July 28, 2011

Even the safest haven could become dangerously overcrowded

Sir, Richard Milne’s “Beware of safe havens when seeking next financial crisis” July 28, makes reference to the truth that “Risky assets do not cause crises. It is those perceived as being safe that do” and to the immense regulatory bias in favor of the “not-risky”, especially the good sovereigns and the triple-A rated, and against the risky, like the small businesses and entrepreneurs.

(Mr. Milne must know, because of the emails he has received, that those arguments is part of the criticism that, at no irrelevant personal cost, I have for many years voiced quite lonely about the bank regulations that came out of Basel II. In this respect I must say that I am indeed surprised and disappointed that he makes no reference to that in his article. Had I been a PhD from his own Alma Mater, he would not have dreamt of ignoring me.)

His analysis is quite accurate and so I guess the cat is out of the bag. How on earth can the bank regulators explain what they did pushing dangerous “safe assets” and, especially, how can they defend that they mostly want to insist in doing just the same?

That said the article fails to point out the real fundamental mistake committed by the regulators and which is that they blithely ignored the fact that the markets already clear for the safe-haven perception when it sets the risk adjusted interest rate. And so, when the regulators also based their capital requirements for banks on exactly the same safe-haven perception, they turned what is a natural and reasonable pursuit of a safe haven, into an unnatural and unreasonable stampede in search of a safe and profitable haven… and even the safest haven can turn into mortal traps, if they become overcrowded. Milne mentions “Follow the debt” as to where investors should be looking for trouble. I have since 2003 told regulators “Follow the AAAs” as to where the next bank crisis will be.

Milne quotes Professor Geoffrey Wood of Cass Business School calling the “push by regulators for banks to own sovereign debt” as “premeditated theft”, but in my AAA-Bomb blog I have for a long time called sheer communism.

Finally what Milne also fails to point out, perhaps because the implications are so frightening is that, given that huge regulatory bias in favor of sovereign debt, we really do not know what the underlying real interest rates of public debt are… and so we are in fact flying blind with dysfunctional instruments.

July 27, 2011

Alan Greenspan, silently fade away, please

Sir, Alan Greenspan writes “Had banks and other financial entities maintained adequate equity capital-to-asset ratios before the 2008 crash, then by definition no defaults or contagion would have occurred as the housing bubble deflated…. Bank management, currently repairing their flawed risk management paradigm…”, “Regulators must risk more to push growth” July 27. What on earth is Greenspan talking about? 

If the regulators, like Greenspan, had not decided that the capital requirements for the banks were to be set in accordance to the perceived risk of default of each individual asset, then those triple-A rated securities backed with lousily awarded mortgages to the subprime sector, and which in essence became to coffin of the housing bubble, would not even have existed. 

Of course any safety buffer comes at a cost, but also, if that cost is not shared equally, the final real cost could go up exponentially. In this case the regulators, by discriminating against those perceived as “risky”, like the small businesses and entrepreneurs, have, just like the Lilliputians tied up Gulliver, effectively tied up the Western World in an arbitrary and defeatist risk-adverseness, and that we must urgently break away from. 

Greenspan, as the other regulators, after what they´ve done and in much are still doing, have no right to sermon anyone about the need of risk-taking. He, for his own good, should just do as old soldier are said to do… silently fade away, instead of hanging around trying to impose on history their version of their Basel-Waterloo. I hold this because in order to understand the real need for risks, you have to be able to understand the real dangers of risk-aversion.

July 25, 2011

The “arbiters under fire” should be the bank regulators.

Sir, unfortunately, Aline van Duyn and Richard Milne, in “Arbiters under fire”, July25, fail to clearly identify the reasons why the current bank regulations based on credit ratings are so utterly wrong and make a decoupling such an urgent matter. Those reasons are in short the following: 

1. The market already considers the credit ratings when setting the risk premiums for a borrower which means that also using the same ratings when setting the capital requirements for banks give these ratings an exaggerated weight. Any information, exaggeratedly considered, is made wrong even if originally right. 

2. Regulators do not need to be concerned with credit ratings being right they should only worry about these being wrong. In this respect designing capital requirements for banks that are based on the credit ratings being absolutely right is absolute madness. 

3. Heisenberg´s uncertainty principle coming into play… the more precise you try to measure the creditworthiness of a borrower the more you might affect that same creditworthiness. 

4. The more you try to assure yourself the credit rating agencies perform their duties right, the more you are bound to trust them and consequentially the more fragile will the resulting financial system be. 

I am and have never been a bank regulator, but March 2003, in a published letter to the Financial Times I wrote “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds”. Those arbiters who should really be under fire are the bank regulators.

July 22, 2011

The Dodd-Frank Act stays stubbornly on the wrong course towards the regulators no-risk Utopia.

Sir, Barney Frank writes in reference to the Dodd-Frank Act that “it allows financial institutions to perform vital of accumulating capital and making it available to the productive elements in our society, while minimizing the likelihood of irresponsible practices that contribute little to productive economic activity”, “We are on course to stop a new financial crisis” July 22. 

That is not true. As long as regulators keep indulging in that irresponsible regulatory practice of arbitrarily discriminating, by means of different capital requirement for banks, in favor of those perceived as “not-risky”, like the triple-A rated and the “decent” sovereigns, and against those perceived as “risky”, like small businesses and entrepreneurs, nothing has changed, since the course towards the regulator´s no-risk Utopia remains steadfastly the same.

PS. Loony bank regulations explained in an apolitical red and blue!

Global warming and bank regulations

Sir, Philip Stephen in “Spasm or spiral? The west´s choice”, July 22, analyzes the current problems of the west. His analysis would have benefitted from a better understanding of global warming, because anyone looking for evidence of it, would have noticed that, for instance in terms of bank regulations, the parallel that used to define a banana-republic has move northward and has now reached Basel. 

I say this because it is evident that only banana-republic styled regulators could have concocted regulations that allow banks to hold extremely little capital when lending to what is perceived as not-risky, as measured by the officially outsourced risk-Kommissars, the credit rating agencies, when compared to the capital required when lending to the “risky”. 

Any non-banana-republic bank regulator would have known that the perceived risks of default were already cleared for by the markets, and that these capital requirements would only exaggerate the reliance on some ex-ante perceptions, which would of course have calamitous consequences, sooner or later. 

And, of course, the politics in the west, are also of course acquiring the standard characteristics of the banana-republics.

July 21, 2011

The “risky” must unite! Their risk-adjusted dollars should be worth just as much as others.

Sir, Joseph Stiglitz, in “Now the central bank must act” July 21, makes a reference to “risk-adjusted interest rate”. That is good. I thought our 2001 Nobel Prize winner might have no idea of such concept. And I say that because of the following. 

Stiglitz was the Chair of The Commission of Experts of the President of the UN General Assembly on Reforms of the International Monetary and Financial System. That Commission in its report of September 2009 and though finding that “Regulators need to be aware of distortions in capital allocation when provisioning and capital adequacy requirements do not accord well with actuarial risks”, fails to point out with sufficient clarity the odious and arbitrary discrimination present in bank regulations. 

According to Basel II, when $1 in risk adjusted interest rate is paid by highly rated sovereigns or a triple-A rated client, it can be leveraged on bank equity 62.5 to 1, while the same $1 in risk adjusted interest rate, when paid by less well rated sovereigns or “risky” small businesses and entrepreneurs, is only authorized to leverage bank equity 12.5 times to 1. It is inexplicable that regulators could find some risk adjusted interest rates are five times as good as others. 

The consequences of such regulatory madness, something which by the way is still going on, is to drive the banks excessively into the arms of what is ex-ante perceived as not-risky and away from what is perceived as risky; and that is why banks have drowned in exposure to triple-A rated instruments and “strong” sovereigns, and that is why bank lending to not so well rated sovereigns, small businesses and entrepreneurs, is either drying up completely or has to be done with much higher compensating interest rates. And that is plain crazy! 

The “risky” must unite! Their risk-adjusted dollars should be worth just as much as others’. 

PS. Loony bank regulations explained in an apolitical red and blue! http://bit.ly/mQIHoi

July 20, 2011

It was naïve bank regulators who never contemplated the possibility of the credit ratings being wrong.

Sir, bank regulators, not me, told banks that if they lent to sovereigns such as Greece, and could obtain a 0.4 percent risk and cost of transaction adjusted margin, then they would be able to earn 25 percent on their capital, because since they were only required to post 1.6 percent capital against that lending they could leverage 62.5 to 1. A small business or entrepreneur, since lending to them required 8 percent in capital, which allowed for a leverage of only 12.5 to 1, would have to pay 2 percent in risk and cost of transaction adjusted margin to the bank in order to provide the bank the same return on equity Greece did… for some time. Could there be any doubt of why banks went overboard lending to sovereigns, like Greece. 

John Kay, in “American lessons in how to run a single currency” July 20, answering “Why were interest rate spreads in Europe so small?” writes that “Many participants simply did not care about default possibilities”. That is not precisely right. The correct answer is that bank regulators did not care about the possibilities of the credit ratings being wrong, and therefore ordered no reserve contingencies for that event, which should of course have been expected to occur, sooner or later. In other words we had scandaliciously dumb bank regulators, but the worst, is that they are still allowed to regulate as if credit ratings can never be wrong.

I invite to see the loony bank regulations explained in an apolitical red and blue!

July 15, 2011

President Obama and the US Congress are debating the debt ceiling blindfolded

Sir, with respect to the current debate in Washington on lifting the US debt ceiling it is important to reflect on the fact that had there been no quantitative easing programs, or bank regulations that favor so much sovereign debt, the interest rates on US debt would have long ago been so much higher so as to make perhaps this debate completely superfluous. 

In essence, because of the interference, the President and the Congress they do not know what the real market interest rate is on the US public debt, and they are therefore debating blindfolded.


Sir, bank regulators who presume being able to make our banks safer by assigning different capital requirements on lending based on the perceived default risk of the borrower’s, apply voodoo-regulations. 

Because capital requirements make banks lend excessively to “good” sovereigns and to whatever had a triple-A rating, and they also keep us from perceiving the real market rates free of regulatory interference, we are now immersed in a huge crisis. 

That even FT keeps on trusting those same voodoo-regulators just shows the tremendous allure their voodoo-promises have.

PS. Loony bank regulations explained in an apolitical red and blue!

July 13, 2011

The vicious communistic styled bank-regulatory circle

Sir, John Plender, in “Time for eurozone policymakers to grasp the nettle” July 13, makes reference to a “vicious circle [between government and banks] at the heart of the eurozone”.

It is the vicious communistic styled bank-regulatory circle that has been present before our eyes for many years, of which I have written so often about, but that all, you included, preferred to ignore. That circle goes like this:

“I, the Government, commit to give the credit rating agencies strong evidences that I will support you, the big banks, so that you, the big banks, can get good ratings and raise funds cheaply.

And I, the Regulator, commit to set zero or very low risk-weights so that you, the banks, do not need to hold capital when lending to the government… of course for as long as you allow us to keep our jobs.

And you, the big banks, you just do as the incentives and the disincentives tell you to do.

And so we, the Government, the big banks and the regulators will live forever happy… until the scheme collapses and citizens and taxpayers find out what we have been up to.”

The conclusion, Governments and communistic bank regulators de-facto conspired and colluded in order to have our bank savings nationalized.

July 12, 2011

Bank regulators should read up on Heisenberg´s uncertainty principle.

Sir, Mark Carney and Fabio Panettame discuss the growing sovereign risk in “Why banks and supervisors must act now” July 12, since “the risk-free status of sovereign debt is now in question”.

Let us be clear, although concepts like “risk-free interest rates” and similar have been used as theoretical shortcuts for many practical purposes, the only ones who have ever formally awarded a risk-free status to sovereigns, or to anything else for that matter, are the bank regulators with their naïve zero percent weightings of sovereign, which imply that banks needed to hold no capital at all when lending to “risk-free” sovereigns. 

Those mindless capital requirements turned into the cancerogenous substance that originated this crisis. This is the mistake that must be first formally acknowledged by the regulators, so that we can then begin the adjustment process needed to grow out of this hole, instead of allowing the regulators to dig us even deeper into it.

What a pity that regulators never applied Heisenberg´s uncertainty principle, then they would have understood that just measuring the present credit ratings, even with the maximum precision possible, would determine the future credit ratings… in ways they were not capable of understanding.

PS. Loony bank regulations explained in red and blue! http://bit.ly/mQIHoi

July 07, 2011

The confidence in the dollar and USA’s defense capabilities are as connected as they can be

Sir, when Sebastian Mallaby in “American power requires economic sacrifice”, July 7 discusses USA’s spending on defense he fails to mention one important related question namely… how much of the world’s clearly extreme confidence in the US dollar depends on the US conserving at least the appearance of omnipotence? My answer would be “much much more than what you think… this is really terrain where realpolitik reigns”. 

In this respect any defense savings that comes, for instance, from not fighting useless wars will be acceptable, but any saving that leads to a perception of a lessened military readiness of USA would become extremely expensive, as a result of the dollar being worth less, or the markets demanding higher interest rates to hold US public debt.

“Unwittingly”… or simply stupidly and irresponsibly?

Sir, Charles Goodhart in “Basel marches down wrong path to tackle systemic risk” July 7, writes “Regulation may unwittingly have actually added to procyclicality and systemic fragility by encouraging similar behavior.” Seriously, where goes the border line between “unwittingly” and either stupidly or irresponsibly?

In January 2003 the Financial Times published a letter I wrote which ended with “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds.” And if that was clear to me, an ordinary strategic and financial advisor, that should have been perfectly clear to bank regulators. 

The regulators bet the health of the financial sector on capital requirements for banks based on the credit ratings being right, instead of taking the precautions to safeguard the financial system for when these ratings would, sooner or later, be wrong, and now we are all paying the price of it. 

Sir, if FT’s “Without fear and without favour” motto means anything to you why do you insist on being so lenient with the bank regulators? If it had been many bridges collapsing because of structural design flaws, I am sure you’d gone after the engineers responsible of that. Is it really so that a BP management can be held accountable but a Basel Committee not? It is truly amazing to see basically the same bank regulators keep on regulating with basically the same faulty paradigms... and an FT keeping mum!