Better confused than wrong!

Sir Saskia Scholtes writes that “Agencies’ differences add to confusion” March 11, describing how credit rating agencies differ in their appreciation of companies in this case of bond insurance companies, to which I would just have to add a Hallelujah!, since it is clearly better being confused than wrong.

It is precisely the fact that the whole concept of risk relates to so many different variables that can be analyzed with so many possible methodologies over so many different time horizons, and that makes it impossible to come up with a true risk assessment, that the world should never have allotted so much power and influence to some few credit rating agencies.

The mess these credit rating agencies got the world into by all three of them giving prime ratings to securities collateralized with junk mortgages, is bust just a small example of why we should welcome more of the confusion that reigns in real life and that real investments are all about.

Stripe the credit rating agencies´ powers

Sir “Ratings agencies move to restore the credibility” by Saskia Scholtes, February 7 and “Rating agencies face struggle to make the grade” by Michael Mackenzie, February 9 are but two of thousand of articles that refer to how the credit rating agencies will try to make amend and become better.

Unfortunately, our real underlying structural problem goes into the complete opposite direction. The more the few we have empowered to tell us about where to go get better at it, the more likely we all are to follow them where we should not go.

Allow for credit rating agencies, they are useful, but please stripe them from their artificial powers.

The government needs to help turn subprime dollars into prime

Sir Saskia Scholtes writes that the "Helping hand could prolong subprime pain", December 22, and though she argues it well it really does not have to be that way, if the helping hand knows how to help.

Let us suppose that a subprime borrower has a set amount of dollars that he could pay to service his mortgage. In the financial markets, because of discounting of risks, the worth of that dollar cash flow is much lower if it is classified as a subprime lending operation than whether it is viewed as coming from a prime operation. And here is where the government could help turning his subprime dollars into real prime dollars. Could it really be so hard? I mean they are still exactly the same dollars.

A thousand dollars paid monthly during 15 years discounted at 11 percent is worth 88.000 dollars today while the same payments discounted at 6 percent is worth 118.500…35 percent more!

If the government is willing to guarantee, up to a specified amount, the mortgage payments of those who currently own and live in a subprime mortgage financed house then this would empower the borrower to renegotiate with the lender some much better terms, for each of them. This is a win-win strategy for them. Freezing the rates but keeping them subprime is, at best, just a win-lose proposition.

Could this cost the taxpayer some dollars? You bet! But then again someone has to pay for the bank regulators having appointed the credit rating agencies as their financial overseers and with that allowed some small sub-primely awarded mortgage virus to spread globally.

Who do they think they are?

Having much argued for that the bank regulators should give the banks more time to adapt their capital requirements when there is a systemic downgrading going on of course I would agree with that the monoline insurers should be given some time to improve their capital position so as to avoid a downgrading, as stated in Gillian Tett´s and Saskia Scholtes´ “Bond insurers act to keep their rating” November 19. My question though is about who on earth gave the credit rating agencies these type of power to stay the execution of a downgrading and who is responsible for what happens during the stay? It would really seem that the credit rating agencies are moving up from being mere opinion makers to policy makers.

Development rating agencies?

Sir Saskia Scholtes and Chrystia Freeland report that “Moody’s to revise ratings by end of year” and that it is now contemplating something to be marketed as “fundamental value”. Now, if that rating is only to be based on risk considerations then it does not really seem to be of such fundamental value to me. 

Of course a bank should be able to repay his deposits and that is why bank regulators in Basle are using risk to establish the minimum capital requirements. But a bank’s function is not only to be able to return the deposits but also to help promote growth and development and to assist the society in the distribution of opportunities. Otherwise a mattress would suffice. 

In this respect, besides the credit rating agencies, we perhaps should also be thinking of incorporating the criteria of development rating agencies and opportunity distribution rating agencies into the capital requirements of a bank. Only then would we be able to start talking about really fundamental values. 

It is very sad when a developed nation decides making risk-adverseness the primary goal of their banking system and places itself voluntarily on a downward slope but it is a real tragedy when developing countries copycats it and falls into the trap of calling it quits.

PD. Are the Basel Committees’ bank regulations good for development?

Regulators, please make the financial flows free to flow again

Sir, when Saskia Scholtes reports that “Moody’s alters its subprime rating model” September 25, we get a glimpse on what is the inherent weakness of any rating system that does its rating from the desk. It is not that the borrowers were subprime that caused the current difficulties since there clearly are many prime mortgages to subprime borrowers, it was that some of those shady operators that always exist in any market exploited the Achilles heel opportunity provided by the credit agencies themselves when they assigned prime ratings to very sub-primely awarded mortgage loans. Anyone should have been able to tell those mortgages were lose-lose propositions if only they have left their desk for just a second to go and have a look.

The above describes perfectly the systemic risks or even the moral hazard that can and will arise from empowering any agent in the market too much and there is no way on earth you can really correct that, and much less so if you insist on doing the ratings by monitoring real life from afar.

I do appreciate the credit ratings efforts and that we should be able to benefit much from their services, but this can only occur if the market is also totally free from not having to use them. Regulators please make the financial flows free again.

Unfortunately Northern Rock is not the war, it is just a war incident and on top of it only a minor one.

Sir Martin Wolf in “From a bank run to the nationalization of deposits” September 19 takes a Polaroid photo (if anyone in this digital world remembers what they were) and that tells little of the story. Not only because the events that lead up to this Northern Rock moment have been in the pipeline for a very long time but also because, unfortunately, we are still very far away from where we could be able to discern the end of the story and in fact we should all count our blessings if this all stays as the “Northern Rock” moment. Wolf is of course aware of this when he answers his own question on whether this is the end of the story with “a far from it”

The fact then that Wolf raises so early the questions of whether the disaster could have been prevented, whether the crisis could have been better handled and finally on what to do about it in the future can only be explained in terms of a very human desire of wanting to believe its over, looking to numb those fears that Wolf and so many of us share and that make us “tremble at what may happen”.

Wolf sees the events as an “unwinding of past excesses” sort of like shedding some kilos, while I having been much more sceptical of what has been in the doings see the need to unwind much more than that, among other a bank regulatory system that has placed us on the clear course of fewer and fewer bigger banks, until we hit the very biggest final bank bang. For a brief look ahead, read Saskia Scholtes “Credit turmoil set to benefit big banks”, September 19, where you can read on how central banks are already in despair outsourcing their responsibilities to the banks... while naturally crossing themselves.

Credit rating agencies should be free to rate but the markets should also be free from not having to follow them.

Sir, every comment in Richard Beales and Saskia Scholtes´ extensive and detailed “Critical focus turns on rating agencies”, August 16, seems to underline the idea that credit rating agencies can do a better job, while the most important fact we need to realize is that to correctly rate credits is such an impossible thing to do that we should never adjudicate special powers to any agency to influence the market. The first thing we need to do is to start dismantling the system of using credit rating agencies. Of course they are free to rate, but the markets should also be free not to follow them.

In the stupid/intelligent, coward/valiant chart where will history plot today’s investors?

Sir it is clear what Saskia Scholtes is driving at in “Fear rather that fundamentals is driving trading” August 11, but as she readily admits that it can become self-fulfilling, we should never forget that fear can easily morph into a fundamental. You can fear finding a bear in the woods but if it appears you’d better treat it as a real fundamental or you pay for it. Now how you handle that fundamental and avoid panicking well that is a totally different matter which brings us to a graph where on the axis we plot from stupid to intelligent and on the y axis from coward to valiant, and then sit back and wait for history to plot us…on a minute by minute basis.

Investing in people losing their homes?

Sir, June 1 Saskia Scholtes reported of hedge funds' "Fear over a helping hand for home loan defaulters¨ and June 5 Richard Beales says that Fitch ratings could downgrade bonds backed by subprime mortgages if the loan's terms are changed to help borrowers keep their homes. It takes some time for the implications of such news to set in but when it does it really knocks you down. Do they mean that in all the risk diversification (or risk hiding) that has been occurring through derivatives we have now actually created a group of investors with a vested interest in people losing their homes? Sorry, something sounds wrong and this surely must be something more than your regular moral hazard. Can I go long on a nuclear missile index?