Indeed, reforming the credit rating market is an urgent necessity. Indeed, shame on the regulators

Sir, Arturo Cifuentes concludes, “Reforming the credit rating market is an urgent necessity. Shame on the regulators” “Few lessons have been heeded 10 years after Lehman collapse” August 23.

Yes shame on the regulators! But also for some other reasons than those Cifuentes mentions.

Just for a starter, the credit rating agencies would never ever have caused so much damage had their opinions not been leveraged immensely by the risk weighted capital requirements for banks. Imagine, Basel II, 2004, allowed banks to leverage 62.5 times if only a human fallible credit rating agency assigned an asset an AAA rating. 

It should have been crystal clear that with that the regulators were introducing a huge systemic risk in the banking sector. That I mentioned for instance in a letter published by FT in January 2003; and I loudly explained and protested it while an Executive Director in the World Bank during those Basel II preparation days.

In Europe, the EU authorities even overrode the credit rating agencies opinions and assigned Greece a 0% risk weight, which of course doomed it to its current tragic condition. 

Then, let us mention the mother of all regulatory mistakes; for their risk weighted bank capital requirements, initiated in 1988 with Basel I, the regulators used the perceived risk of assets instead of the risks of those assets conditioned on how their risks are perceived? How loony, how sad, what a distortion, what a recipe for disaster was not that? And still, 30 years later, they do not even acknowledge their mistake.

By the way, when Cifuentes denounces that Solvency II, with its myopic risk view, will discourage insurance companies, the natural holders of illiquid assets, to hold these investments, and it will therefore increase the systemic risk by making their portfolios less diversified, I could not agree more.

Sir, you know that for over more than a decade I have written to Financial Times 2.787 letters objecting to the “subprime banking regulations”, this one not included. Galileo could indeed be accused for being obsessed with his theories, but, could those doing their utmost to silence his objections, the inquisitors, not be accused of the same?

PS. Cifuentes mentions “Olivier Blanchard’s 2016 admission that incorporating the financial sector in macro models would be a good idea”, I might have had something to do with that.

PS. Here is somewhat more extensive aide memoire on the mistakes in the risk weighted capital requirements for banks.

@PerKurowski

The credit rating agencies made mistakes, the regulators showed lack of judgment

Sir Arturo Cifuentes concludes “Time to start rating the full influence of bond graders”, July 28,“Leaving [the credit markets] at the mercy of the [credit rating agencies] that showed so much bad judgment in what was supposed to be their core competence seems like a terrible idea.” I must correct him. The credit rating agencies just made mistakes instead it was the regulators who, by giving the agencies the powers, showed a total lack of judgment.

We need to stop this financial hocus-pocus!

Sir Arturo Cifuentes writes “Weak Basel II may not be enough to calm credit fears” December 18. Of course not! Basel II is just digging us deeper in the hole where the regulators placed us when they so unwisely thought that risks could be determined; and came up with their minimum capital requirements for banks based exclusively on risk, as determined in Basel I by the credit rating agencies and in Basel II by the models of the banks themselves. Those arbitrary regulations were the main cause for all the financial hocus-pocus we are now suffering.

If there is anything rational for the regulators to do now it would be to swallow their pride and require the same percentage of capital for all credits; give the banks some time to orderly adjust to this; and let the markets price the risk of the banks, for instance by forcing the banks to issue subordinated debt as was suggested by the Shadow Financial Regulatory Committee back in 2000.

To top it up, based “the bigger they are the harder they fall” I would also add some additional progressive capital requirements or insurance payment based on size.

Do credit ratings stop capitals from going where they should?

Sir Arturo Cifuentes in “Credit of the big rating agencies under fire”, September 12, explains very well some of the problems that arise from that many market participants do not know what the credit ratings really mean. Also and although Cifuentes does not fully enter into that very delicate terrain of explicitly wondering whether the bank regulators who enforce the use of these ratings know what these mean, he at least dares to ask the question of “Under the current regime, is it safe to determine capital requirements? , and for this he should be commended.

Now, having been very critical of how we have substituted the no matter how technically correct still limited vision of a few credit rating agencies for the real biodiversity of criteria of a free market, the most important question we need to ask about the credit ratings is not so much in reference to the calculation of the capital requirements of the banks, but on how these credit ratings can influence the directions of the capital flows in the world. It is of course bad if banks do not have enough capital but let us remember that it is far worse if capitals do not go where they can best deliver results.