March 25, 2011

Confusion not only still lurks, it’s getting bigger!

Sir, LEX in “Who knows what evil lurch” March 25, refers to Andrew Haldane, the Bank of England’s executive director for financial stability arguing “The shift form Basel I to Basel II bank capital standards increased the calculations behind tier one capital ratios from six to 200m” and that “this greater complexity failed to prevent an epochal credit crisis.”

Mr. Haldane, it not only failed to prevent the crisis, it caused it. The risk-weights based on perceived risk of default applied under the table to a market that already cleared for perceived risk of default over the table applying their risk premiums shook the Ground Zero of financial markets and created the mother of all confusions.

The premiums applied by the market in order to make the lending or investment alternative equivalent from a perceived risk of default point of view, were then made unequal when regulators ordered different capital requirements for the lending or investments based on the same perceived risk of default. This double counting translated into that the expected return for banks of doing operations with what is officially perceived as risk-free (sovereigns and triple-As) catapulted when compared to the expected returns from what was officially perceived as risky (small businesses and entrepreneurs). As a result our banks have drowned, or find themselves trampling desperately in triple-A waters and public debt.

And then some have the gall to call this massive regulatory failure, a market failure! And Basel III is not correcting for it, and in many ways making it worse. I have been arguing this for years but unfortunately I cannot find the words gentle enough to get through to the regulators… I hope FT and LEX will.

A not so simple simple question to FT

If banks, by means of capital requirements based on the perceived risk of default are given special incentives to go to what is officially perceived as low risk areas and shun what is officially perceived as risky… is it for the rest of us to pick the slack so to balance that all out?

March 24, 2011

The credit rating agent’s cloister conundrum

Sir, everywhere we turn we read about the impacts of upgrading and downgrading of the credit ratings, as when Jennifer Hughes reports “CLO ratings set to benefit from Moody’s re-evaluation” March 24.

Having given these credit ratings so much importance, should we not also have to construe cloisters where the credit rating agents can isolate themselves from the temptations? But, answering that question let us not also forget that if we isolate the credit rating agents in their cloisters, then it will most probably be us who will fall into the wrong temptations. What a conundrum!

March 23, 2011

And what about a special intellectual property monopoly tax?

Sir with today´s technology I am not that sure John Lennon will never ever sing another song, as John Kay holds in “It´s mad to give my heirs rights to a student lit crit essay” March 23. But, yes, John Lennon will not write another song, and even if some computer wizards used his old material to generate a new John Lennon song, we can rest assure John Lennon would not appear as the beneficiary of that copyright.

This touches on an issue not covered in John Kay´s excellent article, namely that all or at least most of the intellectual production rights, gets credited only to whom who ran the last leg of the corresponding human relay... and that to top up that injustice, the rest of us have to pay for the protection of these rights. I have often held that revenues that derive from the monopoly rights the society has awarded should be taxed on a higher rate than those revenues someone has to fight for all alone and without a protective shield.

March 22, 2011

Another FT Special Report on Risk Management in Finance that did not mention the risk of regulations

Sir, you publish a special report titled “Risk Management: Finance” March 22. In it not once do you refer to the fact that the current supreme financial risk managers of the world are the banking supervisors in the Basel Committee, and who so arrogantly assume it is their right to set Ground Zero for the rest of the risk managers.

With their risk-weights in Basel II, these inept nuts, and there really is no other word for them, decided that the banks returns on capital could be dramatically increased, by allowing leverages of more than 60 to 1, as long as they kept doing operations related to an officially confirmed no risk situation, a triple A credit rating.

Paul Davies explains “why there is now a greater understanding that there is little guidance to be found from the past when preparing for the future”. But that is only so because most still refuse to look at the recent past, and understand from it than bank regulators cannot discriminate as they did, and do, by means of capital requirements for banks based on perceived risks, without creating monstrous systemic risk.

Brooke Masters writes “now that regulators have moved to impose tougher capital and liquidity requirements, attention is turning to other systemic risk”, which ignores that it was not the lack of toughness of the capital requirements that mostly caused the disaster but the way how they discriminated. What better evidence is there that the 8 per cent capital requirement in Basel II for what is rated BBB+ to BB- has proven more than sufficient and that it is only in the area covered with AAA to A ratings where problems have surged.

Richard Milne writes “Follow the line of debt to spot the coming crisis” and refers to a possible bubble in the public sector, while not saying one word about the fact that banks can lend to the public sector with infinitesimal capital requirements, as long as these sovereigns are rated AAA to A.

But worst of all, the special report again fails to mention the fact that the market’s risk management already clears for perceived risk of default, which includes of course the credit ratings, by means of deciding the risk premiums to be charged in each case, and making all the alternatives investments equal. And so that when the regulators then come and intrusively layer on their own risk biases on the banks, the only thing they are doing is distorting the financial markets, and becoming themselves the greatest source of systemic risk.

March 18, 2011

I denounce!

Sir I hereby formally denounce that your financial regulators, in following the precepts of the Basel Committee, are causing damage that could prove to be irreparable to your homeland´s economy.

By leveraging the market´s own bias against risk-taking with their own risk-adverseness, they are directly hurting the resilience and the dynamism of the UK economy, as well as its job creating potential, and which as in all other economies is much a direct function of the willingness to take risks. This occurs when, on top of the risk-premiums already charged by the market, they impose capital requirements for banks that are based on an officially perceived risk already known and considered by the market.

The basic capital requirement for banks in Basel II, 8 percent, has proved to be more than sufficient to cover whatever lending or investment exposure the banks had in what was officially perceived as “risky” and the current crisis resulted solely from the extremely low risk-weights that discriminated in favor of the capital returns of lending or investing in what was officially perceived as “not risky”.

In terms of a health-insurance plan, your current financial regulations require that those rated unhealthy, and even though they because of that already pay higher premiums, have to cover for a larger part of the capital requirements of your insurance companies, with the result of then being able to offer even lower premiums to those rated healthy and that already were paying lower premiums. What kind of system is that and what capital reserve cushion will there be if the health-raters miss some symptoms or if a new disease that attack only the healthy strikes?

It is sincerely laughable to read about stress tests performed on banks by bank regulators that have proven not knowing what they do. What is perceived as risky has never ever set off a financial crisis!

You are the Financial Times… do you really not care… how long will you keep a lid on this argument? Do you really think your country will remain strong with your banks regulated by bureaucratic wimps?

FT is unbelievably inconsistent!

Sir suppose that the market, which includes banks, looks at the credit information, which includes credit ratings, and decides that the risk premium of a triple-A rated company should be 1 percent; and then it similarly looks at a company rated BBB and decides that the risk premium there should be 4 percent.

Now if a bank would have to hold 8 percent in capital for all its assets and therefore be able to leverage its capital 12.5 to 1 it would receive 12.5 percent of risk premiums on its capital when lending to a triple-A rated company and 50 percent of risk premium on its capital when lending to a BBB rated company, and it has deemed these risk returns to be equivalent.

But then comes the Basel Committee and in Basel II tells the bank that in the case of triple-A rated companies it can leverage 62.5 to 1 which means that now suddenly the banks receives 62.5 percent of risk premiums on its capital when lending to triple-A rated companies which in this case is, even on a gross basis, more risk premiums than what is obtained when lending to BBB rated companies.

How can you then reward Boldness in Business March 17, and yet not say a word about the distortive risk aversion of current bank regulations? You are being unbelievably inconsistent.

Did the financial crisis originate from anything officially or unofficially perceived as risky? Of course not! They never do.

March 12, 2011

Did Inside Job do an inside job on The Academy of Motion Picture Arts and Sciences?

Sir, in “Why the public wants its pound of banker’s flesh” March 12, Gillian Tett refers to the Oscar won for best documentary by Inside Job which covers the financial meltdown.

That documentary does not mention even once the Basel Committee for Banking Supervision, that global financial regulator which provided the intellectual back-drop for the more than 60 to 1 bank capital leverages authorized, and which drove the banks into the waters of the triple-A rated securities collateralized with lousily awarded mortgages that detonated the crisis. The only way I can explain that Oscar is by suspecting that the Inside Job did itself an inside job on The Academy of Motion Picture Arts and Sciences.

And by the way I do not care a iota about a pound of banker’s flesh, I would be more than satisfied having the Basel Committee regulators parading down 5th Avenue wearing cones of shame… and of course being banned from regulations forever.

March 11, 2011

Monothematic regulators are really not interested in interest rate risk

Sir, Gillian Tett asks on March 11 “Have we really learnt lessons of 1994´s sharp rate spikes?” The answer must be NO, foremost because regulators seem not the least interested in that topic.

Current banks regulations are 100 percent based on perceived risk of defaults… and so all other risks… like the interest rate risk Gillian Tett points out, or the risk that our financial system does not perform adequately its capital allocation function that I worry about… or the thousand of unknown risks that I lie around any next corner, are all ignored by these monothematic regulators.

Sir, Martin Wolf writes “Pension reform makes sense up to a point” March 11 and I hope he takes the opportunity to also look in at the rates of return of pension funds used in actuarial valuations.

As an Executive Director of the World Bank (2002-2004) I continuously held that “It really is not possible for the value of investment funds to grow, forever, at a higher rate than the underlying economy, unless they are just inflating it with air, or unless they are taking a chunk of the growth from someone else. Therefore when we observe how many Social Security System Reforms are based on the underlying assumption that the average pension fund will obtain returns of 5 to 7 percent, in real terms, forever, I have to wonder when we are going to use our knowledge, and inform the world that this is just plain crazy.”

And even after the crisis, the world mostly uses those overly optimistic expected rates of returns in… what cheats they are!

PS. The extract is from my book Voice and Noise, of 2006, one of which I also then gave Martin Wolf. Unfortunately Mr. Wolf must not have read it otherwise he would not have perhaps wasted so much valuable opinion space on his macroeconomic-imbalances explanations for this crisis, and would have understood better and earlier the monstrous regulatory imbalances.

March 10, 2011

FT, dare to look beneath the tip of the iceberg!

Sir, Jennifer Hughes in “Bank dip into tool box for Basel III” March 10, insists, as you all do, on keeping her eyes firm on the tip of the regulatory iceberg, without the slightest concern of what lies beneath. She, as you all do, speak about the minimum equity capital ratio as a percentage of risk-weighted assets while ignoring that if these risk-weights are wrong this has no meaning.

For instance, early this morning Spain was still weighted 0 percent and now, as a result of the two-notch downgrading of its credit rating, suddenly its risk-weight has become 20%; and which means, in Basel II terms, that banks will now need a whopping 1.6 percent in capital when lending to Spain... which means that banks will now be allowed to only leverage their capital a meager 62.5 to 1… poor banks!

March 07, 2011

You need some warning labels on the transparency pills offered

Sir it is not “when citizens do not know how much the governments are paid” in resource revenues that lies behind the real resource curse… it is much more when governments get paid too much, like more than 5% of GDP, 15% of its exports, or 25% of all tax revenues received from the citizens, “Stop digging deep for the kleptocrats” March 7.

In those cases of evident lack of balance of the societal powers, those transparency pills that the Extractive Industries Transparency Initiative offers, will in the best of cases act as placebos, and it the worst, be feeding on those illusions of a better tomorrow that help maintain petrocrats and oiligarchs in power.

Financial rules must do more for development…anywhere!

As a former Executive Director of the World Bank (2002-2004) I am extremely pleased to see Vincenzo La Via of the World Bank speaking up on the development angle of bank regulations. “Financial rules must do more for development countries” March 7. But, as I have done precisely that, for well over a decade, it might be appropriate to remind the readers that this is not a solely a developing country issue.

Even in developed countries those regulations, by blatantly discriminating against those perceived as more “risky”, are doing just as much harm for the development of their own small businesses and entrepreneurs.

Abundant surrealism is present in the discussions on bank regulations and stress tests

Sir, Patrick Jenkins and Brooke Masters report “Europe’s bank regulator attempts to restore faith” March 7. In it we read again experts opining on the basic percentage of capital requirements indicated by Basel III but not a word is said about the risk-weights which in Basel II diluted the banks required capital into nothing. How surrealistic is that?

Is that because no one wants to acknowledge the fact that European banks, while all the credit rating agencies downgrades are of the outlook for the ratings and not of the ratings themselves, are still allowed to lend, for instance to Spain, against zero capital?

March 04, 2011

Openness is just a placebo when lifting a real resource-curse

Sir whenever a government receives in net resource revenues more than 5% of GDP, 15% of its exports, or 25% of all tax revenues received from the citizens, the balance of power has been fundamentally altered and real democracy cannot breath. In these cases the transparency of which George Soros speaks of in “Openness can help lift the curse of resources” March 4, is just a placebo. In fact transparency there amounts to little more than allowing the tortured seeing the pliers that is to be used to extract his fingernails.

That Extractive Industries Transparency Initiative, EITI, and that Soros speaks so highly of is without any doubt well-intentioned, but they have no idea of what the real oil-curse is all about. Anyone who did would not, as EITI does, proclaim the 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.”

That principle supports keeping on concentrating oil-wealth in hands like Gaddafi’s, while the only means of breaking an oil-curse of that size is handing over the oil revenues directly to the citizens. But what would a George Soros or an EITI know about that? … at the end of the day they are not really oil-cursed citizens.

March 03, 2011

Don´t give microfinance a blanket approval!

Sir in “Dhaka´s spiteful attack on Yunus” March 3, you write “microlenders have small margins in spite of their high interest rates… their loans are cheaper than those provided by traditional money lenders, and free of the social conditions attached to credit in feudal relationship” and I must ask… how on earth do you know that?

As a former Executive Director of the World Bank and very interested in the subject I have closely followed the debate on microfinance, and I have quite often found the need to remark on the fact that most evaluations of the sector are geared to establish the profitability of micro-finance and very little or nothing is said about for instance the rates the micro-borrowers have to pay.

There is much good in microfinance but there is also an enormous amount of hypocrisy, not the least among a crowd of those who make a career and a living out of being microfinance groupies. If you like the concept of microfinance, as I indeed do, then hold it to strict standards and do not give it a blanket approval. (Or otherwise accept it as any other kind of non-holy business).

And of course this has nothing to do with approving or condoning whatever is being done to Mohammed Yunus the founder of Grameen Bank, something of which I know too little about to opine.

Sorry FT… it just seems like the same dumb old banking to me!

Sir in “Brave new banking” March 3 you write that “financial markets were guided less by an invisible hand than by the hands of a blind”. That blind was and is the Basel Committee’s paradigm of capital requirements for banks that discriminate based on perceived risks. You yourself say that “More credit is good when channeled to productive investments” and yet that is not what Basel I, II, or III hold… those regulations hold exclusively that more credit is good when channeled to “not risky” proposals.

Patrick Jenkins, Megan Murphy and Haig Simonian report Oswald Grübel, ex of UBS, saying “If in one part of the world you have an 8 per cent capital requirement, and in another part of the world, 19 per cent… you know where the business is going”. He is absolutely correct, just as is: “If in order to lend to small businesses you need 8 per cent capital requirement, but when lending to triple-A rated securities, or Greece you only need 1.6 per cent … you know where the credit is going”

Sir (please get it!) the 8 percent capital requirement established in Basel 1 and II when lending to what is perceived as risky has proven to be sufficient to cover the losses incurred when banks lend to what is perceived as risky, so there is no need to increase those requirements. What originated this crisis lies exclusively with operations a priori perceived as “not risky”. Before that is realized and fully corrected for, which means eliminating all regulatory discrimination that is layered on top of market discrimination … it just seems like the same dumb old banking to me.

March 02, 2011

Beware of cuddling up too much with comforting regulatory teddy-bears, they could be poisonous.

Sir, John Kay in “Don’t blame luck when your models misfire” March 2, gets to the core of our problems with the regulatory monopoly of the Basel Committee that has been empowered, God knows how.

The Basel Committee instead of as regulators be highly skeptical about anyone’s ability of perfectly understanding and measuring risks, arrogantly took upon themselves to act as the risk-managers of the world and with their risk-weights which caused the capital requirements for the banks to be absurdly low whenever a triple-A rating was involved, they altered Zero Ground and naturally tempted the bankers to enter into the triple-A rated waters where the sharks of the real economy were waiting for them.

During my days as one of 24 Executive Directors in the World Bank (2002-2004) I repeated over and over the arguments presented by John Kay, but no one wanted to really listen, (just like FT doesn’t want to) since the thought of being able to control for risks sounds so comforting no one wants to give it up… and so the possibilities of finding clientele for the next risk controlling potion introduced are of course boundless.

In such circumstance the best we can do is to try to make certain that the systemic risks of any risk-avoidance scheme to which we want to snuggle up sucking thumbs are not themselves larger than the risks we want to be protected from. Unfortunately there are many who have a vested interest in hiding the fact that they sold us a poisoned regulatory teddy-bear.