To achieve a sensible pricing of risk, you need to avoid any opaque risk discrimination

Sir Francesco Guerrera writes “In the post-crisis world, risk must be sensibly priced” April 26 and of course he is right, because it was not sensibly priced risk that created the current crisis.

It would seem though that Guerrera might not understood it all yet, because, as he discusses the need for margins to be put up by corporate counterparties when dealing in derivatives with the bank; and he accepts that “banks adjust the cost [of derivatives] based on the credit profile of the buyer”, he does not mention the certain risk that margin requirements, if applied in any discriminatory way, will make the price discovery of risk, much more opaque, and wrong.

Not “bad” bank assets, bank capital heavy assets

Sir Francesco Guerrera and Patrick Jenkins report “Citi in sales of bad assets as Basel III rules loom” April 19. The titling is not that accurate since what is being done has very little to do with whether the assets are good or bad and all to do with whether they require more or less of those capital requirements that Basel tied up our banks with when the regulators decided to become risk-managers themselves. What a sad world!

And how sad too that a Financial Times have yet not said one word after so many letter I have written about that huge regulatory mistake the regulators committed in Basel II when considering the credit ratings for setting the capital requirements even though these credit ratings had already been considered by the banks and the markets when setting their risk-premiums and interest rates.

ABACUS 2007-AC1: The whole truth and nothing but the truth!

Sir I refer to the extensive report by Patrick Jenkins and Francesco Guerrera, “Goldsman versus the regulator” April 19. Yes Goldman Sachs might have behaved unethically and even illegally but the whole truth and nothing but the truth would in this case have to include the following facts, no matter how politically or agenda inconvenient they might be.

IKB the German bank bought the two tranches of ABACUS 2007-AC1 almost exclusively because of the following two reasons:

First both tranches, the A1 paying Libor plus 85 basis points, and the A-2 paying Libor plus 110 basis, points were rated Aaa by Moody’s and AAA by S&P when purchased by IKB.

Second, in order to invest $150 million in these securities, which because of their ratings were risk-weighted by Basel II at only 20%, IKB needed only to have $2.4 million of capital, 1.6%, when compared to the $12 million it would be required to have if lending that amount to unrated small and medium sized German companies.

If IKB had known that Paulson had had his hand in the picking and known fully about his motives then they might have asked for a slightly higher interest rate, perhaps 10 basis points, and still bought the securities.

If the securities did not have the splendid credit ratings assigned to them by the credit rating agencies then they would probably not have bought them even if Mother Teresa had done the picking.

If the regulators had placed the same type of capital requirements on all assets then IKB would have stayed home, probably lending to their traditional clients, instead of going to California to dig prime rated subprime gold.

And so while naturally we should lend all our support to efforts to eliminate wrong-doings like those described in the action by the SEC against Goldman Sachs that should not signify we take our eyes of the unfortunate truth of the world having been saddled with grossly inept regulators who created grossly bad regulations.

PS. The truth was even worse. Years later I found out the EU authorities, in a gesture of misunderstood solidarity had assigned Greece a 0% risk weight, which meant European banks could lend to Greece against no capital at all.

Never forget who really paid for the bonuses.

Sir, on your front page Patrick Jenkins, Brooke Masters and Francesco Guerrera reports on the “Banker’s fury at UK bonuses supertax”, December 10. Because there could be some shady collusion of interests that could want us all to ignore it, it might be convenient to remember that the real payers of those bonuses, or taxes, are the clients of the financial intermediaries. If we are going to have true fiscal transparency then perhaps the supertaxed part of the bonuses should be returned to the clients of the banks, and if so needed, taxed there.

Please, may we have a small but growing capital charge on governments?

Sir if your bank lends your government 100 pounds then it is not required to have any equity but, if it lends that amount to your unrated neighbour, then it has to put up 8 pounds in equity. That might sound very reasonable to you I do not know your neighbour, but be sure that in the long term it will just mean we will all end up more and more entangled in the web of the government.

In this respect when we read Aline van Duyn and Francesco Guerrera report in “Geithner plan fuels cost fears”, May 19, that “companies face capital charges against hedges” one wonders when they will start imposing some capital charges on what seem runaway governments. A small increasing capital charge on anything to do with governments is probably an essential element to help stimulate the banks into lending more to the private sector again.

It must hurt GE so much

Sir I have nothing whatsoever to do with GE but when Francesco Guerrera reports “Moody´s strips GE of triple A rating it has held for 42 years”, March 24, I truly commiserate with them. It must hurt so much being stripped of your AAA rating by one of those primarily responsible for your current problems.

The bank directors have the mother of all the good excuses.

Sir Francesco Guerrera and Peter Thal Larsen wrote a full pager on June 26, 2008 titled “Gone by the Board?” on why the directors of big banks failed to spot the credit risk. Though it is not my intention or role to defend bank directors I must in all honesty say that they completely left out the most important argument the directors could use in their defence.

Just think about a knowledgeable and a responsible director’s chances to convince his fellow directors that the securities backed with subprime mortgages and rated prime by the credit rating agencies and appointed to such a task by the bank regulators themselves were not prime as he had heard rumours that the mortgages were not awarded with the same usual care. None? I would say so.

If you want a board to act you have to let it act and not let them believe that the credit rating agencies are doing the job for them.

We need the regulators to backtrack on their own ideas

Sir Francesco Guerrero wants "ideas to stop backlash from regulators" March 8 and there is nothing like reminding them of the blame they have in this mess.

A market with many participants measures many type and dimensions of risks, applying many different time horizons and using many different risk measuring techniques. The final result might not be perfect but at least it avoids the risk of leveraging excessively on any presumption and opinion that might turn out to be dangerously mistaken.

It was when the regulators forced the market to give special consideration to what some few credit rating agencies told it about risks of default over a short period of time, that the information capacity of the market was constrained and extremely dangerous regulatory biases and fresh systemic risks introduced.

Although there is such a thing as prime mortgages awarded to the subprime sector it was only because credit rating agencies gave good ratings on securities collateralized with badly awarded mortgages, that this pure junk could grow into incredible volumes and travel so far that a German bank became their first casualty.

And there are currently almost more courses given about how to analyze how the credit rating agencies might change their ratings that there are about analyzing the underlying credits and companies.

This has to stop, urgently; and it is not a question of the credit rating agencies becoming better at what they do since that will only force or induce us to follow them even more to a precipice.

Without fear and without favour we need to punish the regulators!

Sir, John Authers in “Home to roost” July 27 quotes William Poole, governor of the St Louis Fed in reference to the current subprime woes saying “The punishment has been meted out to those who have done misdeeds and made bad judgments”. Forget it, soon it is going to be time to punish the real brains behind this mess, namely the bank regulators that displaying an amazing lack of wisdom, empowered a couple of credit rating agencies with so much say over the markets. Had it no been for some haphazardly awarded credit ratings the not subprime but criminally irresponsible behaviour of some mortgage brokers would have been contained in a couple of banks and not leveraged into the problem it now represents.

On your front page the same day there is also a report by Francesco Guerrera and David Wighton on “US executives find favours to analyst can secure better ratings” and honestly anyone who could be surprised by this have not walked the streets enough to be a regulator. Sir look around you and you could find more courses on how to obtain a good rating than on how to manage your real business. This all is lunacy and we are being set up for even bigger disasters and it must end, before it ends us. We need urgently to punish the regulators, at least on the count of being very naive.

We need to slam Moody too!

Sir, “Moody’s slams private equity” is how Francesco Guerrera and James Politi title their report on July 9 about the strong criticism that this credit rating agency is making about the private equity industry; and I believe it is high time for us to slam Moody as clearly the powers they yield over the markets is getting to their heads. Who do they think they are? Is a neutral credit rating agency supposed to get involved into what business their clients do? If they do not like how the business is structured, and believe it will affect negatively the credit ratings, then they should say so, in their ratings. To come up with unsolicited a priori advices that could only bias their future outlooks is not what they are supposed to do. Next time they might just opine on the cars that GM should produce to get a rating.

Let’s face it, if we do not stand up to the credit rating agencies we will help to create and strengthen some real financial Frankenstein monsters, authorized to dictate their feelings about anything. And, do not get me wrong, there is not a world in Moody’s comment about the private equity industry that I would object to, I just object, totally, that they should be the messenger. The credit rating agencies have already far too much power for their and our own good.

About the low cost of equity and the need of Chinese “sovereign” walls

Sir, John Plender in “An unseen risk in sovereign wealth funds” (from China) June 22, mention that they might lead us “from unusually low interest rates to the conundrum of an artificially low cost of equity capital”. It sounds correct but then when later reading, that same day and just four pages away, “One door opens…” by Francesco Guerrera and James Politi that describes Blackstone’s core business as “buying companies and assets, loading them up with debt and selling them for a profit; and Ben White’s “A banking flotilla offers safe passage” that indicates a proposed Blackstone valuation of “about 26 times last year’s pro-forma economic net income, Plender’s risk prediction becomes more a reporting of facts. Also, given that China’s willingness to keep on continuing financing the market will have an impact on interest rates one cannot help but to think of how to adapt the corporate concept such as a “Chinese wall” which separates traders with conflicts of interest to a sovereign environment.