October 30, 2012

What would the consequences be for failed bank regulators if failed air-traffic controllers or cruise ship captains?

Sir, Kara Scannell, in the analysis on US housing, “After the gold rush”, October 30, with respect to the mortgage frauds writes: “Critics say that prosecutors have gone after easy targets – low level fraudsters - while going easy on Wall Street executives whose banks packaged billions of dollars worth of toxic mortgage securities.”

Indeed, and though it might be difficult to condemn any one of those executives for something illegal, by now we should at least have had on the web a list of the 20 most important toxic mortgage packagers, so as to be able to shame them.

But, that said, and since for me the subprime mortgage mess was a direct consequence of the regulators having created irresistible temptations for banks to holding any AAA rated securities, namely allowing them to hold these securities against only 1.6 percent in capital, the first thing that should have happened, is for these regulators to be sent home, in utter disgrace. But that has not happened.

Not only is the name of most regulators unknown to us, but some of them have even been put in charge of drawing up new regulations, Basel III, and others promoted, like for instance Mario Draghi, from being Chairman of the Financial Stability Forum, later the Financial Stability Board, to being the President of the European Central Bank. Amazing!

But let me be even clearer about what I mean:

In November 2004, in a letter published by the Financial Times I wrote: “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector (sovereigns)?”

But yet, even if a little me, not a regulator nor a banker, could have been sufficiently preoccupied about the excessive lending to sovereigns to write that, the regulators allowed the banks in some cases to lend to sovereigns against zero capital, and for a sovereign rated like Greece was, required the bank to hold only 1.6 percent in capital. That signified allowing a bank to leverage its equity some mindboggling 62.5 times to 1 when lending to Greece.

And so let me just ask: what would have happened to airport controllers or cruise ship captains who had made mistakes of this exorbitant nature, and caused damages as huge as this financial crisis?

I have absolutely nothing personal against any of the regulators, and I do not know any one of them. But what I I do know is that if we are going to have bank regulations with a global reach, like those produced by the Basel Committee for Banking Supervision, we absolutely need those regulators to be held much more accountable for what they are up to.

Yes the credit rating agencies let the regulators down... but it was they who gave the credit rating agencies such an excessive importance and they should have known; again as little me wrote in another published letter January 2003 in FT: “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

Yes they can argue they trusted the financial models too much… but that is not an excuse. If little me, presumably not more a financial modeler than they were, in a written formal statement delivered as an Executive Director of the World Bank, in October 2004, could warn: “[I]believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions” they should also have been suspicious about the models.