May 27, 2009
In May 2003 at a Risk Management Workshop for Regulators at the World Bank, as an Executive Director, I said: “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.”
John Taylor in “Exploding debt threatens America” May 27 writes that he believes the debt projected level of US debt to be systemic. Yes indeed the debt could be so large that it could bring us an awful inflation but what really propels it as a systemic risk is not so much its size but the fact that the current minimum capital requirements for banks in the case of public debts rated triple-A is an astonishing zero, which not only subsidizes the growth of public debt but also leaves the system totally unprotected.
This type of systemic risk led us to the precipice of the badly awarded mortgages to the subprime sector just as it will help to lead us to the precipice of governments too much in debt.
May 26, 2009
In order for current regulations to stand a chance of being corrected the first thing that has to happen, is for the regulators to acknowledge that regulations are by themselves a prime source of systemic risks.
May 23, 2009
Sir Henny Sender “This year’s model for cash raising – the GMAC way” May 23, begs the question whether we should trust the used bank salesmen; a question that is difficult to answer when it is so hard to assess what’s under the hood of a bank, especially now when their assets are disclosed in “risk-weighted” terms.
GMAC is reported to have $173.bn of risk weighted assets, but taking away the impact of the weights, the real nominal asset exposure could easily be ten times that amount. For $173bn of risk-weighted assets an additional need of $11.5bn sounds “so reasonable”, but then it could just all be a mirage produced by that dangerous cocktail of faulty credit ratings and arbitrarily imposed risk-weights and that have hit and obscured the financial sector ever since Basel II got going.
The fact though is that while in Germany the sales of new cars are subsidized by a payment to scrap old used cars, in the US it is the financiers of used cars that are receiving government support and that sort of reflects quite different workout strategies.
Do you have any idea where the rates would be if it had not been for the quantitative easing? It sure puts a big question mark when it needs to recur to quantitative easing in order to sell itself as a safe-haven. The greatest mistake made by the US government and Congress in their current handling of the crisis is that they might have taken the world’s wish for a temporary safe-haven as a wish for a permanent home.
Behind our backs bank regulators in Basel decided that lending to a triple-A rated government required zero bank equity while lending to an ordinary non-rated private company required 8 percent... and the governments loved it... wouldn’t they? The markets though requires x percent return for lending 100 to triple-A rated governments and y percent return for lending exactly the same 100 to a non-rated private company all without any reference to capital requirements.
Therefore though you can subsidize governments and temporarily confuse the market by means of arbitrary regulations in the long term you cannot simply instruct markets to behave as if a dollar lent to the government is any different than a dollar lent to a private company. Having then to reduce the current implicit subsidy to the governments contained in the minimum requirements for banks will also put further pressure to increase the interest rates on public debt... just when the world seems least to afford it.
The gorilla is there in the room roaring and pounding his chest... let’s pray we’ll never have to pay him off, informally, over the counter, with some gold coins.
May 22, 2009
In this respect when Martin Wolf in “Why Britain has to curb finance” May 22, refers to UK regulators having “an influence on the world economy out of proportion to the country’s size” he is either too parochial or he still completely misunderstands what has happened. Also a sheer reference to a “light touch” in the context of financial regulations would be almost laughable if not for the sad and serious consequences of the very heavy handed and truly relevant regulations that from Basel hit the world, London included.
Frankly the UK cannot afford to curb anything, less it wants to be left out completely. And the Financial Times should be the first to know that. Go City of London go!
What I cannot comprehend though is how the SEC can get away with the one year of ownership criteria... how on earth does one year of ownership change ownership? Could there now be an opportunity to sell the shares but keep them in your name, so as to offer the one year ownership on record? I mean in this severe crisis one has to look under every stone for any value to be unlocked.
May 21, 2009
That is of course as long as some of that fog that comes from having the assets reported as seen through the eyes of the credit rating agencies and risk-weighted arbitrarily by the regulators is dissipated. As is everyone, regulators included, might keep on focusing on the wrong exposure where a real 40 to 1 leverage is reported as only a 10 to 1 assets to capital leverage. Let the markets have a better look at what’s really in the banks… otherwise we will just have the blind leading the blind.
May 20, 2009
Through their minimum capital requirements for the banks the regulators allowed for a 62.5 to 1 leverages (and that in some cases can even reach 179 to 1) and all based on the credit rating agencies’ triple-As. How on earth could the free play of market forces in finance stand a chance to correctly handle that?
If you really want the market to regain confidence then you have to explain what really happened.
In this respect the Rasputins have now a clear and vested interest in blaming the oligarchs in order to protect themselves. John Kay rightly says “We need to reassert the notion that roles of authority are positions of responsibility rather than declarations of personal merit and routes to personal enrichment.” And that should apply equally to bankers and regulators.
May 19, 2009
Are you not aware that this currency rate in that it does not by far reflect the FX rate that applies to the whole Venezuelan economy is totally fictitious. That is has been fixed there since February 2003 and that those not favoured by having the government receive their Bolivar Fuerte in order to convert them into dollars, need currently to use at least 3 times as many Bolívar Fuerte to get a dollar.
For how long does FT play along in this charade of the Venezuelan government? If you want to put an end to it I suppose you have two alternatives the first to simultaneously publish an estimate of the rate in the unofficial market, which would provide your readers with more information, and the second not to publish any rate at all.
May 14, 2009
If a bank regulator decided that the minimum capital requirements for the banks depended on how much some few specially designated fashion experts fancied the colour of the tie that the borrower´s chief executive officer wore; and that capital requirements so determined could then vary between a high of 12% of the loan and a low of 0.56% would you call this a free market? Of course not, not even if instead of the colour of ties what was used were the ratings of some vaguely defined credit-default risks.
But, if even Martin Wolf, the chief economics commentator of the Financial Times, almost two years into the crisis, can still write about “why free-market capitalism went off the rails” and that the “era of financial liberalisation has ended”, “Seed of its own destruction” May 12, when one could very well argue that free-market capitalism was actually placed on rails heading over cliffs, then clearly Balcerowicz’ article is still much needed and appreciated. Clearly those from Poland have a clearer or at least more recent concept of what state dirigisme really means.
May 13, 2009
That the US, and the dollar are in trouble, that there can be no doubt about, but the truth is that the US and the dollar could still remain for a very long time the most de-facto triple-A in the world, because, at the end of the day, risk is always relative, except of course, when we really reach the end of the day.
Now on the rest of David Walker’s message I could not agree more. Last year, during the annual meeting of the World Bank and the IMF, I went around asking “how are we going to pay for it all?”, and proposing a new generation of taxes, such as taxing income from protected intellectual property rights, only to be met with a “what is he talking about?”
May 11, 2009
In other circumstances looking at the Treasury versus private securities from a liquidity angle might be correct but, at this particular injunction, the bottleneck for the banks is equity and not liquidity.
In this respect let me remind you that the minimum capital requirements concocted by the Basel Committee holds that in contrast to claims on private assets that do require holding some equity, although in some cases ridiculously small, claims on sovereigns rated AAA to AA- do not, as they are given a 0% risk weight.
As food for thought just think about what are fore-bankers would have thought of making a zero-reserve when lending to a Crown. But of course, a zero equity requirement is what the Basel Committee had to stipulate in order for the finance ministers in their AAA or AA- countries to cheer them on. Now if a sovereign were to be down-rated to A+ to A- then the risk weight goes up to 20% and if that would happen they would either have to change the minimum capital requirement or face the mother of all demand for bank equity.
May 09, 2009
Assume that Citibank had one of those super-seniors rated AAA and that according to paragraph 615 of the Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework - Comprehensive Version of June 2006 carried a risk weight of only 7%.
This meant that a $1430 investment was going to show up as only $100 in risk-weighted assets, which in fact believe it or not, signified an authorized leverage of (1430/8) of 179 to 1, and therefore required only $8 in equity (8% of 100).
If the market value of those $1430 then fell 2 percent to $1401 the bank would first have to register a $28 loss but if that “super-senior” was also concurrently down-rated to an “awful” A, then the new risk weight applied was 20 percent which signified that the risk-weighted assets increased to $280 (20% of $1401); and therefore requires $48 in additional equity ($280 times the 8 percent equity minus the $8 of previous equity).
And so we not only have $28 in mark-to-market losses that must be covered but the bank has also to find additional equity of $48 to cover for the higher equity requirements... and so the bank is induced to sell those super-seniors but for which there is now not a market since buyers have been scared off by a credit rating downgrade... and so down and down it goes... not so much because of the intrinsic quality of the super-seniors but because of the minimum capital requirements for the banks
The above describes the most vicious part of the current vicious circle in the bank sector and the Basel Committee is fully responsible for it. Never ever has the financial regulators and the financial experts been so gullible and naive like when they believed that “risk-weighted assets” were correctly risk-weighted assets.
By the way when reading the recent stress tests prepared for the largest 19 bank holdings in the US the possibility of this misconception still being in existence is what frightens me the most.
May 08, 2009
First it hard for us to interpret the results of the stress test because they all refer to risk-weighted assets” and this we know that no matter its pompous name this does not mean anything absolute. Not only are the weights completely arbitrary, like for instance 20% for triple-A rated assets, but also those weighing, the credit rating agencies, have clearly shown themselves not to be the most very trustworthy risk surveyors. It also makes any comparisons between BHCs impossible since the differences between the risk-weighted assets could be larger than between apples and oranges.
But second and most importantly the stress test does not include any type of recommendation. Do we want to strengthen the weaker BHCs so that these survive or are we looking to show who are weak so that we can strengthen the stronger to make sure that some of the BHC survive? Why do we not put all our money in the group outside the BHCs? What a stress!
That said PDVSA with all the richness that it controls, if it was well run, should have to pay only some basis points more than the risk free rate and so, in order for your readers to understand better what is going on, perhaps you should have translated what was painted on the PDVSA oil tanks in the photo. It says "Fatherland Socialism or Death"… hence 16 percent.
The Global Coalition of Oil-Cursed Citizens
What happened was that regulators invented some risk weights and then got themselves some risk surveyors, the credit rating agencies, and produced the line of “risk weighted assets” by which they thought their job regulating banks was all done... and so, to find something to occupy their now fulltime spare-time with they started to pick on the hedge funds.
May 07, 2009
This is why I take strong exception when Matthew Richardson and Nouriel Roubini in “Insolvent banks should feel market discipline”, May 7, though correctly advocating more of Schumpeterian creative destruction, are surprisingly lenient in the case of counterparty risk. They even write “But unlike with Lehman, the government can stand behind any counterparty transaction”. No!
What is counterparty risk? The risk that for example the insurance company you have insured yourself with cannot pay up when it should. This risk is clearly not a risk that an ordinary citizen should have to bear but for the financial system’s overall health it is an absolute must that all the qualified institutional participants bear with the full consequences of it.
In fact, in case they have not read it, current third pillar of the otherwise so discredited bank regulations from Basel – named the market discipline, “aims to encourage market discipline by developing a set of disclosure requirements which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposures, risk assessment processes, and hence the capital adequacy of the institution.” And that of course means the evaluation and the taking of counterparty risks.
And by the way, just as the markets would benefit from more creative destruction, let me also remind you that so would our financial regulators
May 06, 2009
Wolf also considers the possibility that our children “in despair...will even embrace... the absurdity of gold” and I do share Wolf’s feeling since they, and we, deserve more than that; in fact one of the most worrisome aspects of this crisis is how often one finds oneself on the side of those gold-bugs one has always considered being somewhat nuts.
Now what I do not agree with Wolf is when he writes of “inflation targeting”, as a holy gray, since one of the problem could be that the inflation was not adequately targeted. In a letter published by FT in May 2006 I wrote “inflation as they, our monetary authorities know it, is just obtained by looking at a basket of limited consumer goods chosen by bureaucrats and that although they might be highly relevant to the many have-nots, are highly irrelevant to measure the real loss of value of money. For instance, who on earth has decided for that the increase in the price of houses is not inflation? And so what should perhaps be argued is that really our monetary authorities have not been so successful fighting inflation as they claim they have been.”
And then of course we have the financial regulations, and that Wolf does not even wants to mention. Would a runner be a bad runner just because someone trips him up and he falls? In just the same manner must a monetary policy be wrong just because some financial regulations went haywire?
May 05, 2009
There is really nothing like a perfect incentive plan though for an investor who is looking for a five year return he should clearly be better off paying an incentive based on the five years results as easy as that. Diversity is also good... if the whole world starts looking for five year results that will be just as bad as the current one year structures... you see humans, and especially traders, they do adapt.
Which bring us to the most important part of all... knowing what the incentives are. Coates refers to the traders but perhaps more important yet is to refer to the trader’s bosses.
May 04, 2009
It was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on August 19, 2008 and provided background information to the staff report on the 2008 Article IV consultation discussions with Iceland, which was discussed by the Executive Board on September 10, 2008, prior to the recent Board discussion on a Stand-By Arrangement for Iceland.”
It makes fascinating reading, especially in these times when the regulators now want to tackle systemic risks while ignoring that their regulations are in fact the prime source of systemic risk.
In it, dated a month before the crisis exploded at the end of September 2008, we can among other read the following: “The banking system’s reported financial indicators are above minimum regulatory requirements and stress tests suggest that the system is resilient. Bank capital averaged almost 13 percent of risk-weighted assets between 2003 and 2006, dropped to 12 percent in 2007 and to approximately 11 percent in the first half of 2008, but remain above the 8 percent minimum. Liquidity ratios are likewise above minimum levels. Notwithstanding the positive indicators, vulnerabilities are high and increasing, reflecting the deteriorating financial environment”
To me once again, this just proves that no one had the faintest idea of what the “risk-weighted assets” really meant and, if they did, they had no will to question the significance of risk-weighting.
May 02, 2009
Instead of allowing the sceptics to have a voice the regulators forcefully correlated the financial markets to some few credit rating agencies.
Tett does indeed tell us a lot about one of the seeds of the debt disaster but, as someone who has recently even acquired a license as a mortgage loan officer in the US in order to better understand what happened, I believe that it was really the environment that mattered for that seed to bloom into something really bad. More detailed information on the amounts of mortgages awarded to the subprime sector and that were securitized on year by year or even better month by month basis is useful to understand it all and I hope Gillian Tett has provided that in her book.
My explanations for the crisis is much simpler. In synthesis, the financial regulators in Basel correlated the world to the opinions of just three credit rating agencies… and with that they weakened or even displaced from the market the voice of all the many healthy sceptics like Terri Duhon and Krishna Varikooty and the reduced the market weight of more careful individual investors.
The International Convergence of Capital Measurement and Capital Standards in July 1988, even though the minimum capital requirements there are based on risk, they do not even mention the credit rating agencies and the risk weight for all claims on the private sector is 100% and they therefore require the 8% of capital.
By contrast the International Convergence of Capital Measurement and Capital Standards of June 2006 1988 is all about the credit ratings… and for instance the corporations that are rated AAA to AA- are risk-weighted at 20% and so do only generate a capital requirement of 1.6%. And, from that moment on the road to “fool’s gold” was determined to go thru the credit rating agencies.
May 01, 2009
Ricardo Hausmann, during the spring meetings of the World Bank, at a conference titled “Latin America and the Global Crisis: Towards a Rapid Regional Recovery” argued that the US should take on debt and relend to the world. Hausmann, coming from an oil rich country must have remembered that this was exactly what the oil countries did during the 1974-79 oil bonanza when foreign bankers virtually forced credits on them… and the oil exporting countries recycled and imported and recycled and imported... until.
But is this politically viable? Perhaps not, but even so there are major troubles brewing down the line.
First the US, as thee safe-haven par excellence, cannot expect to crowd out the rest of the world from the financial markets, for a lengthier period, without its own waters becoming stale or even having the rest of the world starting to think in terms of sabotaging that safe-haven.
Second if the US, in order to reflate its own economy and which might also help to stop the world from deflating too much, for a while, does so by investing only in its own back-yard, then the returns from those overcrowded back-yards will not be sufficient to repay what will be owed, and so the US taxpayer will start to seriously object having to become the taxpayer of last resort…and with that, again, waive bye, bye to the sweet dollar safe-haven.
Let us not forget that in truth the dollar bill should have imprinted on it “In the American Tax Payer We Trust” but that the US Mint, more pragmatic, more marketing minded and much wiser preferred the much more fundamental “In God We Trust”.