June 26, 2016

Embracing some inefficiency and duplication will improve resilience and recovery; and will reduce system fragility.

Sir, Gillian Tett writes “one of the problems of the modern world is that we live in such a tightly interconnected global system that it is a fantasy to think we can ever abolish all [terrorist] threats” and argues “the sooner our leaders can start talking bout resilience and recovery – and embracing some inefficiency and duplication– the better”, “Resilience in a time of crises”, June 25.

In March 2003, as an Executive Director at the World Bank, in a formal written statement I stated:

"A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind.

Ages ago, when information was less available and moved at a slower pace, the market consisted of a myriad of individual agents acting on limited information basis. Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market and we are already able to discern some of the victims, although they are just the tip of an iceberg.

The Basel Committee dictates norms for the banking industry that might be of extreme importance for the world’s economic development. In Basel’s drive to impose more supervision and reduce vulnerabilities, there is a clear need for an external observer of stature to assure that there is an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth."

But my warnings were ignored. With Basel II in June 2004, not only were credit rating agencies fully empowered to determine what was risky and what safe, but also the whole issue of the need for bank credit to be allocated efficiently to the real economy, was totally ignored.

Just like my over thousand letters on subprime banking regulations have been ignored by all in FT, probably because you cannot fathom the idea that regulators, experts, could be as dumb as I hold them to be.

Ms. Tett, first I dare you to answer this question: What assets are more likely to generate that kind of excessive exposures that could endanger the banking system, prime AAA rated assets or speculative and worse too below BB- rated assets?

And then reflect on that the risk weights for AAA rated assets was set to 20% while that of the below BB- at 150%.

And also reflect on that allowing bank to leverage equity differently, based on perceived risk, guarantees that the allocation of bank credit to the real economy will be distorted.

So Ms. Tett, when you then conclude that Donald Trump and other western politicians should be educated on issues of resilience and recovery, perhaps you might not have earned the right to throw the first stone.

@PerKurowski ©