Mr. Jacques de Larosiėre. You are not telling the truth and nothing but the truth

Sir, I refer to Jacques de Larosiėre’s “Securitised debt could give Europe’s economy the kiss of life” April 22. Yeah, but he must mean a “kiss of life” for the financial intermediaries.

Securitization is the process whereby you lend at the highest possible rate, achievable by convincing the borrower of how risky he is, and then resell it discounted at the lowest possible rate, achievable by convincing the investor of how safe the borrower is…. so neither investors nor borrowers stand to benefit much.

For instance, a $300.000 - 11% - 30 years mortgage to the subprime sector, when it was resold discounted at 6%, yielded the intermediaries a tidy immediate profit of $210.000!

And de Larosiėre ends stating “Reviving the market for securitized loans is the fastest way to bring Europe’s credit shortage to an end”. Not so! The only sustainable way to devolve sanity into the European bank credit markets, is to get rid of those capital requirements which allow banks to earn much higher risk-adjusted returns on equity when lending to the “safe” than when lending to the risky”

Who not an “infallible sovereign”, or a member of the AAAristocracy, can compete for bank credit under such circumstances?

Europe, start by getting rid of all those working on Basel III, they are too busy covering up for their fatal mistake of Basel II.

Excessive regulatory risk-aversion caused the excessively risky bank lending to the “not-risky”.

Sir, Jacques de Larosiėre writes “The crisis has shown that bank failures are not related to specific structures but to excessive risk-taking”, “Do not be seduced by the simplicity of ringfencing” September 27. We need to carefully analyze the real meaning of “excessive risk-taking”, as a lot of dangerous confusion prevails in the debate.

First, it is absolutely clear that none of current bank failures have anything to do with excessive exposures to what was perceived as “risky”. Instead all failures were related, as is ordinarily the case with bank failures, to excessive exposures to what was perceived as “not-risky”, like AAA rated securities, real estate in Spain or “infallible” sovereigns like Greece. 

What was different this time though, and what makes this crisis particularly severe, is that the banks, like never before, were authorized by regulators to leverage their equity immensely, when holding those dangerous assets perceived as “absolutely not risky”. 

And so, in this case, any excessive risk-taking of banks was caused directly by the regulators excessively wanting the banks to avoid the “risky”, and they did so, stupidly, by stimulating the banks to take excessive risky high leverages exposures to what was officially perceived as “not-risky”. 

Sadly the above has not been yet understood by those who so simplistically equate a bad result with taking an undue risk. Sometimes, quite often in fact, a bad result is due from excessively avoiding taking risks.

It is very worrisome to see that Jacques de Larosiére does still not get it!

Sir Jacques de Larosiére in “Basel rules risk punishing the wrong banks” October 25 writes about the risk of the banks reducing “activities with modest margins such as lending to small and medium sized enterprises” If he wants to defend the small and medium sized enterprises then he should not forget that the primary reason for that lending having margins that are modest, relatively, is because the regulators allow other lending to occur with much less bank capital requirements… and of that truly odious discrimination he does not say a word.

He also writes that “The proposal to introduce an absolute leverage without taking into account the real risk of the asset is the most contestable element of the Basel reform, and would push banks to concentrate their assets in riskier operations.” This is pure nonsense as an absolute leverage does not mean that the risk of the assets are ignored, those risks are reflected in the risk premiums charged by the banks, and those risk premiums, higher interest rates, go straight to the capital of the banks.

In fact it was not having an absolute leverage level equal for all assets that drove the banks into an excessive lending or investment in what was perceived ex-ante as having no risk, precisely the place where all financial and bank crisis occur.

How worrisome and sad it is that a man of the statute of Jacques de Larosiére, now more than two years after the crisis detonated, does still not understand why it happened.

Is Jacques de Larosière befuddled or just lobbying?

Sir Jacques de Larosière´s “Financial regulators must take care over capital” October 16, is either a perfect example of how trapped the regulators are in their own groupthink, or a simple lobbying effort on behalf of some European banks.

Larosière starts by rightly declaring “History shows that economic recovery essentially depends on the existence of a strong and risk-taking financial system” but then speaks out in favour of higher capital requirements for banks the higher the risks as “it is the quality of the assets of a bank that matters more than its leverage”; and writes that “imposing a non-risk based leverage ratio could entail serious negative, albeit unintended consequences.”

Well the market already charges for risk though interest spreads and so any additional risk-adjustment, for instance by means of different capital requirements, amounts to an arbitrary intervention by the regulators in favour of what they might consider low risk and quality, but which might have absolutely nothing to do with what the economy really needs.

If we want an example of how “serious negative, albeit unintended consequences” that regulatory mingling with risks could have, it suffices to look at the current crisis with its low capital requirements for the huge exposures to “non-risk” AAA rated operations. And besides, the “quality” of a financial asset is not a function of risk, but a function of its risk-reward relation.

If we are to have banks capable of taking the risks the economy needs to recover, then the first thing we need is for the regulators to stop from arbitrarily interfering with the risk allocation mechanisms of the market. If this signifies special transition problems for the European banks, as Larosière indicates it could, let us solve that by other means than defending and conserving the worst element of our current financial regulations.