October 07, 2018

I trust banks and markets much more when regulators keep their hands off.

Sir, I refer to John Authers’ “In nothing we trust” Spectrum, October 6.

Let me give you brief one page version of my story:

1998, in an Op-Ed (in Venezuela I wrote) “In many cases even trying to regulate banks runs the risk of giving the impression that by means of strict regulations, the risks have disappeared…History is full of examples of where the State, by meddling to avoid damages, caused infinite larger damages”

1999 in another Op-Ed “What scares me the most, is what could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause its collapse”

January 2003, in a letter published by FT 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”

April 2003, as an Executive Director of the World Bank, in a formal statement, I repeated that warning: "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"

June 2004, the Basel Committee on Banking Supervision issued Basel II. By means of their standardized risk weights, they allowed banks to leverage a mind-blowing 62.5 times their capital if only an asset carried an AAA to AA rating issued by a human fallible credit rating agencies.

October 2004, in one of my last formal written statements as an ED at the Board of the World Bank I held: “We believe that much of the world’s financial markets are currently being dangerously overstretched, through an exaggerated reliance on intrinsically weak financial models, based on very short series of statistical evidence and very doubtful volatility assumptions”

After reading an incomprehensible explanation provided in June 2005 by the Basel Committee I have, in hundreds of conferences tried to get the regulators to answer the very straightforward question of: “Why do you want banks to hold much more capital against what, by being perceived as risky, becomes less risky to our bank systems, than against what perceived as safe poses so many more dangers?” I have yet to receive answer.

So we have regulators who still, after a crisis caused exclusively by assets perceived as safe and that therefore banks could be held against less capital, allow especially large bank exposures, to what’s perceived as especially safe, against especially little capital. 

Sir, that dooms our bank system to especially severe crises. Why on earth should I or you trust them?

Sir, in hundreds, if not thousands of letters to you over the last decade, I have also tried to enlist FT in helping me ask that question (one that seemingly shall not be made) and to insist on receiving a comprehensible answer. I’ve had no luck with that either, so, respectfully, why should I trust your motto “Without fear and without favour”?

PS. And this letter does not refer to the horrendous introduction of full fledged statism that happened when with Basel I in 1988 the regulators assigned a risk weight of 0% to the sovereign and one of 100% to the unrated citizen.