December 29, 2011

Has FT just turned into an Occupy Wall-Street extremist?

Or are you just expressing pent-up jealousy about banker’s bonuses? 

In “Restoring faith in the banking system” December 29 you write “Prior to the crisis, bankers garnered great fortunes by loading individuals and companies with excessive and unnecessary debt, or by churning investment portfolios to extract transaction fees.” Frankly, what on earth does that have to do with causing the current crisis? 

We are not in a mess because of the banker having made to much money on that! We are in a mess exclusively because the bankers built up excessive exposures to what was ex-ante officially perceived as not risky, like triple-A rated securities and “infallible” sovereigns; and that happened exclusively because silly regulators allowed the banks to do so against very little or no bank capital at all. If you want to search for the source of income which originated immense bankers’ bonuses, then look no further than to the outrageous leverages allowed for some assets. 

How on earth will the Western World be able to restore its faith in the banking system with editorials like this which seem to indicate that our only possibility is to sit down and wait for the new good bankers?… like waiting for a New Soviet Man. 

Want to restore faith in the banking system? Throw out those who produced Basel I and II, instead of allowing them to concoct an even more dangerous Basel III. 

PS. You write “The asymmetry of risk and rewards in banks has led to poor outcomes for society” and I must ask, what about the information asymmetry powers you exercise in favor of the opinions of those you want to favor? Do we have to occupy FT too? 

December 21, 2011

US, and the Western World, is becoming “the land of the risk-adverse”.

Sir, I, as most humans, am extremely risk-adverse, and that is why I have always appreciated the role of designated risk-takers that the banks perform for the society. We cowards were used to worry our bankers were too cowards to, with their lending of the umbrella while the sun shines and taking it away when it rains. But then came the bank regulators and with their capital requirements that discriminate fiercely based on perceived risks made it all so much worse. 

Martin Wolf comments on the “Great Stagnation” by Tyler Cowen of George Mason University, December 21. What they both fail to identify is that requiring banks to have a lot of capital when the perceived risks are high, and allowing them to hold minuscule capital when the perceived risks are low, stacks the returns on bank equity against what is perceived as risky. And that has nothing whatsoever to do with what made “the land of the brave” big. The US is now, as is most of the Western World, becoming the land of the risk-adverse. 

Not taking risks is about the most dangerous things a society can do… as the only thing that can result from that is the overcrowding of the ex-ante safe-havens

December 13, 2011

Nothing ‘creative’ about destruction of lending to start-ups

Published in FT, December 14, 2011

Sir, Ed Crooks writes that start-up businesses are crucial for creating US jobs but their dwindling birth rate is stalling hopes of recovery (“Cycle of ‘creative destruction’ loses momentum”, Is America working? December 13).

Lending to start-ups, as something perceived as “risky” for the banks, even though its absence would of course be much riskier for the world at large, requires a lot of that bank capital that is so scarce now; especially after the regulators allowed the banks to lend to what was perceived as not-risky, with little or no capital at all.

In Schumpeterian terms, one can say that bank regulators are engaged in simple and plain vanilla destruction.

December 12, 2011

The Western World is in a freefall, and no one is discussing the reason why

Simplified, if the cost of funds for a German bank was 2 percent; if it wanted to earn a 1.5 percent margin; if the cost of analyzing the credit worthiness of a German small business was 1 percent; and if the risk that the borrower would default was perceived as 3 percent, then the German bank would charge the German small business an interest of 7.5 percent. 

And if the cost of funds for a German bank was the same 2 percent; if it wanted to earn the same 1.5 percent margin; if the cost of analyzing the credit worthiness of Greece was zero, because that is paid by Greece to the credit rating agencies to do; and if the risk that Greece would default was perceived as 1 percent, then the German bank would charge Greece an interest of 4.5 percent. 

If the German bank was required to have about 8 percent in capital against any loan, and could therefore leverage its capital about 12 times, the bank could expect to earn 18 percent on its capital when lending to a German small business or when lending to Greece. 

But that was before the bank regulators of the Basel Committee intervened and messed it all up. 

These regulators, ignoring the empirical evidence that bank crisis never occur because of excessive exposures to what was considered risky but only because of excessive exposures to what was considered as absolutely not risky, with their Basel II, told the banks “You German bank, if you lend to a “risky” German small business you need 8 percent in capital, but if you lend to an infallible Greece you only need to have 1.6 percent in capital”. 

And because that 1.6 percent allowed for a leverage of more than 60 times when lending to Greece, the German bank, though it still could earn a decent 18 percent on its capital when lending to a German small business, suddenly could expect to earn 90 percent on its capital when lending to Greece. Hell, the German Bank could even afford to lower the interest rate it charged Greece and still earn more when lending to Greece than when lending to a German small business. 

And of course the German bank, as did all banks in the Western world, started running to the officially perceived safe-havens of Greece, Italy, Spain, triple-A rated securities and others, where they could earn much more; and of course the governments of the safe havens could not resist the temptations of cheap and abundant loans, and all these safe-havens became dangerously overcrowded… while the small German business found it harder and much more expensive to access any bank credit… and while the too big to fail banks grew even bigger.

And, many years into a crisis that has the Western World in a freefall, this issue is not even discussed, and the same failed bank regulators are allowed to work on Basel III, using the same failed loony and distorting ex-ante perceived risk of default based capital requirement discrimination principle.

Hell, even the Financial Times has decided to ignore the hundreds of letter I sent them about it, and this even when they know they published two letters of mine that clearly warned about what was going to happen. In January 2003, “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” and, in October 2004, “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. 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 (sovereigns)? 

Occupy Wall Street? No! Occupy Basel! Hell, occupy the Financial Times too!

December 07, 2011

The blame lies squarely with the regulators not with the credit rating agencies

Sir, Quentin Peel in “Agency’s debt warning provokes angry response” December 7, reports that Christian Noyer the president of Banque de France held that “the rating agencies were one of the motors of the crisis in 2008. 

Mr. Moyer should know better, the motor of the crisis, were the ridiculous low capital requirements for banks allowed by his regulating colleagues in the Basel Committee based on the credit ratings, as if these were infallible and as if doing so would not incentivize the growth of dangerous exposures to what was ex-ante perceived as not risky. 

In January 2003, while being an Executive Director of the World Bank, the Financial Times published a letter where 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”. But it looks like Mr. Noyer and his colleagues did not know that!

December 05, 2011

We were thrown back into the Dark Age... by the Basel Committee

Sir, Tony Jackson’s “Why talk of a coming Dark Age is a touch overdone”, December 5, reminded me of Peter L. Bernstein who in Against the Gods (John Wiley & Sons, 1996) wrote that the boundary between the modern times and the past is the mastery of risk, since for those who believe that everything was in God’s hands, risk management, probability, and statistics, must have seemed quite irrelevant. 

Ironically, we might now be thrown back into the Dark Ages, because of bank regulators who thought themselves Gods, and assigned minimal or even zero percent risk weights, those used when determining the capital requirements for banks, to what they thought were the infallible, the triple-A rated and the solid sovereigns.

Europe, the Basel Committee should and needs to be blamed for the crisis.

Sir, Wolfgang Münchau goes to the core of the European issue when he writes that its leaders’ narrative, which reduces the crisis to a failure of fiscal discipline, is probably the underlying reason why all their crisis resolutions efforts have failed so far”, “France and Germany look set to fudge it yet again”, December 5.

Indeed, had the European leaders understood two letters that I wrote and were published by FT, the narrative would be quite different, in fact Europe could perhaps not even be facing this crisis.

The first letter, January 2003 said “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”. The second, October 2004, “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. 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 [sovereigns]?

From the content of those two letters it is easy to understand that no matter what intrinsic and real problems the eurozone has and no matter the natural fiscal indiscipline of politicians in general, Europe would not have faced this crisis had the bank regulators in Basel known better.

December 02, 2011

Small and frequent tremors might help to keep the big one away.

Sir, Roger Altman concludes “We need not fret over the omnipotent markets” December 2, with “There may be more frequent market crisis. We should not rush to conclude that they will end in tears”. I would word it differently, the more frequent the market crisis, the less the probability it will end in tears. 

In May 2003, as an Executive Director of the World Bank (just 1 of 24) I made the following comment at a workshop for bank regulators at the World Bank: “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” 

In my country, Venezuela, when it trembles just a little, many of us applaud, because we feel that small tremors might help to keep the huge ones away.

December 01, 2011

Right or wrong should not be a calculated risk.

Sir, John Gapper should be congratulated for clearly opining that “Judge Rakoff is just doing his job”, December 1. Judicial deal makings, aka settlements, introduce risk calculations in matters of what is right and what is wrong, that can rot even the strongest society. 

I just wish there would also be a Judge Rakoff out there who would be willing to question the right of the regulators to place a layer of arbitrary discrimination of those perceived as “risky”, on top of the natural market discrimination that already exist against them. In other words, what constitutional right do regulators have to decide that a bank needs to hold substantial capital when lending to a citizen, but needs no capital at all when lending to an infallible sovereign?