January 15, 2013

FT, you must stop pardoning the hubris of Basel bank regulators, and feeding false illusions about credit ratings

Sir, Stephen Foley in “Outlook unchanged” January 15 writes: “Rating agencies’ outsized role in the credit crisis is well known. By validating the transformation of subprime mortgages into triple A-rated securities, based on mistaken assumptions about the US housing market, they contributed to the infection of the global financial system.” 

Indeed, but the only reason why the credit rating agencies detonated the crisis, was the “outsized role” loony bank regulators assigned them, when with their Basel II they allowed banks to hold only 1.6 percent in capital, meaning a mindboggling authorized bank leverage of 62.5 times to 1, only because a human fallible rating agencies deemed a security to be of AAA quality. 

That, as I have so many time explained to you increased the demand for these securities so dramatically that the market, as usually happens, when it ran out of well awarded mortgages, produced bad ones which ended up in some AAA Potemkin rated securities. 

I dare you to answer: When has a bank or a bank regulator most problems, when a bad rating turns out to be correct, or when a good ex-ante rating ex post ends up being incorrect? It is clearly the second. And so explain to me why you think we should allow our regulators to bet our whole bank system on the credit ratings to be correct? 

In January 2003 in FT you published a letter I wrote and where I 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”. 

Sincerely, FT, should be ashamed of yourself feeding the illusion that if we can only get the credit ratings agencies to be better at what they do, then our banks can bet their (and ours) last shirt on the credit ratings. 

Foley also writes “attempts to strip credit ratings of their central role in financial regulation are proving complicated”. But that is only so because regulators foolishly hang on to the idea that, by means of capital requirements for banks based on perceived risk, they can play risk managers to the world. I swear to you, the world cannot afford such hubris. 

Also, again, for the umpteenth time, FT, if banks clear for the information provided in credit ratings by means of interest rate, size of exposure and other terms… why the hell should they clear for that same information in the capital requirements too?