To reform financial regulations we need to reform the Basel Committee.

In May 2003, as an Executive Director of the World Bank, I told those many present at a risk management workshop for regulators the following with respect to the role of the Credit Rating Agencies. “I simply cannot understand how a world that preaches the value of the invisible hand of millions of market agents can then go out and delegate so much regulatory power to a limited number of human and very fallible credit-rating agencies. This sure must be setting us up for the mother of all systemic errors.” And this I repeated over and over again, in FT, even in a formal statement at the Board.

Now as reported by Alan Beattie and James Politi in “IMF points to danger of ‘over-reliance’ on credit ratings for sovereign debtors” September 30, the IMF is finally admitting “Policy makers should work towards the elimination of rules and regulation that hardwire buy or sell decisions to ratings”

That is good, better late than never. But the real question that needs an answer is why on earth it had to take a financial crisis of monstrous proportions to reach a conclusion that should have been apparent to any regulator from the very beginning.

I saw it happen in front of my eyes and I know why it happened. As I wrote in a letter published in the Financial Times in November 2004, it was the result of the whole debate about bank regulations being sequestered by the members of a small mutual admiration club.

Therefore if there is now something even more important than rectifying the faulty financial regulations, that is to break up the Basel Committee and make absolutely sure it represents a much more diversified group of thinkers. That would have at least guaranteed that the basic question of what the purpose of the banks should be would have been put in the forefront before regulating them. Current regulations do not contain one word about that.

Besides me there were not plenty of experts who raised the question of whether the credit rating agencies should have such a prominent role and made many other valid criticisms. These persons should participate in designing and putting in place the needed reforms. It is simply unacceptable that the reforms that carry with them such huge global implications are implemented exclusively by Monday morning quarterbacks.

FT, you are looking in the wrong direction and with the wrong glasses.

Sir, in “A sector still in need of reform” September 27 you write “if the regulator disliked the approach a bank was taking, it could increase the capital charge to offset the higher risk”. May I humbly suggest that phrase proves that, as so many others, you do not really understand the real problem.

If a regulator suddenly disliked something an approach a bank was taking, chances are that the banks would already discovered it themselves and taken measures. Why do you suppose regulators know more than bankers? If you think so why do you not make regulators the bankers? No the real risk, and what caused this crisis and all others, lie always in all the approaches both bankers and regulators like the most, and that precisely because of that can grow into a dangerous systemic risk.

When regulating banks more than concerning yourselves with what you do not like or perceived as risky, you need to worry much more about what you and the bankers like and perceive as not risky.

You need global voices in the World Bank and the IMF

Sir, Paulo Nogueira Batista writes that “Europe must make way for a modern IMF” September 24, and states that “Real reform of the Fund is a critical test of advanced countries´ willingness to adapt to a changed world”. It is impossible to argue against fewer chairs for Europe and more for the developing world, in both the IMF and the World Bank but, if we are really to adapt to a changed world, we would have to assign some chairs to actors that are not bound to territorial considerations… like migrant workers and multinational companies.

As one of the very few, or perhaps even the only Executive Director to have served at the World Bank without absolutely no political or public sector experience (2002-2004), I keep repeating that the party who is most lacking representation in the World Bank is the world at large... planet earth! And I have no idea how we intend to tackle global issues without global perspectives.

In fact a global not territory constrained Executive Director, would be a stronger voice arguing for the world to share the costs of protecting environmentally the Amazon, than what a Brazilian Director could ever be.

If only the UK was rated BB+ to B-…

Then a UK small business would be able to compete with the government on equal grounds for bank credit, because only then would the bank have to post the same capital for both.

The nannies in the Basel Committee decided to hand out, through very low capital requirements for banks, generous incentives for these to go and play in “safe” places, even though, as regulators, they should have known that financial and bank crisis only occur where the perceived safety attracts the excessive volumes that pose a risk for the system… swamp land with alligators might now and again eat up a citizen, but never pose a threat to a nation.

But on top of it all, the Basel nannies also turned out to be communists in disguise, as they ordained that if a bank gave loans to a sovereign rated AAA by their risk kommissars then the bank needed no capital at all… and what small business can compete with that?

More than two years after the crisis started we read in a report by Brooke Masters and Patrick Jenkins that Lord Turner is now announcing tougher bank capital regime. But since he, like Basel III, does not mention a review of the arbitrary and regressive risk-weights that were the real causes of the disaster, we can only conclude he is not really fit to be a regulator, at least not in war time.

Don’t forget the non-AAAs

Sir Peter Spiegel, David Oakley and Ralph Atkins report that “EU rescue fund rated triple A” September 21. Do they really know what that means?

It means that the banks when at some point in the future they are asked to acquire bonds or otherwise lend to European Financial Stability Facility they be able to do so without the need of capital. It will mean that it will be cheaper to fill the hole of the past than to build the mountain of the future. Good or bad? If I owned Greek bonds and wanted to get bailed out I would find that great but, if what I wanted was a bank loan to set up a new venture it would surely be bad, because I would have to pay for the cost of the discrimination in favor of the EU.

Since Basel III kept intact all the risk-weight discriminations in favor of the AAAs and the Jean-Claude Trichet bureaucrats of this world, we should never forget the non-AAAs and private borrowers who are and will have to pay for it all.

It’s the risk-weights, stupid!

Sir what detonated this crisis? The fact that because of the risk-weights the banks needed only to hold 20% of the basic capital requirements when investing in triple-A rated securities backed by the lousily awarded mortgages to the subprime sector. Would it have happened if the risk-weight for those investments had been 100%? Of course not!

In this respect when one, on September 17, 2010, more than two years after the crisis exploded, reads the chairman of the Financial Stability Board Mario Draghy covering in “Next steps on the road to financial stability” about everything under the sun, except for the risk-weights, one feels, no matter how impolite, an urgent need to shout “It’s the risk-weights, stupid!”

The Basel Committee’s lousy Maginot Line

It is impossible not to see now that the financial regulators in the Basel Committee, trying to fend off a bank and a financial crisis, constructed an incredibly faulty Maginot Line.

It was built with lousy materials, like arbitrary risk-weights and humanly fallible credit rating opinions.

And it was built on the absolutely wrong frontier, for two reasons:

First, it was build where the risk are perceived high, and where therefore no bank or financial crisis has ever occurred, because all those who make a living there, precisely because they are risky, can never grow into a systemic risk. Is being perceived as risky not more than a sufficient risk-weight?

Second it was built where it fends of precisely those clients whose financial needs we most expect our banks to attend, namely those of small businesses and entrepreneurs, those who could provide us our next generation of decent jobs and who have no alternative access to capital markets.

Now with their Basel III the Basel Committee insists on rebuilding with the same faulty materials on the same wrong place and it would seem that we are allowing them to do so.

I am trying to stop them… are you going to help me or do you prefer to swim in the tranquil waters of automatic solidarity with those who are supposed to know better?

The implicit stupidity of the current Basel regulations could, seeing the damage these are provoking, represent an economic crime against humanity!

Lex woke up!

Sir the Lex Column "Basel Denominators" September 16 ends with: “Historically, true crisis are caused by assets perceived as low-risk that aren´t.”

That as you all must be aware of by now, has been one of the two main reasons for my criticism against the current regulatory paradigm that has been imposed by the Basel Committee on the banks… that of higher capital requirements on what is perceived as risky and lower for what is perceived as not risky, and that goes against everything that financial history teaches us.

Since realizing the above makes of course current bank regulations completely nonsensical it will be interesting to see how FT handles this issue from now on.

On my second reason for criticizing Basel you might want to go to the last post of Dominique Strauss-Kahn on the IMF blog. http://blog-imfdirect.imf.org/2010/09/14/saving-the-lost-generation/#comment-2762

What good work?

Sir Emilio Botín opines “Now we must build on Basel´s good work” September 16, as if the Basel Committee has done us any good. It undoubtedly created the current crisis by setting up a system of risk-weights for capital requirements that brought much confusion to the major financial markets.

When also reading Botín complaining about the possibilities of being discriminated against by levying additional capital requirements on the “too-big-to-fail” banks, one cannot but think of all the small businesses and entrepreneurs who have been unfairly discriminated by Basel, just because they cannot hustle up the triple-A ratings that would allow the banks to hold negligible capital requirements when lending to them.

Why is it so easy for big-bank-bankers to get a voice in the Financial Times but so hard for the small businesses and entrepreneurs who the banker´s should prioritize their lending to? FT´s “without favour” sometimes does just not ring true.

Break up the Basel Committee

Sir John Kay in “We must press on with breaking up banks” September 15, writes “The Basel regime based on capital controls proved useless in averting the crisis: indeed it was a principal cause of the regulatory arbitrage that led to the proliferation of complex debt instruments” and that the “pledges made in the immediate aftermath of the crisis have proved empty”.

The correctness of the above could not be more evidenced than by Basel III. It is not only a weak response to what it wants to respond, but, worse than that, it does not even try to respond to the problem of the regulatory arbitrage the regulators have caused with their arbitrary and inexplicable risk-weights.

From what we see the effort to break up banks or in other ways fix the financial sector, must start with breaking up the regulatory monopoly of the Basel Committee.

Do not subsidize small and medium-sized enterprises, eliminate the regulations that tax them.

Sir Martin Wolf in “Basel: the mouse that did not roar” September 15, out of the blue writes “to the extent that the public wants a specific form of risk taking subsidized – lending to small and medium-sized enterprise, for example – it should do so directly. Agree! But why does he then approve of the regulatory subsidies given out in terms of discriminatory lower capital requirements to those perceived as having a lower risk?

The capital requirements established in Basel II have been quite sufficient to cover the risks of the small and medium-sized enterprise, what it failed to cover for was for all falsely perceived as being a low risk.

The small business on top of the higher interest rates they need to pays because they are intrinsically riskier must currently pay an additional margin, a regulatory tax, about two percent per year, only to make up for the differences in capital requirement produced when regulators apply to them risk-weights of 100% while letting other slip by with only 20% or, in the case of Sovereign governments rated triple-A, zero percent.

Bank regulators give incentive for betting on failure rather than success.

Sir Peter Chapman at the very end of “Ten lessons of a banking collapse, in Lehman’s terms” September 15, writes “Capitalism now makes money by betting of failure rather that success” but unfortunately he does not expand into the causes of that. So why is it so?

One reason is that bank regulations, by taxing the operations perceived as having higher risk with special capital requirements (risk-weights of 100%) lowers the returns of betting on success where risk is high, while allowing for much lower capital requirements for what is perceived as having a low risk (risk-weights of 20% and even 0%) increases the yield that can be obtained from betting against the perceptions of low risk.

Sir, you could benefit from a class on finance in the kindergarten

Sir with reference to “Basel should stand firm on capital” September 10 you evidence you still cannot understand the real problem with the current capital requirements for the banks established by the Basel Committee. The reason why these have caused so much problem is not really their level but the fact that they arbitrarily discriminate in favor of lower perceived risk, ignoring the fact that never ever has there been a bank or a financial crisis derived from where risks were perceived as high, they have all originated where risks were perceived as low… as only these can grow into having any systemic significance

In case you have an interest in learning the truth about the financial crisis may I suggest a kindergartenish lesson? http://bit.ly/c66DLp

Gideon Rachman, as an historian, should not be allowed to play innocent!

Sir Gideon Rachman’s “Sweep economists off their throne” September 7, ignores completely the question of who put some of the economists on a throne?

I am an economist and I have definitively not been on a throne while for over a decade I have been criticizing some of my not too smart colleagues for not speaking out against outright dumb financial regulations, while the Rachman’s of the world were quite eagerly helping to coronate these economists.

Rachman should not think he can get away that easily from his share of responsibility by just pointing fingers and joining the crowd screaming for Madame Guillotine.

No bank or financial crisis has ever resulted from excessive lending or investments to clients perceived as risky but all have been a direct consequence of excessive lending or investments to clients perceived as not risky, which turns the Basel Committee’s capital requirements for banks based on ex-ante perceived risk into a stupidity of epic proportions. In this respect, may I ask when, Gideon Rachman, as an historian, helped to remind the world of that?

Sheila Blair... keep away from Basel.

Sir Sheila Blair opines that “The road to safer banks runs through Basel”, August 24. She is in her right to ask for safer banks but let me remind her that there are plentiful of people with no savings and no jobs who most want and need the banks to travel on the road of being more productive for the society, and that will not happen by going through the Basel Committee where not a word is spoken about the purpose of the banks.

But even in having the Basel Committee helping making the banks safer, Sheila Blair is wrong, because since that Committee has yet to understand what is wrong with their regulatory paradigm, it is not as she says “now moving to correct the problem”.

Blair correctly indentifies capital misallocation as the cause of the bust, but that was in itself caused by giving the banks, in real and relative terms, higher incentives to pursue what ex-ante is perceived as not risky, the AAA-ratings. We simply need to ask… where else but in excessive investments in what ex-ante is perceived as not being risky have all the bank crisis originated? The answer is nowhere!

The Basel Committee must be made to understand that they do not have the right to interfere in the markets by imposing on it, through the different capital requirements for banks, their own set of arbitrary and regressive discrimination of what is perceived as having higher risk.

Currently small businesses and entrepreneurs, those usually perceived as riskier, but who could perhaps most help us to generate the next generation of jobs, must pay around 2 percent more in interest rates, just in order to be competitive when accessing bank credits, just because of the discriminating capital requirements. The members of the mutual admiration club in Basel seem incapable to understand that… and unfortunately that seems to go for Sheila Blair too.

Stiglitz is still a paradigm away from grasping a new paradigm.

Sir Joseph Stiglitz recognizes “the invisible hand was invisible because it was not there”, and lays the blame for this squarely on “bank managers in their pursuit of their self interest”. “Needed: a new economic paradigm” August 20.

But Stiglitz, is not capable, or willing, of understanding the much more important market interference played by the capital requirements for banks based on perceived risks; which regulators arbitrarily placed as a non-transparent layer of incentives and disincentives on top of the premiums used by the market to clear for risks.

He even speaks about “excessive risk-taking” without getting that since most losses we caused not by for instance investments in Argentinean railroads, but in triple-A rated securities collateralized by mortgages, in the USA, what we really suffered from was an excessive regulatory induced risk-aversion.

That is why I am sure that when Stiglitz mentions that he believes “a new paradigm is within our grasp” he is still just a paradigm as far away from it, as he has ever been.

It is not the capital requirements but the risk-weights that Basel needs to correct

Sir in “Basel faulty” August 20, you argue that “capital ratios…must be at least doubled from Basel II”

What do you mean by that? That when lending to small businesses and entrepreneurs the banks should hold 16 percent in capital instead of the current 8 percent, even if that 8 percent has been more than enough to cover any losses on loans to small businesses and entrepreneurs?

No, what needs to be revised are the risk-weights by which Basel for instance reduces to only 20 percent the value of the risk-exposure when lending to private triple-A rated clients, and which translates in an effective capital requirements of only 1.6 percent. These risk weights should all be set at 100 percent, so as to end that odious and dangerous regulatory discrimination of risk that is non-transparently layered on top of how the market prices for risk.

Increasing all risk weight to 100%, especially after considering that most of the current losses were provoked by AAA rated operations, that would be the right thing to do… over a period of time.

More than making them safer, we need the banks to be more useful.

Sir Stephen Cecchetti affirms that the current proposals from the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS) that will impose higher capital and liquidity requirements on the banks is “A price worth paying to make banks safer”. It is just the same old story! When will we hear about making the banks more useful, or at least less useless?

Cecchetti correctly mentions that “lower capital means higher returns on equity but a smaller buffer against loan defaults and investment losses”. He ignores though the fundamental problem that the lower capital requirements are applied discriminating in favor of what is perceived ex-ante as having lower risks… and therefore increasing the returns of what is perceived ex-ante as having lower risks… and therefore pushing the banks to excessively invest in what is perceived ex-ante as having lower risks… precisely the stuff that financial and bank crisis are made of.

Eliminate the discrimination in the capital requirements and banks will start lending more to the small business and entrepreneurs who though most likely to be perceived ex-ante as more risky are also most likely to hold in their hands more of our future generation of jobs…which will thereby make our banks more useful.

More than two years after and they haven´t got it yet!

Sir, this financial crisis was caused primarily because regulators by means of imposing different capital requirements for banks depending on the perceived risk of default created huge incentives for the banks to excessively pursue what was AAA rated.

In what Brooke Masters and Megan Murphy describe about the new Basel rules, “Suspense over”, August 19, evidences that the regulators, more than two years after the crisis got on its way, do still not understand the problems that their arbitrary regulatory discrimination causes.

In the proposed regulations there are some steps toward lowering the overall leverage possibilities of a bank, but there is not one word about eliminating the discrimination that, on the margin, where it counts, decides so much about where and at what cost bank credits go.

What have the SMEs done to you?

Sir, what have those being perceived as more risky, like the SMEs, ever done to you, for you to agree with the financial regulators they should be discriminated against by generating higher capital requirements for the banks when they are lent funds?

Don’t you know that there is no risk of excessive investments in what is perceived as risky, like the SMEs, since that risk is taken care of by the sole perception that a risk exists. There is though always a risk of excessive investments in what is perceived as not risky, because that is precisely a risk that the perception of no risk creates.

Therefore requiring the banks to hold higher capital requirements when the perceived risks are higher is just a stupid argument ably exploited by those who just want to lower the capital requirements for banks when these lend to them.

The market already discriminates against perceived risk by charging higher risk premiums. Therefore, for regulators to put on an additional layer of discrimination against higher perceived risk by requiring the banks to hold more capital for what is perceived as risky is as wrong as it can be.

To eliminate the capital requirements based on risks will not signify a subsidy of any sort to the SMEs, what it signifies is the elimination of an onerous discrimination against the SMEs.

Beware of Gameboy type regulations.

Sir you hold that “Basel must not yield to pressure” when imposing more stringent capital requirements for banks because “even if the rules do compromise economic growth in the short run, it is a price worth paying for more stable growth in the long run.” July 24.

You have not yet understood this crisis. More than just being low it was the fact that the capital requirements discriminated in favor of what was perceived as risk free which set of the dangerous stampede after triple-A rated operations which got them and us into this mess. There is absolutely nothing in the refinements that Basel is now doing in chapter III of their paradigm that will guarantee a more stable growth in the long run... much the contrary.

Can’t you see it? Our banking regulations have fallen into the hands of a first generation of Nintendo-Gameboy-players’ type of regulators, who believe life, risk and who knows perhaps even love can be controlled by just pushing some buttons.

Now the sophistication of their games will only increase the possibilities of introducing additional systemic risks in the market, creating instability, perhaps plenty of virtual growth, but certainly no sustainable real growth. The regulators in Basel have no interest in that and they have yet to tell us what they think the purpose of our banks should be.

What we least need is a non-transparent “Financial Stability Oversight Council”.

Sir Sebastian Mallaby´s “How to fsoc it to the hedge funds” July 16, clearly indicates that with the Financial Stability Oversight Council, a brand new source of systemic risk has been introduced, much the same when regulators empowered the credit rating agencies with a very important role in setting the capital requirements for banks.

In order to increase our chances to escape from new major disasters, we must avoid the markets having to entertain additional useless speculation about what some holed up “systemic risk experts” might be thinking. In this respect I would suggest that the FSOC is required to open a blog; and place a first post saying “We have the following list of systemically risky institutions” and then allow for the public to comment on whatever they say.

Of course, some good whistleblower protection programs for employees of possible systemically risky institutions might also be useful.

The search engines should scramble and shuffle their algorithms so as to guarantee diversity of results

Sir Marissa Mayer is absolutely correct in that we should “not neutralize the web’s endless search” July 15, because that could mean doing to knowledge, what regulators did to finance when they imposed on the banks the credit risk information oligopoly of the credit rating agencies.

But since Mayer represents a company which we have the right to at least suspect for wanting to sometimes go even further and create a monopoly, we should require more search diversity within every single search engine. The web should open our minds to an endless world of possibilities, and not close it by providing us some findings predetermined by others.

One alternative would be to list hundreds of search criteria, in a much expanded sort of “advanced search option” and then let the individual searcher decide how he wants to look for what he is after. (The one I personally most miss is the one that allows me to find hits between two dates.)

If the individual search option is not used then the search engines should be forced to shuffle and scramble their algorithms, so as to guarantee that no two searches provide exactly the same results, unless of course there are only a very limited number of results.

But the thumbscrews will still be used.

Sir in reference to your “Sovereign defaults”, July 14, let me remind you that whether in a torture chamber or on a conference table, the purpose is still to turn the screws on someone.

Now if both sides suffer a share of that thumb-screwing instead of all falling on either creditor or debtor… that sounds fair enough… supposing of course that half a torture plus half a torture is less than one torture.

The baby-boomers called out “Stop the World, until we get off”… too early.

Sir Martin Wolf painting the horrifying dimensions of the crisis that still lay ahead of us references a paper from 2005 by Raghuram Rajan titled “Has financial development made the world riskier?” “Three years on, fault line threaten the world economy.” July 14.

Though that paper is indeed excellent, especially when treating the subject of how bankers could or would respond erroneously to remuneration incentives, it does not really touch on the even more important issue of the very wrong turn taken at a regulatory crossroad which got us here.

When bank regulators in the early 90’s decided to impose a system of handicap weights based on the perceived risk of default, they basically ordered the world to a halt... “Let us not risk what we got!” Everything big and already established and which therefore already had better access to credit was given an additional boost from causing lower capital requirements for the banks, while anything small and new and which therefore already had more difficulties in getting bank credit, got even more restrained by causing higher capital requirements in relative terms.

Basel II, in 2004, was the ultimate refinement of this “Stop the World, until we get off.” In it, a credit to an unrated client requires the bank to hold 8 percent in capital while any bank operation with an AAA rated client only requires the backing of 1.6 percent.

Unfortunately for the too early out baby-boomers, the finance world immediately went after the extraordinary source of profit that the margin between the official credit rating agency ratings issued and the underlying true reality allowed for. The greater the differences in those margins, like when between AAAs and subprime, the greater the profits. Indeed, one of the much ignored aspects in the current discussions is that an absolute perfect credit rating, leads to no financial intermediation profits at all.

If we are to find ourselves a way of this mess, with or without the baby-boomers, we must understand much better were we come from.

Sir in “Unsafe as houses”, July 13, you lend support to UK‘s Financial Services Authority’s recommendation to “require independent verification of income” when processing a mortgage… arguing that this will “prevent individual risks from turning into systemic ones”.

Have you already forgotten that it was the independent credit rating agencies with their faulty ratings that provided the largest dose of systemic risk for the current crisis?

Do you really want to create a new oligopoly of information providers, the certified income certifiers, and who without no one will be able to lend? If you really think you need to do that for the creditors, then you are better off prohibiting them from being creditors. This is exactly the same type of nanny requirement that got the markets to trust too much the credit rating agencies.

If you want introduce stricter rules on mortgage lending then you are better off with rules that allow for creditors and debtors to come closer, instead of setting up new toll-bridges.

For instance, the rule that I would require, if a regulator, is that all mortgages, especially those that are to be securitized, have to explicitly name who has all the powers, all of the time and on behalf of all the creditors, to restructure the mortgage if need be; and the creditor must approve any change of negotiator. That by itself would not only solve one of the biggest problems currently encountered in the mortgage market, but also create a moral link that represents much more real skin in the game than a couple of percent of exposure.

The AAA pattern is extremely dangerous.

Sir, John Authers in “The Long View”, July 11, quotes Benoit Mandelbrot (who at least I never heard about before) calling the bubbles and crashes “the inevitable consequence of the human need to find patterns in the patternless”. One is left with the question of whether our financial regulators are not supposed to know that sort of stuff when they regulate. At least I always complained how the regulators were developing their own dangerous patterns... the just follow the AAAs.

The capital requirements for banks as determined by the Basel Committee in Basel II requires a bank to hold 1.6 percent in capital when lending to a corporation rated AAA to AA, and 12 percent when lending to a client rated below BB- .

Sir, how many bank crisis have you seen happening because banks have lend too much to AAA or AA rated clients who later turned out not to merit those ratings? All! And how many crisis have you seen happening because the banks lend too much to those rated BB-? None! If so, can you please explain what the regulators were thinking? If anything, would it not seem that the inverse of these capital requirements would be more valid?

Why should a poor BB-rated company, who surely must find it very difficult and expensive to raise finance, on top of it all, have to pay the banks an additional compensation in order to make up for the competitive advantages awarded by the regulators to the much more dangerous AAAs?

And, what comes after in risk-weight targets?

Sir in reference to Samuel Brittan´s “What comes after inflation targets” July 2 I just wish to remember that we also need to remember to change bank regulations targets.

According to an explanatory note issued by the Basel Committee on how the current risk-weights used to calculated the capital bank requirements were set, these were based on a “confidence level of at 99.9%, meaning that an institution was expected to suffer losses that exceed its level of tier 1 and tier 2 capital on average once in a thousand years.

Not that we should increase that confidence level, since what it did was only to drive the banks into an excessive and very dangerous over-exposure to what was perceived as having low-default-risks… precisely that stuff that bank crisis are built from.

When the going gets tough give the tough a chance!

Sir John Plender wrote “Fragile State of banks means recovery is still precarious” June 30 and few would debate him on that. Where he is wrong though is saying “that there is precious little left in the policymakers’ locker”.

At this moment what is most required, as a public regulatory policy, is to immediately reduce the capital requirements for banks on all those operations that just because they were deemed as more risky by the credit rating agencies, had to be backed up with higher capital requirements.

If we do not do that, we run the risks that while the banks are rebuilding the capital lost in AAA-land, they will crowd out completely those tough we so much need to get going now when the going is tough… and that would really be the end.

Current financial regulations discriminate against small businesses and entrepreneurs.

Sir, compared to a traditional regulatory system that set equal bank capital requirements for all type of assets, the current one which imposes different requirements based on some arbitrary risk-weights related to credit ratings, implies that a small business needs to pay about 2 percent (200 basis points) more in interest rates in order to stay competitive when accessing bank credit. Let me explain.

Suppose a bank feels that the normal risk premiums should be .5 percent for an AAA rated company and 4 percent for a small business. If the bank was required to have 8 percent for both assets and could therefore leverage itself 12.5 to 1 then the expected before credit loss margin on bank equity for the AAAs would be 6.25% and for the small business 50%, a difference of 43.75%.

But, since the bank is allowed by regulators to hold only 1.6 percent against AAA rated assets, which implies permitting a leverage of 62.5 to 1, the previous margin for these assets is now 31.25%, which implies a difference in margins on equity of only 18.75% when compared to that generated by the small business.

In order to restore the initial required competitive margin difference of 43.75, now only 18.75% the small businesses will have to generate for the banks an additional gross margin of 25 percent and which, divided by the 12.5 to 1 leverage allowed for their class of assets, comes out to be the additional 2 percent in interest rates I referred to.

Of course a complete analysis would require considering many other dynamic factors, but those would only help to fog the basic truth that our regulators are discriminating against those the banks are most supposed to serve.

What will it take for Financial Times to understand that this is no minor problem, especially when so much of any job recovery lies in the hands of small businesses and entrepreneurs?

What will it take for Financial Times to understand that the regulatory discrimination in favor of the AAAs caused the current financial crisis?

Please just one single capital requirement!

Sir you are absolutely right in that “Shock therapy is best cure for banks”, June 29, except for when ask for new “capital requirements” when what we most need is to a return to just one single capital requirement which would stop the regulatory arbitrage among different assets.

If you have not yet been able to figure out arbitrarily low capital requirements in favor of anything that can dress up in a good credit rating, is not the main cause for the banks being pushed into having an excessive exposure to anything dressed up in a good rating, I cannot but help you are indeed a bit dense… just like the regulators.

From a bank regulatory perspective, subprime and Greek debt were identical and perfect twins.

Sir Eric Posner in “Greek debt troubles reveal parallels with subprime crisis” June 29 fails to mention the most striking parallel, namely that both the securities collateralized with subprime mortgages and Greek debt, when held by banks, required these to hold only 1.6 percent in equity, in other worlds they were authorized to have a 62.5 to 1 leverage.

A bank, if it was making 50 basis points spread on Greek debt, then it was making 32 percent return a year, courtesy of the regulators… not bad eh?

How do you lobby the Basel Committee?

Sir in “The US arms its financial regulators” June 28 you write “The consensus emerging from the Basel III negotiations shows that bankers have rediscovered some of their old clout”. I suppose that with bankers you re refer primarily to the too-big-to-fail group of banks, as we have seen very little coming out that could be helpful for all the other small-enough-to-fail banks.

That raises of course the very interesting question of how one gets around lobbying the Basel Committee.

Are the regulators pulling our legs?

Sir Tom Braithwaite reporting that “US banks face more sweeping overhaul” June 27 writes about setting “aside more capital against their riskier… operations”. Or he has misunderstood it or the regulators have to be pulling our legs.

As this crisis resulted in its entirety from assets that having been deemed safe, because the credit rating agencies said so, were allowed to be financed by the banks against extremely low capital requirements, what we obviously need is higher capital requirements on any operations perceived as not risky.

To place additional capital requirements on operations that are perceived as risky and for which therefore there is already a traditional lack of capital and will to finance, has no logic. Not only did those riskier operations have nothing to do with originating the crisis but they might quite probably also represent our best ticket out of this crisis.

There’s got to be something very wrong with us.

Sir, I don’t get it! That we know that England lost during in the World Cup 1-4 to Germany is one thing, but that it will be registered in history as a 1 to 4 loss when we all know it to be 2-4 that I cannot understand. There’s got to be something very wrong with us.

Financial Times would you mind?

Sir would you mind much if I explained to FT’s sophisticated readers why it is not so much whether the capital requirements for banks are high or low that matters, but more so the way they discriminate among assets based on default risk-weights?

Let us suppose that banks, with no special regulations, would be willing to lend at .5% over their own cost of funds to those who are rated triple-A, and with a 4% spread to more risky small businesses.

If the banks were obliged to hold 8 percent against any asset, which means they can have a leverage of 12.5 to 1 (100/8) then their net results on capital, before credit losses, when lending to the AAAs would be 6.25% (.5x12.5); and 50% (4x12.5) when lending to the small businesses. With such a difference the banks would do their utmost trying to lend well to the small businesses… as there are clearly no major bonuses to be derived from lending to the AAAs.

But when the regulators allow, as they do, the bank to hold only 1.6 percent in capital when lending to AAA rated clients, which implies a leverage of 62.5 to one (100/1.6), then the expected net result on capital for the banks when lending to AAAs, before credit losses, becomes a whopping 31.25% (.5x62.5).

And of course, a bank, and bankers, being able to make 31.25% before credit losses when lending to no risk-AAAs, would be crazy going after the much more difficult 50% margin before credit losses available when lending to the riskier small businesses and entrepreneurs.

And this is how the risk-adverse regulators pushed our banks into the so dangerous “risk-free-AAA-land” while blithely ignoring that no bank or financial failure has ever occurred because of something perceived as risky, they were all the result from something perceived as not risky; and while ignoring that what we most want out of our banks is precisely that they be good in nurturing with credit those small businesses that might grow up to be the AAAs of tomorrow.

And this is really why we find ourselves in a crisis of monumental proportions, never ever before had our regulators dared to be so publicly wimpy so as to ask the banks to so excessively embrace what was, ex-ante, perceived as having no risk.

By the way, who gave the regulators the right to discriminate solely based on perceived default risks? The small businesses, in order to have a chance to access credit, are as a direct consequence of these capital requirements forced by the regulators to pay much more for their loans... as simple as that! Do not forget that whatever little capital the banks currently have, it is mostly because of those perceived as being risky.

Financial Times, please help… save the world from our financial regulators´ regulatory exuberance!

There has never ever been a major or systemic bank crisis that has resulted from the banks being involved with what ex-ante was perceived as risky; they all resulted from lending and investing in what ex-ante was considered as not risky, given the returns offered.


But then came the Basel Committee regulators and, to top it up, lowered the capital requirements for what ex-ante is perceived by the credit rating agencies as having lower risks, which of course increased the banks’ expected ex-ante returns from pursuing these “low risk” opportunities.

And now, when two years after an explosion that resulted from so many banks following the minuscule capital requirements when investing in securities collateralized with subprime mortgages; and there is a bank explosion awaiting round the corner because of bank lending to well rated fancy sovereigns, like Greece, with almost no capital requirements at all; they keep on applying the same regulatory paradigm of risk-weighted assets, we can only deduct that our financial regulators simply do not get it, not even ex-post.

Please, FT, help save the world from our financial regulators´ regulatory exuberance!

In reality Oliver Stone is Mr. Conformist.

Sir in “When Hugo met Oliver”, June 19, Matthew Garrahan refers to Oliver Stone as a non-conformist. Since “conformism” is a term used to describe the suspension of an individual's self-determined actions or opinions in favour of obedience to the mandates or conventions of one's peer-group that is plainly laughable. Oliver Stone, with respect to the beliefs extolled in his particular mutual admiration club, is as conformist as anyone could be.

If I had the chance I would warmly suggest Mr. Stone to read Arthur Koestler’s “Darkness at noon”, as it could be an eye-opener for him. But, then again why would he want an eye-opener when the living on the fast moving and trendy oil blessed left jet set is so enjoyable and profitable?

Yes, we should all have a say in how banks are reformed

John Kay is absolutely right in that “We should all have a say in how banks are reformed” June 16.

Human and economic development includes an incredible number of different risks of different nature and most perhaps not even known to us, just look at BP. Therefore I have for more than a decade protested those regulators who decided to impose capital requirements by discriminating with their arbitrary risk weights based exclusively on the risk of default, a risk that could only be of such a concern to extremely wimpy regulators.

Indeed, that a creditor defaults is about the most natural thing in the world, and the only way it becomes worrisome is if there is a systemic and massive number of defaults; and which is precisely what the regulators finally caused when with their capital requirement they started a mad chase in search of triple-A ratings, and the market found some Potemkin ones.

Also the sole fact that it can go through a regulators head to discriminate in such a way as to assigning zero capital requirements when a bank lends to a AAA rated sovereign but require 8 percent when it lends to its most natural clients namely the small businesses and entrepreneurs, is maddening. If asked I would even prefer it to be exactly the other way round, though I would happily settle for no discrimination at all, as that is what the least confuses the markets.

There are many ways of tightening and easing... and some are better than other

Sir Martin Wolf rightly insists in warning on “Why plans for early fiscal tightening carry global risk” June 16, but he would further his cause focusing more on the needed quality of the fiscal spending. It is not fiscal deficits I am afraid of; it is fiscal useless waste that makes me and many really nervous.

For instance when regulators can allow the banks to lend to sovereigns with zero or minimal capital requirements why can’t they temporarily decrease the capital requirements for the banks when lending to the small businesses and entrepreneurs, those who had nothing to do with creating the mess, those who can perhaps most help us to get out of it. That to me seems a more efficient way of stimulating the economy than having bureaucrats decide on what to spend.

Lower the capital requirements for banks!

Martin Wolf is absolutely right in warning us that “Fear of the markets must not blind us to deflation’s danger” June 9, but I do not understand on what grounds he believes that government can spend and ease us out of our immense problems. What we have seen until now seems surely to have set us up for something worse and one of the reasons for it is exactly that the “wicked” investors have not “suffered punishment” but been bailed-out.

If we are going to stimulate again this time that stimulus has to be carried out by the private sector. How? As I have proposed for soon two years, by lowering substantially the current capital requirements of banks when lending to small businesses and entrepreneurs. It was the ridiculous low capital requirements to any fancy sovereign and triple-A rated operation that got us into this horrendous mess… what wrong can it be to temporarily allow for lower capital requirements when banks lend to those who stand the best chance to get us out of the mess.

Right now if a bank lends to US-UK-Germany-France government it needs no capital at all and with the proceeds the bureaucrats of those nations can decide what to stimulate and who to finance. Is it no better having the banks decide which General Motors or grocers on the corner should get finance?

Yes we have reasons to distrust the banks, though far from as many some agendas want us to believe, but that does not imply that suddenly governments, magically, are better. I at least trust them less than what I trust banks. In any case if we got to keep on rowing close to the waterfalls of inflation and deflation let us at least make sure we all row in the same direction… hopefully away from them.

The odious and arbitrary regulatory discrimination of risks must stop… now!

Sir Jeffrey Sachs in “It is time to plan for the post-Keynesian era” June 8, in his list of proposals, ignores the fundamental change that must occur in our financial regulations.

It just cannot be that our regulators allow banks to lend to fancy AAA rated sovereigns with zero capital requirements, or to sovereigns rated like Greece the last five years with only 1.6 percent of capital, while requiring the banks to hold 8 percent in capital when lending to the small businesses and entrepreneurs.

That odious and arbitrary regulatory discrimination must end now; the coward market discriminates more than enough when pricing for risks; and our financial regulators should immediately be removed as they seem absolutely incapable to understand that there are other risks in life than “the risk of default”.

Societies and human development thrives on risk taking and not on risk-avoidance.

Sir finally, at long last, you have reached the conclusion that we need to “end the pseudo official status of a select group of CRA’s elevated by law and accounting rules into arbiter’s of our banking systems’ risk management”, Rating Credit June 4. Good for you!

Having said that though, you arrive at this conclusion mostly because you feel that the credit rating agencies cannot really perform their rating job correctly, and which is why you find it hard “to do away with risk-weighting altogether” and with that you do your utmost to hang on to some kind of myth of safety.

Sadly, the real life hard truth is that there is absolutely nothing that justifies that a credit, deemed as having less risk to default, should be favored more than it already is by the market. Actually, since the nature of capital nature is and has always been very risk-averse, one could more easily build a case to the contrary since societies and human development thrives on risk taking and not risk-avoidance.

It is only by following the capital requirements for banks and the Potemkin ratings that you can understand our current predicament.

Sir Nouriel Roubini and Arnab Das evidence with their “Solutions for a crisis in its sovereign stage” June 1, that though experts, they are not sufficiently aware of what has really been going on in the area of sovereign finance.

I say this because in the area for “radical reform of finance” though they mention correctly the problem with the too large institutions, they fail completely to make reference to the much larger problem of how the financial regulators, in a non-transparent way and behind the backs of us citizens, are arbitrarily subsidizing sovereign finance by requiring the banks to hold lower capital requirements when lending to governments than when lending to their natural clients the small businesses and entrepreneurs.

Back in 2004 in the Financial Times I wrote: “We wonder how many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector... banks are up to the hilt in public credits.”

In this respect one of the most important information the Financial Times could provide its readers is the following table:

It is only be reading this table that you get to understand why there was a stampede after AAA rated private securities, even when these came with Potemkin ratings, and why there was so much lending to sovereigns… for instance to Greece which because of its ratings over between mid 2000 and December 2009 required the banks only to hold a paltry 1.6 percent.

Very soon the vultures will descend on some European sovereign bond markets

Sir Gillian Tett writes about future haircuts on Greek and other sovereign debt that “will continue to poison the bond markets, “Bondholders jittery over who will bear Greek losses” May 28.

Yes, there will surely be a lot more of it in line but let me assure her that already many bondholders are de-facto taking their share of hair cutting by way of the markets, as interest rates for these borrowers is shooting up, and, if nothing is done, sooner or later the vultures, those who have been preying on other lesser markets might descend in full force on Europe.

There is little anyone can actually do against a market that has discovered something as being unsustainable, and so the decision the European governments have to make now is more about who they wish to encounter on the other side of the negotiation table... the traditional bondholders or the vultures?

When is real Armageddon more likely to occur, when we are impacted or when we discover that we are going to be impacted?

It was the financial regulator who upset the delicate balance between grasshoppers and ants.

Sir Martin Wolf ends “The grasshoppers and the ants – a contemporary fable” May 26, as all fables should end, namely with a moral, in this case being “If you want to accumulate enduring wealth, do not lend to grasshoppers”. Now since that moral cannot in any way classify as a new moral, the question that begs an answer is how come it was so utterly ignored. Let me explain why.

Our financial regulators, fed up with so many bank failures, got together in something they named the Basel Committee and there, in an incestuous petit committee, decided that it did not any longer really matter whether the banks were lending to grasshoppers or ants, as long as they were lending to those who were most certain to repay. And, in order to make sure that their new regulations were duly carried out they empowered some few human fallible credit rating agencies to decide who were most likely to repay… and created monstrously huge incentives for the banks, in terms of ridiculously low capital requirements, to lend to those deemed absolutely safe by the risk-commissars.

And the risk-commissars, grateful for the opportunity to perform a very profitable service, set out by rating their masters, the most reputable sovereigns, as having no risks… crowning them with their AAAs. And then all sort of crazy things started to happen and which brought total confusion to the markets.

The banks began leveraging up lending to sovereigns and other “risk-free” client, and though this should have resulted in the credit ratings of the banks being cut, the risk commissars measured the willingness of sovereigns to assist the banks if need be, and deeming it to be good kept the ratings of the banks; which then could further lend to super-safe-grasshoppers and super-safe-ants alike. But, unfortunately, since there is a natural scarcity of super-safes, as a good regulator should have known, and there was such an extraordinarily demand for these, the market, being what it is, began supplying some fake subprime super-safes... until the forgery was discovered, much too late.

But, meanwhile, since the lending to all of the small ants, those who in their beginnings of course pose higher risk of default were kept under the thumb of much more conservative capital requirements, it also upset the very delicate world balance between grasshoppers and ants, ending in the current disaster of having too many grasshoppers per ant.

Are capital and liquidity rules for the banks out of the domain of the US Congress?

Sir in “Tsunami of regulation batters banks”, May 21, Brooke Masters reports “The Basel Committee on Banking Supervision is aiming to adopt new capital and liquidity rules by the end of the year.”

Given that the current capital rules, which unjustifiably favors the good credit risk ratings already favored by the markets, created the stampede after triple-A rated securities that detonated the current financial crisis, this must surely be one of the most important part of the financial regulatory reform.

Can then anyone explain to me why the Basel Committee is not mentioned even once in the 1336 pages long reform bill presented to the US Senate or in the 1776 pages long H.R. 4173 financial regulatory Act approved by the House of Representatives?

More than about who sets the basic capital requirements for banks a sensible regulatory reform needs to worry about who sets the risk-weights.

Sir Howard Davies and David Green are correct suggesting that the setting of the capital requirements for banks should be placed in the hands of the monetary policy committee or whoever else sets the interest rate policy, as they are tools for a similar purpose, “Final touches for sensible regulatory reform” May 20. Currently that basic capital requirement decision is not even in the UK, having been delegated to the Basel Committee and which, for no special reason at all, seems to have carved out in stone an unmovable 8 percent.

But Davies and Green, much more than about the basic capital requirements, should worry about who takes the decisions on the risk-weights. It is those weights which really explain why, from mid 2000 until December 2009, the banks could lend to Greece with only 1.6 percent capital, while if they lent to any unrated UK entrepreneur they needed 8 percent in equity. This was because the Basel Committee, in Basel II, with precious little and quite dubious explanation, assigned a 20 percent risk weight for sovereigns rated A+ to A and corporate rated AAA to AA, while giving a 100 percent risk weight to any unrated clients. This arbitrary risk discrimination imposed on top of how the market already discriminates based on risk is the fundamental cause of this crisis, as it among others caused the stampede after triple-A rated investments.

http://teawithft.blogspot.com/2004/08/towards-counter-cyclical-basel.html

Where did the regulators get their risk weights from?

Sir John Kay extends “A royal invitation to raise the debate on finance” May 19. Knowing that the value of those commissions lies primarily in how the questions are phrased, since quite often the questions are too general or too many, which tends to obscure the answers, let me suggest one single line of question.

Current capital requirements for banks were established at 8 percent, adjusted for risk-weights. A loan to a small business is risk-weighted at 100%, and the bank needs to hold 8 percent in capital when lending to it. But since a loan to a corporation rated AAA, or to a country like Greece, which until quite recently was rated A, would be risk-weighted at 20% and so then only 1.6 percent in capital would suffice when lending.

So ask the commission… where did the regulators get those 100% or 20% risk-weights from?

We know that the Basel Committee has published for example “An Explanatory Note on the Basel II IRB Risk Weight Functions” but reading the paper only reinforces the urgent need of introducing outsiders to this close circle of regulatory insiders, who are now circling their wagons defending themselves, so successfully that they allowed to dig us even deeper in the hole they placed us in.

The Explanatory Note, prepared in July 2005, states that the risk-weights were developed with a “confidence level of 99.9%, meaning a bank is expected to suffer losses that their capital on average once in a thousand years” How come that confidence level did not last for two years? Who authorized that confidence level? I for one know perfectly well that, if the world would regulate their banks under the assumption that they would fail only once every thousand years… it might as well be dead and buried.

PS. What’s more reproachable? A young girl believing a palm reader’s prediction in a county fair; or grownups believing the self-selected Basel Committee fortune tellers when, for bank capital/equity requirements, they give us their weights of the risks for our bank systems?

It is low capital requirements that generate the type of yield of which great bonuses are made of

Sir Tony Jackson writes that the reason why “banks are up to their eyebrows in dodgy sovereign debt” is they have “fasten to instruments with investment-grade rating and junk-grade yields”, “Politics remains the biggest barrier to bank regulations” May 17. At this point of the crisis it is astonishing how wrong Jackson can be. Where has he been?

These sovereign debts did not pay junk-grade yields they paid relative low rates but these rates were made especially attractive for the banks because these were required to hold very low capital requirements against them.

For example a bank holding debt of Greece, between mid 2000 and December 2009, needed only to have 1.6 percent in capital… which allowed it a 62.5 to one leverage. Take any small margin and multiply it 62.5 times and you will get the type of yields of which great bonuses are made of.

It is not politics but the Basel Committee, who remains the biggest barrier to rational bank regulation.

We need to decrease the credibility asymmetry that exists in the credit information market

Sir I refer to The Lex Column writing about the religion credit rating agencies bring to the markets, with their implied aura of infallibility May 15.

One of the problems with credit ratings is that they are never sufficiently publicly debated, unless when it is too late, and when that happens then it is mostly the case of a small questioner against the mother of all father authorities in the markets.

Too often have I heard bankers ask me “Per, how on earth do you think I could convince my colleagues on the Board that the credit rating agencies were getting it so extraordinarily wrong that we should exit from what seemed to be an extraordinarily good business for us?”

In our efforts to solve the asymmetry in information we have increased the asymmetry of the credibility with respect to financial information, making it now almost impossible for divergent opinions to nudge the markets on the margin, and being only considered when the causes for the divergence become much too apparent, which is of course then much too late.

The first thing that should happen is that the credit rating agencies should be required to post, real time, all the questions and answers received with respect to every particular ratings, so to allow the market to express their viewpoints and to allow configure the necessary opinion majorities that could force the credit rating agencies to revise what they are doing.

If that Bank Director friend of mine could have referred to a public online forum where those same suspicions were uttered by others, then he would stand a much better chance of being heard.

But the regulatory geeks never passed calculus!

Sir Gillian Tett in “Risks posed by get-rich geeks are not just a flash in the pan” May 14 is right on the dot when she writes that “it all seemed so mind-numbingly geeky and dull to ordinary mortals and very few journalists, politicians, or even regulators, had much interest asking the right questions”

In 2003, at the World Bank, in a brief speech I gave to some assembled risk-manager-regulators I told them “…we can already begin to see how Basel II is forcing bank regulators to make a real professional quantum leap. As I see it, you will have a lot of homework in the next years, brushing up on your calculus—almost a career change.”

Clearly they did not pass calculus, but nor should they have had to, because if regulations are not comprehended by the weakest of the team, they are just too complicated. My problem in my relation on the subject of the very subprime financial regulations with the journalists of the Financial Times is exactly that, because very few of them, if anyone, has found the necessary calm and tranquility to sit down and read Basel II, so as to even begin to understand what absurd paradigm the regulatory geeks want us to follow.

The conventionals scorched the earth but still reign!

Sir again Martin Wolf in “The economic legacy of Mr Brown” May 14 refers to a “light touch” [financial] regulatory regime. I object, never before has there been such a heavy handed intervention as when the regulators created huge incentives, by means of ridiculous low capital requirements, to lend to anything related to a triple-A, and in effect subsidizing risk adverseness to such an extent that markets followed fake-triple-As into disaster.

Also Martin Wolf repeats several times the correct assessment that one of Mr. Brown’s faults was to follow too much the conventional wisdom. Not only do I find it difficult to put what happened in relation to any “wisdom” but I also believe it would have been more elegant for Wolf to acknowledge that, from his own high pedestal in the Financial Times, he himself has been an important feeder of those conventions.

The worst though is that, with or without Mr Brown, the conventionals still reign... suffices to see how the Financial Stability Board is digging us even deeper in the hole.

Mr. Padoa-Schioppa, you helped to pick out "the intelligent", so now you better live with them

Sir it is somewhat hard to comment Tommaso Padoa-Schioppa’s “The euro remains on the right side of history” May 14, because it includes so much of that glorious babble that I produce when I have had a glass of wine too many. That said let me remind Padoa-Schioppa that when he describes those enemies who besiege his euro and refers to “targets selected by the intelligence of three credit rating agencies” he should do well remembering that he himself was among those empowering these credit rating agencies and innocently believing them to be so intelligent that you could structure your whole financial regulations around them.

I am also left with a lingering doubt, is he suggesting that the omnipotent nations-state of Europe should be replaced by an even more omnipotent union. Mind you I am all for EU, as long as it is subservient to the citizens… since deal-making Maastricht bureaucrats can be just as obnoxious as deal-making Westphalia kings.

The Champions of the Basel Committee

Sir there is not one regulator capable to stand up and with a straight face look us into our eyes and tell us why a Sovereign rated A to A+, like Greece was from mid 2000 to late 2009, were risk-weighted 20% which allowed banks to lend it with a capital requirement of only 1.6 percent in equity meaning being able to leverage 62.5 to 1, while the small business in our neighborhood was risk-weighted 100%, meaning for banks, 8 percent in equity and 12.5 to 1 in leverage.

But luckily for those regulators, they will never be asked those questions, as long as they can count on Champions like Martin Wolf, Paul de Grauwe, and so many others, insisting on blaming just the private financial sector, “Governments up the stakes in their fight with markets”, May 12. How long will it take to hear a proposal to define all European sovereigns as de-jure rated AAA, so that they can be risk-weighted at zero percent, so that banks do not require any capital at all when lending to them, so that their leverage can be infinite?

They´re just plain dumb

Sir Arvind Subramanian is absolutely right when in “Greek deal lets banks profit from immoral hazards” May 7, states the case that there has to be a debt restructuring that includes a lot of hair-cutting to turn Greece´s economy into something reasonably viable, something reasonably livable.

But then he goes into a lot of convolutions trying to explain why the parties in charge do not understand it, but leaves out the most simple and the most normal human possibility, that of them being plain dumb.

I mean anyone who has allowed banks to stock up on Greek and alike debt by authorizing them a 62.5 times to one leverage can´t be anything but plain dumb… and we the dumber allowing them to do so.

The best is to name every single investor as super-duper sophisticated.

Sir Gillian Tett in suggest a new intermediate level of financial sophistication, college level perhaps, to handle the protection of those investors who might find themselves in the no man land of in between, “Sophisticated investor debate takes on a new dimension” May 7. I do not agree one category suffices the “super duper sophisticated”. Give each investor notice they have been considered to belong to this category and let the investors take it from there in the knowledge that when push comes to shove they are on their own.

And in the debate about bankers´ fiduciary duty the best way is for them to declare, in each operation, on behalf of whom they act, whether the buyer, the vendor or just themselves, which is also in their right, and then hold them strictly to that. What is worse is misrepresentation or lack of representation.

We had a monstrously dumb and stupid, government failure

Sir, Samuel Brittan in “A credo for a revived capitalism” May 7 reminds us that we need to discuss more about “government failure”. He is absolutely right.

In October 2004, as an Executive Director of the World Bank, I who am not an investment banker, nor a financial regulator, presented at the Board a written statement were I opined: “We 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.”

And long before that and during my whole term as an ED I repeated, as much as I could, bordering on annoying, that the ratings issued by the credit agencies were just a new breed of systemic error to be propagated at modern speeds… and that we should not follow the money but follow the triple-As.

The real question now is what keeps the world from listening when the innocent child screams out “the emperor is naked”?

Look at the European governments, accepting the dictates of the Basel Committee and allowing their banks a 62.5 to one leverage when stocking up on Greek debts and alike… if that is just not a monstrously dumb and stupid government failure, what is?

They hold too many Greek bonds, courtesy of the communists in the Basel Committee

Sir Gillian Tett, in “Grim echoes of Wall Street crisis as investors face mental Rubicon” May 6, asks “How many Greek bonds do German banks hold? The simple answer is too many! It could not be any other way with regulators who have allowed banks to leverage their capital 62.5 times to one in the case of bonds rated like those of Greece, and only 12.5 times to one when lending to small businesses and entrepreneurs.

Don’t you get it? For all practical purposes these regulators in Basel are nothing but disguised communists.

Respectfully, may I express a doubt?

Sir in your “The case for change” May 4 you write that the Financial Times stands for a “liberal agenda: a small state...” May I respectfully doubt it?

No one that stands for a small state can agree that if his deposit in the local bank is loaned out by the bank to a small business the banks needs to hold eight percent in capital, but if his bank lends instead that money to the government it needs to hold no capital at all.

About this I have written you many letters during many years but you keep on ignoring the issue.

Basel Committee, why don´t you just shut up!

Sir who do these Basel Committee regulators really think they are bullying us around with an arrogant “the banks should be sensible and realise that it might backfire if they protest too much”? as reported by Brooke Masters, May 4.

They themselves are the ones who thought everything would be fine and dandy if they just had some few credit rating agencies determine default risks and then gave the banks great incentives, by means of different capital requirements, to follow those credit risk opinions. They themselves are the ones who believing in the abundance of safe triple-A rated lending and investments, caused the world to stampede and fall over the subprime mortgages. They themselves should shut up, because rarely has the world seen such a gullible naive and outright stupid bunch of regulators.

Now the banks, in the midst of a crisis, need to build up the equity they do not have precisely because the Basel Committee did not require them to have; precisely when we the most the banks to lend. The regulators, instead of bullying banks, should busy themselves day and night finding ways for severely capital stretched banks to be able to lend to those small businesses and entrepreneurs who have had to pay the cost of higher capital requirements but who had absolutely nothing to do in generating this crisis.

And just in case, for the record, I am no banker, only a citizen, very upset with the fact that in the 347 pages of the regulations known as Basel II, there is not one single word that describes the purpose of those regulations. Basel Committee why do you not start defining a purpose for what you are doing? Is that too much to ask?

Europe, please, do not risk the EU to save the Euro!

Sir you are aware that I have been thinking that a Greek (and some other) defaults is the most logical way out of an unsustainable illogical situation, and so of course I agree with what Wolfgang Münchau on that “Europe’s choice is to integrate or disintegrate” May 3, though much more than he knows.

You see for me I am not so worried about the Eurozone but more so about the EU, since trying to save the Euro signifies seriously endangering the EU, and that is something much worse.

That´s why the markets are schizo!

Sir Tony Jackson could just the same have titled his “Caught between business as usual and more aftershocks” May 3, with “Caught between wanting to make money and wanting to salvage as much as possible”. The problem as we know is that both wishes requires entirely different strategies, which is why the markets are schizophrenic.

The Euro or the EU?

Sir Alan Beattie is right deriving “Lessons for the Greek crisis from Philip II of Spain” May 1. Greece is of course much better of keeping all the help they can get for the morning after than for the night before… especially when in this the night before, though very late, it is so hard to discern any morning light.

Only a speedy restructuring of Greece´s debt can avoid having to choose between the Euro and the EU.

Financial Times is equally a promoter of “metaphysical presumptions”

Sir your ‘Faith in numbers” May 1 is truly odious in the way you arrogantly and ironically joke about religious beliefs while blithely ignoring how much you yourself have been helping to give credence to bank regulations that seem to be just the same or even more based on “metaphysical presumptions”.

Or what would you call having the capital requirements for our banks based on some opinions of the credit rating agencies and as arbitrarily weighted by the high priests of the Basel Committee? If that is not pure purposeless mumbo-jumbo or hocus-pocus, what is?

But what were the regulators smoking?

Sir in “Double or quits for the eurozone” April 29, you say that “Credit raters made things worse by again following the markets they are supposed to advise”. Would you care to expand a little bit on that?

To me it was really the regulators who made things worse by telling banks to have capital in accordance to what the credit rating agencies say... and for instance allowed the banks to stock up on Greek public debt with only 1.6 percent of capital... in other words authorizing the banks to have a 62.5 to 1 leverage when dealing with Greece! What were the regulators smoking?

Triple-A securities did not turn into junk, they were junk made into triple-As, simply because there are not enough real triple-As to go around.

Sir John Gapper writes “this crisis was of a severity beyond others in the past, and triple-A securities were at its heart” ‘Time to rein in the rating agencies” April 29. The first letter of mine, and that you published on January 12, 2003 ended with “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”. At last count I have sent you 391 letter more on this topic and so it would seem that after a definite statement like Gapper’s I should now be able to let it go. Not yet!

When Gapper in his quite comprehensive article states “If all the subprime mortgage securities they rated triple A had not turned to junk…” he completely misses the point. It was the shear existence of the credit ratings that, when combined with absurdly low capital requirements for banks when lending or investing in triple-As, which provided all the incentives for the markets to manufacture the “junk”.

Given the possibility of accessing a triple-A rating the worse the mortgage, the higher the interest rates, the larger the difference between the real and the perceived value and therefore the larger the profits.

Sir, please grow up and face the facts of life. There are not enough true triple-A investment opportunities to go around for all the coward capital that exists in the world. Pursuing triple-As too much will either lead us to false triple-As or to absolutely unproductive triple-As, like putting your savings in a mattress and having it stored at Fort Knox, paying a custodial fee.

If the incentives are correctly aligned all bonuses make sense.

Sir, John Kay in “When a bonus culture is just a poor joke” April 28, that he would have felt insulted if as a teacher he were to receive a bonus from a student on the successful completion of a course.

Why should he feel that way if the incentives were well aligned? You see it is really not the completion of a course that matters, as Kay seems to believe, but what you do in life with that completion. In this respect let me share with Kay some brief paragraphs I posted on one of my umpteenth blogs a couple of years ago.

Don’t give your teacher an apple; offer him a couple of basis points in your earnings instead.

Parent and students need some way of sorting through the reams of college information in order to make rational investments, but may I remind you that even when finding the absolute perfect college that you might benefit from aligning the incentives better.

In this respect what I am currently recommending my young friends when they take off for their MBA is that they offer a couple of basis points on their first 10 years earnings to those teachers they feel could best advance their careers…it makes wonders! 

Aligning the incentives could in the long run also be the best way of getting information for the picking of a college to, as education should in fact be a joint venture between students, teachers, and colleges.

I refuse to follow Martin Wolf down the road to financial obscurantism

Sir when comparing the ease or even gusto with which Martin Wolf has supported government spending to bail out the economy, imposing no public debt to taxpayers willingness ratios at all, with the way he now wants to strictly limit the banks’ lending activity, I am truly shocked, “Why cautious reform of finance is the risky option”, April 28.

Wolf, after years of receiving, acknowledging and ignoring my letters about the excessive leverage ratios allowed to banks on assets perceived as having low risk, like 62.5 to one on anything related to an AAA rating, now suddenly goes into full reverse and opines that “Leverage ratios of 30 to one are crazy. Three to one looks far more sensible”.

Well let me assure you that just even searching for a three to one capital ratio for banks world, would make us lose all our hopes of trying to solve the rest of the world’s urgent problems, and most certainly lead us to financial obscurantism with pure gold bartering and no credit at all. I refuse to follow Martin Wolf there!

In fact the 12.5 to one capital ratio, allowed to banks when lending to small businesses and entrepreneurs, and which of course had nothing to do causing this crisis, should perhaps even be increased slightly, now when we are in so much deer need of jobs.

Plain stupid or shameless… have a pick

Sir on your front page in “Moody’s admits to failings over crisis”, April 24, Stephanie Kirchgaessner and Kevin Seiff report that “The chief executive of Moody’s admitted to a Senate panel yesterday that the US credit rating agencies failed to anticipate the severe deterioration in the US housing market that led to the financial crisis”.

If Raymond McDaniel does not know what role the AAA ratings had in creating the worst part of the bubble in the US housing market and which had to explode, then he is plain stupid, but, if he is not that stupid, then he is just shameless… Have a pick!

Why should George Soros be licensed to kill and not the bankers?

Sir George Soros in “America must face up to the dangers of derivatives” April 23 describes these as “a licence to kill” and he is wrong.

Just as a gun a derivative can do good or bad depending on who pulls the trigger on what and with what accuracy. In this respect, and given that in matters of investment George Soros could also readily qualify as just another gunslinger perhaps he should hand in his licence to kill too.

Undue influence?

Sir amazed I read on FT’s front page “”Bankers influenced rating agencies… unduly” April 23. I ask, did not the regulators unduly influence banks and investors to give undue weight to many unduly prepared opinions of the credit rating agencies? Is not overselling one’s product something perfectly normal? Why would the credit rating agencies’ opinions be more covered by the 1st Amendment’s freedom of expression rights than the opinions of the bankers?

Don’t fight it… accept it… on the subject of the hundreds of letter I have sent you denouncing the very subprime bank regulations that were concocted by the Basel Committee and which that caused this crisis… you have let yourself to be unduly influenced by the undue opinions to withhold from the general public my very correct opinions by some of your own opinionated writers.

I expected the Canadian bankers not wanting to live in never-risk-land.

Sir when the heads of the six major Canadian banks, those banks which better health makes them the object of envy of so many regulators and taxpayers in the world, issue a joint communiqué, we should read it very carefully “It is time to press on with bank reform” April 22. Unfortunately, my expectations were too high and I was disappointed.

Not only did it read almost like a Julia Child recipe... a little bit more of Tier 1 capital here.... and some more leverage testing there... but it also showed that neither they have a clear idea of what hit us.

Though they correctly state “Regulators do not need to specify which businesses banks should enter” they do not realize that is exactly what regulators do when they risk-weigh assets. Markets discriminate risks by charging different interest rates and so, when regulators award the lending to some assets lower capital requirements, because these are perceived by the credit rating agencies as less risky, they are actually instructing bankers to go to “risk-free” land. And, our problem, as a society, and though we do appreciate the efforts of lowering the risks in banks, is that we are not sure our best interests or future really lies in Never-risk-land.

They also write that if no distinctions, in terms of capital requirements, between low-risk and high-risk assets, something that I much favour, this “would encourage financial institutions to take more risk, which could make the system less stable”. Are they blind? Have they not wakened up to the fact that this crisis resulted from capitals stampeding in the search of AAA ratings, precisely as a consequence of the low capital requirements?

Where are the bankers who want to have the right to lend to their traditional client small businesses and entrepreneurs on their way to capital markets, without being distracted only because regulators favours what is perceived as having less risk? I had hoped these bankers were in Canada, now I am not any longer sure of that.