Those who have no business interfering should not be allowed to use that a consequence was unintended as an excuse

Sir, Robin Wigglesworth writes: “Overlaying safeguards on an immensely complex financial system may have the unintended consequence of making it more intricate and therefore more fragile” "Regulators seek ways to stem fragility caused by hyper-fast trading", November 7.

Again there is that reference to “unintended consequence” which seems always ready to serve as an excuse for any kind of dumb and mindless interfering. An example:

Never have bank crises resulted from lending out too many umbrellas when it rained, they have all resulted from lending out too many umbrellas when the sun was shining radiantly.

But nevertheless bank regulators decided that, in order to make banks safe, they had to give them even more incentives to lend out the umbrella when the sun shines and to take it back hurriedly when it looked that it might rain. And so they imposed credit-risk weighted capital requirements for banks; more risk more capital – less risk less capital.

And of course the result was excessive bank exposures to what was perceived as safe, this time aggravated by banks holding specially little capital against it… was that an unexpected consequence?

And of course the result is excessive few bank exposures to what is perceived as risky, like SMEs and entrepreneurs, something very dangerous for the real economy… is that also an unintended consequence.

And then the regulators decided that a few human fallible credit rating agencies were going to decide on the riskiness of credits.

In January 2003, in a letter published in the Financial Times I wrote: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds”

And yet many present the ensuing disaster with the AAA rated securities backed with mortgages to the subprime sector in the US as an “unintended consequence”. Have they no shame? Are we so dumb we allow them to get away with that?

@PerKurowski ©

The “risky”, those who regulators deny fair access to bank credit, might welcome back Dominique Strauss-Kahn.

Sir, Anne-Sylvaine Chassany writes about the possibilities of Dominique Strauss-Kahn entering politics again “The discreet redemption of Strauss-Kahn” July 14.

On October 7 2010, during a Civil Society Town Hall Meeting, I asked the then Managing Director of the IMF Strauss Kahn the following:

“Right now, when a bank lends money to a small business or an entrepreneur it needs to put up 5 TIMES more capital than when lending to a triple-A rated clients. When is the World Bank and the IMF speak out against such odious discrimination that affects development and job creation, for no good particular reason since bank and financial crisis have never occurred because of excessive investments or lending to clients perceived as risky?”

And Strauss-Kahn answered: "Well, the question about requirements, a couple of requirements for banks. You know, it's a very technical question and a very difficult one, but the way you asked the question, which is why there any kind of discrimination against SMEs is an interesting way of looking at that. In fact, there is no reason to have any kind of discrimination. The right thing for the Bank is to know whether or not their borrower is reliable, but you can be as reliable being a small enterprise than not reliable when you're a big company. So this kind of systematic discrimination has, in our view, no reason to be.

I have not been able to publicly obtain such a clear answer on the issue of how those who by being perceived as “risky”, are already naturally discriminated against by bankers, are now also odiously discriminated against by regulators. And so at least all the ex-ante perceived risky borrowers could welcome Strauss-Kahn’s return… as he might speak up for their rights of having a fair access to bank credit.

In case you want to view it, here is the link to the video of the conference. My question is in minute 47:35 and Dominique Strauss-Kahn's answer minute 1:01:05

@PerKurowski

If FT cares more about bankers pay than about the distortions that caused the tragedy of Greece… what’s for the rest?

Sir, I do not know how many articles I have read in FT, since the crisis of 2007-08, about how much too much bankers are paid; the latest Laura Noonan’s "Top US bank chiefs race ahead of rivals on pay” July3.

But I sure know there have been very few articles, if any, in FT about the distortion that credit-risk weighted capital requirements for banks cause in the allocation of bank credit to the real economy.

Because of Basel II, between June 2004 and November 2009, and because of Greece’s credit ratings, banks had to hold only 1.6 percent in capital when lending to the government of Greece… an authorized bank leverage of more than 60 to 1 when lending to Greece? Have you ever heard such a crazy notion? Of course that distorted and made banks lend much too much to the government of Greece… Has anyone for instance asked Merkel about the responsibility of German banks in satisfying the spending addiction of the Greek governments? When it comes to the use of drugs don’t we usually punish the pusher more than the consumer?

But no, clearly how much bankers earn is of much more interest to FT.

FT why don’t you try to figure out how much bonuses were paid out to bankers from book profits derived from pushing loans to Greece? That would perhaps be a more interesting angle.

PS. Greeks, beware of Basel Committee's bank regulators bringing gifts to your government!

@PerKurowski

Poor rich Oprah Winfrey should get herself a buyer-power-rating, issued by one of few big agencies.

Sir, I refer to James Shotter´s “Swiss image suffers after asylum row and Winfrey furore” August 10.

Poor rich Oprah Winfrey considers herself discriminated against because of how a certainly much poorer sales assistant in an upmarket Zurich boutique, dared to express the opinion that a ludicrous expensive handbag was too expensive, instead of perhaps increasing its price 50 percent as any much more able vendor would have done.

Frankly, this whole affair is so incredibly petty when I compare it to that other official discrimination which also originates in Switzerland, through the Basel Committee. That one establishes that even though “The Infallible” borrowers are already much favored in the markets, and “The Risky” much disfavored, that banks are allowed to hold much less capital when lending to the former, and thereby earn a much higher expected risk-adjusted return on its equity, than when lending to the latter.

I guess that if these bank regulators were asked, they would suggest that Oprah Winfrey equips herself with an AAA buyer power rating, issued by one of few formidable buyer-power-rating agencies.

Of course, the instinct of any normal ludicrous expensive handbags store owner, upon seeing an AAA buying-power-rating, would be to increase the listed price of the handbag, but I am sure that our Basel Committee regulators could also come up with a way of favoring these ultra rich buyers, and thereby discriminate against those who, immensely poorer, just want to feel like an Oprah Winter holding that completely unaffordable handbag in their hands for some seconds.

It is truly amazing how much we can hear about any discrimination based on color or other factor, when compared how little the officially sanctioned discrimination based on perceived risks are not even debated. Could it be because we are ashamed of having to admit to ourselves that we have changed from being risk-taking into risk-adverse nations?

In the name of my constituency, my granddaughter, I protest though: “Damn you Basel Committee… for having castrated our banks”

AIG, instead of suing those who bailed them out, should sue those who got them in problem, namely the bank regulators.

Sir, Tom Braithwaite reports that “AIG considers suing US over bailout terms” January 9, something that sounds indeed a bit surrealistic.

Basel II’s 8 percent basic capital requirement for banks allowed a 12.5 times to 1 leverage of bank equity. But it could be reduced to a minimal 1.6 percent, pushing up the allowed leverage to 62.5 to 1, if the bank exposure could be construed as guaranteed by something possessing an AAA rating.

Therefore, had bank regulators not turned the AAA-rating of AIG into an amazing magical capital requirement for banks shrinking machine; something which created an insatiable demand for AIG's credit default swaps, absolutely nothing bad would have happened, as even the whole 2007-08 financial crisis would have been avoided.

Therefore, if the AIG board absolutely must sue someone, because it feels that is the only way it can discharge its responsibilities, according to current traditions, then instead of suing those who bailed them out, they should sue those who got them in problem, the bank regulators.... and perhaps even the US tax-payers would join them in order to turn it all into a class action.

Don’t downgrade the rating agencies, downgrade the regulators.

Sir, already a couple of years into this crisis Philip Stephen shows a surprising lack of understanding of it, in his “Downgrade the rating agencies”, January 20. 

Suppose that human fallible credit rating agencies were able to produce absolutely perfect ratings, in terms of measuring the risk of default, and which are of course used by the banks to choose who to lend to, how much, and at what rate. 

But consider the fact that regulators imposed capital requirements for banks that were also based on the same ratings, and which functioned therefore like a hallucinogen, a veritable LSD; increasing the banker’s sensitivity to risk, so that he perceived a good ratings in a much brighter light, and a not so good ratings took on an even scarier appearance. 

As should have been expected by any independent regulator, not part of a incestuous group-think, the consequences were: 

A growing excessive bank exposures to what is officially perceived ex-ante as not risky, like the triple-A rated securities and infallible sovereigns, leading to a dangerous overcrowding of the safe-havens and; 

A growing bank underexposure to what is officially perceived as risky, like in lending to small businesses and entrepreneurs, equally dangerous, because of the lost opportunities to create the next generation of jobs for our grandchildren. 

So again it was not primarily the rating-message’s fault it was the fault of those who ordered how those rating-messages were to be read. Downgrade those regulators! 

Occupy Basel! http://bit.ly/dFRiMs

“Unwittingly”… or simply stupidly and irresponsibly?

Sir, Charles Goodhart in “Basel marches down wrong path to tackle systemic risk” July 7, writes “Regulation may unwittingly have actually added to procyclicality and systemic fragility by encouraging similar behavior.” Seriously, where goes the border line between “unwittingly” and either stupidly or irresponsibly?

In January 2003 the Financial Times published a letter I wrote which ended with “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds.” And if that was clear to me, an ordinary strategic and financial advisor, that should have been perfectly clear to bank regulators. 

The regulators bet the health of the financial sector on capital requirements for banks based on the credit ratings being right, instead of taking the precautions to safeguard the financial system for when these ratings would, sooner or later, be wrong, and now we are all paying the price of it. 

Sir, if FT’s “Without fear and without favour” motto means anything to you why do you insist on being so lenient with the bank regulators? If it had been many bridges collapsing because of structural design flaws, I am sure you’d gone after the engineers responsible of that. Is it really so that a BP management can be held accountable but a Basel Committee not? It is truly amazing to see basically the same bank regulators keep on regulating with basically the same faulty paradigms... and an FT keeping mum!

You journalist who write about banking regulations, should you not find it somewhat curious at least?

Friend

If you as reporters on finance and bank regulations observe that someone has asked the global bank regulators in the Basel Committee some reasonable questions, for about a decade, and they have not yet been answered, would that not strike you at least as something curious?

The Questions:

Can you think of any major bank crisis that was caused by excessive lending or investments to what was perceived as risky? Is it not so that these crises have resulted from either unlawful behavior of bankers or excessive lending or investment to what was wrongfully perceived as not risky?

No and yes? If so can you explain why bank regulators have set the capital requirements for banks based on perceived risk? Ludicrous as it sounds, would then not totally opposite capital requirements than the current make more sense, like higher capital requirements for what is perceived as not risky, than for what is perceived as risky?

Since we know that the banks already consider the credit ratings when deciding whether to lend or not to a client, what amounts and at what interest rate, is it logical that the regulators t also use exactly the same credit ratings when deciding the capital requirements for banks? Is that not sort of double counting? If you consider good information excessively, does this not distort the value of that information?

We know that one of the prime objectives for our banks is to attend the credit needs of those small businesses and entrepreneurs that are so vital important for the creation of jobs, but who have no access to capital markets and who cannot even afford to get their creditworthiness rated by the agencies. If so does it make any sense to discriminate against the small businesses and entrepreneurs by means of forcing the banks to carry relatively much higher capital when lending to these than when lending to something with for instance a triple-A rating?

And now I ask you, if the Basel Committee and the Financial Stability Board are not able to satisfactory respond these simple questions, do you think they should have the right to dig us further down into a black-hole of regulatory complexity with their Basel III?

Per Kurowski

A former Executive Director at the World Bank (2002-2004)

http://subprimeregulations.blogspot.com/

We need to bring the credit ratings down to earth

Sir, John Authers´ “Easter parade of worries over Uncle Sam´s credit”, April 24, refers to the rating agencies wielding “real power”, but then describes that power only in terms of “affecting the rates at which companies or countries can borrow”; without making any reference to what has yielded the rating agencies the excessive power they posses, namely that the ratings also play a role when defining how much capital a banks needs to have.

It is that the credit ratings are given a double consideration, which has elevated their importance to the skies and brought us the current crisis. Let´s go back to Basel I days, or better yet Basel 0, set one single capital requirement for all bank lending; and then we have brought down the opinions of the rating agencies to something more in harmony with what they really are, a bunch of fallible humans who, had they been laboratories, would have long ago been sued out of the waters for their harmful mistaken opinions.

If you thing “sustainability” is important, propose something that impacts it sustainably.

Sir, if you really cared so much about “Sustainability” in finance, as you want for the world to see you do, then you would be arguing for capital requirements for banks based on sustainability ratings, instead of the useless credit ratings that distort and leads our bank off into productive nowhere.

How long are regulators allowed to persist with their foolishness?

Sir I refer to so many news, about when a downgrading of credit ratings cause much havoc, like for instance Nicole Bullock´s report on April 19 “Muni bond risks grow after S&P’s DeKalb cut”.

It is high time to ask our regulators some basic questions like when they believe banks incur in the risk of lending, when they make a loan or when the borrower is down-rated. Of course, when they make the loan!

And so I ask how long should we allow the regulators to insist on a foolish system with retroactive corrections, based on credit ratings, and which makes the difficulties encountered with a client that turned out to be worse than he was originally rated even more difficult, and not a system of upfront capital requirements independent of ratings.

The truth about the crisis that the different silos, including FT’s, does not want or cannot see.

Sir, if all sovereign and private bank clients were paying the banks exactly the same risk-premiums, then the risk-weights used in Basel II to apportion the basic capital requirements for banks according to the various categories of credit ratings could have been right. But, they don’t!


The banks and the markets already incorporates in the setting of their risk-premiums the risk information provided by the credit rating agencies, and so when the regulators also used the same credit ratings for setting their risk-weights they made these ratings count twice. It was a huge mistake that resulted in:

1. The setting of minimalistic capital requirements that served as growth hormones for the ‘too-big-to-fail’.

2. That banks overcrowded and drowned themselves in shallow waters, whether of triple-A rated securities backed with lousily awarded mortgages to the subprime sector, or of equally or slightly less well rated “rich” sovereigns, like Greece.

3. A serious shrinkage of all bank lending to small businesses and entrepreneurs as lending to these generated, in relative terms, much higher capital requirement, which made it difficult for them to deliver a competitive return on bank equity.

With Basel III, regulators might be trying to correct for this mistake, instead of correcting the mistake. In other words, the Basel Committee would be digging us deeper in the hole where they placed us.

To rebalance the flows we need to rebalance the regulations.

Sir, Martin Wolf in “Waiting for the great rebalancing”, April 6, writes about “an ‘uphill’ flow from poor to rich countries, predominantly into supposedly safe assets”. According to Wolf, Mervyn King, the governor of the Bank of England, explains the flow as resulting from “export promotions… a decision to accumulate foreign reserves… and the combination of low levels of financial development with inadequate social safety nets”.

May I suggest that Mr. King, perhaps because of some conflict of interest, left out the most important explanation, namely the incredible push the importance the credit ratings got, when the regulators based the capital requirements for banks on these. All over the world there was only one message going out loud and clear, which was that the credit rating agencies knew what they were doing, and that if you want lower risk you should better follow their triple-A ratings. That the AAA ratings are highly correlated with rich countries, well that is a quite different issue.

Let us hope now that whatever rebalancing must come will include the rebalancing of the regulations of banks, so as to get rid of that arbitrary discrimination in favor of those who are perceived as not-risky and who are already more than sufficiently favored by the markets.

A not so simple simple question to FT

If banks, by means of capital requirements based on the perceived risk of default are given special incentives to go to what is officially perceived as low risk areas and shun what is officially perceived as risky… is it for the rest of us to pick the slack so to balance that all out?

The credit rating agent’s cloister conundrum

Sir, everywhere we turn we read about the impacts of upgrading and downgrading of the credit ratings, as when Jennifer Hughes reports “CLO ratings set to benefit from Moody’s re-evaluation” March 24.

Having given these credit ratings so much importance, should we not also have to construe cloisters where the credit rating agents can isolate themselves from the temptations? But, answering that question let us not also forget that if we isolate the credit rating agents in their cloisters, then it will most probably be us who will fall into the wrong temptations. What a conundrum!

The regulator was the noisiest!

Sir, Justin Baer in “Noise of the financial herd will drown out risk concerns? February 5 writes that the crisis exposed flaws in the way Wall Street measures and limits risks. That might be, but let us never forget that the biggest flaws of them all were those present in the bank regulations of Basel II, which allowed banks to leverage their capital 60 times and more just because a triple-A rating was involved in the operation, like in the case of most of those collateralized debt obligations referred to in the article.

If there was a margin of 1 percent in the operation, then the returns on capital could be catapulted into over 60 percent a year. Talk about real noise!

A case for capital requirements for banks based on corporate organization and management´s stake

We outsiders, we taxpayers, we do not run the risks of the clients of a bank we run the risk of how the bank is managed. Therefore, much more than being concerned with the credit ratings of the clients of a bank, we need to concern ourselves with how the bankers of that bank react to those credit ratings.

In this respect John Kay´s “How trust in finance was carried off by the carpetbaggers” January 19, makes a splendid case for having bank capital requirements for banks depend on such aspects as to how much of the risks of the bank are shared by the management of the bank. As an example, for a bank operating as a full partnership or a mutual, the capital requirements could be 6 percent of all assets, while for a fully public bank 12 percent, with the in-betweens covered proportionally.

Sometimes bad credit ratings are pure bliss.

As a citizen from a country that no matter how bad the credit ratings were they should always have been worse so as to help us to stop our governments from taking on debts, and therefore quite knowledgeable about the bliss that sometimes follows bad news, I cannot but agree with John Kay´s “Learn to love the candid bearer of bad news”.

The fundamental problem with using credit ratings is that if they are 100% right on the dot then a financial transaction based on it would be just but would not provide any party with a profit. In order for credit ratings to generate profit, for a borrower or a lender, for a buyer or a seller, they have to be wrong… and to blindly base your regulations on something that needs to be wrong in order to generate profits does not sound like the wisest thing to do.

PS. You might like to read “The riskiness of country risk” which I published in 2002.

http://unsustainabledebtsustainability.blogspot.com/2002/09/riskiness-of-country-risk.html

We need also new rules to keep bank regulators alert and on their toes

Sir, Lord Adair Turner the Chairman of the FSA sustains “We need new rules to keep bankers honest” December 8. Though hoping one could keep all bankers honest with rules sounds a bit too optimistic, we all agree… that is of course as long as it does not affect the rational capital allocation function of the banks by making the bankers too risk-adverse

But, what about those rules we need to keep bank regulators alert and on their toes? Given that it was the regulators who allowed the banks to leverage 62.5 to 1 when investing in triple-A rated securities or lending to Greece or Irish banks, a rule like that one which he proposes for incompetent bankers, namely that they will not be “allowed to perform a similar function at a bank, unless…” should equally apply to regulators.

The minimum minimorum I would ask all current regulators to do is to go back to bank regulating school and take course 101 and which teaches that the only risks that pose a real systemic risk are those perceived as low… and most specially when perceived as low by regulators and bankers alike.

Without any disrespect, Lord Turner would also benefit immensely from such a course.

Should we not have a serious man to man conversation with our bank regulating chaps at the Basel Committee?

Sir, if you and I were going to design some capital requirements for banks based on the risk of default of borrowers as measured by the credit rating agencies, would we use the default rates those credit ratings generally imply, or would we use the default rates suffered by the banks after the bankers received that credit rating information? I am sure you and I would agree on using the second alternative, since the first really makes no sense as it would imply that bankers do not take notice of the credit ratings, something that with the capital requirements based on these ratings, we are really making sure they do.

If we so then use the default risk for banks after credit rating information, would we also adjust our risk-weights to the fact that those perceived as riskier are charged much higher interest by the banks than those perceived as less risky? I am sure we would definitely consider that important risk mitigation factor and do so, since otherwise we would be perceived as foolishly assuming that all borrowers paid the bank the same interest rate.

But since we now know that our bank regulating chaps at the Basel Committee did nothing of the sort, they just used gross default rates unfiltered by the bankers applying their own credit analysis criteria, and they completely ignored the mitigation of a higher default risk provided by higher interest rates, isn´t it time we call them home so as to have a serious man to man conversation about what they are up to? I mean before they go on to tackle even much bigger problems like counter-cyclicality and systemic risk. I mean so as to inform them about the fact that they, in their own right, are becoming our greatest source of systemic risk.

 

I believe we should. Just consider the mess they did by making the banks stampede after some lousy securities just because these were rated triple-A; and all the small businesses and entrepreneurs who have seen their access to bank credit curtailed or made more expensive just because their odious regulatory discrimination against perceived risk.

A verse of a Swedish Psalm reads: “God, from your house, our refuge, you call us out to a world where many risks await us. As one with your world, you want us to live. God make us daring!”

“God make us daring!” That is indeed a prayer that the members of the Basel Committee do not even begin to understand the need for.

Psalm 288 Text: F Kaan 1968 B G Hallqvist 1970, Music Chartres1784