Beware of Gameboy type regulations.

Sir you hold that “Basel must not yield to pressure” when imposing more stringent capital requirements for banks because “even if the rules do compromise economic growth in the short run, it is a price worth paying for more stable growth in the long run.” July 24.

You have not yet understood this crisis. More than just being low it was the fact that the capital requirements discriminated in favor of what was perceived as risk free which set of the dangerous stampede after triple-A rated operations which got them and us into this mess. There is absolutely nothing in the refinements that Basel is now doing in chapter III of their paradigm that will guarantee a more stable growth in the long run... much the contrary.

Can’t you see it? Our banking regulations have fallen into the hands of a first generation of Nintendo-Gameboy-players’ type of regulators, who believe life, risk and who knows perhaps even love can be controlled by just pushing some buttons.

Now the sophistication of their games will only increase the possibilities of introducing additional systemic risks in the market, creating instability, perhaps plenty of virtual growth, but certainly no sustainable real growth. The regulators in Basel have no interest in that and they have yet to tell us what they think the purpose of our banks should be.

What we least need is a non-transparent “Financial Stability Oversight Council”.

Sir Sebastian Mallaby´s “How to fsoc it to the hedge funds” July 16, clearly indicates that with the Financial Stability Oversight Council, a brand new source of systemic risk has been introduced, much the same when regulators empowered the credit rating agencies with a very important role in setting the capital requirements for banks.

In order to increase our chances to escape from new major disasters, we must avoid the markets having to entertain additional useless speculation about what some holed up “systemic risk experts” might be thinking. In this respect I would suggest that the FSOC is required to open a blog; and place a first post saying “We have the following list of systemically risky institutions” and then allow for the public to comment on whatever they say.

Of course, some good whistleblower protection programs for employees of possible systemically risky institutions might also be useful.

The search engines should scramble and shuffle their algorithms so as to guarantee diversity of results

Sir Marissa Mayer is absolutely correct in that we should “not neutralize the web’s endless search” July 15, because that could mean doing to knowledge, what regulators did to finance when they imposed on the banks the credit risk information oligopoly of the credit rating agencies.

But since Mayer represents a company which we have the right to at least suspect for wanting to sometimes go even further and create a monopoly, we should require more search diversity within every single search engine. The web should open our minds to an endless world of possibilities, and not close it by providing us some findings predetermined by others.

One alternative would be to list hundreds of search criteria, in a much expanded sort of “advanced search option” and then let the individual searcher decide how he wants to look for what he is after. (The one I personally most miss is the one that allows me to find hits between two dates.)

If the individual search option is not used then the search engines should be forced to shuffle and scramble their algorithms, so as to guarantee that no two searches provide exactly the same results, unless of course there are only a very limited number of results.

But the thumbscrews will still be used.

Sir in reference to your “Sovereign defaults”, July 14, let me remind you that whether in a torture chamber or on a conference table, the purpose is still to turn the screws on someone.

Now if both sides suffer a share of that thumb-screwing instead of all falling on either creditor or debtor… that sounds fair enough… supposing of course that half a torture plus half a torture is less than one torture.

The baby-boomers called out “Stop the World, until we get off”… too early.

Sir Martin Wolf painting the horrifying dimensions of the crisis that still lay ahead of us references a paper from 2005 by Raghuram Rajan titled “Has financial development made the world riskier?” “Three years on, fault line threaten the world economy.” July 14.

Though that paper is indeed excellent, especially when treating the subject of how bankers could or would respond erroneously to remuneration incentives, it does not really touch on the even more important issue of the very wrong turn taken at a regulatory crossroad which got us here.

When bank regulators in the early 90’s decided to impose a system of handicap weights based on the perceived risk of default, they basically ordered the world to a halt... “Let us not risk what we got!” Everything big and already established and which therefore already had better access to credit was given an additional boost from causing lower capital requirements for the banks, while anything small and new and which therefore already had more difficulties in getting bank credit, got even more restrained by causing higher capital requirements in relative terms.

Basel II, in 2004, was the ultimate refinement of this “Stop the World, until we get off.” In it, a credit to an unrated client requires the bank to hold 8 percent in capital while any bank operation with an AAA rated client only requires the backing of 1.6 percent.

Unfortunately for the too early out baby-boomers, the finance world immediately went after the extraordinary source of profit that the margin between the official credit rating agency ratings issued and the underlying true reality allowed for. The greater the differences in those margins, like when between AAAs and subprime, the greater the profits. Indeed, one of the much ignored aspects in the current discussions is that an absolute perfect credit rating, leads to no financial intermediation profits at all.

If we are to find ourselves a way of this mess, with or without the baby-boomers, we must understand much better were we come from.

Sir in “Unsafe as houses”, July 13, you lend support to UK‘s Financial Services Authority’s recommendation to “require independent verification of income” when processing a mortgage… arguing that this will “prevent individual risks from turning into systemic ones”.

Have you already forgotten that it was the independent credit rating agencies with their faulty ratings that provided the largest dose of systemic risk for the current crisis?

Do you really want to create a new oligopoly of information providers, the certified income certifiers, and who without no one will be able to lend? If you really think you need to do that for the creditors, then you are better off prohibiting them from being creditors. This is exactly the same type of nanny requirement that got the markets to trust too much the credit rating agencies.

If you want introduce stricter rules on mortgage lending then you are better off with rules that allow for creditors and debtors to come closer, instead of setting up new toll-bridges.

For instance, the rule that I would require, if a regulator, is that all mortgages, especially those that are to be securitized, have to explicitly name who has all the powers, all of the time and on behalf of all the creditors, to restructure the mortgage if need be; and the creditor must approve any change of negotiator. That by itself would not only solve one of the biggest problems currently encountered in the mortgage market, but also create a moral link that represents much more real skin in the game than a couple of percent of exposure.

The AAA pattern is extremely dangerous.

Sir, John Authers in “The Long View”, July 11, quotes Benoit Mandelbrot (who at least I never heard about before) calling the bubbles and crashes “the inevitable consequence of the human need to find patterns in the patternless”. One is left with the question of whether our financial regulators are not supposed to know that sort of stuff when they regulate. At least I always complained how the regulators were developing their own dangerous patterns... the just follow the AAAs.

The capital requirements for banks as determined by the Basel Committee in Basel II requires a bank to hold 1.6 percent in capital when lending to a corporation rated AAA to AA, and 12 percent when lending to a client rated below BB- .

Sir, how many bank crisis have you seen happening because banks have lend too much to AAA or AA rated clients who later turned out not to merit those ratings? All! And how many crisis have you seen happening because the banks lend too much to those rated BB-? None! If so, can you please explain what the regulators were thinking? If anything, would it not seem that the inverse of these capital requirements would be more valid?

Why should a poor BB-rated company, who surely must find it very difficult and expensive to raise finance, on top of it all, have to pay the banks an additional compensation in order to make up for the competitive advantages awarded by the regulators to the much more dangerous AAAs?

And, what comes after in risk-weight targets?

Sir in reference to Samuel Brittan´s “What comes after inflation targets” July 2 I just wish to remember that we also need to remember to change bank regulations targets.

According to an explanatory note issued by the Basel Committee on how the current risk-weights used to calculated the capital bank requirements were set, these were based on a “confidence level of at 99.9%, meaning that an institution was expected to suffer losses that exceed its level of tier 1 and tier 2 capital on average once in a thousand years.

Not that we should increase that confidence level, since what it did was only to drive the banks into an excessive and very dangerous over-exposure to what was perceived as having low-default-risks… precisely that stuff that bank crisis are built from.