March 15, 2013
Sir, Gillian Tett asks us to “Remember the lessons of the rush into “junk” in 2007”, March 15.
Does she mean that ultra-safe AAA rated junk, which banks were allowed to purchase or lend against holding only 1.6 percent in capital, meaning they could leverage 62.5 to 1 their equity, or does she refer to other junk?
She writes “many banks are reducing loans to risky corporate names because of new capital regulations” and that is not correct. Banks have been reducing loans for a long time to what is perceived as risky, and this because of "old" Basel II regulations, which allowed them to have very little capital for what was perceived as safe. And now, when some of those perceptions turned out to be very wrong, and they were left with little capital, they just have no choice but to run away even more from "risk-land" into "safe-land".
She also writes “So far the short-term money that has gone into the corporate debt world does not appear to be associated with too much leverage; this makes the picture notably different from the asset-backed commercial paper market or repo sector in 2007”.
Yes, indeed there is a difference, and that is explained by the difference between “ultra-safe-AAA-rated-junk” and “risky-junk”. It is always the former which is the most dangerous, though our current sad crop of bank regulators just forgot or preferred to ignore that.