But what were the regulators smoking?

Sir in “Double or quits for the eurozone” April 29, you say that “Credit raters made things worse by again following the markets they are supposed to advise”. Would you care to expand a little bit on that?

To me it was really the regulators who made things worse by telling banks to have capital in accordance to what the credit rating agencies say... and for instance allowed the banks to stock up on Greek public debt with only 1.6 percent of capital... in other words authorizing the banks to have a 62.5 to 1 leverage when dealing with Greece! What were the regulators smoking?

Triple-A securities did not turn into junk, they were junk made into triple-As, simply because there are not enough real triple-As to go around.

Sir John Gapper writes “this crisis was of a severity beyond others in the past, and triple-A securities were at its heart” ‘Time to rein in the rating agencies” April 29. The first letter of mine, and that you published on January 12, 2003 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”. At last count I have sent you 391 letter more on this topic and so it would seem that after a definite statement like Gapper’s I should now be able to let it go. Not yet!

When Gapper in his quite comprehensive article states “If all the subprime mortgage securities they rated triple A had not turned to junk…” he completely misses the point. It was the shear existence of the credit ratings that, when combined with absurdly low capital requirements for banks when lending or investing in triple-As, which provided all the incentives for the markets to manufacture the “junk”.

Given the possibility of accessing a triple-A rating the worse the mortgage, the higher the interest rates, the larger the difference between the real and the perceived value and therefore the larger the profits.

Sir, please grow up and face the facts of life. There are not enough true triple-A investment opportunities to go around for all the coward capital that exists in the world. Pursuing triple-As too much will either lead us to false triple-As or to absolutely unproductive triple-As, like putting your savings in a mattress and having it stored at Fort Knox, paying a custodial fee.

If the incentives are correctly aligned all bonuses make sense.

Sir, John Kay in “When a bonus culture is just a poor joke” April 28, that he would have felt insulted if as a teacher he were to receive a bonus from a student on the successful completion of a course.

Why should he feel that way if the incentives were well aligned? You see it is really not the completion of a course that matters, as Kay seems to believe, but what you do in life with that completion. In this respect let me share with Kay some brief paragraphs I posted on one of my umpteenth blogs a couple of years ago.

Don’t give your teacher an apple; offer him a couple of basis points in your earnings instead.

Parent and students need some way of sorting through the reams of college information in order to make rational investments, but may I remind you that even when finding the absolute perfect college that you might benefit from aligning the incentives better.

In this respect what I am currently recommending my young friends when they take off for their MBA is that they offer a couple of basis points on their first 10 years earnings to those teachers they feel could best advance their careers…it makes wonders! 

Aligning the incentives could in the long run also be the best way of getting information for the picking of a college to, as education should in fact be a joint venture between students, teachers, and colleges.

I refuse to follow Martin Wolf down the road to financial obscurantism

Sir when comparing the ease or even gusto with which Martin Wolf has supported government spending to bail out the economy, imposing no public debt to taxpayers willingness ratios at all, with the way he now wants to strictly limit the banks’ lending activity, I am truly shocked, “Why cautious reform of finance is the risky option”, April 28.

Wolf, after years of receiving, acknowledging and ignoring my letters about the excessive leverage ratios allowed to banks on assets perceived as having low risk, like 62.5 to one on anything related to an AAA rating, now suddenly goes into full reverse and opines that “Leverage ratios of 30 to one are crazy. Three to one looks far more sensible”.

Well let me assure you that just even searching for a three to one capital ratio for banks world, would make us lose all our hopes of trying to solve the rest of the world’s urgent problems, and most certainly lead us to financial obscurantism with pure gold bartering and no credit at all. I refuse to follow Martin Wolf there!

In fact the 12.5 to one capital ratio, allowed to banks when lending to small businesses and entrepreneurs, and which of course had nothing to do causing this crisis, should perhaps even be increased slightly, now when we are in so much deer need of jobs.

Plain stupid or shameless… have a pick

Sir on your front page in “Moody’s admits to failings over crisis”, April 24, Stephanie Kirchgaessner and Kevin Seiff report that “The chief executive of Moody’s admitted to a Senate panel yesterday that the US credit rating agencies failed to anticipate the severe deterioration in the US housing market that led to the financial crisis”.

If Raymond McDaniel does not know what role the AAA ratings had in creating the worst part of the bubble in the US housing market and which had to explode, then he is plain stupid, but, if he is not that stupid, then he is just shameless… Have a pick!

Why should George Soros be licensed to kill and not the bankers?

Sir George Soros in “America must face up to the dangers of derivatives” April 23 describes these as “a licence to kill” and he is wrong.

Just as a gun a derivative can do good or bad depending on who pulls the trigger on what and with what accuracy. In this respect, and given that in matters of investment George Soros could also readily qualify as just another gunslinger perhaps he should hand in his licence to kill too.

Undue influence?

Sir amazed I read on FT’s front page “”Bankers influenced rating agencies… unduly” April 23. I ask, did not the regulators unduly influence banks and investors to give undue weight to many unduly prepared opinions of the credit rating agencies? Is not overselling one’s product something perfectly normal? Why would the credit rating agencies’ opinions be more covered by the 1st Amendment’s freedom of expression rights than the opinions of the bankers?

Don’t fight it… accept it… on the subject of the hundreds of letter I have sent you denouncing the very subprime bank regulations that were concocted by the Basel Committee and which that caused this crisis… you have let yourself to be unduly influenced by the undue opinions to withhold from the general public my very correct opinions by some of your own opinionated writers.

I expected the Canadian bankers not wanting to live in never-risk-land.

Sir when the heads of the six major Canadian banks, those banks which better health makes them the object of envy of so many regulators and taxpayers in the world, issue a joint communiqué, we should read it very carefully “It is time to press on with bank reform” April 22. Unfortunately, my expectations were too high and I was disappointed.

Not only did it read almost like a Julia Child recipe... a little bit more of Tier 1 capital here.... and some more leverage testing there... but it also showed that neither they have a clear idea of what hit us.

Though they correctly state “Regulators do not need to specify which businesses banks should enter” they do not realize that is exactly what regulators do when they risk-weigh assets. Markets discriminate risks by charging different interest rates and so, when regulators award the lending to some assets lower capital requirements, because these are perceived by the credit rating agencies as less risky, they are actually instructing bankers to go to “risk-free” land. And, our problem, as a society, and though we do appreciate the efforts of lowering the risks in banks, is that we are not sure our best interests or future really lies in Never-risk-land.

They also write that if no distinctions, in terms of capital requirements, between low-risk and high-risk assets, something that I much favour, this “would encourage financial institutions to take more risk, which could make the system less stable”. Are they blind? Have they not wakened up to the fact that this crisis resulted from capitals stampeding in the search of AAA ratings, precisely as a consequence of the low capital requirements?

Where are the bankers who want to have the right to lend to their traditional client small businesses and entrepreneurs on their way to capital markets, without being distracted only because regulators favours what is perceived as having less risk? I had hoped these bankers were in Canada, now I am not any longer sure of that.

Why, for a change, not listen to those who proved beyond reasonable doubt they knew?

Sir, in November 1999 I wrote in Economía Hoy, Caracas the following:

“The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse of the OWB (the Only Bank in the World)... Currently market forces favors the larger the entity is, be it banks, law firms, auditing firms, brokers, etc. Perhaps one of the things that the authorities could do, in order to diversity risks, is to create a tax on size.”

And you of all must be aware of the literally hundreds of letters that I, though accused of boring and monothematic, have sent you about the extremely faulty financial regulation that were produced by the Basel Committee… and this before the current Big Bang.

That is why I read with much satisfaction that Martin Wolf titles his article “The challenges of halting the financial doomsday machine” April 21, better late than never. Since he is planning to address what to do about it the next week, I do hope he will consider some of what I have written to FT and to him… if only because I sure gave evidence of that I knew and know what was and is wrong… and this even though I am not a member of his group of great influential economists with their PhDs.

ABACUS 2007-AC1: The whole truth and nothing but the truth!

Sir I refer to the extensive report by Patrick Jenkins and Francesco Guerrera, “Goldsman versus the regulator” April 19. Yes Goldman Sachs might have behaved unethically and even illegally but the whole truth and nothing but the truth would in this case have to include the following facts, no matter how politically or agenda inconvenient they might be.

IKB the German bank bought the two tranches of ABACUS 2007-AC1 almost exclusively because of the following two reasons:

First both tranches, the A1 paying Libor plus 85 basis points, and the A-2 paying Libor plus 110 basis, points were rated Aaa by Moody’s and AAA by S&P when purchased by IKB.

Second, in order to invest $150 million in these securities, which because of their ratings were risk-weighted by Basel II at only 20%, IKB needed only to have $2.4 million of capital, 1.6%, when compared to the $12 million it would be required to have if lending that amount to unrated small and medium sized German companies.

If IKB had known that Paulson had had his hand in the picking and known fully about his motives then they might have asked for a slightly higher interest rate, perhaps 10 basis points, and still bought the securities.

If the securities did not have the splendid credit ratings assigned to them by the credit rating agencies then they would probably not have bought them even if Mother Teresa had done the picking.

If the regulators had placed the same type of capital requirements on all assets then IKB would have stayed home, probably lending to their traditional clients, instead of going to California to dig prime rated subprime gold.

And so while naturally we should lend all our support to efforts to eliminate wrong-doings like those described in the action by the SEC against Goldman Sachs that should not signify we take our eyes of the unfortunate truth of the world having been saddled with grossly inept regulators who created grossly bad regulations.

PS. The truth was even worse. Years later I found out the EU authorities, in a gesture of misunderstood solidarity had assigned Greece a 0% risk weight, which meant European banks could lend to Greece against no capital at all.

Where were the regulators on April 26, 2007?

I just read in the Washington Post that the CDO discussed in the suit against Goldman Sachs, ABACUS 2007-AC1, and in which investors lost more than $ 1 billion, was created on April 26, 2007

Just out of curiosity I went back to my blog TeawithFT and found the following letter:

On March 19, 2007: Let us pray the estimates are wrong

Sir, let us pray for that the estimate that 2.2m of American families could lose their homes and that John Gapper mentions in “The wrong way to lend to the poor” is totally wrong. If not, then let us prepare for the worst, as the political consequences of such fallout in the sub-prime mortgage market would by far surpass whatever all other thorny issues such as Iraq and the illegal immigration could all produce, together.

What I miss in this scarily good saddening and scaring article, is some words of how it came about that some 2.2m obviously individual shaky loans could have, when all was said and done, produced the sufficiently good ratings needed to attract so much money. The credit rating agencies sure must have some explaining to do, as has those Bank regulators responsible for giving the credit rating agencies so much power to begin with.

You can find it here http://bit.ly/9clEC9 ... but that’s not all friends;

On April 13 I responded to an article of Gillian Tett in FT titled “Subprime proposals could broaden litigation risk all around” http://bit.ly/d9I0rt

Also on April 13, 2007 I responded to an article in FT by Richard Beales titled “A whiff of double standards” http://bit.ly/d2vopp

And on April 18, 2007 I responded to a comment in FT by Desmond Lachman titled “Housing bubble burst into American elections” http://bit.ly/cxKT3P

And so there obviously has to be so much more to it? Where were the regulators on April 26, 2007?

Growth requires a willingness to take risks!

Sir Martin Wolf holds like most would do that “Growth is the fix for British Finances” April 16. To that effect he mentions among other, the interesting possibility of ending interest deductibility, though that could create some serious transition problems while markets adapt such a dramatic change.

But what he does not mention is the need to completely overhaul the current bank regulations. These regulations, by means of allowing special and low capital requirements for banks when involved with anything related to an AAA rating, benefits what already benefits from being perceived as having low risks. In doing so, the regulations quite explicitly discriminate against the risk-taking that is required to achieve what Wolf wants, namely growth, promotion of exports and a healthy manufacturing sector.

Plain “bad” regulators!

Sir Gillian Tett is obviously right in that this crisis was not the fault of “maths” or “economics” but of the “bad” maths and economics that was used and abused, “What happen to markets when numbers don’t add up”, April 16.

The question is why we cannot equally accept that the problem was not the lack of regulations but the existence of truly “bad” regulations. Is it really so impossible to imagine that the world landed in the lap of a particularly inept bunch of regulators, who were allowed to unsupervised empower credit rating agencies too much and concoct venomous capital requirement potions? The evidence of that being the case is overwhelming… and it really behoves us to act accordingly.

ps. Below, as part of the “overwhelming evidence” I refer to above, are some examples of how financial regulators set the capital requirements for the banks depending on whom they lent to.

Sovereigns rated AAA to AA were given a risk weight of 0% which results in a cap.req of zero percent.

Corporations rated AAA to AA were given a risk weight of 20% which results in a cap.req of 1.6 percent.

Small businesses or entrepreneurs, unrated, well they were risk-rated at 100% which results in a cap.req of 8 percent.

It is not that 8 percent is high but, when given the opportunity of zero or 1.6 percent capital… where did you think the banks went?

Should bank regulators not known that sovereigns and AAA corporations already have access to the capital markets and so that the first role of our banks is to help those small businesses or entrepreneurs who provide dynamism to the economy and the jobs we need, and to support them on their way to the capital markets?

Should regulators not know that in a world of coward capitals those perceived as being low risk are already favoured by lower interest rates and do not really need the assistance of further benefits given to them by regulators?

Should regulators not have known that by adding another layer of benefits to the AAAs they could create a stampede, turning safe-havens into dangerously overcrowded havens?

Should regulators not have known that sooner or later credit rating agencies would make mistakes or be captured?

EITI, unwittingly, is an obstacle to other cursed-citizen's requests.

Sir I refer to your Oily transparency April 15. In the debate on what to do with an oil curse the Extractive Industries Transparency Initiatives occupies so much space it does not leave much room for others who like me want the oil revenues distributed directly to the citizens.

In fact EITI is more of an obstacle since it states as its 2nd Principle“We affirm that management of natural resource wealth for the benefit of a country’s citizens is in the domain of sovereign governments to be exercised in the interests of their national development.”

When seeing how much oil-richness has been wasted in the hands of oiligarchs, petrocrats or plain thugs it is truly amazing such a principle should exist. I guess it is because it is always more fun to talk to an oil blessed politician or technocrat than with a poor oil cursed citizens.

http://theoilcurse.blogspot.com/

But freedom does not require formality and survives even in prisons

Sir Russell Napier holds that “Tower of debt will force a roll back of the free markets” April 14. I do not understand where he gets such an outlandish idea… if anything the markets, whether free or controlled, will topple the growing public tower of debt.

He also says “Commercial bank’s new capital adequacy ratios already require banks to hold higher levels of government debt”. Well no, the already quite old capital “inadequacy ratios”, allow banks to hold higher levels of debt if these debts are without risk and bank capitals are right now under enormous pressure because these public debts are being downgraded.

In fact that public debt has received such an unjustified preferential treatment by the financial regulators was just their pay-back to governments for giving them their independence and leaving them alone in their secluded quarters in Basel.

And so when Napier writes that “Western governments are left with no option but to restrict and corral markets and force capital private sector capital into action is support of public debt markets” what he is describing is not necessarily an exit plan but how we got into the mess to begin with.

Yes governments might be tempted to impose “capital controls”… perhaps like those China has and which allows it to keep an undervalued currency… but, as I see it, that could just lead to accelerate the rate by which the world goes informal, illicit and illegal, in order to survive their respective governments. The more capital controls the more are the havens worth… ask China… whose government does not even dare to spend its own money in China.

What a great short phrase!

Sir it is always a pleasure seeing someone able to describe perfectly a difficult situation in just one sentence. Therefore I would wish to congratulate Jennifer Hughes, The Short View, April 13, for saying it all summing up the market reactions to the “Greek bail-out” with: “In essence, investors appeared less relieved yesterday than they were worried last week”.

It is all there in only 87 characters and so that after adding 7 with the space for “Greece” she would still have 46 to go on her tweet!

Zapatero is just another Rolly Polly Doll

Sir we read in you interview of Spanish leader José Luis Rodríguez Zapatero, “A legacy in limbo” April 12, that he is “ready to be judged on plans to take control of public finances”. Are they not amazing these Rolly Polly Dolls when they with so much bravura announce they are willing to be held accountable on how they get us out of the mess they helped to get us into? They do all sound and act like financial regulators.

Secretariat of the European Systemic Risk Board… wow!

Sir on April 8, 2010, in the Financial Times I read the European Central Bank seeking candidates to occupy several positions in the Secretariat of the European Systemic Risk Board, “established with the purpose of identifying, monitoring and assessing potential risks to financial stability in the EU that arises from macroeconomic and financial developments”. I had to say wow! ... and cut it out to save it as a memento.

When will they ever learn? They set up the Basel Committee, which allowed those truly miniscule capital requirements like 1.6 percent so that helped already big banks grow to be the too-big-to-fail banks and they empowered the credit rating agencies so much that half of Europe followed them to dig nonexistent subprime gold in California… and they do not yet even know, much less accept, that they were themselves the largest creators of systemic risk.

And ECB wants to send out a message that they’ve got Europe’s systemic risks under control? Who is going to tell ECB that the candidates most likely to be useful in such a monumental quest are probably the least likely to be accepted by them?

When spotting bubbles, make sure you look at the right one!

Sir Kenneth Rogoff writes “Spotting the tell-tale signs of bubbles approaching” April 8, but ignores the risk of looking at the wrong bubble. Take the so called real estate bubble in the US for example.

If the triple-A credit ratings on the securities collateralized with the subprime mortgages had been correctly awarded, then the increase in the prices of the houses would perhaps not have occurred or, if they did, those prices could have reflected a reality of supply and demand and not a bubble. This is so because the real bubble we had was a mega bubble of unjustified trust in the credit rating agencies; and which started when the bank regulators foolishly and trustingly outsourced the risk watching to these agencies to such an extent that they allowed the banks to hold only a meagre1.6 percent capital if the rating was a triple-A.

Right battlefield, wrong combatants!

Sir John Plender in “Rules will decide the New York vs London Battle”, April 7, considers that one reasonable safe bet is that a new Basel agreement… will provide the basis for a level playing field on capital and liquidity” though “where the balance will fall between the two financial centres on all this is anyone’s guess”. Are we going to fall again for the same trick? It was with the excuse of reducing regulatory arbitration between banking centres that Basel created the regulations that served as growth hormones for the big banks. It is not about New York against London, Basel might be the battlefield, but the combatants are the too-big-to-fail banks and the underdogs, the too-small-to-matter-to-the-regulators banks.

Mexico needs to speak out against China´s renminbi manipulation

Sir I find myself 100 percent in agreement with Martin Wolfs “Evaluating the renminbi manipulation” April 7, since manipulation is what it clearly is. But that said perhaps more than the US talking and taking actions, others like Mexico, being the most affected, as it is their exports that are being displaced, should also do their share of loud screaming and hollering.

Financial Times, if you do believe in small state and open markets, you are certainly not showing it.

Sir in your editorial of April 7, “The UK must look beyond the crisis” you state with some hubris “The Financial Times stands for a small state social justice and open markets”. Sincerely, if that’s so, you’re not showing it.

Current Basel regulations require a bank to have 8 percent in capital when lending to a small business or an entrepreneur but if lending to a government of a sovereign rated AAA to AA- the banks needs zero equity, and this with any lens used is a clear expression of an immense bias in favour of the state.

On November 18, 2004 you published a letter I wrote that said “We wonder how many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

But since that, and after almost some 100 letters more on the same issue; and after you must have seen sufficient evidence of how banks all over the world, and especially in Europe, loaded up on public debt, not once have I seen express your disgust over something that most clearly goes against “a small state and open markets”.

And how would US’s California stand up to EU’s Spain?

Sir Spencer Jakab makes a very valid point in “California and Kazakhstan – just who is the underdog? April 3. Sadly though, he used an oil cursed nation to make his case and that is a bit like comparing apples and oranges.

Having much experience in debt restructurings I am used to look not only at the possibilities of default but also at what could be left “the morning after”. In the case of Kazakhstan, if it goes down the tube, most likely it will disappear as the nation it never really became but in the case of California it will still be California, a vibrant state of the US that is of course unless Mexico makes an offer no one can refuse.

It would be interesting if Spencer Jakab repeated the analysis comparing the California of the US with the Spain of EU.

But the AAA-ratings-bubble was the fault of very few!

John Authers is correct in that “Bubbles are the fault of the many – not the few” April 3, but that is of course with the exception of the AAA-ratings-bubble and which when it blew up caused the current crisis.

That bubble was the fault of only 3 credit rating agencies and of those very few regulators who empowered the credit rating agencies with so much credibility when they made their credit risk analysis of the clients of the banks, determine how much capital the banks should have… even to the extent of allowing the banks to hold a truly minuscule 1.6 percent in capital when lending to a private AAA client and, good grief, no capital at all when lending to a sovereign AAA.

The financial regulators should parade down 5th Avenue wearing their cones of shame

Sir David Roche writes “Watch out for sovereign black holes in the credit universe” April 1, as if the world should have to be warned now.

When regulators came up with the idea that if the sovereign was rated AAA to AA- then your local bank needed no capital at all when lending to its government, compared to the 8 percent required when lending to your unrated local entrepreneur… the future was there for all to see. Exploding public debt and black holes made up by the lack of bank equity. Just like what happened when banks were only required to have 1.6 percent in capital when lending to a triple-A rated company.

Where were the Financial Times and all other experts when their opinions could really have mattered? What percentage of the regulatory experts, or schemers, had an inkling of what was doomed to happen if they regulated the way they did? Does that not tell us something about the quality of the regulators? Should they, as a bare minimum, not be made to parade down 5th Avenue wearing their cones of shame?