More than how the credit ratings are determined, it is how these are used that is important.

Sir, Gene B. Phillips makes some very common sense comments on the proposals in Brussels concerning credit ratings and the credit rating agencies. “Don’t see rating agencies all as one” October 31. That said both Mr. Phillips and all those in Brussels fail completely to identify the most important changes that need to occur, with respect to how those ratings are used by the regulators.

The first is that regulators should concern themselves more with the fact that credit-ratings could be wrong, instead of betting it all, as they have done with the capital requirements based on perceived risk, on the human fallible credit risk raters being correct.

Second, the regulators should have no business using the credit ratings to play risk-managers for the world, by means of assigning the risk-weights that determine the effective capital requirement for banks. Instead they should concern themselves more with how the bankers act and react to the credit ratings.

If the regulators had done that, they would not have placed us in the hole we now are in.

Even in very shallow waters one finds regulatory arbitrage

Sir, Gillian Tett in “Baggy surf shorts, ´top freedom´ and the greater cover up” October 29, seems be confessing having engaged in regulatory arbitrage when admitting that she never wore bikini tops in the UK but rarely wore bikinis tops in France”. 

Since Gett, when reporting, seems to be quite happy in general with the rulings of the Basel Committee for Banking Supervision, and this even when those regulations have resulted in serious “malfunctioning”, I wonder whether she might be suggesting we could benefit from a Basel Committee on Beach Dress Code. 

Indeed, that could put some global order on this delicate issue? But also, and from a pure tourism competitiveness point of view, is it really fair that some beaches allow nudity and others do not? I know, I hear you loudly, it depends on the quality of the nudity, but still, could this not be an issue for WTO?

Mr. Obama. Does no one inform you about what is happening?

Sir, I read President Barack Obama’s “Now for a firewall to stop Europe’s crisis spreading” October 28, and it makes me wonder about who is supposed to inform the US President about what is happening, as obviously he is not. 

The financial fire started with the AAA rated securities backed with lousily awarded mortgages to the subprime sector, which had become too popular with the banks because, as these were officially perceived as not-risky, they could be purchased against only 1.6 percent in capital, which allowed therefore the banks to leverage their equity 60 times and more, something which of course must sound pure music for the ears of bonuses recipients. 

When that “not-risky” AAA was discovered to be very-risky, the banks had to immediately look for other officially “not-risky” and where they for instance found Greece, and swamped it with credits until Greece also drowned. 

And so now they are looking for new officially “not-risky” borrowers, who they can lend to without much scarce bank capital being required. Therefore, in the current fire, the flames are jumping from one officially-“not-risky” tree to another officially-“not-risky” tree and the last standing officially-“not-risky” tree will presumably be the US dollar and US public debt, but once the flames reaches there, it will also burn. 

The only way to start building a firewall, or to rebuild what has been burned already, is to allow banks to lend to the officially-“risky”, like those small businesses and entrepreneur s and which, as a class, have never ever been the cause of a systemic bank. Mr. President may I humbly remind you of that when the going gets risky, we need so urgently the risky risk-takers to get going.

Mario, for God’s sake, cut off the gas

Sir, Martin Wolf calls out “Be bold, Mario, put out that fire…” October 26. And I would call out “Mario, for God’s sake, first cut off the gas”. 

The capital requirements for banks based on perceived risk and the scarcity of bank capital is forcing banks out of anything that is becoming perceived as more risky and into what, for the time being, is still perceived as less risky. This is making the financing of the already perceived as risky so much more difficult while at the same tome creating the excessive exposures that will finally turn the last standing absolutely not-risky into the mother of all risks. Mario Draghi… or whoever… this gas that feeds the fire needs to be cut off, immediately.

On a side note since Martin Wolf writes “The capital to protect the European banking system from big defaults by important sovereigns simply does not exist” I cannot refrain from asking and whose fault is that? Could the regulators who allowed the banks to lend to sovereign against basically no bank capital have anything to do with that?

We do not need bold stability, we need bold risk-taking!

Sir, Barry Eichengreen and Raghuram Rajan in “Central banks need a bigger and bolder new mandate” October 25, write “Financial stability must become an explicit objective of central banks, along with price stability” and I just must ask… what is so bold about that? 

The authors also opine the world has been rethinking bank regulations to make economies more stable and that has clearly not been the case. Basel III like Basel II is built upon the pillar of capital requirements for banks that discriminate based on ex-ante perceived risk and it was precisely that which caused this crisis by means of giving the banks those fabulous incentives that led to the buildup of so dangerous excessive exposures to what was ex-ante perceived as not risky. 

No what we need is bold rethinking which starts by asking Central banks and bank regulators to dare to tell us what they believe the purpose of our banks is… since nowhere is that to be found. 

The Western World became what it is based a lot on the willingness of banks to take risks… and especially when the going gets to be risky as now and we need our risk-takers, like small businesses or entrepreneurs to get going, we cannot allow some nannies to turn our banks into veritable wimps in the name of some misunderstood quest for stability.

We are better off with free market vigilantes

Sir, George Soros plan to save the eurozone, October 25, includes for the banks “to take instructions from the ECB on behalf of governments” and “installing inspectors to control risks banks take for their own account”… so that “markets will be impressed”. 

Has Soros gone mad or is he just a communist? Are we supposed to be impressed by our banks being supervised by those who authorized these to leverage their equity more than 60 to 1 when lending to Greece… and now complain about the downgrading of the credit ratings of sovereign? 

Oh no, I think we are much better off with free market vigilantes.

PS. If you have not seen it, here´s a video that explains a fraction of the stupidity of our bank regulations, in an apolitical red and blue! http://bit.ly/mQIHoi

Is it not time for Euro II?

Sir, Wolfgang Münchau, in “How Europe is now leveraging for a catastrophe” correctly paints scenarios so horrendous we wish we all were just having a nightmare. 

What if we could wake up and find a Euro II, with all European governments, Germany included, having given their creditors exactly the same haircut, for instance 40 percent, and used the excessive hair-cut in some countries, to compensate for the insufficient haircut in others. 

Why not? The bank regulations that allowed European banks to lend to Greece against only 1.6 percent capital, an authorized leverage of 62 to 1, and which of course pushed to create Greece’s excessive debts, were not just a Greek idea but a shared European one. 

And if thereafter Europe helps to avoid a repeat… like for instance requiring bankers to put up exactly the same capital when lending to a European sovereign as it has to put up when lending to a European small business or entrepreneur… could we all not wake up, hurting a lot, but at least looking forward immediately to a better future?


PS. This was written before I knew of the Sovereign Debt Privilege that assigned all eurozone sovereigns a 0% risk weight even if they were taking on debt denominated in a currency that de facto was not their own domestic printable one. That was even crazier than Basel I or II.

Should Lord Turner have the right to throw the first stone?

Sir in your “Sustainable banks” October 22 you refer to a speech by Lord Adair Turner in which the chairman of the Financial Services Authority referred to the need for more transparency and less opaque pricing in banking. Right so, indeed… but is Lord Turner the right person to throw the first stone? 

The banks, when lending to those officially perceived as less-risky, like for instance Greece was perceived to be, were allowed to hold much less capital than when lending to those officially held as “risky”, like the unrated small businesses and entrepreneurs in the UK. 

How much in extra interest rates, or in less access to credit, have the small businesses and entrepreneurs have had to pay because of that? Fortunes! Has Lord Turner been transparent about that? 

Has Lord Turner been transparent about the fact that these misguided capital requirements, based on ex-ante perceived risks, are to blame for the current dangerous excessive exposures of banks to what was perceived ex-ante as not risky… and which might even have been turned into risky, precisely because of that regulatory nanny like anti-perceived-risk bias? 

PS. In case you need some reminders, here´s a video that explains a small part of the craziness of our bank regulations, in an apolitical red and blue! http://bit.ly/mQIHoi

Mr. Daniel Tarullo, first, stick to your area!

Sir, according to Robin Harding and Michael MacKenzie, in “Fed urged to weigh new moves to boost economy” October 21, Daniel Tarullo, whose “main area of focus is banking supervision and regulation rather than monetary policy” refers to that the US Federal Reserve “should consider large-scale purchases of mortgage backed securities if the economy does not improve”. 

As most of these securities have already seen their values adjusted in the market, I cannot see what good that would do… unless it is part of a huge plan of restructure all the underlying mortgages in accordance of their market value, not something totally senseless, but that would certainly require a major administrative effort and the consideration of moral hazard. 

Much easier it would be for Mr. Tarullo to concentrate on his area and push, for instance, for the immediate drastic reduction in capital requirements for banks, when lending to any business with total liabilities, for instance, below a level of 10 million dollars. That would be a good way to start alleviating the damages done to all small businesses and entrepreneurs by the fact that bank are allowed to lend to others perceived as not-risky, with much lower capital requirements. 

PS. In case you want more details, here´s a video that explains a small part of the craziness of our bank regulations, in an apolitical red and blue! http://bit.ly/mQIHoi

Hollywood would never have allowed Basel III after the Basel II magna flop

Sir, Kishore Mahbubani writes “Now we know that bankers produced no economic value. Instead they produced financial weapons of mass destruction that almost destroyed the world… European bankers… ignoring common sense… lent money to Athens on the assumption that Greece was as solvent as, say Germany”, “To become rich is great but to pay taxes is glorious”, October 21. 

That shows precisely what happens when the whole truth is not allowed to surface. It was the bank regulators who, when they allowed the banks to leverage differently their equity, by means of capital requirements based on ex-ante perceived risk, Basel II, which created what I have called the AAA-bomb… a truly massive weapon of mass destruction. 

It was those regulations which allowed banks to stock up on Greek sovereign debt against only 1.6 percent capital, a leverage of 62.5 times, while at the same time forcing banks to hold 8 percent when lending to small businesses or entrepreneurs, a leverage of 12.5 times, which gave the incentives to created the huge exposures to where all bank crisis occur, namely where the risk is ex-ante perceived as almost non-existent. It was those odiously distorting regulations that short-circuited the markets… and still keeps these from functioning. 

And because this is silenced, we allow the same producers of the failed Basel II, to produce Basel III, with only minor changes in the script. Friends, Hollywood would never allow such a thing. No, to be able to hold bank regulators accountable, that is what would be really glorious.

Even the most perfect monetary union would not withstand what attacked the Europe and the Euro

Sir, Steve Rattner holds with respect to Europe that “today’s crisis is structural… stemming from the euro’s flawed design. “Look to America for lessons in sharing currency” October 21.

The same week the euro was launched, in an Op-Ed, I predicted all the problems that could arise, with one notable exception. What I did not predict was the possibility of having bank regulators allowing the banks to leverage 62 times, at least, when lending to the European Sovereigns. And that my friends, is an attack that not even the most perfect monetary union could have defended itself against. 

To honestly recognize that is a must, in order for Europe to understand that it was not really the Euro or Europe which failed, to avoid the self-doubts, so as to be able to regain the confidence necessary to move the Euro and Europe forward.

The Basel bank reforms are just the continuation of a failure

Sir, Brooke Masters, while reporting “Countries fail to enact Basel bank reforms” October 19, writes: “Basel II is seen as having contributed to the 2008 banking crash by allowing banks to understate risk and hold too little capital against unexpected losses”. 

“Allowing banks to understate risk”? What is she talking about? If you read the risk-weights assigned by the regulators in the Basel II documentation you would find, for instance, a risk-weight of a mere 20 percent for a sovereign rated like Greece was during its build up of public debt, and which allowed banks to hold only 1.6 percent in capital when lending to Greece, and which therefore allowed the bank to leverage their capital 62 to 1 when lending to Greece. It was, without any doubt, the regulators who understated the risks! Don’t let them get away with that! 

It is also reported there that the “risk-based structure remains an essential tool of the stricter Basel III framework which includes higher capital requirements”. I do not want to be a party pooper but, let me remind you that the stricter and higher the basic capital requirements for banks are, the worse the dangerous distortions produced by the discriminating risk-weights. 

That some countries fail to enact the reforms is not that surprising, since what’s really incredible is that so many of these allow the same producers of the utterly failed Basel II to produce Basel III, while keeping the same script faults.

To stand a better chance of a sunlit future, we must pour sunlight on the truth.

Sir, Martin Wolf in “There is no sunlit future for the Euro” October 19, writes with respect to the banks holding Greek debt, “Fools who lent money, without asking questions, deserve to share in the pain.” That is undoubtedly true, but not focusing with the same impetus on the role of the regulations in building up Greece’s excessive debt, impedes the truth from coming out. The fact was that during the whole period of Greek debt buildup, banks were authorized, by Basel II, to leverage their capital 62.5 times to 1 when lending to Greece. That meant that banks were able to make immensely higher risk-adjusted returns on equity when lending to Greece as compared for instance when lending to a European entrepreneur; and that mean that Greece was required to pay lower interest than would have been the case without that regulatory interference with the market. 

Why do I after hundreds of ignored letters to the Editor of FT about this, insist on sending them. Simply because I know that the basic level of capital requirements for banks had nothing to do with this crisis, it was the specific capital requirements after the risk-weights that caused it. You might find a solution to a problem without knowing its real cause, but, it is so much easier when that real cause is recognized. So let us start by pouring sunlight on that! 

Wolf makes sensible suggestions for the increase by governments of the capital of banks. But, lowering the capital requirements for banks, especially when these are very high given the current scarcity of bank equity… could provide the same results. I am indeed curious as to why Wolf, who supports increased fiscal spending, even in light of huge public debt and enormous deficits, does not support allowing the banks to do their lending job easier.

A market adjusted very risky sovereign debt could be less risky than an AAA-rated sovereign debt.

Sir, Patrick Jenkins, Ralph Atkins, Peter Spiegel and Alex Barker in their “Europe’s banks face 9% capital threshold” write that according to the European Banking Authority’s board of supervisors, “banks should be made to raise their core tier one capital ratios – the key measure of financial strength even after absorbing write-downs on the value of their sovereign debt holdings.” 

Here are two questions: Should the credit rating be the same for a debt acquired at its nominal value of 100% than the credit rating of that same debt for someone who acquired it after for instance it has been discounted in the market for the credit risk to be worth only 50 percent? Or, could not a BBB rated debt acquired at 50 percent be safer than an AAA rated debt valued at 100 percent? 

In answering them, you will understand why the bank regulators have placed us in a hole and why they only keep digging us deeper in it. 

You can have the regulators measuring the risks, not recommended, or you can have the market doing that, but, what you cannot do, under no circumstances is to use and add those both measures simultaneously, and expect to obtain something reasonable. 

Stefan Ingves, defends a bank leverage of 33 times to 1. Why?

Brooke Master reported on October 10 that Stefan Ingves, the new chairman of the Basel Committee for Banking Supervision said: “It all boils down to capital ‘the ultimate brake’ If you don’t have enough simple common equity you will run into problems… If one looks at banking systems running into troubles, you almost always find ex-post facto that there was too much leverage”. On that we all agree. 

But then, ipso facto, Ingves says, “I find it hard to argue that you would need to go above leverage of 33 times”… and I, as a tax-payer, as one of the ultimate picker-uppers, or at least as a grandfather to one, must ask, why on earth that high? Why not 12 to 1 for example? 

If Stefan Ingves wants to defend a 33 times bank leverage he is of course in his right, but the least we can do is to ask him to explain the purpose of that. Is it so that banks can help us to create jobs? In that case would it then not be better to reserve that bank lending power for the small businesses or entrepreneurs, instead of wasting it on those perceived ex-ante as having no-risk and who, almost by definition, must be the largest suppliers of those dangerous “unexpected losses” he speaks of?

Or could it just be that the whole purpose of our banking system has been reduced to have banks making profits? If it is so, how vulgar of the regulators.

Jean Claude Trichet (and Mario Draghi) should not to be condoned by FT

Sir, you hold that “Trichet leaves Europe in his debt” October 8, as the responsibility for “reckless bank lending”, “rests largely with national politicians and policymakers”, and I must most firmly disagree. 

Jean Claude Trichet, as the President of the European Central Bank, must have been much more aware than the politicians of the existence of the outrageous bank regulations which allowed European banks to leverage 62.5 to 1 and more their equity when lending to almost any sovereign in Europe or investing in triple A rated securities… and he should be held accountable for that, something which equally applies to the incoming president of ECB Mario Draghi. 

If you harbor any doubts about what I am saying, just go back to the hundreds of articles between 2008 and 2010 where your own reporters spoke of the banks having reasonable leverage ratios, completely fooled by the zero and 20 percent risk-weights applied by regulators and that was hiding humongous risky bank exposures.