What if a Basel Committee had regulated the payouts of casinos?

Sir, in “The risks of fund­ing states via casi­nos” FT, July 3, Martin Wolf writes: “In the run-up to the GFC, the dom­in­ant form of lend­ing was to the private sec­tor, particularly in the form of mort­gages.”

The dominant form of lending was indeed mortgages but that obscures the truth of what really happened.

Mortgages to the subprime sector were packaged into securities which, if obtaining an AAA to AA rating could, thanks to 2004 Basel II, be held by US investment banks and European banks against only 1.6 percent in capital, meaning they could leverage 62.5 times with these. 

As should have been expected, the temptation to package MBS sausages with the worst ingredient, which maximizes profits when then able to sell these as made with pure tenderloin, proved irresistible.

Sir, how long will FT keep being obsessed with minimizing the distortions of the Basel Committee’s risk weighted bank capital requirements?

Casinos? Ask Mr. Wolf whether he believes there would be any casinos left if its regulators ordered these to make higher payouts on safer bets, e.g., red or black than on riskier ones, e.g., a number?

https://subprimeregulations.blogspot.com/2012/12/the-basel-ii-roulette-manipulation.html

Free markets were set up to go bad, because of bad bank regulations.

John Thornhill writes: “The global financial crisis of 2008 exploded the ideology that markets always deliver the goods” “Three game-changing ideas to shape the post-pandemic world” Life and Arts, May 30.

Sir, that is the problem, because that is exactly what all those against free markets want us to believe. 

The 2008 crisis resulted from huge exposures to securities collateralized with mortgages to the subprime sector in the USA, turning out risky. 

And those huge exposures were a direct result of: Regulators allowing European banks and US investment banks to hold these securities, if these were rated AAA to AA, which they were, against only 1.6% in capital; meaning banks could leverage their equity an amazing 62.5 times. 

Securitization, just like making sausages, is the most profitable when you pack the worst and are able to sell it of as the best. If you can sell someone a $300.000 mortgage at 11 percent for 30 years, which was a typical mortgage to the subprime sector, and then package it in a security that you could get rated a AAA to AA, so that someone would want to buy it if it offered a six percent return, then you would pocket an immediate profit of $210.000. 

The combination of those two temptations proved irresistible.

The worse the mortgages packaged, the higher the potential of securitization profits was (is)

Sir, FT’s big read by Mark Vandevelde and Joe Rennison “The story of a house” September 6, leaves out two important facts:

First: Christopher Cruise, who ran popular courses in mortgage origination, is quoted with “You had no incentive whatsoever to be concerned about the quality of the loan or whether it was suitable for the borrower” 

But yes you did, only in a direction quite different than usual. The worse the borrower and the worse the mortgagor, the higher the potential of profits of packaging it in a securitization sausage bound for a high credit rating. All involved in that securitization would profit, immensely, except of course those who were being packaged into that sausage. Imagine, if that sausage obtained an AAA to AA rating, US investment banks and European banks were allowed by the regulators to leverage 62.5 times their capital with these.

Second: “Société Générale, the French bank, was one of those that took out insurance against a collapse in the value of Davis Square, buying exotic derivatives contracts from the insurance group AIG.”

That was not solely for insurance. Because AIG was AAA rated, whatever lower rated securitized mortgages it added its signatures to also gave the banks the possibility of a mindboggling 62.5 times leverage. 

Profit potential: If you convinced risky and broke Joe to take a $300.000 mortgage at 11 percent for 30 years and then, with more than a little help from the credit rating agencies, you could convince risk-adverse Fred that this mortgage, repackaged in a securitized version, and rated AAA, was so safe that a six percent return was quite adequate, then you could sell Fred the mortgage for $510.000. This would allow you and your partners in the set-up, to pocket a tidy profit of $210.000

Sir, credit rating agencies using fallible humans did not stand a chance to get it right! 

@PerKurowski

Where would America be today had not bank regulators distorted credit and central bankers kicked the crisis can forward?

Martin Wolf, expressing concerns we all deeply share asks, “Who lost “our” America?” and he answers: “The American elite, especially the Republican elite… They sowed the wind; the world is reaping the whirlwind. “How we lost America to greed and envy” July 16.

I respectfully (nowadays not too much so) absolutely disagree. That because supposedly independent technocrats generated the two following events:

First, in 1988 regulators with their so sweet sounding risk weighted capital requirements, promised the world a safer bank system, but then proceeded to design these around the loony notion that what was perceived as risky was more dangerous than what was perceived as safe. That distorted the allocation of bank credits in favor of the "safer" present and against the "riskier" future. That must have stopped much of any ordinary social and economic mobility.

Then in 2007/08, instead of allowing the crisis to do its natural clean up, central bankers, starting with the Fed but soon to be eagerly followed by ECB and other central banks, just kicked the can forward, favoring sovereigns and existing assets. Just as an example, with their repurchase of the failed securities backed with mortgages to the subprime sector, they saved the asses of many investors and banks (many European) while very little of that sacrifice flowed back to those who, in the process, had been saddled with hard to serve mortgages.

Martin Wolf, and you too Sir, would benefit immensely in trying to imagine how the world would be looking now, without that unelected and inept technocratic interference! What had specifically Republicans, or Democrats, to do with that interference?

As I see it if that had not have happened Trump would not even have been thinking of running as a candidate.

PS. An aide memoire on some of the mistakes with the risk weighted capital requirements.

@PerKurowski

Do subprime borrowers or investors in mortgages benefit from securitization? No, now all profits go to intermediaries

Sir, Ben McLannahan, with respect to securitization of subprime mortgages quotes Julian Hebron, head of sales at RPM Mortgage with: “Making credit available to borrowers who are subprime is national policy and it is an important part of economic growth” “Financial crisis: 10 years on: The return of subprime” September 2.

Q. Do the subprime borrowers get any interest reduction from having their mortgages securitized, such reduction that could make these mortgage a safer investments for those investor who acquires these at lower rates? A. No!

Convincing risky Joe to take a $300.000 mortgage at 11 percent for 30 years, packaging it in a security, and then with a little help from the credit rating agencies convincing risk-adverse Fred that this mortgage is so safe that a six percent return is adequate, allows that mortgage to be sold for $510.000.

The $210.000 profit is now shared in it entirety by those originating the subprime mortgage, those packaging it, and those obtaining the excellent credit rating for the resulting security.

If that is “an important part of economic growth” that merits being part of a national policy, I don’t get it. Do you Sir?

If for instance 70% of those profits were paid back to those borrowers who lived up to their obligations, that would indeed imply a different and much more positive incentive structure.

Is that not something like for which cooperatives are often intended but not always achieve?

@PerKurowski

Regulators placed delicious cookies on the table and only banks are being punished for falling for the temptation

Sir, again, December 24, we read on your front page about banks being hit with penalties for the subprime mess, and still not a word about the responsibility of regulators creating the temptations they should have known that, sooner or later, some would not resist.

Here are four factors that explain the subprime mess, or at least 99.99% of it.

Securitization: The profits for those involved in securitization are a function of the betterment in risk perceptions and the duration of the underlying debts being securitized. The worse we put in the sausage – and the better it looks - the higher the profits. Packaging a $300.000, 11%, 30 year mortgage, and selling it off for US$ 510.000 yielding 6% produces and immediate profit of $210.000 to be shared among those involved in the process.

Credit ratings: Too much power to measure risks was concentrated in the hands of some very few human fallible credit rating agencies. The systemic risk with using credit ratings so much should have been anticipated by regulators.

Borrowers: As always there were many financially uneducated borrowers with needs and big dreams that were easy prey for strongly motivated salesmen, of the sort that can sell a lousy time-share to a very sophisticated banker. 

Capital requirements for banks: Basel II, June 2004, brought down the risk weight for residential mortgages from 50% to 35%. Additionally, it set a risk weight of only 20% for whatever was rated AAA to AA. The latter, given a basic 8%, translated into an effective 1.6% capital requirement, which meant bank equity could be leveraged 62.5 times to 1.

So, clearly the temptations became too much to resist for many of those involved.

The banks, like the Europeans, thinking that if they could make a 1% net margin they could obtain returns on equity of over 60% per year, went nuts demanding more and more of these securities; and the mortgage producers and packagers were more than happy to oblige, signing up lousier and lousier mortgages and increasing the pressure on credit rating agencies.

Of course it had to end bad... and it did… in sort of less than 3 years.

Financial Times, is this a version of the real truth that is not to be named?

PS. “DoJ penalties hit $58bn. If banks leverage 12 to 1, that means $696bn in credit capacity. Why do they not collect these fines in bank shares?

@PerKurowski

This would be my brief testimony about what caused the 2008 bank crisis… if ever allowed

Sir, John Authers writes: “This week, Senator Elizabeth Warren, said the next president should reopen investigations into senior bankers who avoided prosecution, and that the FBI should release its notes on its investigations. The failure to punish any senior bankers over the scandal angers the populist left and right, the world over.”, “We are still groping for truth about the financialcrisis” September 17.

The following, if I am ever allowed to give it, as so many would not like to hear it, would be my brief testimony on what caused the 2008 bank crisis

Sir, as I have learned to understand it, the 2008 crisis resulted from a combination of 3 factors.

The first were some very minimal capital requirements for some assets that had been approved starting in 1988 for sovereigns and the financing of residential housing; and made extensive in Basel II of 2004 to private sectors assets with good credit ratings.

These allowed banks then to earn much higher expected risk adjusted returns on equity on some assets than on other, which introduced a serious distortion. After Basel II the allowed bank equity leverages were almost limitless when lending to “sound” (or friendly) sovereigns; 36 times to 1 when financing residential housing; and over 60 to 1 with private sector assets rated AAA to AA. Just the signature, on some type of guarantee by an AAA rated, like AIG, also allowed an operation to become leveraged over 60 times to 1.

The second was Basel II’ extensive conditioning of the capital requirements for banks to the decisions of some very few (3) human fallible credit rating agencies. As I so many times warned about (in a letter published in FT January 2003 and even clearer in a written statement delivered at the World Bank), this introduced a very serious systemic risk.

The third factor is a malignant element present in the otherwise beneficial process of securitization. The profits of that process are a function of how much implied and perceived risk-reduction takes place. To securitize something safe to something safer does not yield great returns for the securitization process. Neither does to securitize something risky into something less risky.

What produces BIG profits is to securitize something really risky, and sell it off as something really safe. Like awarding really lousy subprime mortgages and packaging them in securities that could achieve an AAA rating. A 11%, 30 years, $300.000 mortgage, packaged into a security rated AAA and sold at a 6 percent yield, can be sold for $510.000, and provide those involved in the process an instantaneous profit of $210.000 

With those facts it should be easy to understand the explosiveness of mixing the temptations of limitless , 36, and more than 60 to 1 allowed bank equity leverages; with subjecting it too much to the criteria of few; with the profit margins when securitizing something risky into something “safe”. Here follows some indicative consequences:

As far as I have been able to gather, over a period of about 2 years, over a trillion dollars of the much larger production of subprime mortgages dressed up in AAA-AA ratings, ended up only in Europe. Add to that all the American investment banks’ holdings of this shady product.

To that we should also add Europe’s own problems with mortgages, like those in Spain derived in much by an excessive use of “teaser interest rates”, low the first years and then shooting up with vengeance.

And sovereigns like Greece, would never have been able to take on so much debt if banks (especially those in the Eurozone) would not have been able to leverage their equity so much with these loans.

Without those consequences there would have been no 2008 crisis, and that is an absolute fact.

The problem though with this explanation is that many, especially bank regulators, especially bank bashers, especially low equity loving bankers, do not like this explanation, so it is not even discussed.

The real question though is: Who is the guiltiest party, those who fell for the temptations, or those who allowed the creation of the temptations?

I mean how far can you go blaming the children from eating some of that deliciously looking chocolate cake you left on the table, at their reach?

Sir, John Authers, tell me if you believe I at least have a point, should that not merit a discussion?

@PerKurowski ©

When securitization wedded the capital requirements for banks, the subprime mortgages' inferno overheated.

Sir, I refer to Gillian Tett’s “Unorthodox answers to the inflation enigma” April 1.

Ms Tett writes: “If the Fed, or any central bank, wants an illustration of why ethnographic research matters, they need only look at the last credit bubble, when most economists missed the subprime mortgage boom because they shunned on-the-ground research. Fed officials need to get into consumers’ lives. Or else hire a few anthropologists to work with those office-bound, and baffled, economists.”

Unfortunately central bankers have yet to understand the missed subprime mortgage boom, and so has anthropologists like Gillian Tett.

Anyone who has read Kirsten Grind’s spectacular tale of the Washington Mutual failure “The Lost Bank” 2012, Gillian Tett has praised it, should have been intrigued by a question the book poses but that remains unanswered. Why was there especially such huge demand for basically the lousiest mortgages?

An objective researcher would then have found that combining the dark secret of securitization, with the importance given to the credit rating agencies for determining the capital requirements for banks, created a temptation impossible for any ordinary humans to resist.

What “dark secret of securitization”? That the worse the assets to be securitized are, the more can those involved in the securitization process profit. Selling of a $300.000, 30 years, 11 percent mortgage, packaged in a security for which an investor thought that 6 percent was a great return, would immediately yield $210.000 in profits.

And on credit ratings, if a security got an AAA to AA rating, then the banks, according to Basel II, needed only to hold 1.6 percent in capital against it, and were therefore allowed to leverage a mind-blowing 62.5 times to 1.

The problem with any central bank research though, is that it would lay much blame on all central bankers involved with bank regulations… and, among colleagues, we can’t have that, can we?

Oh how I wish Kirsten Grind would go back to the subprime inferno and research the causes for why it overheated.

@PerKurowski ©

With no ​​jobs to pay mortgages or utilities, at least we are living in great houses. Thank you bank regulators!

Sir, I refer to Tim Harford’s “Why a house-price bubble means trouble” November 22.

In it Harford writes “Booming housing markets attract bankers like jam attracts flies, sucking money away from commercial and industrial loans. Why back a company when you can lend someone half a million to buy a house that is rapidly appreciating in value?”

That is far from being the whole story.

Regulators, because they thought or wanted to think about the financing of houses as something absolutely safe, also allowed the banks to do it against very little bank capital, meaning very little equity… especially if someone managed to dress up the mortgages in AAA ratings.

And that allowed banks to earn much higher expected risk-adjusted returns on equity when financing houses than when financing the “risky” small businesses and entrepreneurs, those who could create jobs, and for which their regulators required them to hold much more equity.

And so here we now find ourselves… living in expensive houses with too few good jobs to allow us to pay the mortgages and the utilities. Is that not sort of bad planning?

Clearly the chief of Wells Fargo cannot tell us the whole truth about the "bad mortgages", so the more reason for us to expect FT doing so.

Sir, Camilla Hall writes “The US is still picking over the wreckage of the financial crisis, in which some mortgage originators willfully ignored underwriting standards to sell as many loan as possible to government-backed institutions and private investors”, “Wells chief warns on mortgage lending” August 27.

What a tremendous loss of short term memory!

First all those lousily awarded mortgages were not sold directly to any government-backed institutions and private investors, but to security re-packagers who were able to confound credit rating agencies so much that they obtained an AAA rating for these.

Secondly the investors were not buying mortgages, God forbid, they were buying AAA rated securities backed with mortgages… something entirely different.

And thirdly and most important, the only reason why there was such an intense demand for these AAA rated securities so that all caution was thrown to the wind, over €1 trillion of European investments were sunk into those securities in less than 3 years, was that Basel II, approved in June 2004, had the audacity of allowing banks to own these securities, or give loans against these securities, holding only 1.6% in equity, meaning being able to leverage their equity a lunacy of 62.5 times to 1.

Fanny Mae? Fanny Mae did not originate one single of these mortgages to the subprime sector. It also mainly got to these through the purchase of the AAA rated securities, when it could not resist the temptation.

No! If history is not told correctly how can we avoid making mistakes?

How do I know what happened? First I had warned over and over again about the risks of trusting so much the credit ratings, and when the crash came… I also took the examinations to be a certified real estate and mortgage broker in the state of Maryland, with the primary purpose of finding out what really happened.

And to hear stories told by small real estate agents being pressured into signing whatever lousy mortgage… because it did not matter… because what was important was that the interest rate was as high as possible and that the terms were as long as possible, since that would maximize the profits when selling it at low AAA rates… and because they would make bundle of commissions that would make them rich… and because “stop asking questions about what you cannot understand”… was something truly saddening.

No Sir, it is obvious that the chief of Wells Fargo cannot tell us the whole truth and nothing but the truth, as that would have to include spelling out that his regulators were stupid, but, therefore, the more the reasons we have to expect FT to do so.

Just like we do not like overly sissy nannies to educate our kids, we do not want overly sissy regulators to regulate our banks.

Sir, Sam Fleming and Gina Chon begin by quoting David Wright, secretary general of Iosco saying “It is extraordinary that here we are, nearly seven years in [from the financial crisis] and we still have an inadequate understanding of some of the key aspects of financial markets” “Push begins to put lenders’ house in order”, June 19.

But then reporting on the meltdown of the subprime loans, and even though they mention that some regulators “have imposed though capital requirements on investors who buy asset-backed securities, they basically support putting the blame on some “shadow finance”, and do not even mention the role extreme low capital requirements, for the banks in the sunshine, played in creating the demand for bundled subprime loans which caused the crisis.

Those low capital requirements resulted because sissy regulators, personally scared of some risks, thought those were the risks which were dangerous to our banks. And, in doing so, they are killing our economies, by keeping our banks refinancing the safer past and not financing the riskier future that our young unemployed so much need to be financed, in order not to become a lost generation.

No Sir! We, who have thrived on risk taking, cannot afford our banks now being in hands of so sissy regulators.

And those journalists too sissy to dare holding the regulators truly accountable, we do not need them either.

Is Thomas Piketty, with his “Capital” unwittingly working for the big time Oligarchs and Plutocrats?

Sir, I refer to Gillian Tett’s “The lessons from a rock-star economist”, April 26.

Anyone wanting to tax more wealth and income, in order to make up for an inequitable distribution, without first identifying and remedying the causes of such inequities is, de facto, working to increase the wealth and power of the big time Oligarchs and Plutocrats, because if no other changes, to them is where all those new taxes paid by the other wealthy is going to go, before the end of the day.

And I have not really understood the reason for the great hullaballoo around Thomas Piketty´s 685 pages long Capital in the Twenty-First Century. Of course it contains many interesting arguments but… what is really its new news? Gillian Tett might be quite right when she says “it has forced Americans to confront a growing sense of cognitive dissonance”… though perhaps one could equally describe that as having created the opportunity for some to exploit a growing sense of cognitive dissonance.

The book is based on a gross simplification that forces reaching the wrong conclusions. Already in the flap cover we read: “The main driver of inequality-the tendency of returns on capital to exceed the rate of economic growth-today threatens to generate extreme inequalities…But economic trends are not acts of God. Political action has curbed dangerous inequalities in the past, Piketty says, and may do so again”.

Much more accurate, and meaningful, would have been to start the analysis by asking … why is there a tendency of returns on capital to (in between crises) to exceed the rate of economic growth”. Most, if perhaps not all of those causes, are to be found directly linked to one sort of rent seeking or crony capitalism, something which clearly involves the hand of politics and governments, and something which has little to do with real capitalism. But that might not have been a welcomed conclusion to those who want to work at both ends… where the inequalities and the headaches are created and where the aspirins are handed out.

And of course to me, when Piketty writes “there is absolutely no doubt that the increase of inequality in the United States contributed to the nation’s financial instability” he is totally wrong. It was bad bank regulations which basically permitted banks to work with less and less capital, and the exaggerated importance given to the financing of home ownership, which caused the nation’s instability.

And when Piketty writes: “one consequence of increasing equality was virtual stagnation of purchasing power… which inevitably made it more likely that modest households would take on debt, especially since unscrupulous banks… freed from regulation and eager to earn good yields on the enormous savings injected into the system by the well-to-do, offered credit on increasingly generous terms”, it frankly reads like a simple provocateur pamphlet. By the way “increasing generous terms”? What a laugh! He clearly never saw the terms of the bad mortgages awarded to the subprime sector. 

And when Piketty writes “the financial crisis as such seems not to have had an impact on the structural increase of inequality”, we are left with the question of … why do you think that is so Professor?, since he seems to wish to ignore the role of Tarp and QEs in saving the wealth, at the price of even increasing the inequalities.

What can I say? I just hope for the sake of its many fans, that by next year they will not see in bookstores a bestseller titled “How we masterfully launched Piketty’s Capital”.

PS. I have read about one third of the book jumping from here to there. If I find something that will make me change my opinion while reading the rest, I will let you know.

Are car loans with adequate risk premiums to "risky" citizens really riskier than loans to “infallible” sovereigns?

Sir Gillian Tett, jogging our memory with the problems of mortgages linked to subprime borrowers, expresses concern for that subprime, even so called “deep subprime” car loans have been growing too much lately, “American subprime lending is back on the road” April 11. Poor her, she need not to worry, these loans are completely different from those loans that were so badly awarded because they could be dressed up in AAA clothing.

But she is indeed right when stating that “cheap money has a nasty habit of creating distortions in unexpected places”. Just look at all those of her colleagues who now suggest government should take advantage of extraordinarily low costs of finance in order to do so much more. That ignores that the cost of those currently so low interest rates, in much a direct result of the fact that banks do not need to hold much capital against loans to the “infallible” sovereigns, will most likely be paid by the lenders in the future, by one or another sort of financial repression.

No Martin Wolf, excessive trust in the government is the real dangerous delusion of the ignorant.

Sir, Martin Wolf writes: “The authorities can affect the lending decisions of banks by regulatory means – capital requirements, liquidity requirements, funding rules and so forth. The justification for such regulation is that bank lending creates spillovers, or ‘externalities’. Thus, if many banks lend against the same activity – property purchase for example… [it] might lead to a market crash, a financial crisis and a deep recession.” “Fear of hyperinflation is a delusion of the ignorant”, April 11.

Oh boy has Martin Wolf got things wrong! Who created the “externalities” that caused the recent crisis? Would there have been so many bad property loans dressed up in AAA clothing, or bad loans to Greece, had regulators required banks to hold as much capital against these assets as what they needed to hold when lending to for instance a small business? Of course not! No Wolf, I assure you, excessive trust in the government is not only the real delusion of the ignorant, and it’s also extremely hazardous to his wellbeing.

I am sure waiting for his explanation of why it would be better to leave the creation of money, and presumably the channeling of it, in the hands of the state and not in the hands of properly regulated and not distorted private profit seeking businesses. Why do I get so often get the feeling that Martin Wolf is a closet communist?

PS. Sir as always, I will not be copying Martin Wolf with this comment since he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.

Ms Tett, in the case of “derivatives”, their biggest danger lies in how delightfully sophisticated they sound!

Sir, Gillian Tett writes about “the mortgage credit derivatives that proved so deadly in that credit bubble”, “The female face of the crisis quits the spotlight” April 4.

One of the problems with understanding our way out of this crisis, are all those who wants us to chase anything they cannot explain, like the sophisticated sounding derivatives. And that stands in the way of attacking the real easy straightforward “vanilla” problems which caused the crisis.

As an example, that which “proved so deadly”, were real securities backed up with different tranches of very real though utterly badly awarded mortgages, something which has nothing to do with derivatives. And the reason these securities, if AAA rated, became so attractive they blinded the markets, was that banks, according to Basel II, could hold these against only 1.6 percent in capital… meaning being able to leverage their equity 62.5 time to 1.

Again what had problem loans to Greece, Spain’s real estate sector, Cyprus’ banks and much else to do with derivatives?

Let me try to explain the issue in my words. In derivatives you always have a winner and a loser, and in this sense, with exception made for the very serious counterparty risk, and which in itself is not a derivative risk but a normal credit risk, what derivatives do, is to redistribute the profit and the losses… in other words they are a wash out.

It is only the losses in the values of real assets which can create the real losses which can cause serious recessions. We should never forget that… while we keep allowing our banks to incur into dangerously large exposures to “ultra-safe” real assets… like infallible sovereigns and the AAAristocracy.

Fabrice Tourre has been duly scalped, but where is the SEC’s mea culpa?

Sir, I have no doubt whatsoever that the prime responsible for the current financial mess were dumb bank regulators. That’s is why I dislike so much reading when Tracy Alloway and Kara Scanell report “SEC elated after claiming Tourre’s scalp.” August 3.

The whole story can either begin with the little guy, the mortgage underwriter underwriting bad mortgages to the subprime sector; and those bad ingredients were then sold by underwriter bosses to security packagers, who packaged these bad mortgages into very bad subprime sausages; but who were are able to turn these into valuable delicacies, only because of the high credit ratings these received from human fallible credit rating agents. And then the story could end with those selling the sausages to the investors, and some of them, like Goldman Sachs, even taking bets on that these would make their buyers puke. And all involved in the bad sausage chain made huge profits… and should all be ashamed, some more than others.

Or the story can begin with bank regulators, the Basel Committee, who with its Basel II of June 2004 authorized banks to hold AAA rated sausages on their books against only 1.6 percent in capital (equity), which meant they authorized banks to leverage their capital a mindboggling 62.5 to 1 times with these sausages; and who with this created the irresistible profit motivations that induced all humans previously mentioned to break all the rules.

Fabrice Tourre’s own word “More and more leverage in the system, the whole building is about to collapse any time now” says it all. Those directly responsible for that leverage were the bank regulators. Without the explicit blessing of regulations which allowed it, the system would never ever have been able to leverage as much. And the SEC was all in agreement with is, as can be read in its Open Meeting records of April 28, 2004.

Yes, Fabrice Tourre and all others involved in the subprime sausage chain are guilty and should be held responsible. But, if we allow regulators to get away, feeling elated, without even a mea culpa, then we truly have not learned the lessons we most need to learn from this crisis.

Does Gillian Tett suffer from blind faith in the experts?

Sir, Gillian Tett analyses “The blind faith in wishful thinking” of bankers with respect to those securities baked with mortgages to the subprime sector which collapsed in 2007, March 23. 

But again Tett refuses to refer to what having regulators allowing banks to leverage the expected risk adjusted margins of those AAA rated securities on their equity, a mindboggling 62.5 times to 1, must have done to feed any blind faith. Talk about hype!

The pillar of all Basel bank regulations are the capital requirements based on perceived risk, and which are crazy in that they clear for risks already cleared for. 

Has Tett, as a journalist asked any of the regulators to explain to her the rationale behind those capital requirements, in terms beyond of what that fuzzy “more-risk-more-capital less-risk-less-capital, it sounds logical” provides? 

Is she not curious? Or is it that she herself suffers from blind faith in the experts?

Do they really trust credit rating agencies less?

Sir, Claire Jones and Robin Harding quote Frederic Mishkin of the Fed saying on August 7, 2007 “The point of the subprime market is just that we now trust the credit rating agencies less,” said Frederic Mishkin. “Fed red-faced as notes reveal officials failed to grasp dangers of 2007” January 19. 

Is Mishkin really sure about that? Last time I looked the Basel Committee for Banking Supervision, on top of the capital requirements for banks based on perceived risks, and as perceived fundamentally by credit rating agencies, and which remain firmly entrenched, are now adding a layer of liquidity requirements also based on perceived risks, and also as fundamentally perceived by credit rating agencies.

When are our utterly naïve regulators going to wake up to the fact that in banking it is what is perceived as safe which can cause most risk since what is perceived as risky takes perfectly care of itself?

FT, you must stop pardoning the hubris of Basel bank regulators, and feeding false illusions about credit ratings

Sir, Stephen Foley in “Outlook unchanged” January 15 writes: “Rating agencies’ outsized role in the credit crisis is well known. By validating the transformation of subprime mortgages into triple A-rated securities, based on mistaken assumptions about the US housing market, they contributed to the infection of the global financial system.” 

Indeed, but the only reason why the credit rating agencies detonated the crisis, was the “outsized role” loony bank regulators assigned them, when with their Basel II they allowed banks to hold only 1.6 percent in capital, meaning a mindboggling authorized bank leverage of 62.5 times to 1, only because a human fallible rating agencies deemed a security to be of AAA quality. 

That, as I have so many time explained to you increased the demand for these securities so dramatically that the market, as usually happens, when it ran out of well awarded mortgages, produced bad ones which ended up in some AAA Potemkin rated securities. 

I dare you to answer: When has a bank or a bank regulator most problems, when a bad rating turns out to be correct, or when a good ex-ante rating ex post ends up being incorrect? It is clearly the second. And so explain to me why you think we should allow our regulators to bet our whole bank system on the credit ratings to be correct? 

In January 2003 in FT you published a letter I wrote and where I said “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”. 

Sincerely, FT, should be ashamed of yourself feeding the illusion that if we can only get the credit ratings agencies to be better at what they do, then our banks can bet their (and ours) last shirt on the credit ratings. 

Foley also writes “attempts to strip credit ratings of their central role in financial regulation are proving complicated”. But that is only so because regulators foolishly hang on to the idea that, by means of capital requirements for banks based on perceived risk, they can play risk managers to the world. I swear to you, the world cannot afford such hubris. 

Also, again, for the umpteenth time, FT, if banks clear for the information provided in credit ratings by means of interest rate, size of exposure and other terms… why the hell should they clear for that same information in the capital requirements too?

Some questions on bankers’ doubts

Sir, I refer to Richard Milne’s interview of Pär Boman, the chief executive officer of Handelsbanken titled “The back-to-the-future banker” January 14.

In it Mr. Boman recounts that having been offered some triple-A rated mortgage backed securities by some US investments banks, Handelsbanken executives, led by him, visited the bankers in New York and asked to see the underlying documentation of the mortgages. And when that proved not to be possible, he went to the west coast and visited some of the houses used in the bonds, and from which he reached the conclusion of “it was very clearly nothing for us”.

Yes clearly that was a great job by Mr. Boman and he should be commended for having doubted. But that said it would be very interesting hearing his opinions on the following:

When presented with operations which involve triple-A ratings, at what size of potential exposure and to what extent of additional not recoverable research costs, is a banker supposed to doubt the validity of the credit ratings?

If it is possible to doubt the quality of the ratings what does that say about the quality of the regulators who with Basel II allowed banks to hold those same securities Boman so wisely rejected, against only 1.6 percent in capital, and thereby allowing bank equity to leverage 62.5 times to 1.

And if a bank discovers great reasons to doubt a credit rating, what is their responsibility in terms of communicating their doubts to the market and to the regulators?

And what is a bank to do if the doubting also extends to the supposedly infallible sovereigns... the paymasters of its regulator?