Bank regulators caused lenders to also argue borrowers’ creditworthiness. Not so smart!

Sir I refer to Frank Partnoy’ “The Fed’s magic tricks will not make risk disappear” March 5.

In it Partnoy to that “complex rules create incentives for banks to… hide risks”, and he is perhaps more right than he knows.

For instance, what did we have before Basel Committee´s credit risk weighted equity requirements? We hade the banks interested in arguing the credit risk of the borrowers, so to be able to charge them higher interest rates; and the borrowers interested in proving they were very creditworthy safe, so to get larger loans at lower rates.

This of course created a certain tension that could only benefit a regulator… and helped foster an efficient allocation of bank credit.

What do we have now? We now have bankers and borrowers on the same side. Now the banker also wants to convince the regulator that the borrower is very creditworthy, so as to be able to hold less equity when lending to it, and thereby generate higher risk-adjusted returns on its equity. That cannot be helpful for a regulator, and can only lead to an inefficient allocation of bank credit. Not so smart!

The most extreme example of the previous is the alliance between banks and sovereigns. That one is based on: “I the sovereign lend you the bank my full support; and in return you the bank lend me the sovereign a lot of money; and to facilitate all that we both assume that I am an infallible sovereign, and represent no credit risk whatsoever, and so therefore, you banker, need to hold no equity when lending to me.

So Sir, when it comes to gaming regulations, the regulators, who work for governments, they also know how to game regulations, in order to take care of themselves, by taking care of their bosses’ wishes.

PS. How do you fire a regulatory mandarin who sucks up to his boss so much that he defines him to be an infallible sovereign?

What kind of parents are you?

Sir, Frank Partnoy more than suggests that lawyers might have been more of enablers and emboldeners of bank shenanigans and concludes: One lesson from recent scandals is that banks need reliably independent in-house counsel, with a strong moral backbone”, “Who are the true villains of the StanChart tragedy?” August 9. Does that not go for regulators too? 

I mean if your children’s nanny had allowed, even pushed, one of them to go bungee-jumping, on account of the child begging, and some safety rating agency deeming that safe, and then a fatal accident happened… what would you do with the nanny? Would you still retain her services? If so, what kind of parent would that make of you? 

Currently those same nannies who with Basel II authorized banks to lend to Greece holding only 1.6 percent in capital, only because credit rating agencies deemed it safe, and which signifies a mindboggling authorized 62.5 to 1 leverage, have been retained and put in charge of coming up with Basel III, if not, like Mario Draghi, kept busy as president of the European Central Bank. What kind of parents does that make you?

How do we get better regulations with the same not-accountable regulators?

Sir Frank Partnoy holds that “It is ironic that credit rating agencies still retain such power. They were a significant cause of the crisis. They helped fire the fatal bullet by giving unreasonably high credit ratings to ´super senior´ tranches of subprime mortgage-backed collateralised debt obligations. It is astonishing that their views would matter to anyone at this late date. Yet government regulations continue to rely on ratings.”, “Prepare to bury the fatally wounded big banks” January 19.

Indeed it is ironic, even outright disgraceful, and the only explanation for it must be found in the total lack of accountability of the financial regulators. These regulators are now conveniently shielding themselves behind all those calls for more regulations, and which become so hard to explain if one is forced to accept the fact that there is such thing as bad regulators.

Give more freedom to the commercial banks

Sir of course I agree with Frank Partnoy in that we need to “Do away with rating-based rules” July 9 (my over 100 letters on the subject to FT should attest to that) but I would not necessarily stop at picking a substitute like the risk assessments made continuously by the market and as Partnoy seems to suggest, but change the whole current system of minimum capital requirements that differentiates among risks and go for flat percentage capital requirements, that could be higher or lower depending on the conditions of the economy.

That way we put the responsibility for taking the financial decision squarely back on the shoulders of the market and the individual bankers by eliminating the almighty excuse impossible to avoid of “I just followed the advice of the credit rating agencies that my bank regulators appointed”.

The traffic signs set up around the world by the credit rating agencies indicating low risks and the minimum capital requirements for the banks hijacked the commercial banks. It is high time to free them since we do indeed need their cooperation in channelling our resources to more productive uses than the building of subprime-mortgages financial pyramids.

Authorized trading could be even worse than not authorized trading

Sir Frank Partnoy does quite well to remind us that for a shareholder a dollar lost is a dollar lost independent on whether it comes from an authorized trade or not, “Kerviel is just a part of a global rogue’s gallery”, January 28. In fact one could make the case that the huge losses on duly authorized but never really comprehended investments are much more worrying.

Markets also abhors experts not behaving like experts

Sir, Frank Partnoy in “Markets abhor the vacuum left by derivatives” August 10 describes very well why the volatility has increased as a result of the investors finding out that their investments are in many cases not accurately or timely valued and that they might be up for some nasty surprises. Add to this the fact of having to see how good grades were awarded to mortgage collateralized debt obligations by the credit rating agencies without them even leaving their desk and do a little check-up on how those mortgages were issued and you might see the perfect volatility storm coming into sight.