June 30, 2010

When the going gets tough give the tough a chance!

Sir John Plender wrote “Fragile State of banks means recovery is still precarious” June 30 and few would debate him on that. Where he is wrong though is saying “that there is precious little left in the policymakers’ locker”.

At this moment what is most required, as a public regulatory policy, is to immediately reduce the capital requirements for banks on all those operations that just because they were deemed as more risky by the credit rating agencies, had to be backed up with higher capital requirements.

If we do not do that, we run the risks that while the banks are rebuilding the capital lost in AAA-land, they will crowd out completely those tough we so much need to get going now when the going is tough… and that would really be the end.

Current financial regulations discriminate against small businesses and entrepreneurs.

Sir, compared to a traditional regulatory system that set equal bank capital requirements for all type of assets, the current one which imposes different requirements based on some arbitrary risk-weights related to credit ratings, implies that a small business needs to pay about 2 percent (200 basis points) more in interest rates in order to stay competitive when accessing bank credit. Let me explain.

Suppose a bank feels that the normal risk premiums should be .5 percent for an AAA rated company and 4 percent for a small business. If the bank was required to have 8 percent for both assets and could therefore leverage itself 12.5 to 1 then the expected before credit loss margin on bank equity for the AAAs would be 6.25% and for the small business 50%, a difference of 43.75%.

But, since the bank is allowed by regulators to hold only 1.6 percent against AAA rated assets, which implies permitting a leverage of 62.5 to 1, the previous margin for these assets is now 31.25%, which implies a difference in margins on equity of only 18.75% when compared to that generated by the small business.

In order to restore the initial required competitive margin difference of 43.75, now only 18.75% the small businesses will have to generate for the banks an additional gross margin of 25 percent and which, divided by the 12.5 to 1 leverage allowed for their class of assets, comes out to be the additional 2 percent in interest rates I referred to.

Of course a complete analysis would require considering many other dynamic factors, but those would only help to fog the basic truth that our regulators are discriminating against those the banks are most supposed to serve.

What will it take for Financial Times to understand that this is no minor problem, especially when so much of any job recovery lies in the hands of small businesses and entrepreneurs?

What will it take for Financial Times to understand that the regulatory discrimination in favor of the AAAs caused the current financial crisis?

June 29, 2010

Please just one single capital requirement!

Sir you are absolutely right in that “Shock therapy is best cure for banks”, June 29, except for when ask for new “capital requirements” when what we most need is to a return to just one single capital requirement which would stop the regulatory arbitrage among different assets.

If you have not yet been able to figure out arbitrarily low capital requirements in favor of anything that can dress up in a good credit rating, is not the main cause for the banks being pushed into having an excessive exposure to anything dressed up in a good rating, I cannot but help you are indeed a bit dense… just like the regulators.

From a bank regulatory perspective, subprime and Greek debt were identical and perfect twins.

Sir Eric Posner in “Greek debt troubles reveal parallels with subprime crisis” June 29 fails to mention the most striking parallel, namely that both the securities collateralized with subprime mortgages and Greek debt, when held by banks, required these to hold only 1.6 percent in equity, in other worlds they were authorized to have a 62.5 to 1 leverage.

A bank, if it was making 50 basis points spread on Greek debt, then it was making 32 percent return a year, courtesy of the regulators… not bad eh?

June 28, 2010

How do you lobby the Basel Committee?

Sir in “The US arms its financial regulators” June 28 you write “The consensus emerging from the Basel III negotiations shows that bankers have rediscovered some of their old clout”. I suppose that with bankers you re refer primarily to the too-big-to-fail group of banks, as we have seen very little coming out that could be helpful for all the other small-enough-to-fail banks.

That raises of course the very interesting question of how one gets around lobbying the Basel Committee.

June 27, 2010

Are the regulators pulling our legs?

Sir Tom Braithwaite reporting that “US banks face more sweeping overhaul” June 27 writes about setting “aside more capital against their riskier… operations”. Or he has misunderstood it or the regulators have to be pulling our legs.

As this crisis resulted in its entirety from assets that having been deemed safe, because the credit rating agencies said so, were allowed to be financed by the banks against extremely low capital requirements, what we obviously need is higher capital requirements on any operations perceived as not risky.

To place additional capital requirements on operations that are perceived as risky and for which therefore there is already a traditional lack of capital and will to finance, has no logic. Not only did those riskier operations have nothing to do with originating the crisis but they might quite probably also represent our best ticket out of this crisis.

There’s got to be something very wrong with us.

Sir, I don’t get it! That we know that England lost during in the World Cup 1-4 to Germany is one thing, but that it will be registered in history as a 1 to 4 loss when we all know it to be 2-4 that I cannot understand. There’s got to be something very wrong with us.

June 26, 2010

Financial Times would you mind?

Sir would you mind much if I explained to FT’s sophisticated readers why it is not so much whether the capital requirements for banks are high or low that matters, but more so the way they discriminate among assets based on default risk-weights?

Let us suppose that banks, with no special regulations, would be willing to lend at .5% over their own cost of funds to those who are rated triple-A, and with a 4% spread to more risky small businesses.

If the banks were obliged to hold 8 percent against any asset, which means they can have a leverage of 12.5 to 1 (100/8) then their net results on capital, before credit losses, when lending to the AAAs would be 6.25% (.5x12.5); and 50% (4x12.5) when lending to the small businesses. With such a difference the banks would do their utmost trying to lend well to the small businesses… as there are clearly no major bonuses to be derived from lending to the AAAs.

But when the regulators allow, as they do, the bank to hold only 1.6 percent in capital when lending to AAA rated clients, which implies a leverage of 62.5 to one (100/1.6), then the expected net result on capital for the banks when lending to AAAs, before credit losses, becomes a whopping 31.25% (.5x62.5).

And of course, a bank, and bankers, being able to make 31.25% before credit losses when lending to no risk-AAAs, would be crazy going after the much more difficult 50% margin before credit losses available when lending to the riskier small businesses and entrepreneurs.

And this is how the risk-adverse regulators pushed our banks into the so dangerous “risk-free-AAA-land” while blithely ignoring that no bank or financial failure has ever occurred because of something perceived as risky, they were all the result from something perceived as not risky; and while ignoring that what we most want out of our banks is precisely that they be good in nurturing with credit those small businesses that might grow up to be the AAAs of tomorrow.

And this is really why we find ourselves in a crisis of monumental proportions, never ever before had our regulators dared to be so publicly wimpy so as to ask the banks to so excessively embrace what was, ex-ante, perceived as having no risk.

By the way, who gave the regulators the right to discriminate solely based on perceived default risks? The small businesses, in order to have a chance to access credit, are as a direct consequence of these capital requirements forced by the regulators to pay much more for their loans... as simple as that! Do not forget that whatever little capital the banks currently have, it is mostly because of those perceived as being risky.

June 21, 2010

Financial Times, please help… save the world from our financial regulators´ regulatory exuberance!

There has never ever been a major or systemic bank crisis that has resulted from the banks being involved with what ex-ante was perceived as risky; they all resulted from lending and investing in what ex-ante was considered as not risky, given the returns offered.

But then came the Basel Committee regulators and, to top it up, lowered the capital requirements for what ex-ante is perceived by the credit rating agencies as having lower risks, which of course increased the banks’ expected ex-ante returns from pursuing these “low risk” opportunities.

And now, when two years after an explosion that resulted from so many banks following the minuscule capital requirements when investing in securities collateralized with subprime mortgages; and there is a bank explosion awaiting round the corner because of bank lending to well rated fancy sovereigns, like Greece, with almost no capital requirements at all; they keep on applying the same regulatory paradigm of risk-weighted assets, we can only deduct that our financial regulators simply do not get it, not even ex-post.

Please, FT, help save the world from our financial regulators´ regulatory exuberance!

June 19, 2010

In reality Oliver Stone is Mr. Conformist.

Sir in “When Hugo met Oliver”, June 19, Matthew Garrahan refers to Oliver Stone as a non-conformist. Since “conformism” is a term used to describe the suspension of an individual's self-determined actions or opinions in favour of obedience to the mandates or conventions of one's peer-group that is plainly laughable. Oliver Stone, with respect to the beliefs extolled in his particular mutual admiration club, is as conformist as anyone could be.

If I had the chance I would warmly suggest Mr. Stone to read Arthur Koestler’s “Darkness at noon”, as it could be an eye-opener for him. But, then again why would he want an eye-opener when the living on the fast moving and trendy oil blessed left jet set is so enjoyable and profitable?

June 16, 2010

Yes, we should all have a say in how banks are reformed

John Kay is absolutely right in that “We should all have a say in how banks are reformed” June 16.

Human and economic development includes an incredible number of different risks of different nature and most perhaps not even known to us, just look at BP. Therefore I have for more than a decade protested those regulators who decided to impose capital requirements by discriminating with their arbitrary risk weights based exclusively on the risk of default, a risk that could only be of such a concern to extremely wimpy regulators.

Indeed, that a creditor defaults is about the most natural thing in the world, and the only way it becomes worrisome is if there is a systemic and massive number of defaults; and which is precisely what the regulators finally caused when with their capital requirement they started a mad chase in search of triple-A ratings, and the market found some Potemkin ones.

Also the sole fact that it can go through a regulators head to discriminate in such a way as to assigning zero capital requirements when a bank lends to a AAA rated sovereign but require 8 percent when it lends to its most natural clients namely the small businesses and entrepreneurs, is maddening. If asked I would even prefer it to be exactly the other way round, though I would happily settle for no discrimination at all, as that is what the least confuses the markets.

There are many ways of tightening and easing... and some are better than other

Sir Martin Wolf rightly insists in warning on “Why plans for early fiscal tightening carry global risk” June 16, but he would further his cause focusing more on the needed quality of the fiscal spending. It is not fiscal deficits I am afraid of; it is fiscal useless waste that makes me and many really nervous.

For instance when regulators can allow the banks to lend to sovereigns with zero or minimal capital requirements why can’t they temporarily decrease the capital requirements for the banks when lending to the small businesses and entrepreneurs, those who had nothing to do with creating the mess, those who can perhaps most help us to get out of it. That to me seems a more efficient way of stimulating the economy than having bureaucrats decide on what to spend.

June 09, 2010

Lower the capital requirements for banks!

Martin Wolf is absolutely right in warning us that “Fear of the markets must not blind us to deflation’s danger” June 9, but I do not understand on what grounds he believes that government can spend and ease us out of our immense problems. What we have seen until now seems surely to have set us up for something worse and one of the reasons for it is exactly that the “wicked” investors have not “suffered punishment” but been bailed-out.

If we are going to stimulate again this time that stimulus has to be carried out by the private sector. How? As I have proposed for soon two years, by lowering substantially the current capital requirements of banks when lending to small businesses and entrepreneurs. It was the ridiculous low capital requirements to any fancy sovereign and triple-A rated operation that got us into this horrendous mess… what wrong can it be to temporarily allow for lower capital requirements when banks lend to those who stand the best chance to get us out of the mess.

Right now if a bank lends to US-UK-Germany-France government it needs no capital at all and with the proceeds the bureaucrats of those nations can decide what to stimulate and who to finance. Is it no better having the banks decide which General Motors or grocers on the corner should get finance?

Yes we have reasons to distrust the banks, though far from as many some agendas want us to believe, but that does not imply that suddenly governments, magically, are better. I at least trust them less than what I trust banks. In any case if we got to keep on rowing close to the waterfalls of inflation and deflation let us at least make sure we all row in the same direction… hopefully away from them.

June 08, 2010

The odious and arbitrary regulatory discrimination of risks must stop… now!

Sir Jeffrey Sachs in “It is time to plan for the post-Keynesian era” June 8, in his list of proposals, ignores the fundamental change that must occur in our financial regulations.

It just cannot be that our regulators allow banks to lend to fancy AAA rated sovereigns with zero capital requirements, or to sovereigns rated like Greece the last five years with only 1.6 percent of capital, while requiring the banks to hold 8 percent in capital when lending to the small businesses and entrepreneurs.

That odious and arbitrary regulatory discrimination must end now; the coward market discriminates more than enough when pricing for risks; and our financial regulators should immediately be removed as they seem absolutely incapable to understand that there are other risks in life than “the risk of default”.

June 04, 2010

Societies and human development thrives on risk taking and not on risk-avoidance.

Sir finally, at long last, you have reached the conclusion that we need to “end the pseudo official status of a select group of CRA’s elevated by law and accounting rules into arbiter’s of our banking systems’ risk management”, Rating Credit June 4. Good for you!

Having said that though, you arrive at this conclusion mostly because you feel that the credit rating agencies cannot really perform their rating job correctly, and which is why you find it hard “to do away with risk-weighting altogether” and with that you do your utmost to hang on to some kind of myth of safety.

Sadly, the real life hard truth is that there is absolutely nothing that justifies that a credit, deemed as having less risk to default, should be favored more than it already is by the market. Actually, since the nature of capital nature is and has always been very risk-averse, one could more easily build a case to the contrary since societies and human development thrives on risk taking and not risk-avoidance.

June 01, 2010

It is only by following the capital requirements for banks and the Potemkin ratings that you can understand our current predicament.

Sir Nouriel Roubini and Arnab Das evidence with their “Solutions for a crisis in its sovereign stage” June 1, that though experts, they are not sufficiently aware of what has really been going on in the area of sovereign finance.

I say this because in the area for “radical reform of finance” though they mention correctly the problem with the too large institutions, they fail completely to make reference to the much larger problem of how the financial regulators, in a non-transparent way and behind the backs of us citizens, are arbitrarily subsidizing sovereign finance by requiring the banks to hold lower capital requirements when lending to governments than when lending to their natural clients the small businesses and entrepreneurs.

Back in 2004 in the Financial Times I wrote: “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... banks are up to the hilt in public credits.”

In this respect one of the most important information the Financial Times could provide its readers is the following table:

It is only be reading this table that you get to understand why there was a stampede after AAA rated private securities, even when these came with Potemkin ratings, and why there was so much lending to sovereigns… for instance to Greece which because of its ratings over between mid 2000 and December 2009 required the banks only to hold a paltry 1.6 percent.