Tame the tamers!

Sir John Plender’s “How to tame the animal spirit” September 30 leaves me utterly confused. What animal spirit does Plender refer to? That spirit which caused trillions to invest in AAA rated securities that offered a couple of basis points more or those who leveraged their investments in AAA rated securities because the regulator allowed them to do so by requiring ridicule small capital requirements on these?

As I see it those we really need to tame are the tamers, and in fact, looking at the global challenges the world needs to confront, perhaps we could benefit immensely from a little bit more of that old fashioned real animal spirit.

The wrong lessons learned.

Sir Martin Wolf ends his review of Carmen Reinhart’s and Kenneth Rogoff’s book “This time is different” with “Crisis will always be with us. But maybe this realization will reduce their frequency”, September 28.

Why is that Mr. Wolf? That seems to be the wrong lessons learned. I would hope this realization would lead us in a complete different direction of where the Basel Committee is taking us, and instead make us increase their frequency so as to try to reduce their magnitude.

On our own

Sir flooding can occur because excessive waters overflows the levee, which is what Wolfgang Münchau is most concerned about; or because the levee breaks down in a point and channels too much water to one single place, as occurred when the AAA ratings opened a whole and the subprime mortgages sector was drowned, and which is what I have been more concerned about.

Today Münchau, in “At last, recognition of the deep roots of the crisis”, September 28, sounds like an ignored child who finds great consolation in that his mother has at least noticed him. As one of the subjects of Münchau’s jealousy, one who received too much attention as the “world’s most powerful leaders [were] obsessed with the minutiae of banking regulations, let me inform him that the sad truth is that mother’s attention wavers from one to another of her sons, not because of love for both but because she has not the faintest idea of what to do, and prefers thinking of the crisis like a measles that will just go away on its own.

Meanwhile, Brother Wolfgang, the levee is still exposed to disasters, of both kinds, and we are still on our own.

There is a not so secret “low-risk” leverage-enrichment facility in Basel.

Sir excuse me if I insist on it but after some hundreds of letters to you, I am still looking for the words that could help FT understand what was really the origin of the current financial crisis and why we will not be able to get out of it without getting rid of a paradigm that has chained our financial regulators, that of having the capital requirements of our banks depend on risk-weights.

Henny Sender in “Washington is the cheerleader but sentiment remains fragile” September 26, quotes a private equity executive saying “CDO´s destroyed prudent lending in America. It was like a nuclear bomb to good lenders”. What does prudent lending mean? Shying away from risks? No! Prudent lending means investing according to your risk tolerance and getting the right reward for it. In this respect prudent lending should have its own financial returns and not returns derived from arbitrarily set lower capital requirements.

What is the worth of one dollar invested in an operation perceived as having a higher risk? One dollar! What is the worth of one dollar invested in an operation perceived as having a lower risk? Also one dollar! Then how on earth can anyone sustain that a dollar lent to a BBB+ to BB- rated corporation is worth one dollar, while a dollar lent to an AAA to AA- rated one only represent 20 cents? Well this is exactly what the regulators did with their capital requirements for banks based on default risks and as assessed by human fallible credit rating agencies.

When a bank invests $1.000bn dollars in anything related to an AAA then that is subject to an arbitrary risk-weight of 20% and so the “risk-weighted assets” are reported as only $200bn, leading to low reported bank leverages, and which after a short while fooled even the designers.

And this is what has been produced in the not so secret “low-risk” leverage-enrichment facility in Basel and that has been proven to be so explosive and that I have been describing in http://theaaa-bomb.blogspot.com/

Sir it is so unimaginably risky to fool around with risk. Please consider that even if all the credit ratings had been absolutely precise, the world could still go so very wrong, as nobody in his sane mind will hold that the world’s future lies so much in areas perceived as having low financial default risks, that the investment in these areas have to be given especial incentives.

Friends, we need to urgently rid ourselves of regulators that can only dream about a world without bank defaults and put in their place regulators that dream of a better world, and who know that in order to reach such a world you have to learn to embrace risk… in a prudent way.

The world has had more than enough with this imprudent prudence!

Cheers

Per

Why don´t Europeans agree first...they seem worlds apart!

Sir Peer SteinBrück, the German finance minister, in “A tax on trading to share the costs of the crisis”, September 25, proposes a tax on financial transactions of 0.05 percent that could “yield up to $690bn a year.

But, Bernard Kouchner, the French minister of foreign affairs in “A tax on finance to help the world´s poor” September 17, he spoke about a tax of 0.005 percent that would “raise €30bn”.

Why don’t the Europeans agree first among them what they want to propose to the world? Now, they seem worlds apart.

That said before any tax of this sort, the world´s poor, and most of the rest of the world, would benefit more from taking away that financial tax that the current capital regulations for banks represent in that, above of what the market already charges for risk differentials, it creates arbitrary costs, far from minuscule, that directly taxes those more prone to be considered as more risky, like the poor and the development countries. http://bit.ly/4yX7k1

Mr Zoellick, as the president of the World Bank, has an even more important issue to bring up in Pittsburgh.

Sir Robert Zoellick, the president of the World Bank, makes an inspired call for that “Pittsburgh should be a turning point for the poor” September 24, 2009.

Sadly, and though it should be the prime responsibility of a development bank to draw the attention to the issue, he completely ignores to mention that current bank regulations introduce an arbitrary regulatory bias in favor of the rich and the developed, and against the poor and the developing. This is so because the capital requirements are based on perceived risk of defaults as measured by credit rating agencies, and we all know where these perceived risks tend to live.

For example if a bank lends to an AAA rated sovereign it is currently required to hold zero percent in capital and if lends to an AAA rated private corporation only 1.6 percent, but when lending to a BB+ to B- rated sovereign or any unrated corporation it is required to hold 8 percent in equity. The significant different costs derived from these regulations, are to be added or deducted from what the markets would normally charge for financing different risk levels, and as a result these arbitrary regulatory interferences only makes the differences wider.

The World Bank should be the first one interested in putting on the agenda the fact that the world could have been better place had not some bank capital requirements empowered the credit rating agencies so much so that with their AAA could, over just a couple of years, mislead trillions of dollars over a precipice of financing a basically useless house price boom in the US.

The World Bank should also be the first one to remind the world of the fact that risk-taking is indeed the oxygen of any development and that therefore taxing it can prove truly disastrous for the world.

The regulators, thinking themselves Gods, misinform the markets and the experts

Sir, when is FT going to do an “Analysis” on what the risk-weights signify for the reported bank-leverages. The sooner the better, since that could save many experts (including some of your own) from making fools out of themselves.

Andrew Kuritzkes and Hal Scott in “Markets are the best judge of bank capital” September 24 quite correctly state that “We need to complement regulation with more effective market discipline. This requires better information”.

But, in their discussion of bank leverage and even though they mention the possibility that “capital requirements are imperfectly linked to bank-risk taking” they seem unable to realize that the reason the capital requirements relative to risk-weighted assets turned out to be so faulty, had nothing to do with the basic 8 percent level established, and all to do with the risk-weights used.

The use of arbitrarily set regulatory risk weights, like those which give only a 20% weight to an AAA asset misinformed the market and experts like Kuritzkes and Scott, making them all unable to understand what was going. The sooner we free ourselves from regulators playing Gods calibrating risks, as if they possess the whole truth on risk, the better.

Is it not more important to make sure we would want to send our banks flowers?

John Gapper in “Where there’s a will there’s a way” September 24 discusses the issue of having banks draw up their testaments, a will, so as to make their possible disappearance a more orderly affair.

Of course all that sounds so very neat and tidy and reasonable but frankly, before discussing their funeral arrangements should we not give a little bit more thought on how the banks are supposed to live their lives? I mention this since in all the 347 pages of the bank regulations known as Basel II there is not one single phrase, much less a paragraph that has anything to do with establishing a purpose for our banks.

http://www.bis.org/publ/bcbs128.pdf

Mr Caruana and his fellow regulators deserve months of humbling community service and being banned for life from any regulatory activity.

Sir when a previous member of the Basel Committee like Mr. Jaime Caruana says “Basel II is evolving” and was not a contributory factor to the crisis, and that “You don’t see a correlation with the adoption of Basel II and the difficulties” as is reported by Patrick Jenkins in FT on September 21, this is indeed an insult to our intelligence and to humanity.

Mr. Caruana is well aware that when the Basel Committee demanded from the banks a capital requirement of only 1.6 percent, which is equivalent to authorizing a leverage of 62.5 to 1, when the banks were involved with a client or a security rated AAA by the credit rating agencies, they set off a world-wide race in search of the AAAs; and which, over just a couple of years, led trillions of dollars over the precipice of the subprime mortgages in the US, and created misery for hundreds of millions of people all over the world.

The least Mr Caruana and his fellow regulators deserve, is six months of a very humbling community service and, of course, being banned for life from any regulatory activity.

Is regulation really rocket science?

Sir as is published in my “Voice and Noise” 2006, on May 2, 2003 at a Risk Management Workshop for Regulators at the World Bank, I said the following:

“There is a thesis that holds that the old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, was much wiser than today’s no burning at all, that only allows for the buildup of more incendiary materials, thereby guaranteeing disaster and scorched earth, when fire finally breaks out, as it does, sooner or later.

Therefore a regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.

Knowing that “the larger they are, the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size. But, then again, I am not a regulator, I am just a developer.”

And so when I now read William White´s “Some fires are best left to burn out”, September 17 I can´t but agree and since I see that he is a former economic adviser at the Bank for International Settlements, the home of the Base Committee, I would ask him whether he does not believe the regulators should not have been aware of all this, in a timely fashion… is regulation really such a rocket science?

Mr Bernard Kouchner, you better beguine by taking away the tax on the world’s poor.

Sir I do not believe that the markets´ capability to arbitrage away disequilibrium would be seriously compromised by a minuscule tax on financial transactions and so I do not oppose it, in fact I support it as “a time for a second thought tax” helpful for everyone. And of course I do not reject the idea of “A tax on finance to help the world´s poor” as argued by Bernard Kouchner, September 17.

That said let me be absolutely clear that the world´s poor, and most of the rest of the world, would benefit much more from taking away that financial tax that the current capital regulations for banks represent in that, above from what the market already charges for risk differentials, it creates arbitrary costs, far from minuscule, that directly taxes those more prone to be considered as more risky, like the poor and the development countries.

And so, Mr Bernard Kouchner, I would much prefer you forget your well-intentioned tax and instead eliminate your non-intentional tax.

John Kay is utterly lost!

Sir over the years I have often commented on John Kay’s articles, sometimes I have agreed, sometimes I have disagreed. But now I have been utterly disappointed discovering that Mr. Kay does not really know what he is talking about. In “Narrow banking can help protect the taxpayer” September 16 he writes “An 8 per cent capital cushion is inadequate as the amounts for winding up these banks will show”. Absolutely wrong! For those credits not perceived as risk-free and for which the banks took their ordinary precautions the 8 per cent equity requirement was most probably quite sufficient. What was highly insufficient was the only 1.6 percent capital requirement allowed by the regulatros for any operation involving an AAA rated security or client.

It was not the risky which provided the explosive material for this crisis but the not-risky, something that Mr Kay proposes we pursue even more, burrowing ourselves into narrow banks, so that once again we can feel the bliss of believing we are safe… so that once again we place ourselves further away from the risks we need to take in order to move forward.

No, Mr. Baby-boomer Kay, move over and let the future take over, even if it entails risks.

Madame Guillotine could be better than assisted euthanasia

Sir, Martin Wolf is absolutely right when in “Do not learn the wrong lessons from Lehman’s fall” September 16 he writes that “No normal profit-seeking business can operate without a credible threat of bankruptcy”. But then he goes into some mumbling about living-wills and assisted euthanasia and though it sounds kind and gentle both these alternatives start when it might already be too late, and so we should not forget that what we could really require is for Madame Guillotine to enter swifter into action.

Even governments represent counter-party risks

Sir in “The legacy of Lehman Brothers” you write “Policymakers must own up to the fact that there are some institutions they can never credibly claim they will let fail. They must identify who they are implicitly backstopping so that they can charge a fee for that insurance” September 14.

This is indeed truly dangerous talk when what we need is for our regulators to be much more trigger happy, allowing bad institutions to fail; and when we know that the fees for such eternal life insurance would never be set objectively nor would it be set apart in a reserve, and so that, sooner or later, the final failure of any of these supreme institution, could bring the State down with it.

The economy does not need more government insurances than the ones currently awarded to individual depositors up to limited amounts, and to give more is counterproductive to the well-being of all of us, since an insurance is only worth as much as the insurance company is worth; and we do face a counter-party risk even when dealing with governments.

Not safer, better!

Sir once again in “The legacy of Lehman Brothers” you talk about the need of “a strategy for making finance safer” September 14 and you are wrong. What we need is a strategy for making finance serve our needs better. An absolutely failsafe bank can be an absolutely useless bank.

FT don’t be such a wimp. How can we get better regulations of the financial sector without, like the whole Basel regulations, speaking a word about the mission of the banks?

But be careful of not adding to the confusion

Sir it sounds so utmost reasonable what Joseph Stiglitz mentions in “Towards a better measure of well-being” September 14 that I guess no one would, in principle, argue anything different. That said, there is clearly room for a warning, especially with the recent evidence provided by the crisis, on what can happen when someone arbitrarily plays around with the numbers.

The regulators fed up with adding AAapples with Bbbananas as fruits decided to give the first a risk-weight of 20 percent and the latter one of 100 percent when calculating the capital requirements of the banks and we ended up with such a confused world that most experts, FT, included had no idea of what bank leverages they were talking about, in fact most still don’t know.

And so whatever we do to measure what we want better, and a lot of improvements are indeed needed in this area, let us see that we just do not add to that confusion the politicians love to hide behind.

Markets price risk solely in interest spreads which is why the regulators’ “risk weights” only brings confusion.

Sir with respect to Martin Wolf’s “Turner is asking the right questions” September 11, and who I see is now much closer to accept that this crisis was caused more by bad finances than by the abundant economic disequilibrium that existed and still exist, my very fundamental difference in opinion is the following.

Because the market prices risk solely through interest rates spreads, the interference of the regulators pricing it by means of “risk weights”, which lead to different capital requirements, creates much confusion in the risk allocation mechanisms; and we therefore need to eliminate all regulatory risk-discrimination. In other words, between a Tobin tax that can function as a speed bump and provide some “due diligence”, and capital requirements that “forcefully” channel funds into different risk territories I am all for the first and all against the latter.

As a consequence the credit rating agencies should revert to their traditional role as risk informers instead of being the risk decision makers the regulators turned them into.

Since Basel has become too one minded to regulate we must break up the regulator too

Sir not only do I agree with Philip Augar and John McFall in that “To fix the system we must break up the banks” September 11, but perhaps we need to break up the regulators too…because Basel has become too one minded to regulate. (It is probably not comme il faut to quote from another newspaper, but it is such a small paper so here I go.)
In February 2000 in the Daily Journal of Caracas, Venezuela, in an article titled “Kafka and global banking” I wrote:
A diminished diversification of risk. No matter what bank regulators can invent to guarantee the diversification of risks in each individual bank, there is no doubt in my mind that less institutions means less baskets in which to put one’s eggs. One often reads that during the first four years of the 1930’s decade in the U.S.A., a total of 9,000 banks went under. One can easily ask what would have happened to the U.S.A. if there had been only one big bank at that time.
The risk of regulation. In the past there were many countries and many forms of regulation. Today, in Basel, norms and regulation are haughtily put into place that transcend borders and are applicable worldwide without considering that the after effects of any mistake could be explosive.
Excessive similitude. By trying to insure that all banks adopt the same rules and norms as established in Basel, we are also pushing them into coming ever closer and closer to each other in their way of conducting business. Unfortunately, however, nor are all countries the same, nor are all economies alike. This means that some countries and economies necessarily will end up with banking systems that do not adapt to their individual needs.
Sir and I hold that I am still right.

Greed comes in many shapes and forms

Sir in “more comment online”, “Roubini cameo” we read about a documentary Oliver Stone is preparing on bankers and greed. September 11. Well greed comes in many shapes and forms, not just pecuniary but also ideological. Oliver Stone has for instance recently shown much ideological greed (who knows, perhaps pecuniary greed too) filming a documentary on Hugo Chavez, “South of the Border” where he does not even mention such facts that Chavez cheats the poor of Venezuela, to the tune of about 10% of GDP, by selling petrol at about two US dollar cents per litre (gas at 10 cents per gallon)

And my warnings were silenced by the FT establishment

Sir Dirk Bezemer, in “Why some economist could see it coming”, September 8, argues correctly that many did indeed see it coming but that “they were ignored by an establishment”. FT should know about that.

In February 2000 in the Daily Journal of Caracas, Venezuela, in an article titled “Kafka and global banking” I had written:

A diminished diversification of risk. No matter what bank regulators can invent to guarantee the diversification of risks in each individual bank, there is no doubt in my mind that less institutions means less baskets in which to put one’s eggs. One often reads that during the first four years of the 1930’s decade in the U.S.A., a total of 9,000 banks went under. One can easily ask what would have happened to the U.S.A. if there had been only one big bank at that time.

The risk of regulation. In the past there were many countries and many forms of regulation. Today, in Basel, norms and regulation are haughtily put into place that transcend borders and are applicable worldwide without considering that the after effects of any mistake could be explosive.

Excessive similitude. By trying to insure that all banks adopt the same rules and norms as established in Basel, we are also pushing them into coming ever closer and closer to each other in their way of conducting business. Unfortunately, however, nor are all countries the same, nor are all economies alike. This means that some countries and economies necessarily will end up with banking systems that do not adapt to their individual needs. http://bit.ly/HIi3x

And, in January 2003, the Financial Times published a letter I wrote and which ended with “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.” http://bit.ly/5i1Bu

But then, I was shut up by the Financial Times establishment, who had perhaps decided there were only some macro economic problems and not any problems resulting from bad financial regulations, and wanted to hear no monothematic contradictions on that.

Basel regulations increase the world’s Gini coefficient

Sir from reading your “Capital ideas for financial reform” September 8 I get the feeling that you have not understood the real problem, as you are not at all clear about the how the equity of banks has to be increased.

It is not a question of just increasing capital requirements, across the board, but of increasing them only for those operations that were benefited with extraordinary low capital requirements.

Currently a normal loan to an unrated client requires the bank to hold eight percent in equity, which is not a low capital requirements at all, and which I bet you has proven to be more than sufficient to cover for any losses sustained in operations with non-rated clients, but, for a loan to an AAA rated client, the banks is only required to hold 1.6 percent in equity. As a result the clients perceived by credit ratings as having a higher credit risk are currently effectively shouldering the responsibility for the banks having capital, and thereby subsidizing those who are perceived as having a lower default risk… as if default risks is all what finance is about.

Let me explain it some harsher development terms. The current minimum capital requirements for banks based on risk assessments increase the world’s Gini coefficient and are only compatible with a world full of risk-adverse baby boomers who want to lie down and die.

Mr Geithner, and the rest of you regulators… you are so wrong.

Sir Timothy Geithner writes that “Stability depends on more capital” September 4, and he is so wrong. Stability depends almost exclusively on getting the right sustainable growth since with the wrong kind of growth you would need 100 per cent of capital and even then you probably only your real stability until you find yourself ten feet under the ground.

The hard truth Geithner needs to understand, and come to terms with, is that even if the credit rating agencies had been absolutely right in their ratings, the end results for the economy would be wrong; because subsidizing risk adverseness and taxing risk-taking, that is something that only a society that has had enough and wants to lie down and die does... and we can’t expect the whole world to be baby-boomers... can we?

Of course the regulators need to increase the current capital requirements for banks, but only for those operations where they decreased them so dramatically, like for instance allowing a 62.5 to 1 leverage when lending to anyone able enough to hustle up an AAA.

Mr Geithner please give us one single reason for why the regulators should specially favour banks lending to clients rated AAA. To me that is a pure senseless discrimination that will not lead us anywhere except over the next subprime cliff.

Jean-Claude Trichet sooths his own nerves.

Sir I feel a bit bad about Jean-Claude Trichet, the president of the European Central Bank, having to go out and affirm that he is a good and responsible parent, “Europe has mapped its monetary exit” September 4. Somehow one gets a feeling he is whistling in the dark so as to sooth his own nerves. Of course he should have an exit strategy for the current financial measures that looks to deliver price stability, and of course he should be willing to apply it, at least a priori, but both we and he know that this is just the beginning, since in any disciplinary approach a lot will depend on the children’s response.

Perfection is indeed the enemy of the good

Sir, Samuel Brittan in “We do not prosper by income or happiness alone” September 4 writes about Amartya Sen book “The idea of justice” in which the author proposes, among other, the “the piecemeal removal of specific injustices in the absence of an ideal society." That is absolutely right. 

In my book “Voice an Noise”, 2006, where I described some of my experiences as an Executive Director at the World Bank I held that, at sixty years of age, that institution “should perhaps be renewing its vows in order to move up from “knowledge” into wisdom and instead of trying to advance impossible agenda like justice and social responsibility might do better settling for fights much easier to monitor, such as one  against injustices and social irresponsibility. 

Also in El Universal, Caracas Venezuela, 2004 in “McPrisons” I wrote: “Justice is something very difficult to understand with precision, since it is situated along a continuum that becomes finite only when it reaches Divine Justice. 

On the other hand, injustices are much easier to identify and, in our countries, prisons themselves represent one of the greatest injustices. In terms of the use of scarce resources, as an economist I am convinced that programs of Judicial Reforms would be better served by improving prisons than by investing in Supreme Court buildings.”

Why should our regulators favour our banks to lend to AAA rated clients? Senseless discrimination?

Sir Martin Jacomb in “Regulators and bankers must share the blame” September 3 is so close to the truth that it hurts. He pinpoints exactly “the singular regulatory error: the failure of the Basle international rules to impose weighty capital requirements on the super senior tranche of securitized mortgage obligations” but then he describes it more as a mistake made and does not question the capital requirement for banks method itself; and this is wrong.

The really hard truth we need to understand and really grapple with is that even if the credit rating agencies had been absolutely right the end results for the economy would be wrong; because the method subsidizes risk adverseness and taxes risk-taking, and that is something that only a society that has had enough and wants to lie down and die does.

No, give me one single economic reason why we should favour banks lending to clients rated AAA? That, to me, is pure senseless discrimination.