Would adequate SIFIs’ designations have helped to avert the last crisis? Of course not!

Sir, I refer to Patrick Jenkin’s “MetLife ruling poses threat to drive towards global financial stability” April 5.

Jenkin sounds very much upset: “This is absurd. The FSOC — with its expert mandate and responsibility for “identifying risks and responding to emerging threats to financial stability” — is being torpedoed by an inexpert judge.”

Sir, you know I hold that the regulator, the Basel Committee and friends, was the real responsible for the crisis that errupted in 2007-08. Its risk weighted capital requirements for banks distorted the allocation of bank credit to the real economy, and allowed banks to leverage absurdly much on assets deemed, decreed or concocted as safe… and all this when history clearly shows that “safe” assets is precisely the stuff that big bank crises are made of.

Had the oversized exposures to AAA rated securities and sovereigns to Greece anything to do with what the regulators now tries to catch with their SIFI methodology? No is the simple answer.

In fact working on how to manage SIFI’s, keeps regulators from working on mending their own mistakes. And frankly I see no reason for Jenkins to deposit so much naïve faith in the expertise of FSOC or FSB or any other member of the regulatory logia.

He writes “The time may have come for the G20 to give the FSB proper statutory powers to ensure shortsighted political interests do not put the world on the road to financial ruin once more”

He should know that there is nothing as shortsighted as the risk weighted capital requirements. These have stopped the banks from financing the risky future and have them only refinancing the, for the very short term, safer past.

If anything Sir, I would wish for that “inexpert judge” to also look into whether the unauthorized discrimination against the access to bank credit of the “risky”, which is imbedded in that regulation, should really be allowed in the Home of the Brave.

It is high time the world starts to reflect on whether it really wants to allow an Ultra Important Regulator to introduce, as it wishes and thinks fit, dangerous systemic risks into the banking system.

The absolute minimum we must ask for is for the regulator to first give us its working definition of what is the purpose of our banks, so to see if we agree.

“A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

@PerKurowski ©

A globalized harmonized regulatory approach, imbeds the greatest potential of producing truly fatal systemic risks.

Sir, Rick Lacaille, of State Street Global Advisors concludes with “Only a globally harmonised approach — where regulators and asset managers work together to scrutinise and overcome issues linked to systemic risk — will assure global financial stability.” “Regulators must keep tabs on twin risks of leverage and liquidity” November 26.

I find myself on exactly the opposite side. In 1999 in an Op-Ed I wrote “the possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause its collapse”

Let me just here quote from a list of regulatory mistakes, some relevant principles that are ignored by the current meddling scheming regulators. These are in much perfectly applicable to regulations of asset managers.

To allow bank equity to be leveraged with net margins of assets differently, distorts the allocation of bank credit.

The scarcer the bank capital is, the greater the distortions produced by the risk weighted capital requirements.

Bank capital is to cover for unexpected losses, yet regulators base the requirements on expected credit losses.

The safer something is perceived the greater is its potential for unexpected losses.

The risk of a bank has little to do with perceived risk of assets, and much to do with how the bank manages risks.

Any perfectly perceived risk causes the wrong actions if the risk is excessively considered.

The undue importance given to few information sources, credit rating agencies, introduced a serious systemic risk.

Regulators ignored that imposing similar and specific regulations on a system stiffens it and increases its fragility.

Any regulatory constraint that can be gamed will be gamed benefitting those gaming the most, in detriment of other.

Lacaille writes: “In our view, leverage should remain the guiding indicator of systemic risk. Regulators particularly need to look for managers that operate leveraged strategies, with a focus on identifying and closing loopholes for disguised leveraging.”

The best way of avoiding disguised leveraging is of course not allowing the costumes. One simple capital requirement for all assets would be the most transparent and the least risky way to go.

Will that lead to more risk-taking? Yes, but not to excessive systemically important financial exposures to what is risky. The dangers will, as always, remain being that of excessive financial exposures to what ex ante is perceived as safe, but that ex post can turn out to be risky.

@PerKurowski ©

FT, I’ve blown the whistle on bank regulator’s foul play many times. But Gillian Tett does not want to hear it. Why?

Sir, I refer to Gillian Tett’s “Finance needs to blow the whistle on foul play” May 28.

I have sure blown my whistle. On my TeaWithFT blog I have, with this, 141 comments directed to Gillian Tett over the years. Surely more than half of these have to do with the lunacy of bank regulators.

With their credit-risk-weighted capital (equity) requirements for banks, that favors lending to what is perceived as safe over what is perceived as risky (as if that would be needed) they manipulate and distort the bank credit markets… clearly foul play. And all that for absolutely no good reason, since all major bank crisis have only resulted from excessive exposures to what was ex ante perceive as risky but that ex post turned out to be risky.

Sir, could you please ask Ms. Tett, as an anthropologist, to explain why journalists like her give so much more credence to those who for unexplained reasons have been named bank regulators, than to ordinary bankers who at least have to compete with other bankers… or citizens like me?

For instance from where can a professional like Ms. Tett derive the notion that a Mario Draghi, just because he was named chair of the Financial Stability Board by some unknown bureaucrats, knows more about risk managements and how banks should behave than any ordinary banker or finance professional?

If simply stating: “I am the regulator” makes someone less prone to make mistakes or to behave badly than the one being regulated, and to have that nonsense believed by journalists, then we are definitively screwed.

PS. For instance, before the approval of Basel II, I loudly blew the whistle on the dangerous systemic risks of using credit rating agencies too much in bank regulations… both as an Executive Director at the World Bank and in FT. Nobody wanted to hear it  L

A world obsessed with Best Practices may calcify its structure and break with any small wind

In reference to Mr. Flash Crash’s supposedly malevolent disruption of the market in 2010, John Plender writes interestingly about globalization, regulations and fragility “Global financial regulation meets a cul-de-sac” April 23.

In this respect I would like to recall a written statement that I delivered as an Executive Director of the World Bank on April 2, 2003, while discussing its Stategic Framework 04-06. In it I wrote:

“Ages ago, when information was less available and moved at a slower pace, the market consisted of a myriad of individual agents acting on limited information basis. Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market and we are already able to discern some of the victims, although they are just the tip of an iceberg.

A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind. Who could really defend the value of diversity, if not The World Bank?"

http://subprimeregulations.blogspot.com/2003/03/my-comments-on-world-banks-strategic.html

@PerKurowski

Never allow anything to be classified as unexpected or unintended consequences, unless proven beyond doubts to be such.

Sir, I refer to Gillian Tett’s “Emerging markets brace for a bumpy ride” September 19.

I agree with absolutely all she writes about the losses many emerging nations suffered with their exposure to derivatives in 2008 “when the dollar suddenly surged in value as a safe haven currency”, except for when she argues“It is a lesson in unexpected consequences in a tightly interconnected world”.

As I see it, nothing should be classified as an unexpected, or much less an unintended consequence, if it has not been proven to be beyond any reasonable doubt to be so. Otherwise it just serves as an excuse for stupid behavior.

For instance, in January 2003 in FT I wrote “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 I was no bank regulator.

And so no one should be allowed to talk about unexpected or unintended consequences of ordering the banks to follow so much the credit ratings as Basel II did. But yet, how often have you not heard about the unexpected or unintended consequence of credit rating agencies not rating correctly?

In the real world, not the world of unaccountable regulators, anyone guilty of such a mistake, would have had two minutes to collect his personal items and hit the door, never to return. And yet there they are as if nothing happened… even expected to save the day.

Could what happened because of the exposures in derivatives Tett describes not be an unexpected consequence? Of course it could... but let them prove it to us first.

What would the consequences be for failed bank regulators if failed air-traffic controllers or cruise ship captains?

Sir, Kara Scannell, in the analysis on US housing, “After the gold rush”, October 30, with respect to the mortgage frauds writes: “Critics say that prosecutors have gone after easy targets – low level fraudsters - while going easy on Wall Street executives whose banks packaged billions of dollars worth of toxic mortgage securities.”

Indeed, and though it might be difficult to condemn any one of those executives for something illegal, by now we should at least have had on the web a list of the 20 most important toxic mortgage packagers, so as to be able to shame them.

But, that said, and since for me the subprime mortgage mess was a direct consequence of the regulators having created irresistible temptations for banks to holding any AAA rated securities, namely allowing them to hold these securities against only 1.6 percent in capital, the first thing that should have happened, is for these regulators to be sent home, in utter disgrace. But that has not happened.

Not only is the name of most regulators unknown to us, but some of them have even been put in charge of drawing up new regulations, Basel III, and others promoted, like for instance Mario Draghi, from being Chairman of the Financial Stability Forum, later the Financial Stability Board, to being the President of the European Central Bank. Amazing!

But let me be even clearer about what I mean:

In November 2004, in a letter published by the Financial Times I wrote: “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector (sovereigns)?”

But yet, even if a little me, not a regulator nor a banker, could have been sufficiently preoccupied about the excessive lending to sovereigns to write that, the regulators allowed the banks in some cases to lend to sovereigns against zero capital, and for a sovereign rated like Greece was, required the bank to hold only 1.6 percent in capital. That signified allowing a bank to leverage its equity some mindboggling 62.5 times to 1 when lending to Greece.

And so let me just ask: what would have happened to airport controllers or cruise ship captains who had made mistakes of this exorbitant nature, and caused damages as huge as this financial crisis?

I have absolutely nothing personal against any of the regulators, and I do not know any one of them. But what I I do know is that if we are going to have bank regulations with a global reach, like those produced by the Basel Committee for Banking Supervision, we absolutely need those regulators to be held much more accountable for what they are up to.

Yes the credit rating agencies let the regulators down... but it was they who gave the credit rating agencies such an excessive importance and they should have known; again as little me wrote in another published letter January 2003 in FT: “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

Yes they can argue they trusted the financial models too much… but that is not an excuse. If little me, presumably not more a financial modeler than they were, in a written formal statement delivered as an Executive Director of the World Bank, in October 2004, could warn: “[I]believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions” they should also have been suspicious about the models.

Regulators are quite busy fooling themselves.

Sir in “A smaller role for Wall Street” December 29 you write “Above all, regulators do not want to be fooled again”. Let me assure you that no one fooled the regulators more than they fooled themselves, and, from the looks of Basel III, they still keep on doing that.

June 2010, in Washington D.C. I commented to Lord Adair Turner, the Chairman of the FSA, that he as a regulator was acting like a confused handicap officer on a horse-racetrack, taking away the weights of the good runners (triple-As) and placing these on the bad runners or debutants (small businesses and entrepreneurs), without even informing the bettors and the bookies, and believing this would lead to a fair and good race. This layer of discrimination, slapped on top of the market´s natural adverseness to risk, pushed the banks excessively into AAA land and is affecting quite seriously the real economy.

I also reminded Lord Turner that even from a pure limited regulatory perspective it made no sense, as the only thing capable of posing a systemic threat to the banking system was precisely what was perceived as not risky, by banks and regulators alike. Lord Turner, in an email answered that “Our ability to know ex ante what is low and high risk is clearly limited” and that my “argument certainly poses a challenge which I need to think about”. It would seem he is still thinking about it… or trying to forget the inconvenience.

The mother of all the systemic risks is believing that the systemic risks are under control.

Sir if systemic risk is strictly defined as the issue of institutions being too large for a financial system then I fully agree with William Donaldson’s and Arthur Levitt’s “Tackling systemic risk is no job for the status quo” November 20. But, if we by systemic risk also mean the risks that can be introduced to the system, then I would not want to see a “systemic risk oversight board” (SROB) be in charge of it, precisely because of the systemic risk that the belief that systemic risks have been controlled represents.

Have the regulators not learned their recent of what happened to them so recently when they appointed the credit rating agencies as their sentries, and then went to sleep? Don’t the regulators know that they were the ones who introduced the systemic risk of having the system believe that default risks were accurately measured?

The scary cognitive dissonance of the Basel Committee

Sir Whitney Tilson in “Lessons to be learnt from losses” February 10 writes about some harmless “cognitive dissonance” in a group “who believed the earth was going to be destroyed by a flood on December 21, 1954” and then extrapolates from that in order to explain some recent investment behaviour.

But there is also quite dangerous “cognitive dissonance”. For instance the way in which the Basel Committee is now responding to its absolute failure in trying to avoid a crisis by creating disincentives for bank to assume credit risks as measured by others, is now slowly evolving into the belief that they could and should measure and fight systemic risk. That is indeed a really scary “cognitive dissonance”.

Anything you can rate I can rate better!

We have just been served proof of how dangerous systemic risk are was when the regulators induced the world to follow the advice of some few credit rating agencies; and millions will lose their life savings and millions could even die as a direct consequence; and now Lasse Pedersen and Nouriel Roubini propose to dig us even further in the hole we are in with their “A proposal to prevent wholesale financial failure” January 30; where they suggest to adjust the capital requirements of the banks by rating their systemic risk. What Gods do they think they are, believing they can fully understand systemic risks and that their interference on a lower level would not alter the system and produce even much more advanced and dangerous systemic risk?

From the start I was opposed to the bank regulations emanating from Basel suspecting that these could easier lead us to something bad than to something good, but on this proposal I just know it to be so. Please… can we go in the other direction of simplifying how we regulate, so that we all understand more what we are doing?

Geithner could be heading onto the wrong direction.

Sir FT reports quite extensively on the confirmation hearings of Timothy Geithner, the Treasury nominee held by the US Senate’s Finance Committee on January 21. Though he did not give away much on what he will do I cannot say that I disagreed with most of what he said… it all sounded so reasonably. But given that we do not live in reasonable times what most interested me was whether he possessed the type of deep-core beliefs or philosophy that helps anyone to stand firm against the storming winds, and I must confess I felt somewhat disappointed.

When Geithner referred to the credit rating agencies he mentioned they were guilty of “systematic failures in judgement” but he did not say a single word about the regulator’s fatal mistake when empowering the credit rating agencies they created the systemic risk bomb that was bound to explode, sooner or later, as it sure did. Anyone who at this moment might be inclined to dig us even further down in the regulatory hole we’re in is someone that I cannot feel truly comfortable with.

The regulators took us back to the dark ages!

Sir, though I agree with most of John Kay’s “Could Napoleon have coped in a credit crunch?” October 29, I protest when he says that “The financial innovation that was once the means of spreading risks is now an unmanageable source of instability.” The source of instability was not the financial innovations per se; the prime source of instability was that those financial innovations were rated triple-A and that we so much believed in the ratings.

In Against the Gods Peter L. Bernstein (John Wiley & Sons, 1996) wrote that the boundary between the modern times and the past is the mastery of risk, since for those who believe that everything was in God’s hands, risk management, probability, and statistics, must have seemed quite irrelevant. Now and as far as I am concerned, when the bank regulators put so much faith into the credit rating agencies, they inadvertently took us back to the past.

Why does Martin Wolf keep mum!

Sir Martin Wolf in “Asia’s revenge” October 9, (the why for the title is not very clear), spends many paragraphs describing the accumulations of huge surpluses with many origins that recycling went to pursuit better opportunities in the US and failed miserably. Wolf puts much of the blame on a “housing bubble” but as he admits this is partially a circular argument since part of the house bubble was also a response to the huge demand for investments those surpluses created. Also let us remember that in all other countries, house bubbles as large as or even larger than that in the US, have not resulted in anything as destructive like what came out of the build up of financial instruments around the subprime mortgage sector in the US.

Wolf quotes Carmen Reinhart and Kenneth Rogoff saying “Over a trillion dollars was channelled into the subprime mortgage markets, which is comprised of the poorest and least creditworthy borrowers within the US” and which is of course true. The question though is how come Martin Wolf avoids even posing the most natural and most important question of… How come they did that?

UNCTAD in their policy brief titled “The Crisis of the Century”, released on October 6 state “There are a few quick regulatory fixes that can be taken at both the national and international levels. The first is to reassess the role of credit rating agencies. These agencies, which should solve information problems and increase transparency, seem to have played the opposite role and made the market even more opaque.

And of course Unctad is absolutely right. It was the credit rating agencies, empowered by the regulators that guided the recyclable funds into subprime swamplands.

Again, why does Martin Wolf keep mum on it?

Unctad more on top of financial issues than FT?

P.S. Why can I be accused of monomania, writing so much on what I believe is the very harmful error of empowering the credit rating agencies too much while those ignoring this blatant mistake are not accused of a similar obsession?

Be careful in not promoting the dark ages

Sir John Eatwell and Robert Reoch in “‘Greater transparency’” will not reduce systemic market risk”, October 7, conclude that “Those who argue that greater transparency is the answer don’t understand the question”. Since, to get there, they argue that “Greater transparency means more firms share the same information” in which obviously they are right, but follow up with, “and have access to the same procedural knowledge and even the same modelling” and which obviously has absolutely nothing to do with transparency, it is clearly they who don’t understand what has happened.

The information on how badly the subprime mortgages were being awarded was out there for anyone to see, had they taken their time. The problem arose in that no one felt there was a need to do so, after the regulators non-transparently favoured few information digesters, the credit rating agencies, to do the modelling and number crunching on behalf of everyone.

Let us make good and permanent use of our disorientation.

Sir Gillian Tett writes that “Gridlock and panic follow loss of compass” September 19 and wants to know “how to end the disorientation”. As I see it though our current problems derives more from the regulators having imposed too much orientation believing themselves and making the markets to believe that a financial risk compass was just like any other compass.

In this respect we should perhaps welcome our disorientation and use it to diminish dramatically the role of the credit rating agencies, so that we do not follow them next time around over a precipice even more dangerous than that of the lousily awarded subprime mortgages.

The risks never gone are now coming back with vengeance.

Sir Roger Altman in “Modern history greatest regulatory failure” September 18 ascribes this to the extraordinary leverage that some institutions took on and the development of a huge financial system outside the normal banking network.

He is right in the secondary causes but the origin of the whole leisured and blasé attitude to risks of the market that allowed for leverage to happen had its origin in the crazy notion that you can have some credit rating agencies correctly measuring risks without creating systemic risks; and the push for a system outside of banking was a direct result of the regulatory arbitrage that arose when the regulators imposed on banks minimum capital requirements based on risks.

Everyone were busy congratulating each other they had beat the risks and so everyone relaxed… and there you have it, the risks never gone are now coming back with vengeance.

Accountability, for all!

Sir I find it strange to say the least that a professor of economics at Harvard University and a former chief economist of the International Monetary Fund can write an article as “America will need a $1,000bn bail-out”, September 17, from such a detached observer’s point of view, as if he had absolutely nothing whatsoever to do with the current mess.

Where was Kenneth Rogoff when a world needed to be told that, as a financial regulator, you just do not go out and decide that risk can be measured, and outsource that measurement to a few credit rating agencies, and tell the banks they have to raise capital in accordance to what those few credit ratings opine, and then think that nothing systemic would come out of that?

Accountability Professor! You too!

Recognizing you don’t either have a clue is a good place to start

Sir in your “Dangerous animals in the banking zoo” February 23 you suggest that the banks need traders with trading mentality in order to supervise the traders. This might indeed help to reduce some operational risks but, unless you have managed to tame those supervising traders into non-trader bankers the question then becomes who will supervise them.

Exactly the same fundamental approach as you are suggesting led the regulators to appoint the credit rating agencies as the knowledgeable risk overseers and see how far that has taken us. The credit rating agencies have now become themselves our largest systemic risk creator running around correcting their mistakes, downgrading here and there and placing ultimatums like “raise your capital in 48 hours or I will downgrade you”.

No, why do we not try something of the old traditional sensible stuff like not getting involved in something we do not fully understand and place through the banks professionals with sufficient moral standing to admit to that fact when it is true.

Come to think about it why does not FT give a good example and spell out that it does not understand it at all either, before suggesting we dig ourselves deeper in a trading hole.

FT seems not to want to see the forest because of the trees.

Sir your editorial “Ratings reform” February 12 shows that you like others quite stubbornly do not really want see the forest because of the trees.

You write it is ”meaningless to say that the ratings agencies were wrong in hindsight – the question is whether they made responsible use of the data they had in 2006 or early 2007”. Hold it there! This is not a question of given points for performance or style in a high jump contest. The credit ratings were empowered by the regulators to impose on the market their criteria not because they were going to responsibly use any specific methodology but because they were supposed to be right! If they cannot be right...who cares about whether they act responsibly or not... we do not need them...in fact the more credible they are the more the dangers that we will follow them where we should not.

Yes I do blame the credit rating agencies, who should as a bare minimum inspected a sample of the subprime mortgages offered as a collateral to see if they even belonged to the same universe of data they had before taking them as a good guarantee, but, much more do I blame the regulators who empowered the credit rating agencies to begin with and thereby set us up to extremely dangerous systemic risks.

But the regulators should have known!

Sir, Charles Calomiris and Joseph Mason are exactly right when in “We need a better way to judge risks” August 24, they say that there is no “use blaming the rating agencies, which are simply responding to incentives inherent in the regulatory use of ratings” and recommend that we just have to avoid “settings standards for permissible investments by regulated institutions”.

Now it is most important that we understand that the real reason for abandoning the regulatory enforcement of the use of the credit rating agencies is not because the credit rating agencies have been bad at what they have been doing, the subprime mortgages is a big exception of course, but the simple fact that the better they get; and therefore the more we would tend to automatically follow their opinions and the harder it would be to express contrarian views, the higher the risks that the world will encounter some systemic risks of truly catastrophic proportions. And that the regulators should have known.