred in what supposedly was risky.

The sole concept that risk-free investment opportunities can be determined makes the “first pillar” of our current bank regulations fundamentally flawed. Instead of acknowledging this problem the running wild and free regulators seem intent to dig us even deeper in the hole we’re in thinking themselves also capable of determining what the systemic risks are. Please, will someone save us from this lunacy?

PS. That FT, after so many letters I have written about this and well into the second year of the deepest financial crisis has yet not once picked up on this issue and much less mentioned the truly astonishing 62.5 to 1 leverage that is still allowed, makes me sadly conclude that there is a fundamental flaw in FT too.