And which is the ‘real’ market of the Financial Times?

Sir I am sorry to say that as an end of this particular 2008 year editorial “The return of the ‘real’ economy” December 31 is, simply put, bad. You base it on “It is mistaken in seeing finance as unproductive. . . Nor is financial innovation mistaken in principle” and frankly I do not know anyone of importance who would contradict you on this.

That said many areas of finance might in fact be truly unproductive, for instance I harbour serious doubts on the validity of much of the financing of consumption; and much of the financial innovation, although perhaps valid in principle and theory, has resulted in disasters that makes it obvious that we need to reign our tendency to give any innovation the full benefit of doubt.

The Financial Times does a lot better defending the financial sector when it points to the real connections between the financial and the other sectors of the economy but, if that results in a shrinkage of the financial sector so be it, that in itself does not mean it is bad.

Finally your humble acknowledgement that “finance is riddled as it is always has been, with gamblers using other peoples money, chancers taking risks but calling it genius, and worthy people following the crowd into collective insanity” but completely leaving out the regulators who with their excessive empowerment of the credit rating agencies laid all the foundation for this crisis has nothing to do with “Without fear and without favour”. Perhaps the Financial Times needs to reflect a bit more on its own real market.

Too many monkeys with razorblades!

Sir Stephen D. Young states quite strongly that “Professionals recognise that blindly following any model is foolish” and he is absolutely right but which leaves us with the problem of what to do when so many that are identified as professionals do. I have no problem with finance using sophisticated mathematical models, that’s what these tools are there for, but sometimes I get the impression that our professionals are sent too early to the frontiers without enough basic Boot Camp training. What are you to do if in the trenches your laptop suddenly stops functioning?

In my country, whenever some one goes out in real life believing too much in the tools he takes with him or having too much power for the knowledge he possesses, we usually refer to him as a “monkey with a razorblade”. May I suggest that too many monkeys with razorblades have joined the professionals?

Please unshackle the markets

Sir, in a “Shake-out could help the markets” August 14 you make it clear that Central Banks should offer liquidity but not rate cuts and I fully agree, as you, based on the evidence we have seen. Central Banks are there to be there when needed but always with ever more demanding conditions and rates.

What they could also do is to suspend, until further notice, hopefully forever, that so much of the market in its investment allocations, has to heed the criteria of the credit rating agencies. Now is the time to unshackle the market and allow it to better find its own way out of the mess.

I wonder if also the Central Banks should not give a second look at those minimum capital requirements that the Basel banking regulating community has imposed on the commercial banks. I mean from yesterday to today it is not like the banks have become more risky, it is more that they are discovering how risky they really were, and so the Central Banks should perhaps help to ease that tragic moment of realization.

Where the buck really needs to reach

Sir, David Hale in “The Credit crunch and the quandary of the Fed” August 14, is just another one in the long line of commenter on the current financial turmoil that refuse to apportion responsibilities where they should go. For instance when he says that “the rating agencies facilitated the boom by giving high credit scores to securities with loans of dubious quality” the facilitated is by all means an understatement since they in fact have a great responsibility for that boom. Mind you, not that the “buck” should stop with the credit rating agencies. In the first line of responsibility, without any doubt, are those regulators that instructed and even in some cases ordered the market participants to stop thinking for themselves and heed the expert opinion of the credit rating agencies.

If we don’t realize all this and furiously back-peddle from our current setup, if we survive this turmoil, we will not do so the next time around. There is just too much systemic risk fabrication going around.

This time though ignorance was mostly fabricated

Sir John Kay in “The same old folly starts a new spiral of risk” August 14 recounts a story from the files of Lloyd’s to make a case for how “people who knows a little of what they are doing pass risks to people who knows less” and so therefore risks tend not to spread but to concentrate setting us up for an explosion. I agree that we might or should have already learned our lessons from that but in the current turmoil there are in fact two new elements that give a fresh perspective on financial history. The first, the most ironic, seems to be that it was in fact those most knowledgeable participants that with their excessive arrogance fabricated with their sophisticated financial models their own ignorance and second, more tragic, that the market was not allowed to apply its own and perhaps even more wise ignorance, but was instructed, by the regulators, to follow the advice of the experts, the credit rating agencies. The concentration of risks under such circumstances could prove to be even much more explosive.

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.

We need to attach a warning message to the credit ratings.

Sir Andrew Ward reports August 10 that President George W. Bush has said there was a “proper role for government” in enhancing financial literacy as “we had a lot of really hardworking Americans sign up for loans and the truth of the matter is they probably didn’t fully understand what they were signing up for”.

Mr Bush might have a point but from what we currently see those most in need of a financial literacy course seem to be all the investors struggling to make head and tails out of credit rating grades or financial models that really do not mean what they say.

Of course it also cannot only be a question about the reading but also about the writing. For a starter, as a minimum role for the government, I would suggest they start by making obligatory, whenever credit ratings are disclosed the inclusion of a “Warning, following these ratings blindly is dangerous to the financial well being of your portfolio.”

That is not the route!

Sir, Jeffrey Garten’s “We need rules for sovereign funds” August 8, includes a mind-boggling list of proposals “that many will see . . . as having a protectionist thrust.” No kidding? The only real conclusion I reached was to tell my daughter to watch up if she was thinking of studying international trade or finance at Yale.

Not only does Garten analyze the issue of sovereign funds as if trying to carve out for himself the role as The High Priest of financial nativism but also, even if he was absolutely right about his deepest misgivings, the type of solutions he proposes, like requiring from the government owned investment companies that they “publish internationally audited reports on their entire portfolios at least twice a year” could not serve any rational purpose and could in fact even serve as a dangerous valium.

What on earth is Garten up to? Trying to extend Sarbanes Oxley to the rest of the world governments? Asking the credit rating agencies to rate the sovereign funds? Allowing these funds only to buy government paper? Good luck! This type of approach would only have much of the current world imbalances try to go underground, making them so much harder to manage. Do I then mean that sovereign funds do not pose any threat? Of course not…some do, the same way that some non-sovereign funds could also be dangerous for any sovereignty.

Now let us connect urgently the lessons learned with the what to do.

Sir, Desmond Lachman, in “America’s subprime blues have historical echoes” August 3, is absolutely right when he says “At the heart of today’s subprime crisis is the unfortunate interaction of financial innovation gone awry, inept market regulation [by which we might presume he also refers to inept regulators] and a failure of the rating agencies to exercise their fiduciary responsibility to protect the average investor.” By the way the credit rating agencies would probably argue that part about “fiduciary responsibility” since they way they describe it, they only give opinions in accordance with their freedom of expression rights.

Now what Desmond Lachman does not yet do, is to connect the lessons learned with the what to do. As I see it and following that old advice of when in a hole stop digging, the first thing we have to do is clearly to recall all the empowerment awarded to the financial fortune tellers, the credit rating agencies, to dictate so much about where the financial flows can or should not go. Let us pray that the current problems are just a minor tremor that serves us as a warning and that we still have time to runaway from construing a financial system on top of a systemic fault that if we do not amend will produce mind-boggling catastrophes.

PS. "minor tremor"? The 2008 Global financial crisis GFC

Have 100% guaranteed incomprehensive financial model…will travel!

This is a great and handy tool for hedge funds when valuating portfolios and that will produce maximum commissions; and for the large US banks that have recently been authorized by their regulators to apply Basel II rules and now need to catch up with European competitors in lowering their capital requirements.

Low maintenance costs with access to an exclusive well churned and pliable data set licensed by the proprietor and that reaches back to 1840 and is equally impossible to scrutinize.

It is we that have to learn the lesson from the rating agencies handling of Enron.

Sir, Dr Len Rosenthal in his letter “Ratings need to learn lessons from Enron”, June 27, gives many good recommendations for how the rating agencies could perform better their jobs and avoid the risks of being “hoodwinked”, but he makes the fundamental mistake to presume that the Enron’s of this world are detectable and avoidable.

This could be since as he belongs to a Department of Finance of a college he might have a vested interest in selling the gospel that all risks can be derivated away. I on the contrary find it not so hard to accept having to live with the risks of the Enron’s since as individual risks they could all be digestible but what I really find unacceptable is the systemic accumulation and or hiding of the risks that is embedded in having to follow the advice from some very few credit rating agencies, and this no matter how many courses they take with Dr Rosenthal.

There’s just been a change of shackles.

Sir, Martin Wolf writes so intelligently about the “Risks and rewards of today’s unshackled global finance”, June 27, that I almost feel ashamed about raising the question of whether the global finance really has been unshackled, as I believe that it has only had a change of shackles.

We have shackled much of the market to the opinions of some few credit rating agencies; we have shackled the market into the belief that risks can actually be derivated away and will not reappear elsewhere; and we have shackled the financial reward structure to something more akin to the time-share industry, rewarding those that are in fact restructuring the long term realities of our portfolios with success fees paid out immediately, based on the vendors own valuation models, and which most certainly do not bear much relation to our true long term results; and finally, the mother of all the shackles, the mind-boggling financial positions that have been built up around the world without really knowing how to get out of them, in an orderly way.

Cutting out short term data will not fix it, more important is sending out the right long term signals.

Sir, of course that US economic long term competitiveness could be harmed by the companies and markets excessive short term focus but to believe that US economic long term competitiveness could somehow be helped along by cutting quarterly guidance is to be completely out of focus. Do not get me wrong, I am all for scrapping the quarterly guidance, although there are people making a living out of them, but what I mean is that for the US to be able to link more responsibly with the future, much more important is to start out sending the right long term signals. For instance, may I suggest a gasoline tax that prices gas at the pump at US$ 7 a gallon?

Laziness and arrogance

Sir, In “Lots of unknowns”, June 25 you write that now the Bank for International Settlements, the central banker’s central bank, says that “our understanding of economic processes may even be less today that it was in the past”

That is something they should have discovered long time ago had they not been so busy taking credits for the counter inflation benefits brought about by globalization; and driving banking risks out of banking to such an extent that so many of the risks were forced to hideout in the more informal world of the hedge-funds and in the algorithms of some derivatives. In order for them to be able to monitor the world’s financial flows, from their desks, they reduced the relations between borrowers and creditors to digital data, and they chained much of the world’s financial flows to the opinion of some hired credit rating agencies.

Now, when crisis is breeding around the corner, the most important thing to ascertain is that when the fire breaks out we do not send out the firemen who installed the sprinkler system and that are more interested in covering their shoddy piece of work.

Boy, were they arrogant. Even a World Bank was ordered to shut up and harmonize with the International Monetary Fund, one of the most famous clubhouses of the central bank’s bankers.

The growth of global finance is not that free or muscular.

Sir, all you say in “Why finance will not be unfettered” June 25, might be indeed be right but nevertheless you say it wrong. Yes the market has grown tremendously but if you truly believe that this has more to do with “seeking out pockets of undervaluation” than the exploitation of new instruments for temporary overvaluation, you are a true optimist. Unfortunately when the marking to the market of today’s almost incestually benign models and conditions need to be marked to the markets of the future, and we begin discovering where the risks have been hiding out, will probably find a lot of fat and very little muscular tissue in the growth. And to talk about “liberation of finance” and “unchained financial capitalism” when you have forcibly chained so much of the market to the opinions of some very few credit rating agencies reminds me of when Arthur Koestler describes how he as a young and utterly illusioned student, was able to see freedom in the communist Soviet.

Whistling in the dark

Sir, Gillian Tett wrote in “Collateral values thrust to the fore by woes at Bear Stearns” June 21, about the problem of discovering hidden losses in assets that are rarely traded and that are valued through financial models when they have to be sold and most especially if in the case of a fire sale. In the respect I would like to make two innocent questions? First, how much value do these assets that are rarely traded and only valued by models represent? Through the answer we might get a better appreciation of what could happen if real life came around and forced upon us its usually brutal mark to market.

Second, are these gaps not what used to be registered as losses? With all the derivatives and hedge funds flying around is not really our problem that the financial crises, while already been happening have not been noticed as they have gone underground or informal.

If it could be said that Italy based only on its formal growth rate would have long since disappeared but that they are alive and well thanks to the informal sector, could not the opposite be held; that the formal sector that looks to be doing well could in fact have disappeared because of what is going on underground? Thinks are indeed quite scary, and so we better keep on whistling in the dark!

Please let us learn instead and not believe more in the pure blessings of using credit rating agencies

Sir, Gillian Tett ends her “Confidence in CDO rating system showing signs of strain”, June 15, with “Let us hope that the rating agencies and regulators can find a way to make us true believers again” though what we really should be learning is not to believe more in the possibility of a system whereby through the use of some few designated rating agencies we think we can help to direct the world’s financial flows without setting it up to some dramatic systemic risks. Would not using credit rating agencies to more bank crisis and other problems? Perhaps, but that way we would at least vent the system and not allow for the systemic accumulation of risks that can only build up to a truly horrendous explosion. By the way since in these discussions there is mostly a mention of the credit rating agencies when they miss by giving a too high rating, let me also remind you of their equally intrinsic and real cost when they give a too low rating. Any credit not given because of a bad rating, could in, sys fact be the best opportunity missed the world has ever seen.

Why not deregulate the banks instead?

Ian Morley from the Alternative Investment Management Association in “Hedge funds and regulators can work together” May 6, tells us that hedge funds are a positive force in markets by providing liquidity while at the same time on the opposite page Roger Merrit, from Fitch Ratings, in “Hedge fund behaviour in credit markets is untested” poses some serious questions about just that, and of course they are both right, for good and for bad.

Having said that when reading Morley’s spirited defence of voluntary regulations and of the fact that regulators should instead help to enforce these instead of coming up with their own I just want to ask where was he when the banking regulators decided for instance to force down the throat of the market, the opinions of a couple of few credit rating agencies. As one could argue that it is the excessive regulation of the banks that has been the main driving force for the hedge fund industry and that banks should in fact be more important than hedge-funds, perhaps what Morley should ask for is some deregulation of banks, but of course that is not what the alternative association is paying him to do.

Please assure Mr. Merton that no one is holding him personally responsible

Gillian Tett does a splendid work interviewing Mr Robert Merton “The appliance of financial science” May 21 and let us hope that on the behalf of all of us she has really been able to convey that we really will not hold him personally responsible for whatever could happen with all of his and his friend’s inventions and creations such as derivatives, option pricings and what have you, just as no one does holds Einstein and his friends responsible for what more bad the nuclear bomb might bring. Of course it will all come down to how these great and useful inventions are used.

Having said that I would like to comment on that when Merton says “Just think of all the crises that haven’t happened, say with the downgrade of General Motors and Ford” it really does not mean the negative effects have disappeared, just that they have been so diluted that we do not notice it. Spreading ink in a lake instead of a bathtub will get less noticed but keep on doing it and then suddenly you will have a whole lake go ink-blue and that could suddenly turn to be even catastrophic.

Question. Are derivatives a way of pushing things forward to future generations so as to better being able to enjoy the blissful ignorance bubble?

Incest and irony

Sir, by reading your “CPDOs add more complexity”, March 30, that states “The rating agencies are key to creating the [financial] products” and that “The “agency is working with numerous banks on various deals”, one must realize how the rating agencies have in fact themselves become more and more a part of the same product they are rating. This does present the potential for some very incestuous relations and given that so much of the decision power about where the financial flows in the world should go has been (stupidly and arrogantly) deposited in the hands of very few credit rating agencies, this is without any doubt something extremely dangerous.

Now also, while observing the ever growing financial complexities, one cannot but reflect on how ironic it is that the whole financial world is currently holding its breath, just because some extremely primary and basic mortgage lending seemingly went haywire. Could it be time to ask all those experts that work so diligently in their financial laboratories, to take a short respite, and walk around in the real world for a while?