Regulators, please do no harm, you’ve done enough!

Sir Viral Acharya in “Why bankers must bear the risk of ‘too safe to fail´ assets” March 18, points out that “though AAA –rated tranches and repo financing are relatively safe, their entire risk is systemic in nature” and therefore [bank] regulations “should be more concerned about seemingly fail-safe assets… rather than worrying much about riskier assets”.

As you must have been able to gather from my many (unpublished) letters making the same argument I believe he is absolutely correct. My deepest concern though is how we all landed in the hands of bank regulators so naive as to believe that in a world of intrinsically coward capitals disaster looms where risk is perceived as high and not where the risks are perceived as low and therefore create conditions for stampedes towards safety and that could dangerously overcrowd even the ex-ante safest haven.

Again, for the umpteenth time, we need for our regulators to be fully aware that their regulations could be the source of the worst kind of systemic risk and, if they’re not, then we are much better off without any sort of regulation.

When selecting the regulators we must reduce the risk of a systemic fault or similarity in their thinking process. Now we have only single-minded gnome clones.

The pastor risk is the risk that investors just share into blissful ignorance.

Sir, Wolfgang Münchau is correct when saying “A risk shared may be more risky, not less”, April 23. As arguments he presents, first the deceased US economist Hyman Minsky’s general pessimism (or may we dare say realism) that instability is an inherent part of the system, and then Raghuram Rajan’s, former director of research at IMF, who argues along the line that the investor’s increased willingness to invest in “tail risk” and their “herd” mentality could lead to a catastrophic meltdown.

I myself have been writing and warning on these specific issues for a long time, though mostly on the risk present in assigning too much market decision power to very few credit rating agencies and which introduces not a herd but a “systemic pastor” risk.

For instance in the ongoing subprime mortgages debacle, the distance between the borrower and the final lender increased too much, just because everyone counted on others to be able to provide sufficient oversight. When we now start seeing how credit rating agencies rated without even sending a team to walk the streets in order to sample how those subprime mortgages originated, we should be able to conclude that the investors besides sharing risks, were also sharing blissful ignorance.