​​Too many, FT included, approve of postponing all cleansing, even knowing that will make the après nous le deluge so much worse.

Sir, as an Executive Director of the World Bank, 2002-04, in a Risk Management Workshop for Regulators I argued: “A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises”

And in 2006 in a letter published by FT in 2006 I argued for the “Long-term benefits of a hard landing”.

And so you should be able to understand how much I agree with Roger Blitz’s “Central bank medicine risks creating addicts”; subtitled “Regulators’ desire to treat all ills is storing up problems for the future” July 21

@PerKurowski ©

Sovereign Debt Restructuring Mechanisms (SDRM) starting with salvaging and not with preventing, are moral hazards

Sir, Elaine Moore’s when reporting on Sovereign Debt Restructurings Mechanisms quotes Anne Krueger with: “Government should be able to declare bankruptcy, just as companies do. Instead of bailouts and lost decades of austerity, they should be able to wipe the slate clean and start again.” “Economist in a hurry” August 8.

“No!” if it means irresponsible governments will find it easier to start from clean slates

“No!” if it means irresponsible creditors will be bundled together with responsible ones.

“Yes!” if it means responsible governments will have a chance to restart their country.

“Yes!” if it means odious creditors will be required to assume the largest share of sacrifices.

And for the latter to happen, nothing better than assuring that any Sovereign Debt Restructurings Mechanism developed, diminishes the possibilities of being needed.

In this respect I believe any acceptable SDRM should begin with:

First and foremost by eliminating all incentives that can help governments contract too much debt… like banks being allowed to hold much less capital when lending to sovereigns than when lending to citizens.

And then by defining clearly what, when compared to ordinary credit to the public sector, should be deemed as odious credit. For instance, credit not awarded in a transparent way, or awarded when it was clear that the resulting debt might not be sustainable, and was therefore of speculative nature, should not receive the same treatment in a SDRM, as public credit awarded transparently and when there was no doubt about the sovereigns capacity to serve it.

Anne Krueger holds “If you get to a stage where a country’s debt is so large that it cannot grow, then you need to rethink”… and that to me, as an ordinary citizen, is best done by thinking and rethinking about how it landed itself in such a mess.

PS. The article ends quoting Krueger with “And there will be a next crisis, though where it comes from is likely going to take everyone by surprise”. If only she could convince our bank regulators of that. They still believe that the unexpected problems, for which banks need to hold capital, should be based on the expected problems derived from credit risk.

@PerKurowski

Failures and mistakes is something that needs to be nurtured in order to have a better future.

Sir, Gillian Tett is absolutely correct when she writes: “What is still missing, in many quarters, is a mindset – most notably a recognition by bureaucrats and bankers that failure is an inevitable part of the market system, and that it sometimes pays to wipe the slate clean rather than endlessly sweep problems under the carpet”, “Jingles that sound the beginning of recovery” October 24.

That is exactly what I referred to in a letter you published in August 2006 in which I wrote about “the long-term benefits of a hard landing” and the dangers of dabbling in topics such as debt sustainability ignoring the value of pruning or even, when urgently needed, of a timely amputation.”

But, I also think it is very important that the wiping-the-slate-clean, also applies to banks. As an Executive Director of the World Bank, in 2003, I told many regulators during a Basel II preparation conference: “A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.”

But no, the Basel Committee preferred to proceed down the road of nurturing the too-big-to-fail banks.

PS. By the way, Ms. Tett might be interested that in the US, the jingle she refers to, is not allowed when it comes to educational debt.

If Venezuela defaults, two have tangoed, an incompetent government and highly irresponsible lenders.

Sir, I refer to John Paul Rathbone’s “Call for default underscores Venezuelan incompetence” September 8.

In it Rathbone analyses Ricardo Hausmann’s and Miguel Angel Santos’ recent “Should Venezuela default?” where they so correctly argue that Venezuela’s government, though being current on its debt service, has already de facto defaulted in so many ways on “its people”, something which signals a “moral bankruptcy”.

Venezuela’s government has clearly shown absolute incompetence, the highest disdain for Venezuela’s constitution and for instance, according to Human Right Watch, has also committed crimes against humanity. And facts like gasoline-petrol being given away at US$ 1 cent per gallon, 278 times less than the price of milk… makes all of the above as evident as can be.

But, let it us be very clear, all equally points to highly irresponsible lenders who do not care one iota, as long as the price, the risk-premiums, are right.

Rathbone reminds us that “Venezuelan bond yield on average 12.3 percentage points more than US treasury”. Let us then suppose a bond issue yielding 20% that is going to finance the building of some concentration camps. Where do you draw the line on what is morally admissive lending? Where do you draw the line on what kind of intermediation fine reputable investment banks can do before they become morally repulsive?

As I have been arguing for some time, anyone investing in a bond that (when rates are as low as the current) pay for instance 4% more than the risk free rate, should know he is buying morally questionable pre-defaulted bonds… and that he must renounce to the possibility of having the cake and eat it too, meaning aspiring to get 100% of risk premiums and 100% of principal.

As a Venezuelan citizen let me also remind all that currently the government receives directly 97 percent of all the nation’s exports and, while so, as I see it, has no right to take on any debt whatsoever.

PS. During the Venezuelan default in the 80s I asked a foreign banker “How come you lent especially much to this entity that is emblematic of all non-transparency, corruption and mismanagement in Venezuela?” His answer was: “At the end of the day it is all going to be government debt, and this entity pays the highest interest rates”. I felt like slapping his face, I wish I had!

“Careful, take cover, run for the shadows!”

Sir, Gillian Tett in “Why they´re happy in the valley of the shadow banks” June 28 worries because “notwithstanding the fact that the financial crisis largely started in the non-bank sector, or shadow bank world, thus far at least, western regulators have focused most of the reform efforts on the regulated banks”. Where does she get that first part from? And why would she assume that the shadow world behaves worse than the formal regulated one? For instance, there are no regulations on hedge funds, but rarely do you see any of them being leveraged more than 10 to 1, but you sure found regulated banks with a duly authorized leverage of over 50 to 1. Let me be frank, with bank regulators like the current, the only reason why I would place my money in regulated banks, is not because of the regulations, it is for the protections that might anyhow be present… in other words a 110% moral hazard risk.

Right now, even after the recently increased capital requirement of 9 percent to be applied to global systemic important financial institutions, these might still leverage 55 to 1 when lending or investing in what carries a risk-weight of 20%, the same risk-weight that applied for triple-A rated securities collateralized with mortgages to the subprime sector, for lending to Icelandic banks, or for lending to Greece. Sincerely, observing that, any advisor could have all the right to shout out “Careful, take cover, run for the shadows”

Too much longing for stability creates the perfect storm conditions for instability

Sir, Samuel Brittan refers to “artificial suppression of volatilities in the name of stability” “The follies and fallacies of our forecasters” May 27. That is precisely what as an Executive Director of the World Bank I was referring to when, in May 2003, in pre-Basel II days, I told a large group of regulators gathered for a risk-management workshop at the World Bank, the following: 

“There is a thesis that holds that the old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, was much wiser than today’s no burning at all, that only allows for the buildup of more incendiary materials, thereby guaranteeing disaster and scorched earth, when fire finally breaks out, as it does, sooner or later. 

Therefore a regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.”

The regulators did not understand what I was talking about… mostly because they wanted so much to believe in forever stable banks.

PS. As you can see here, the link to Brittan’s article is gone.

Caught between moral hazards and moral duties

Sir, Lawrence Summers rightly ask us to “Beware the moral hazard fundamentalist”, September 24, but ends up sounding a bit fundamentalist himself listing the three conditions that if all met makes “a strong case for public action”, namely that there are contagion risks; that it is a liquidity and not a solvency problem; and that it will not cost the taxpayer any money. Very helpful indeed! Under those conditions the moral hazard of not intervening would seem to loom large.

But what if for example the problems were derived from the fact that the regulator through the use of minimum capital requirement rules had ordered or, somewhat softer, induced the financial institutions to dismantle or, somewhat softer, to scale down their own credit risk departments and follow more the criteria of the credit rating agencies, would the authorities in that case not also have a moral duty to help out?

On moral hazards

Sir, one prime problem with subprime mortgages is that it is given subprime terms and so, if a lender would agree to write off a 20% of the value of all subprime mortgages and give the current debtor prime terms, it would not be something outrageous to have the government chip in offering some partial payment guarantee on the balance owed, callable only if the loan is delinquent after a cool-it-of period of perhaps two years, and thereby allow the prime terms to be warranted.

That this could imply the moral hazard of allowing some guilty and bad intentioned borrowers to benefit? Absolutely, exactly in the same way that moral hazard exists when bailing out investors. The final question, as always, is just what side of the equation you most need (or want) to benefit, the debtor or the investor.

To do nothing then?... and have the housing market crash, which could of course help some youngster to at last afford buying a house, but make it harder for other youngster to find a job. You see? It is not easy, even for politicians, as life is only about a continuous choice among so many different moral hazards.