The Emperor in Basel is freaking naked!

Sir, all general bank crisis, as well as most individual bank defaults, have NOT resulted from lending or investing excessively in something perceived as risky, but from either unlawful behavior, or the excessive lending or investment in what was wrongfully perceived as not risky.

Against that backdrop… can you please explain to me the rationale of having capital requirements for banks based on perceived risk? If anything, should these not then be higher for lending or investing in that which is perceived as not risky?

But No! The regulators in the Basel Committee and the Financial Stability Board, they insist on discriminating against those bank clients and operations their official risk-perceivers, the credit rating agencies, perceive to be risky, or have not looked at... like the small businesses or entrepreneurs we wish and need to have access to bank credit. And, in doing so they also, of course, become the most important pushers of excessive lending or investment in that extremely dangerous zone of what is officially perceived as not risky.

And that is why, frankly, I cannot, for instance, muster as much enthusiasm as you do, for a Mario Draghi.

Is the Basel Committee´s mistake a taboo in FT?

Sir, Aline van Duyn and Nicole Bullock report “Banks braced for knock-on effect of credit ratings” April 29. There, and though they refer to issues such like that the ratings of the banks could suffer because of the close relation with the risks of their respective sovereign, and of outright losses if selling sovereign debt at a loss, amazingly they do not say one single word about the increase in capital requirements for the banks those downgrading in the credit cause, retroactively.

All bad that can happen when lenders have followed high credit ratings and these are suddenly downgraded, are currently compounded by the fact that the regulators use exactly the same credit ratings when establishing the capital requirements for banks. This was the biggest mistake of the Basel Committee, and of which I have written to you countless times. Has it now even become a taboo to discuss that in FT?

Neville Chamberlain’s Munich vs. Regulator Draghi’s Basel

Sir reading your “Draghi does it best”, April 28, makes me want to ask: How come a Neville Chamberlain coming back from Munich with his “Piece in our time” was booted when the war broke out, even though the war was not his fault, while those who came back from Basel with their “Never a bank crisis in our time” are still praised, even when they did cause the crisis?

What kind of intellectual strangle lock do these regulators have on a Financial Times?

Europe needs and merits someone better than Mario Draghi

Sir, when Guy Dinmore, Quentin Peel and Peggy Hollinger report” Mario Draghi poised for ECB job”, April 27, they refer to "his prominence as head of the Financial Stability Board”. Let me remind you that the most adequate name for that board would be the “Financial Fragility Board”. With their artificial and global regulatory construes they are introducing a fragility that has made and will make the financial system more prone to breaking. When you for instance build resistance against earthquakes, more than the basic strength of material you need to consider their flexibility.

Since Mr. Mario Draghi is one of those who so many years into this crisis has not yet understood the immense damage the regulators of the Basel Committee produced, when they considered the credit ratings for the capital requirements of banks, even though these had already been considered when the market and banks set their risk premiums, he does not seem qualified for such an appointment. A Europe that is so messed up because of the excessive build up of sovereigns and “triple-A rated debt, very much induced by the Mario Draghis of this world, needs someone better.

What about accountability? Giving him a promotion? Would you have made a Chamberlain with his “Peace in our time” the War Minister? I don’t think so! But, that indeed seems to unfortunately be the name of the game, in a world where the too big to fail banks are allowed to grow bigger still.

Wimps! Should our banks be as safe and useless as a mattress stashed away in Fort Knox?

In “Protecting finance from its demons”, April 26, you hold, we face the choice of “protecting the economy from finance” or “protecting finance from the economy”. May I ask, and what about finance helping the economy? Is that not what finance is supposed to be all about?

You quote Paul Tucker, the Bank’s deputy governor for financial stability saying that this “prevails where the financial system is sufficiently resilient that worries about bad states of the world do not affect the confidence of the system to deliver its core services to the rest of the economy”. Yeah, yeah, great sound bite, but… which are “its core services to the rest of the economy”? Mr. Tucker and his colleagues should first be clear about that, before regulating, so that our banks do not become some useless mattresses stashed away in a Fort Knox.

In the whole regulation literature produced by the global bank regulators we know as the Basel Committee, there is not one single word about the purpose of the banks, and anyone regulating something without defining its purpose, has no idea about what he is doing.

PS. The original link to this FT editorial does not appear any longer.

To achieve a sensible pricing of risk, you need to avoid any opaque risk discrimination

Sir Francesco Guerrera writes “In the post-crisis world, risk must be sensibly priced” April 26 and of course he is right, because it was not sensibly priced risk that created the current crisis.

It would seem though that Guerrera might not understood it all yet, because, as he discusses the need for margins to be put up by corporate counterparties when dealing in derivatives with the bank; and he accepts that “banks adjust the cost [of derivatives] based on the credit profile of the buyer”, he does not mention the certain risk that margin requirements, if applied in any discriminatory way, will make the price discovery of risk, much more opaque, and wrong.

We need to bring the credit ratings down to earth

Sir, John Authers´ “Easter parade of worries over Uncle Sam´s credit”, April 24, refers to the rating agencies wielding “real power”, but then describes that power only in terms of “affecting the rates at which companies or countries can borrow”; without making any reference to what has yielded the rating agencies the excessive power they posses, namely that the ratings also play a role when defining how much capital a banks needs to have.

It is that the credit ratings are given a double consideration, which has elevated their importance to the skies and brought us the current crisis. Let´s go back to Basel I days, or better yet Basel 0, set one single capital requirement for all bank lending; and then we have brought down the opinions of the rating agencies to something more in harmony with what they really are, a bunch of fallible humans who, had they been laboratories, would have long ago been sued out of the waters for their harmful mistaken opinions.

If not the dollar, then no other fiat currency either

Most of the world´s concern with the dollar is in fact not with the dollar itself but more of the “if not the dollar then what?” type, since, if looking at the forest and not the trees, makes it clear that no country´s fiat money stands a chance to survive a dollar failure. That is how globalized we have become… that is why some non US are even toying with the notion of supporting a tea party, no matter how doubly distant they feel from some of those partying there … no matter they serve corn on the cob instead of cucumber sandwiches… and others buy gold.

Let us suppose the US officially presented to the world the possibility of a 40% haircut on its debt. Would that be the same as an Argentinean haircut? No way José, since the day after the US would again find unwilling willing takers of US debt, and at quite low rates, because it would think that the day after the US imposed some debt ceiling that really became a real roof.

China, India? Good luck Warren Buffett, but we do not have all that much money to afford the luxury of trying.

In truth, if we would still use fiat money, then the Dollar II would still be better positioned than all other.

The Torturer and the Haircut

Sir, your “Europe must use borrowed time well” April 21, reminds us of how scary it is when we see someone calculating with complex formulas a sustainable debt level of a sovereign; just like a refined torturer calculating the pain tolerance of the tortured, to keep the poor bastard from passing out.

Also, who are the least hard for politicians to order a haircut? The sovereigns, their creditors the banks, the current voting tax payers, or the future generation of voting tax payers? Is it so hard to guess?

As always, the race is between postponement and realities-catching-up. As always, we are looking on with masochistic fascination, praying and biting our nails.

If you thing “sustainability” is important, propose something that impacts it sustainably.

Sir, if you really cared so much about “Sustainability” in finance, as you want for the world to see you do, then you would be arguing for capital requirements for banks based on sustainability ratings, instead of the useless credit ratings that distort and leads our bank off into productive nowhere.

If you are short on capital you naturally go where less of it is needed.

Sir, John Plender in “Why the rush by UK banks into property needs watching” April 20, asks “Why the enthusiasm for an asset class that has been a graveyard for lenders in countless busts?” The simple answer is that going there they are allowed to have less capital than when lending to those officially considered more risky, like the small businesses and entrepreneurs.

Plender also quotes Adrian Blundell-Wignall of the OECD arguing “that the Basel risk weighting formulas are based on a mathematical model that does not penalize portfolio concentration”. That is indeed correct, but much more important is to notice that those risk-weights encouraged excessive concentrations… and even the safest of havens can become overcrowded.

What the “mathematical model” (big words to describe nonsense) used by Basel calculating the risk-weights left out was the fact that the banks were already looking at credit ratings when setting their risk premiums and corresponding interest rates. It might seem a small mistake but it has created thousands times more losses than when a technical confusion derived from simultaneously applying metric and English measures made the Mars Climate Orbiter spaceship miss Mars.

Are we to allow Solvency II do to our insurance companies what Basel II did to our banks?

Sir, Paul J Davies in “Capital rules raise fears over insurers’ risk appetite” April 20, though correct in so many aspects sadly makes precisely the same mistake that the Basel Committee did when they established their capital requirements for banks based on officially perceived risk. He says “The higher returns on risky assets ought to be diluted by a higher capital charge in perfect proportion. That ignores that the “higher return on risky assets” he sees is the result of the market already having looked at the same risk information available and adjusted their risk-premiums and interest rates correspondingly.

Is it not bad enough that Basel II drove our banks excessively into what was officially perceived as not risky assets, carrying no capital at all, to now have Solvency II doing the same of our insurance companies?

Though the outlook is for hurricanes you have not yet seen the roofs flying, just yet.

Sir Martin Wolf, as an economist, stubbornly refuses to even consider those financial regulations, or may I dare to say global capital controls, that directed the worlds capital flows so excessively towards creating excessive debts in areas that were officially perceived as not risky, like the US, UK, Greece and the triple-A rated securities in this world. “Faltering in a stormy sea of debt” April 20. Since what the regulators are currently doing is trying to correct for that mistake, instead of correcting the mistake, we should expect a serious case of regulatory overmedication to also strengthen the storms that await us.

Let me take the opportunity to comment on Standard & Poor’s recent grim outlook for the US debt. Given that the US can always by printing repay its debt in nominal terms that must mean that S&P is, I believe for the first time, considering the possibility of collecting on loans in real terms.

Stealing and rent seeking has nothing to do with “social contracts”

Sir, your reporters, on the issue of fuel subsidies, April 19, wrote: “For oil producers such as Venezuela… fuel subsidies are part of the social contract and relatively manageable.”

Venezuela sell’s its gasoline locally for less than 2 US$ cents per liter. Your reporters should never ever confuse blind and irresponsible rent seeking by which, those in power, usually with cars, rob the implicit value of the petrol or gasoline, from those poor and not in power, usually without cars, with any type or form of “social contract”.

Not “bad” bank assets, bank capital heavy assets

Sir Francesco Guerrera and Patrick Jenkins report “Citi in sales of bad assets as Basel III rules loom” April 19. The titling is not that accurate since what is being done has very little to do with whether the assets are good or bad and all to do with whether they require more or less of those capital requirements that Basel tied up our banks with when the regulators decided to become risk-managers themselves. What a sad world!

And how sad too that a Financial Times have yet not said one word after so many letter I have written about that huge regulatory mistake the regulators committed in Basel II when considering the credit ratings for setting the capital requirements even though these credit ratings had already been considered by the banks and the markets when setting their risk-premiums and interest rates.

How long are regulators allowed to persist with their foolishness?

Sir I refer to so many news, about when a downgrading of credit ratings cause much havoc, like for instance Nicole Bullock´s report on April 19 “Muni bond risks grow after S&P’s DeKalb cut”.

It is high time to ask our regulators some basic questions like when they believe banks incur in the risk of lending, when they make a loan or when the borrower is down-rated. Of course, when they make the loan!

And so I ask how long should we allow the regulators to insist on a foolish system with retroactive corrections, based on credit ratings, and which makes the difficulties encountered with a client that turned out to be worse than he was originally rated even more difficult, and not a system of upfront capital requirements independent of ratings.

The truth about the crisis that the different silos, including FT’s, does not want or cannot see.

Sir, if all sovereign and private bank clients were paying the banks exactly the same risk-premiums, then the risk-weights used in Basel II to apportion the basic capital requirements for banks according to the various categories of credit ratings could have been right. But, they don’t!


The banks and the markets already incorporates in the setting of their risk-premiums the risk information provided by the credit rating agencies, and so when the regulators also used the same credit ratings for setting their risk-weights they made these ratings count twice. It was a huge mistake that resulted in:

1. The setting of minimalistic capital requirements that served as growth hormones for the ‘too-big-to-fail’.

2. That banks overcrowded and drowned themselves in shallow waters, whether of triple-A rated securities backed with lousily awarded mortgages to the subprime sector, or of equally or slightly less well rated “rich” sovereigns, like Greece.

3. A serious shrinkage of all bank lending to small businesses and entrepreneurs as lending to these generated, in relative terms, much higher capital requirement, which made it difficult for them to deliver a competitive return on bank equity.

With Basel III, regulators might be trying to correct for this mistake, instead of correcting the mistake. In other words, the Basel Committee would be digging us deeper in the hole where they placed us.

Ireland’s taxpayers?... and what about holding the Basel Committee accountable?

Lorenzo Bini Smaghi argues that since countries like Ireland took decisions aimed at ensuring a more benign environment for their financial sectors, and thereby had representation, “Ireland’s taxpayers must take their share of the pain” April 13.

What on earth is he talking about? This crisis resulted 99 percent because the Basel Committee diluted the basic capital requirements for banks by arbitrarily establishing some minimalistic risk-weights based on the information provided by the credit rating agencies, even though this information had already been cleared for in the market, when setting the risk-premiums. What representation did Ireland and Irish taxpayers have in such a foolish decision of a global rule setting body?

Mr Bini talks also about “accountability” and I just have to ask him where there is any sign of the Basel Committee being held accountable. From what we see, after failing so utterly with Basel II, they are now happily proceeding to dig us even deeper into the ground with Basel III as if nothing happened with their principal regulatory paradigm.

The risk-weights is what most is causing the tumor growth of the ‘too big to fail’

Sir, John Kay in “The nightmare of taking on “too big to fail” April 13, questions the overall adequacy of a 10 percent capital requirement for banks, ignoring that this will much depend on what risk-weights are applied. In this respect we should not ignore that a meager 6 percent capital requirements, applied across the board for all assets, would produce a far smaller too-big-to-fail bank, than a general 10 percent capital requirement that is allowed to be diluted by applying risk-weights for different assets. Take away the risk-weights that the regulators arbitrarily set and which also distort as they take in account what the market has already accounted for, and you will take away the most cancerigenous element that causes the TBTF tumor.

Let banks capitalize on Darwinians benefits too

Sir, John Kay in “The nightmare of taking on “too big to fail” April 13, mentions that Britain’s Independent Banking Commission “has also recognized that the objective of regulation is not to prevent failure” Below how I phrased that in May 2003, when addressing some hundred regulators at a risk-management workshop at the World Bank.

“If the path to development is littered with bankruptcies, losses, tears, and tragedies, all framed within the human seesaw of one little step forward, and 0.99 steps back, why do we insist so much on excluding banking systems from capitalizing on the Darwinian benefits to be expected?

There is a thesis that holds that the old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, was much wiser than today’s no burning at all, that only allows for the buildup of more incendiary materials, thereby guaranteeing disaster and scorched earth, when fire finally breaks out, as it does, sooner or later.

Therefore 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. But, then again, I am not a regulator, I am just a developer.”

Extracted from Voice and Noise 2006

FT, what is it that you see that I cannot see? Please tell me. I beg you!

Sir if you are capable of understanding that “a bank holding company might have an incentive to seek out riskier assets to compensate for higher equity requirements” how come you cannot understand that it is precisely the same to say that “a bank holding company might have an incentive to excessively seek out the assets that generate the lower capital requirements”, like the triple-A rated or the “rich” sovereigns, and which is what has caused this crisis. “An opening shot at bank reform” April 12.

When the Basel II regulators assigned a 20% risk for the triple-A rated and for slightly less well rated “rich” sovereigns, that meant that they allowed the banks to leverage 5 times more their capital, in order to obtain what was already risk-adjusted interests, when compared to what they could leverage if lending to the normal mortals, like the small businesses or entrepreneurs. Can´t you see it? Or is it something you see that I don´t? If so please tell me. I beg you.

If you account for perfect information twice, you are valuing it imperfectly

Sir, suppose you have perfect credit information… what should you use it for? To set the interest rates you will charge, or to set the capital reserve you should have? If you use that perfect information twice you are valuing it imperfectly. That is the fundamental flaw with the main pillar of the Basel Committee regulations. Because it makes for the same risk information to be accounted for twice, it introduced a totally unwarranted bias in favor of what is officially perceived as “not risky” against what is officially perceived as “risky”.

Unless someone orders that the same interest rate should apply to all borrowers, which I am of course not proposing, then the only valid conclusion is that we must have one sole capital requirement for all lending.

By the way this does not exclude the possibility that the banks need to report what exposure they have to the different official credit risk categories, so as to provide the market a better way to gauge the risk taking of the bank. What happened now, with risk-weighted capital ratios, was that the banks could take on much more risk than what the market (and the regulators) really saw.

To rebalance the flows we need to rebalance the regulations.

Sir, Martin Wolf in “Waiting for the great rebalancing”, April 6, writes about “an ‘uphill’ flow from poor to rich countries, predominantly into supposedly safe assets”. According to Wolf, Mervyn King, the governor of the Bank of England, explains the flow as resulting from “export promotions… a decision to accumulate foreign reserves… and the combination of low levels of financial development with inadequate social safety nets”.

May I suggest that Mr. King, perhaps because of some conflict of interest, left out the most important explanation, namely the incredible push the importance the credit ratings got, when the regulators based the capital requirements for banks on these. All over the world there was only one message going out loud and clear, which was that the credit rating agencies knew what they were doing, and that if you want lower risk you should better follow their triple-A ratings. That the AAA ratings are highly correlated with rich countries, well that is a quite different issue.

Let us hope now that whatever rebalancing must come will include the rebalancing of the regulations of banks, so as to get rid of that arbitrary discrimination in favor of those who are perceived as not-risky and who are already more than sufficiently favored by the markets.

Blefuscu’s and Lilliput’s bank regulators at war

Sir, John Plender’s “UK’s banking climate is making the US look attractive”, April 6, refers to the debate about the basic capital requirements for banks, whether the 7 percent proposed in Basel III or the 16-20 percent championed in this case by David Miles of the Bank of England.

Pure Blefuscu and Lilliput war material. The current crisis had nothing to do with the basic capital requirements and all to do with that these where applied in such a way that discriminated incredibly much in favor of what officially was perceived as having a low risk of default, the triple-As, even though the market already discriminated in its favor.

Three years into the crisis and regulators do no still know what hit them? How on earth can we allow the regulators to produce a Basel III after that incredible box-office flop of Basel II?

“We need to learn how to fail”

Sir, in the first session of IFC’s and World Bank’s “Building Competitiveness” FPD Forum 2011, April 4, titled “Youth, Employment, and Revolution in the Middle East, Amr Shady, the CEO of T.A. Telecom of Egypt, said something like: “US entrepreneurs know how to fail, our entrepreneurs need to learn the skill of failure, so to have access to the resources we can pivot into successes”... That should be applicable to South Africa too.

That is a message that should urgently be conveyed to the Basel Committee for Banking Supervision and the Financial Stability Board where they keep insisting on raising the incentives for banks to lend to what is officially perceived as not risky and to avoid like plague what is officially perceived as risky. With it, instead of having the banks fish for something important and productive in risky deep waters, they make them waste their time fishing in unproductive triple-A rated shallow waters... where they nonetheless overcrowd and drown.

PS. Please free us from imprudent risk aversion 

If Solvency II would be something like Basel II

Sir, in “EU reform plan alarms insurers” April 5, representatives of insurance companies express some reservations about the regulatory package known as Solvency II coming in force at the start of 2013... and I wonder whether some of the insured would have reasons to be concerned too.

I mean if Solvency II for the insurance companies follows the principles of the Basel II applied to banks, then the capital requirements for insurance companies for insuring those perceived as less healthy will be higher than those required when insuring those perceived as much healthier, independently from the fact that insurance companies already charge higher premiums to the first group.

Has anyone heard about some health rating agencies positioning themselves for business?

Where do you get the “more productive” from Mr. Barney Frank?

Sir, Barney Frank in “Greenspan is wrong: we can reform finance” April 4 writes “This combined with the new Basel III capital standards and the ability of regulators to insist on even greater capital, will ensure more prudent and more productive lending”.

One could argue that it might indeed lead to more “prudent” lending, though in this world of Potemkin credit ratings there is of course no guarantee of that. But, what seems a too gigantic intellectual leap is to believe the resulting lending to be more “productive”. There is absolutely not one single word in the whole Basel Committee for Banking Supervision literature that connects the capital standards to the term “productive”, as they are exclusively connected with avoiding defaults. The Basel capital standards are stooped in the banking traditions of providing the umbrella on sunny days and taking it back when it rains.

By the way, it is funny, or sad, to read a US Congressman Barney Frank referring to Basel as a sort of an essential element in bank regulations, and then consider that Basel is not mentioned even once in the over 2000 pages of Dodd-Frank Act.

The Basel Committee makes a shocking confession!

Sir, the Basel Committee for Banking Supervision, speaking for all sophisticated bank regulators around the world, issued today an urgent statement regarding the discovery of a fundamental mistake committed in Basel II and which they now understand was responsible for causing the current financial crisis.

The mistake was that though the markets and the banks were already incorporating the information about the possibilities of default that were contained in the credit ratings when calculating the corresponding risk premiums to set interest rates for their clients, the regulators based the capital requirements for banks on exactly the same credit ratings, and so, unwittingly, accounted for said credit information twice.

The result of it was, of course, the excessive financing of everything that was officially deemed as having a low risk of default, like whatever had swell ratings like Greece and securities backed by lousily awarded mortgages to the subprime sector; and the insufficient financing of whatever was officially deemed as more risky, like the small businesses and entrepreneurs who are vital for maintaining that dynamism of the economy that creates jobs.

The Basel Committee expresses its most sincere regrets for such a mistake and promises to take immediate corrective action.

PS. April Fool´s joke disclaimer: Sorry, unfortunately, the Basel Committee and the sophisticated bank regulators, three years into a crisis of its own making, are still not (publicly) aware of their mistake.

The Independent Evaluation Officer of the International Monetary Fund has recently in an Evaluation Report come to the conclusion that, for IMF at least, “the ability to correctly identify the mounting risks was hindered by a high degree of groupthink…” The reason why the truth of what happened does not come out must probably now be attributed to group-interests.

SDR are just a sort of “In Gods We Trust”

Sir, the Special Drawing Rights of the International Monetary Fund SDRs, although their issuance can provide liquidity, is not really a currency; it is a basket of currencies, a sort of “In Gods We Trust”. If that precise SDR basket became dominant in the market I shiver at the possible speculative frenzy that would happen if the market suddenly perceived the Executive Directors at the IMF were thinking of proposing a different currency composition of the SDR.

I say this because in a world with so many fundamental and real problems I cannot be absolutely 100 percent sure that Joseph Stiglitz “The best alternative to a new global currency”, April 1, is not the most delicate or subtle April fool’s joke ever written. If so... chapeau! If not... well then we would have to see whether the Central Banks of those currencies represented, would really want to relinquish part of their authority to the IMF.