Does not common sense dictate that in good times we want our banks to be weary about what they perceive as safe? Does not what’s seen as risky take care of itself?

Joe Rennison writes: “Investors and rating agencies have warned that companies might struggle to refinance huge debt burdens, resulting in downgrades from triple B into high yield or “junk” territory.” “BIS sounds alarm on risk of corporate debt fire sale” March 6.

What does that mean? Namely the risk that ex ante perceptions of risk might, ex post, turn out really wrong.

Also, “Bond fund managers could then have to sell the bonds as many are bound by investment mandates barring them from holding large amounts of debt rated below investment grade. ‘Rating-based investment mandates can lead to fire sales,’ warned Sirio Aramonte and Egemen Eren, economists, in the BIS quarterly review released yesterday.”

And what does that mean? Clearly procyclicality in full swing! Just like the insane procyclicality caused by the risk weighted capital requirements for banks.

Sir, does not common sense tell you that in good times we want our banks to be weary about what they perceive as safe, as what they perceive as risky takes care of itself? And in bad times, do we not want our banks not to be too weary of the risky, and burdened with having to raise extra capital when it could be the hardest for them?

Sir, so what are regulators doing allowing banks to hold less capital against what they in good times might wrongly perceive as safe, and imposing higher capital on what they would anyhow want to stay away from, especially in bad times?

Sir, for literally the 2,781 time, why does not the Financial Times want to dig deeper into unavailing what must be the greatest regulatory mistake ever? 

Are you scared of then not being invited to BIS’s Basel Committee’s and central banks’ conferences? “Without fear and without favour” Frankly!

@PerKurowski

Bad bank regulations have placed the procyclicality of credit ratings on steroids

Sir, Joe Rennison writes: “Big US companies [have] spent the years since the financial crisis gorging on cheap debt [forgoing] higher credit ratings and [slipping] down into the lower reaches of borrowers deemed “investment grade”, which implies a relatively low risk of default. Growing debt piles have fed fears among investors that… worsening economic conditions… could potentially send credit ratings even lower, into the junkyard of ‘high yield’ [which would make the financing more expensive and thereby increase the difficulties]” “Investors urge debt-bloated US companies to shape up” March 5.

Good times allow good credit ratings giving an easy going; bad times produce worse credit ratings causing harder goings. No doubt credit ratings are procyclical. But then consider the fact that current risk weighted capital requirements for banks, better credit ratings less capital – worse credit ratings more capital, places an additional level of procyclicality on top of it all, and one of the principal faults of Basel Committee’s should lay bare in front of you. 

It has not been corrected yet. It has not even really been discussed yet.

@PerKurowski

The worse the mortgages packaged, the higher the potential of securitization profits was (is)

Sir, FT’s big read by Mark Vandevelde and Joe Rennison “The story of a house” September 6, leaves out two important facts:

First: Christopher Cruise, who ran popular courses in mortgage origination, is quoted with “You had no incentive whatsoever to be concerned about the quality of the loan or whether it was suitable for the borrower” 

But yes you did, only in a direction quite different than usual. The worse the borrower and the worse the mortgagor, the higher the potential of profits of packaging it in a securitization sausage bound for a high credit rating. All involved in that securitization would profit, immensely, except of course those who were being packaged into that sausage. Imagine, if that sausage obtained an AAA to AA rating, US investment banks and European banks were allowed by the regulators to leverage 62.5 times their capital with these.

Second: “Société Générale, the French bank, was one of those that took out insurance against a collapse in the value of Davis Square, buying exotic derivatives contracts from the insurance group AIG.”

That was not solely for insurance. Because AIG was AAA rated, whatever lower rated securitized mortgages it added its signatures to also gave the banks the possibility of a mindboggling 62.5 times leverage. 

Profit potential: If you convinced risky and broke Joe to take a $300.000 mortgage at 11 percent for 30 years and then, with more than a little help from the credit rating agencies, you could convince risk-adverse Fred that this mortgage, repackaged in a securitized version, and rated AAA, was so safe that a six percent return was quite adequate, then you could sell Fred the mortgage for $510.000. This would allow you and your partners in the set-up, to pocket a tidy profit of $210.000

Sir, credit rating agencies using fallible humans did not stand a chance to get it right! 

@PerKurowski

Capital requirements for banks based on how much “distressed debts” hedge funds raise money?

Sir, Joe Rennison’s and Lindsay Fortado’s “Distressed debt tempts investors in anticipation of the next downturn”, June 19, raises the following question:

Could an index that tracks how “US hedge funds specialising in distressed debt are raising money in anticipation [of] the next economic downturn” be useful to base bank capital requirements on? 

At least it should be much better than current regulations, which allow banks to build up dangerous exposures to what is perceived as safe, against especially low capital requirements, especially when a Jason Mudrick, founder of $1.9bn Mudrick Capital can state “This economy is roaring right now”

@PerKurowski

Who in his right mind can believe credits rated BB- are more risky to the banking system than credits rated AAA to AA?

Sir, on October 22 Gregory Meyer and Joe Rennison reported on FT’s front page “US regulators signal first moves to rein risks of high speed trading”. Timothy Massad, chairman of the Commodity Futures Trading Commission was quoted saying “he wanted to safeguard financial markets against algorithms going haywire” That is great, but who is going to guard financial markets from regulatory algorithms going haywire?

Anyone who dares to really enter and analyze the pillar of current bank regulations, the credit risk weighted capital requirements for banks, comes out not believing what he has seen.

For instance, in Basel II, a credit to the private sector rated AAA to AA was assigned a risk weight of 20 percent while a similar credit to someone rated BB- or less was assigned a 150 percent credit risk weight... meaning a 7.5 times higher capital requirements.

And I just ask, who, in his right mind, can believe credits rated BB- are more risky to the banking system than credits rated AAA to AA? Honestly, what could attract more excessive financial exposures?

@PerKurowski ©

CDS were bought more for their capacity to reduce equity requirements for banks, than as insurance against defaults.

Sir, I refer to Joe Rennison’s report “Wall St looks to revive niche CDS” May 20.

It states: “single-name credit default swaps, a derivative contract that tracks the risk of default by a company that sells bonds. Regulators sought to clamp down on the market after the crisis because it was widely blamed for helping to inflate the credit bubble”.

That is not telling it like it really was!

According to Basel II, if a bank wanted to hold a bond that for instance was rated BBB+, it needed to hold 8 percent in equity… meaning it could leverage about 12 to 1.

But, if it bought a CDS for that bond from an AAA rated company, like from AAA rated AIG, then it needed to hold only 1.6 percent in equity and could therefore leverage about 60 to 1.

And that is what really drove the incredible artificial demand for these CDS that helped to inflate the credit bubble.

If CDS are to work, as they should, they need to be traded on their own merits of how they provide insurance against defaults, and not because of regulatory distortions.

Do not let failed regulators get away with their own favorite version of history!

@PerKurowski