The regulators never believed in the Efficient Financial Markets Hypothesis.

Sir, John Quiggin writes: “Claims of a Great Moderation were bolstered by the Efficient Financial Markets Hypothesis, which stated that the prices generated by financial markets represented the best possible estimate of the value of any asset, given the available information. It follows that market bubbles are impossible and that the deregulation of financial markets should help to stabilise the real economy.” “Why austerity and ‘zombie’ ideas are bound to fail” November 30.

That is obviously false because anyone truly believing in the “Efficient Financial Markets Hypothesis” would never have come up with such a screwed up idea of having bank regulators arbitrarily intervene in the markets by setting different capital requirements for banks depending on the perceived risk of default, when that risk was already being cleared for in the markets by their risk-premiums.

The regulators thinking that, with a little help from their friends the credit rating agencies, they had everything under control, allowed the banks to finance triple-A rated securities collateralized with badly awarded subprime mortgages, Greek public debt, or Irish banks with a leverage of 62.5 to 1. An efficient Financial Market, on its own would never have done such a stupid thing. For instance the unregulated hedge funds almost never exceed a 12 to 1 leverage.

We need to start by fixing our banking infrastructure

Sir Martin Wolf correctly writes that “Assets matter just as much as cutting debt” November 26, asking the key question of “What is the sense of cutting spending today if the result is a poorer country tomorrow.” I have for more than a decade asked the very similar question of “What is the sense of trying to make our banks avoid risk-taking so that they do not default if the result is a poorer country”.

If there is some infrastructure that really needs strengthening that is our banking system, something that on top of it all does not require money but just a dose of common sense. If we just ask the bank regulators to tell us what they believe the purpose of the banks to be, and require it to be something more than just avoiding bank failures, which only places us on the road to the too big to fail banks, then we would advance significantly our chances to find the growth we all clamor for.

Let us just accept that by diminishing the capital requirements on what is perceived as not-risky will not lead us anywhere, as all it does is to increase the profitability for banks of doing business with what is perceived as not risky, without insulating us from the risk of the systemic bank defaults which all anyhow result exclusively from excessive investments in what ex-ante is perceived as not-risky.

I strongly object to Basel I, II and III.

Sir, I have written you hundreds of letters that reference my strong objections to the regulatory paradigms used by the Basel Committee and I know my arguments are not baseless… and you know that too. Can you at least once, for the record, publish these objections… or is there something that you want to silence? You are the Financial Times and so I should be able presume this topic should be of interest to you:

I strongly object what is basically the only pillar of bank regulations created by the Basel Committee in Basel I, II and III, namely having the capital requirements for banks to be based on perceived risk of default.

First: All systemic bank failures in history have occurred only as a result of excessive lending to what is perceived as not-risky, and never because of excessive lending to what is perceived as risky, which makes these capital requirements counterfactual.

Second: The market and the banks already discriminate against higher perceived risk by means of the risk-premiums imbedded in the interest rates, and so these capital requirements are just an extra layer of risk-aversion that hinders the banks to help the world to take the risks it needs in order to move forward.

Third: Since needing less capital when doing business with the “less risky” makes the profitability of bank business with the “less risky” to shoot up to the skies, this causes the banks to forget or discriminate against the “risky”, such as the small businesses and entrepreneurs on whom we depend so much for the future generation of jobs.

Ps. And the above does not even mention the problems of having empowered the credit rating agencies with a risk-information oligopoly.

A day at the races

Sir, Michael J. Mauboussin in “Flutter on mispriced US equities could prove a winner” November 24, writes “You don’t make money knowing which horse will win or lose; you make money determining which horse has odds that are mispriced”.

Absolutely, and this is as good an occasion to remind of the fact that if credit-ratings were set perfectly, all bank lending transactions would be perfect barters, and there would not longer be any profit opportunity for any side… and therefore markets and banking would slowly die out. Of course, that is not going to happen because credit-ratings are by definition always imperfect… no matter how much bank regulators want them to be perfect so that they do not have to worry about the only risk that worries them, even if this leaves the rest of the world to worry about all other risks, like the lack of jobs.

By the way, back to the races, do you know why the crisis? The handicap officers place extremely low risk-weights on the triple-A rated horses and much heavier risk-weight on the debutant or weaker BB- horses, without telling the bookies or the gamblers, and thought they were going to have a great and fair race… a total chaos that surpassed what even the Marx Brothers could have come up with in their wildest dreams ensued.

The strangest thing though is that we, bookies and gamblers, allow those same crazy handicap officers in the Basel Committee to keep on deciding the handicap system for our banks.

The diabolical mother of all quid-pro-quos goes back to 1988, to Basel I.

Sir, in “Europe heads back into the storm” November 18, you refer to “a diabolical bargain that has core states lend to peripheral ones so that they can support their banks, all to save financial institutions in the core from losses” but you do not mention the fact that the governments are just keeping up their end of that mother of all quid-pro-quos bargains between states and banks.

When the Basel Committee in 1988, in Basel I, set up capital requirements for banks that were dramatically lower when lending to governments, compared to when lending to their ordinary private clients that was when this Faustian bargain originated. When the Basel Committee accepted, on behalf of the governments, it must have been knowingly, that the credit rating agencies would when rating the banks also include the willingness of the government to support the banks, then the diabolical vicious circle was sublimely completed.

Of course when you say “this game of bail-out on the sly cannot be sustained for much longer” you are absolutely correct, but neither can a bank-regulation on the sly that permit UK banks to lend to the triple-A rated governments, like the UK, against zero capital, be sustained much longer. Why does FT, without fear, call out the first, but then not act without favour, calling out the second?

If only the Basel Committee had known more about behaviouralism

Sir, Ken Fisher writes: “Humans hate losses more than twice as much as they love gains – a 10 percent loss feels as bad as a 25 percent gain feels good. That´s proven behaviouralism”, “Gridlocked governments are good news for equity”, November 18.

Of course he is right. How sad the bank regulators in the Basel Committee did not consider this when they designed their capital requirements which require higher capital for lending when the perceived risk of default are high, and allows for much lower capital for lending when the perceived risks of default are low. Of course, those regulations, only lent further impetus to the creation of a bank crisis, those which always result from excessive lending to what is perceived as having a low risk, and never result from excessive lending to what is perceived as having no risk.

It is not about the bonuses, it is about the artificial profits from which bonuses are made of!

Sir I am so tired hearing about the discussion about unreasonable and outright shameful bonuses paid without making any reference to the fact that these must be based on outright shameful profit margins that are in large a direct result of regulatory interference, Patrick Jenkins, "Remuneration still the big sticking point", November 18.

If a bank when lending to a triple-A rated client were only permitted to leverage its equity as much as when lending to a small unrated business, namely 12.5 to 1, then the bank, if it made a .5 percent on a loan to a triple-A rated client would generate a 6.25% yearly return on equity, good, but nothing to pay huge bonuses on.

But since the Basel Committee authorized the banks to leverage 62.5 to 1 on these loans, the yearly returns, on supposedly risk-free investments, would with the same margins explode upwards to 31.25% a year, and that is indeed something to pay out huge bonuses on.

Forget about regulating bonuses, regulate the regulators instead.

Vikram Pandit might need to go back to banking school

Sir in “We must rethink Basel, or growth will suffer” November 11, Vikram Pandit, the Citigroup chief executive, after making a lot of sensible comments about the difficulties of measuring risk, says: “No one disputes that riskier loans should be backed by higher level of capital”.

Surprising, is Pandit not aware that Citigroup, and all other bank for that matter, charge riskier clients higher interest rates and that does risk-premiums go straight into capital? Does he not know that the risk level of any operation is often not reflected in the amount of capital required but in the cost of capital raised?

Capital requirements based on ex-ante risk perceptions simply do not make sense… except if you are to charge all bank clients the respective weighted-capital cost, plus the same risk-premium. Is Citigroup willing to do that?

Capital requirements for banks based on job creation, makes more sense than those based on risk of default.

Sir and there they are, the G20, in South Korea, lost for words, but yet babbling.

If I were to be given one minute of voice there, I would ask all of them to throw away the capital requirements based on the risk of default, because the risk of default is already being priced in the interest rates of the market, so there’s no need to discriminate through bank regulations against the unrated small businesses and other “risky” elements.

And, if the government official could just not resist meddling with the markets, then I would suggest them to impose capital requirements for banks based on the job creation potential of the borrower… more jobs less capital less jobs more capital… I mean, is not to help create job a primary function of banks?

But, of course, history has recently taught us that we need to be very careful with the job-creation-rating-agencies we empower.

The Fed has not asked the market what it is going to use the QE for.

I do not feel like classifying among the hysterics only because I do not see a real business plan behind the Fed´s new QE by which it is throwing sort of bad money after sort of bad money…. and frankly I do not give much for a business plan which according to Martin Wolf should include as a pillar the commitment of above target inflation so as to “shift inflation expectations upward”, “The Fed is right to turn on the tap” November 10.

Wolf describes “the essence of the contemporary monetary system [to be the] creation of money, out of nothing, by private banks’ often foolish lending” and then asks why a central cannot do that, Well the only reasonable answer to that is simply that no one should do foolish lending, since foolish lending cannot be anything but foolish no matter who does it. Why the all the fuss with Citi’s Chuck Prince not being able to stop dancing, if now all it was about was to allow the Fed to exhaust itself on the dance-floor. The first question all bankers are taught to ask when lending is, “what are you going to use that money for?”, and we have yet heard the Fed asking the markets that. And what if the markets answer... "to invest it abroad"?

Personally while bank regulators, Fed included, insist on discriminating against small businesses and entrepreneurs forcing banks to have much higher capital requirements when lending to these as compared to when lending to triple-A-ex-ante-rated clients and governments I believe the Fed has not earned it right to mambo or tango with our money.

Ps. By the way, is there something like becoming hysterically anti-hysterical?

Gold-bugs are preferable to house-bugs

Sir I cannot understand all the uproar about Robert Zoellick, the World Bank president´s recent comments on gold, “The G20 must look beyond Bretton Woods” November 8.

Sincerely, what is the difference between “employing gold as an international reference point of market expectations” and all that recent rhetoric on the need to measure and avoid assets bubbles? Gold, being movable, should be a more adequate asset to transparently measure market expectations than houses. Gold is allowed to fluctuate up and down, while falling house prices are fought against as if it signifies the end of the world, even though, rationally… what´s wrong with lower house prices?

I much rather have gold-bugs than house-bugs.

Finally some real heavy-weight support!

Sir at long last an important number of academicians are speaking out asking to remove “the biases created by the current risk-weighting system” imposed on the world by the Basel Committee on Banking Supervision for the purpose of determining the capital requirements of banks, “Healthy banking system is the goal, not profitable banks” November 9.

The hundreds of letters related to this issue that I sent to the Financial Times over the last five years, and that were ignored, will serve as proof of the immense difficulties of fighting a regulatory paradigm that sounds so extremely logical as capital requirements based on (ex-ante) perceived risk does, but that is still so utterly faulty. In fact it has proven even more difficult than making Citi’s Charles Prince stop dancing.

I hope that the fundamental revisions to the financial regulations, when they come, as they sure will come, will also include the need of avoiding the trap of placing important regulatory issues in the hand of non-transparent mutual-admiration clubs like the Basel Committee which are not diversified sufficiently so as to avoid the risk of degenerative intellectual-incest.

By the way, just for additional clarity, I wish the title of their letter had said “Healthy and useful banking system is the goal”, but again I am more than glad enough, for the time being.

But who speaks out for the unrated small businesses and entrepreneurs?

Sir Patrick Jenkins, November 8, reports that HSBC considers “Basel III a severe threat to world trade” because the risk-weight for trade finance, increasing from 20% to 100%, would “unjustly” signify having to hold 5 times as much capital against trade finance as is currently required.

HSBC is absolutely right, any regulatory discrimination on capital requirements for banks, given that the markets already price in the risk premiums by means of higher interest rates… is arbitrary, regressive and odiously unjust. But, what about all those small businesses and entrepreneurs who have actually have had to carry a risk-weight of 100% for years now and have therefore been similarly discriminated against? Who speaks out for them? Are they going to be left out in the cold just because lending to them does not belong to the typical bank operations of one of the too-big-to-fail bank mammoths?

Are the banks now to set their own capital requirements?

Sir on October 27, 2010, the Financial Stability Board FSB issued “Principles for Reducing Reliance on CRA Ratings” and by which they endorse a substantial part of the criticisms against current bank regulations and that I have been writing about in hundreds of letters to the Financial Times over the last years and which, for whatever reasons, since 2005, you decided you were better off ignoring.

In fact what FSB states is that the Basel Committee needs to go back to square one and start their regulatory process all over again, since most of what it has on the table is absolutely worthless. It will be interesting to see what the G20 ministers and others will interpret about what they are now supposed to do with Basel III.

What is not yet clear from the FSB statement is how the capital requirements of banks are now to be calculated, because even though it speaks over and over again that “banks should be expected to make their own credit assessments” and “should ensure that they have sufficient resources to manage the credit risk that they are exposed to”, we must assume they do not really mean that banks will from now on set their own capital requirements… if so… that would indeed be real, pure and unbridled de-regulation.

The development economists, they have now been shamed.

Now most development economists have been shamed by none other than Vikram Pandit, the chief executive of the Citigroup and who, in the Financial Times of October 26, is reported by Francesco Guerrera as saying “Under Basel, the ‘sweet spot’ business model for banks in the developed world will be to take retail deposits from mom and pop – small but stable customers – and lend only to big business and the wealthy. I do not believe this is the banking system we want”

Of course this is not the arbitrary regulatory discrimination we need, and I have been arguing against it since 1997 with for example a document I presented at the UN in October 2007 titled “Are the Basel bank regulations good for development?”. Unfortunately much of the development debate has been hijacked by baby-boomer development economists from developed countries and who cannot get it in their head that development requires a lot of risk-taking… and that therefore concentrating too much on avoiding bank failures will hinder the growth and the development of the economy.

As an example it suffices to read the Recommendations by the Commission of Experts of the President of the General Assembly on reforms of the international monetary and financial system chaired by Joseph Stiglitz. Nowhere in it do we find a word about the utterly misguided and odiously discriminatory capital requirements for banks imposed by the Basel Committee and which signify that a bank needs to have 5 TIMES more capital when lending to small businesses and entrepreneurs (100%-risk-weight) than when lending to triple-A rated borrowers (20%-risk-weight); and this even though the first are already paying much higher interest which goes to bank capital; and this even though no financial crisis has ever resulted from excessive lending to those perceived as “risky” as they have all resulted from excessive lending to those ex-ante perceived as not risky.

The Commission of Experts speak of increasing risk-premia but fail to notice that one of the reasons for that is the arbitrary regulatory risk-adverseness. It also speaks out against under-regulated and dysfunctional markets that fail to allocate capital to high productivity uses, without noticing that perhaps the major cause of markets being dysfunctional is often bad regulations, such as those issued by the Basel Committee.

Perhaps it is high-time economists from developing countries start to develop their own development paradigms; some of which might even help developed countries to keep from submerging.

And meanwhile, all you traditional development economists, put on your cones of shame.

A final question should Vikram Pandit now move to the World Bank?

It is very worrisome to see that Jacques de Larosiére does still not get it!

Sir Jacques de Larosiére in “Basel rules risk punishing the wrong banks” October 25 writes about the risk of the banks reducing “activities with modest margins such as lending to small and medium sized enterprises” If he wants to defend the small and medium sized enterprises then he should not forget that the primary reason for that lending having margins that are modest, relatively, is because the regulators allow other lending to occur with much less bank capital requirements… and of that truly odious discrimination he does not say a word.

He also writes that “The proposal to introduce an absolute leverage without taking into account the real risk of the asset is the most contestable element of the Basel reform, and would push banks to concentrate their assets in riskier operations.” This is pure nonsense as an absolute leverage does not mean that the risk of the assets are ignored, those risks are reflected in the risk premiums charged by the banks, and those risk premiums, higher interest rates, go straight to the capital of the banks.

In fact it was not having an absolute leverage level equal for all assets that drove the banks into an excessive lending or investment in what was perceived ex-ante as having no risk, precisely the place where all financial and bank crisis occur.

How worrisome and sad it is that a man of the statute of Jacques de Larosiére, now more than two years after the crisis detonated, does still not understand why it happened.

Is John Auther a closet-paper-money-bug?

Why would John Authers categorize the buying of gold as an “irrationality”, an act of faith, and thereby imply it is entirely rational to trust a piece of paper issued by politicians and marketed with what seems more of a slogan to them namely the “In God we trust”, Remember 1980: all that glisters is not gold” October 23. Could it be that John Auther is a closet-paper-money-bug?

Gold is not a substitute for stocks and properties… but it sure can come in as a handy complement in times when most countries seem to want to win the devaluation race?

Could we have avoided the crisis if Mandelbrot had gone to Basel?

Sir Christopher Caldwell writes how the recently deceased Benoit Mandelbrot “zeroed in on the besetting flaw [with financial] models that understated risk” and references The (Mis)behaviour of Markets a book that Mandelbrot co-authored with Richard L. Hudson in 2004, “Mandelbrot tips of the market”, October 23.

I do not have sufficient memory to recall it but it is very possible that it was the referenced book that, in October 2004, as an Executive Director of the World Bank, made me make a formal written statement that contained: “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.”

The world could have benefitted incredibly from ascertaining the presence of skeptics like Mandelbrot at the Basel Committee for Banking Supervision. I am absolutely sure he would have been horrified at what its members were up to managing risks with truly faulty models and conceptions of the reality and tried his utmost to stop their regulatory nonsense in time.

But since even after its evident failure, the Basel Committee is not going back on anything, but is instead forging ahead and scaling it up, as if nothing has happened, now even wanting to tackle cyclicality and systemic risk, it is most likely that Mandelbrot would not have been heard at all by the self-sufficient scheming high-priests of the regulatory establishment.

Should we not have a serious man to man conversation with our bank regulating chaps at the Basel Committee?

Sir, if you and I were going to design some capital requirements for banks based on the risk of default of borrowers as measured by the credit rating agencies, would we use the default rates those credit ratings generally imply, or would we use the default rates suffered by the banks after the bankers received that credit rating information? I am sure you and I would agree on using the second alternative, since the first really makes no sense as it would imply that bankers do not take notice of the credit ratings, something that with the capital requirements based on these ratings, we are really making sure they do.

If we so then use the default risk for banks after credit rating information, would we also adjust our risk-weights to the fact that those perceived as riskier are charged much higher interest by the banks than those perceived as less risky? I am sure we would definitely consider that important risk mitigation factor and do so, since otherwise we would be perceived as foolishly assuming that all borrowers paid the bank the same interest rate.

But since we now know that our bank regulating chaps at the Basel Committee did nothing of the sort, they just used gross default rates unfiltered by the bankers applying their own credit analysis criteria, and they completely ignored the mitigation of a higher default risk provided by higher interest rates, isn´t it time we call them home so as to have a serious man to man conversation about what they are up to? I mean before they go on to tackle even much bigger problems like counter-cyclicality and systemic risk. I mean so as to inform them about the fact that they, in their own right, are becoming our greatest source of systemic risk.

 

I believe we should. Just consider the mess they did by making the banks stampede after some lousy securities just because these were rated triple-A; and all the small businesses and entrepreneurs who have seen their access to bank credit curtailed or made more expensive just because their odious regulatory discrimination against perceived risk.

A verse of a Swedish Psalm reads: “God, from your house, our refuge, you call us out to a world where many risks await us. As one with your world, you want us to live. God make us daring!”

“God make us daring!” That is indeed a prayer that the members of the Basel Committee do not even begin to understand the need for.

Psalm 288 Text: F Kaan 1968 B G Hallqvist 1970, Music Chartres1784

To help trade and other worthy of help, you first need to stop giving assistance to those who should not need it.

Sir, what sets trade, projects, small businesses and entrepreneurs into a clear competitive disadvantage for gaining access to bank credits is not really that there are capital requirements for banks when lending to them, it is only natural banks should be required to have capital, it is the incredibly low capital requirements allowed the banks to have when lending to others, such as the public sector, housing, or those blessed with triple-A ratings.

In “Impact of Basel III: Trade finance may become a casualty” October 19, as reported by Brooke Masters and Patrick Jenkins we read Simon Gleeson, partner at Clifford Chance, the law firm, arguing “An enormous number of letters of credit are guaranteed by a form of government support, which should mean they carry a zero per cent risk rating”, while the real question should of course be: why the lending to triple-A rated governments have a zero percent risk rating and occurs therefore with zero marginal capital requirements for the banks?

Why should any bank lending for the purpose of buying a house have lower capital requirements than bank lending to that small business which might create a job so that someone can afford to buy a house?

If you really want to help trade, projects, small businesses and entrepreneurs to gain access to bank credit you need to level the capital requirements for all… besides why should the strong triple-A rated public and private clients needs more help than what they are already getting in the market?

Though Martin Wolf has doubts, I am absolutely 100 percent certain!

Sir, Martin Wolf asks “who can confidently state that it must be better to rely on relaunching a private credit boom than on higher public investments? “Britain and America seek different paths from disaster” October 20.

Well I can with total confidence state that it is much better to rely on relaunching a private credit boom than to rely on higher public investments. That is, of course, as long as that private credit boom is free to grow according to what the market indicates and does not have to grow according to where the bank regulators want it to grow with their discriminatory risk-weights and capital requirements for banks... and which precisely caused bank credit to finance overpriced housing while making it much more difficult and onerous for the productive agents of the markets, the small businesses and entrepreneurs to access bank credit.

Let me also assure Mr. Wolf that to keep on financing public investments with bank credits for which there are zero capital requirements, will only increase the slope and the slippery of that slippery regulatory slope where regulators have placed us. And I have absolutely no doubts about that either!

With their “Risk-Weights” it is the regulator who is taking the load off the books of the banks.

Sir, in reference to all being written about that “distasteful” behavior of banks of putting much of their exposure off the books, you should perhaps consider the following:

When the regulators used (and use) a risk-weight of only 20% to reflect the risk-weighted value on the books of banks of for instance lousily awarded mortgages to the subprime sector that manage to hustle up a triple-A rating, it was (is) the regulator who is taking 80% off the balance sheet(books)of the banks.

When the regulators used (and use) a risk-weight of only 0% to reflect the risk-weighted value on the books of banks of loans to a sovereign rated triple-A, like the US or UK, it was (is) the regulator who is taking 100% off the balance sheet(books)of the banks.

Sincerely, I doubt the banks could have managed that kind of disappearance acts on their own.

Basel regulations are also bad for developed submerging countries.

Sir, Michael Taylor holds that “Basel III is bad news for emerging economies” October 15. He is right and I have been arguing so for years at the World Bank at UN and in many other places, since Basel I and II already contained plenty of bad news.

But what we more recently found out was that these regulations were equally bad for developed countries and which, because of them, have now been converted in submerging countries.

Any bank regulation that penalizes risk-taking so much as to force banks to finance only what is perceived ex-ante as having a low risk of default, belongs only to societies who have called it quits.

Why is not the existence of counterfactual bank regulations of interest to the Financial Times?

There is a very curious issue with current bank regulations and about which I have written hundreds of letters to the Financial Times but strangely enough, at least to me, they do not seem at all interested.

I am referring to the fact that since all financial bank crisis in history have resulted from excessive investment or lending to what is perceived as not risky, and no crisis has, naturally, ever occurred from excessive investment or lending to what is perceived as risky, the current only tool in the toolbox of the Basel Committee, higher capital requirements when risks are perceived as low and vice-versa is totally counterfactual.

In fact those capital requirements increased so dramatically the returns on equity for the banks when investing or lending to triple-A rated securities or clients that they stampeded after the triple-As, and went over a subprime cliff.

In fact those capital requirements discriminate so odiously against those perceived as of higher risk that they are making the access to bank finance much more difficult for the small businesses and entrepreneurs, precisely those clients whom banks most should help as they have little alternative access to capital, precisely those clients of banks on whom society so much depends for growth and job creation.

In fact the only truly invisible hand at work was that of the scheming banking regulators messing around with capital-requirement-risk-weights… under the table.

I ask don’t you agree with that what I describe is worthy of more commentaries? Why then is not a word of it reflected by the “Without fear and without favour” Financial Times?

Of course other media should also take it up but as you can see from this blog I have invested many efforts in having the Financial Times echoing my small and tiny though sometimes a bit noisy voice.

Most of the letters to FT I refer to you find in this blog under the label of "subprime banking regulations".

Is the Basel Committee simply insane?

Sir in “An Explanatory Note on the Basel II IRB Risk-Weight Functions" of July 2005 posted by the Basel Committee we read “Interest rates, including risk premia, charged on credit exposures may absorb some components of unexpected losses, but the market will not support prices sufficient to cover all unexpected losses.”

And since we then cannot see the Basel Committee taking in account the “risk premia” charged by the markets because of perceived differences in risk, when calculating the risk-weights used for the capital requirements of banks, we find us facing the distinct possibility that the Basel Committee completely, 100%, ignored the markets.

If so that would explain how they could have so counterfactually stimulated the banks so much to invest or lend to what is perceived as having low risk, like what is rated triple-A.

If so, since the higher interest rates they need to pay would then not count for anything that would help to explain why the regulators so odiously discriminate against those perceived as “risky”, like the unrated small business and entrepreneurs.

And if this is what the Basel Committee really did… then it is simply insane!

Start by controlling the blind runaway fear shown by the bank regulators

Sir, Alan Greenspan is absolutely right in that “Fear undermines America’s recovery” October 7. But instead of complaining about market fear and market risk-premiums, he should attack what really caused the crisis and so much stand against us getting out of it, namely that stupidly blind fear that bank regulators showed, when they ordered banks to have 5 times as much capital when lending to small businesses and entrepreneurs, than when lending or investing to anything related to a triple-A rating.

That is the blind runaway fear that first must be controlled.

FT, for the umpteenth time, it was not deregulation it was bad regulation.

Sir, in “A fresh approach” October 4 you write: “The recent global crisis, also rooted in an excessive faith in deregulation, removed any vestigial credibility from the view that markets always work best when left to themselves”.

I am amazed. Do you not yet know that this crisis was provoked directly by regulations which allowed banks to leverage their equity 62.5 times to 1, or more, when investing or lending to anything related with a triple-A rating? Is this what you call deregulation? I just see it as extremely bad regulations. Do you truly believe the markets would have allowed banks to leverage the way they did if left on their own design? Of course not! Just look at how they keep the unsupervised hedge funds in a much tighter leash.

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.