A chance for many bankers to be much better bankers

Sir my eldest daughter works for a large Canadian bank and so I have a vested interest in Gillian Tett’s “A chance for banker to refocus their talents” April 7. I have another take on this issue.

If there is one thing to be learned from this crisis is that the world is much better off with hundreds of thousands of credit analysts that get to know and truly understand their clients, look them in their eyes, decide and shake their hands, knowing that though they will be personally accountable for their mistakes they will not risk bringing down the world, as some very few high paid credit analysts in the only three credit rating agencies did.

That these good credit analyst won’t make as much money as their supercharged predecessors is clear but they will have the possibility of earning a decent salary in an interesting and worthy carrier instead of just stupidly staring into their monitors looking at what the credit rating agencies opine.

Understanding how the banks dismantled their credit analysis departments as a consequence of the regulations that emanated from Basel helps you to understand the immense potential for recreating the jobs that were.

PS. Though I have a couple of other individual articles that I favour it is clear that based on the full production Gillian Tett deserves the title of Journalist of the Year. Bravo! That said, as an anthropologist she had perhaps an unfair advantage in these times.

The sincerity of the authorities matter more than their commitment to stability.

Sir Martin Wolf in “Credibility is key to policy success” April 3, writes that “a central bank’s unconventional monetary operations are reversible” but says little on the issue that the distributional effects for the citizens of such operations are most probably not reversible at all.

At this moment for many private persons and entities any “quantitative easing” dilutes effectively the current value of their cash, with no guarantee of reversal, making it thereby a very non-transparent tax, and so countermeasures will be taken by the market, for sure.

Keeping up any government’s credibility while it plays hidden games under the table is not an easy trick, for any magician. This is not so much about the “sincerity of the authorities’ commitment to stability” as it is about authorities’ general sincerity.

The worst part though might be that “quantitative easing” makes it also difficult for the government to be sincere with itself as it really does know what the market would look like in the absence of such easing, just like a company cannot be really sure of the price of their shares during a stock-repurchase plan.

The value of our cash is diluted in an ocean of cash, which effectively makes of “quantitative easing” just another tax.

Sir, Krishna Guha in “Easing by world’s central banks take a variety of forms” April 2, mentions that “Expanding the money supply creates relatively little inflation risk in the short term. But this could change when the crisis turns.”

The above is right of course but, let us not forget that however we dress it up “easing” signifies an easing only for those whose instruments are being bought, whether it is the government or the holders of the distressed securities. For the rest of us it just signifies that the real value of our cash gets to be diluted in the ocean of cash produced by the “quantitative easing”, which effectively makes it just another tax, though a much less transparent one.

What we foremost need are capital requirements that cover for the risks that what is rated AAA is not really AAA.

Sir in Chris Giles’ “Harmony is main item on the agenda” April 2 mentions “Banks will be required to hold more capital in future and everyone agrees that capital requirements (for financial institutions) need to become stricter in good times to provide a greater cushion for downturns”. That is of course right yet it behoves all of us to remember that our current predicament had much less to do with “good times” and much more with having incurred in vanilla type plain old fashioned bad investments. In this respect the first thing to do, whether for good times or bad, is to place some capital requirements to cover for the risk that what is rated AAA is not AAA.

Eerie!

Sir Just on word comes to mind when reading your pre G20 summit reports April 2... Eerie!

It feels like sitting in a cellar waiting for the hurricane to come or pass knowing that your cellar is utterly inappropriate for such an event.

To reduce the too many cars it might be better to eliminate some infrastructure, like some roads.

Sir you use as an illustration for Mathew Green’s report on lacking infrastructure a photo from Lagos from which one could conclude that it is not infrastructure that is lacking but the cars that are too abundant, “Crisis puts the brakes on”, April 2. Have this financial crisis already made us forget the energy and climate change crisis?

And then there is also the “too bad to regulate”.

Sir Peter Thal Larsen writing about financial regulations in “A lot to be straightened out” March 31 comments on the option to submit the “too large to fail” to have to pay a hefty fee for the support they enjoy.

As an Executive Director of the World Bank (2002-2004) at a Risk Management Workshop for Regulators held at the World Bank in May 2003 as I said the following.

“Some old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, seem much wiser than today’s no burning at all that only allows for the build-up of more incendiary materials, thereby guaranteeing disaster and scorched earth, when fire finally breaks out, as it does, sooner or later.Therefore a regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.Knowing that “the larger they are the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size.”

Sincerely do we really need regulators that have to wait for a catastrophe before coming to reason? Looking at the regulators utterly silly behaviour over the last decade or so it becomes clear that we also have a problem with regulators that are too bad to regulate.

FT should not give Alan Greenspan voice just so he can utter platitudes.

Sir you keep on giving voice, more than a third of your most important Comment page, second week in a row, to someone like Alan Greenspan who did nothing with all the voice he had to save us from this crisis, much the contrary. And then salting the wounds, he only uses it to utter platitudes.

In “Equities show us the way to a recovery” March 30, he says “Restoration of normal global lending could be as effective a stimulus as any fiscal programme of which I am aware” and that “restoring a viable degree of financial intermediation is the key to recovery. Failure to do so will significantly reduce any positive impact from a fiscal stimulus”. Do you believe there are some of your readers that are not fully aware of the above?

Do you believe there are some of your readers that are not fully aware of that a rising stock market could also be beneficial as the creation of capital gains augment spending and gross domestic product, whereas capital losses lower spending.

I do not wish to imply that Greenspan should be silenced forever, of course not, but the least we should be able to expect in order to give him additional voice is that he uses it for something really important.

Times are hard enough for the press but if the Financial Times does not do a better job of defending the quality of one of its most important pages then it will encounter even harder times.

A wanted safe haven is not the same as a wanted permanent home.

Sir Michael Mackenzie reports on “Concern at size of debt auctions” March 27, and of course they should be very concerned as so much of the current plans of helping the economy recover hinges on the possibilities of finding buyers for the US treasury bonds.

As I have often repeated the danger is that US confounds the eagerness of markets in finding a temporary safe-haven with a willingness of capitals finding a new permanent home in the US and that is as we all should know a totally different animal.

Also there is a clear and present danger in not being able to access the real market signals since the current rates out there have nothing to do with the rates required if the Fed was not doing so much buying. In some ways it is like a bank participating in buying some securities in order to make the harsh mark-to-market truth easier to digest. It only works over a short period of time.

That plus 20%

Sir when Adam Thomson reports that “Calderón challenges Obama on drugs war” he quotes the Mexican president saying in reference to the help the US should offer “The help should be equivalent to the flow of money that American consumers give to the criminal”. What a splendid logical and forceful reply. The only thing that could have been added is a “plus 20% since it is a just cause”.

Greenspan commanded an amazingly naïve and gullible generation of financial regulators.

Sir Alan Greenspan starts out his “We need a better cushion against risk” March 27 with his silly chorus that all this mess was because we trusted “the enlightened self-interest of owners and managers of financial institutions”. If that was true, why would the world have contracted the services of Mr Greenspan?

Thereafter he gets into more real explanations though, like accepting that “regulators cannot fully or accurately forecast whether, for example, sub-prime mortgages will turn toxic”. Of course not, when Greenspan and his buddies in Basel decided that a bank could leverage itself 62.5 times to 1 as long as it lend to corporations rated AAA by human fallible credit rating agencies they showed themselves to be amazingly naïve and gullible regulators

Greenspan also writes about the need for higher capital requirements for the banks but before this even more important is to get the financial regulators to stop meddling and imposing their own risks preferences on the banks and letting that to the market.

If only the AAA had applied

Sir Gideon Rachman in “Sensitive words” March 27 draws our attention to an extremely sensible institution, Companies House that has to approve the use of some sensitive words before they can institutionally be used “because they are thought to convey an impression of authority or trustworthiness”.

How sad that those using “credit ratings AAA” did not submit an application. It would have saved the world quite many trillions of dollars or what´s almost the same pounds sterling.

As a “global risk assessor” there is nothing like keeping the free press on its toes.

Sir Nicholas Stern is absolutely right in that “The world needs an unbiased global risk assessor” March 25, and his proposal on how to set up an independent institution for such purpose sounds absolutely right, yet I have to tell him to brave himself to the fact that it would probably not work. First because it is hard to see how the world would elect the right people to such place, instead of just the correct people. Second because it is hard to see how to guarantee that institution would just not turn into a club of mutual admirers. Lord Stern himself starts going down this last route of perdition when naming some possible candidates that he himself personally admires.

Let us look at the “unbiased global risk assessor” from our current perspective. Would it have been able to alert the world to what was happening? In such a way the world would have listened and acted upon the warning in a timely fashion? I believe not.

Also why use so many resources to try to identify the exact timing of when things go wrong instead of avoiding creating the conditions for things to go wrong. I myself even though I could never be sure of the exact timing of it knew that catastrophe was on its way when our financial regulators in Basel came up with such a silly idea that a bank should be able to leverage itself 62.5 time to 1 as long as it lent to corporations perceived as AAA or AA- by human fallible credit rating agencies.

No, much more important than creating this type of new oversight institution is to make certain that the old oversight institutions work. Like that the free press, like FT, are stimulated enough to pose the right questions, in time, and which for a starter requires their journalists not joining the establishment.

When I see a journalist in the audience frowning and frantically scribbling away on a block I know we got it right. When I see a journalist moderating a discussion as another one among the learned I know we got it all wrong.

Are we multiplying the systemic risk?

Sir I agree completely with Martin Wolf´s concluding reaction “If this is not frightening, I do not know what is” “Why a successful US bank rescue is still so far away” March 25.

Now, that said, one of the things that I find most frightening is the possibility that we could be concentrating too much our efforts on salvaging (or lynching) the Titanics instead of making sure that all other smaller vessels are doing fine. In other words, by insisting on helping all the “systemically significant financial institutions” are we not making these even more systemically significant?

What do we know about all the other regional and smaller community banks? Should we not care about these more?

Where have you been minister?

Sir Karl-Theodor zu Guttenberg is right reminding of us of the need to be very clear about what went wrong to cause this crisis in order not to unlearn the many good lessons we have indeed learned over time, “A new era of accountable capitalism”, March 25.

But, surprisingly then zu Guttenberg goes on mentioning as a principle that “risk supervision by rating agencies and financial authorities must be strengthened on a global level to prevent the build up of systemic risk”. Where has he been? Does he still not get it? It was the mingling on risk by the financial authorities that got this crisis started in the first place. Like when the financial regulators in Basel came up with the naive idea that a bank could leverage itself 62.5 times to 1 as long as it lent to corporations perceived as AAA or AA- by human fallible credit rating agencies.

It must hurt GE so much

Sir I have nothing whatsoever to do with GE but when Francesco Guerrera reports “Moody´s strips GE of triple A rating it has held for 42 years”, March 24, I truly commiserate with them. It must hurt so much being stripped of your AAA rating by one of those primarily responsible for your current problems.

In times like these more willingness to take risk is needed at the IMF and the World Bank.

Sir I entirely support Trevor Manuel´s “IMF needs reform to respond to changing mandates”, March 23, where he calls for much more diversity in the recruitment of staff so as to get more diversity of views. As a former Executive Director I would like that to extend to the World Bank too.

Having said that, there is tough little to be gained from more diversity of opinions if this is not welcomed and nurtured by the management. Currently, in the multilateral finance institutions, there is way too much risk-adverseness among their managers against anything that in the slightest way could upset their somewhat too comfy internal order. In times like these managers must also learn to scale up their willingness to take risk… on all fronts.

A regulatory bias that favours the big prevails

Sir Clive Crook recommends to “Strike faster on death-wish finance” March 23 and he is right though that would clearly require a dramatic reversal of the regulatory bias in favour of the big that now prevails.

In May 2003, at a workshop on risk management for some hundreds of financial regulators held at the World Bank, as an executive director, I said the following:

“A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises. Knowing that “the larger they are, the harder they fall”, if I were regulator, I would be thinking about a progressive tax on size.”

And, as you might guess, that recommendation went unheeded and I would even dare say unwelcomed… unfortunately.

The real question is what does the market have to say in general about retroactive laws?

Forget about the AIG executives, the real question to be made is whether a country that has to hit the markets to the tune of a couple of trillions in public debt can afford to be tinkering with such dangerous-to-confidence issues like retroactive taxes.

The 160 million in cost of the bonuses could pale in comparison to the additional margins the markets could charge the US in risk premiums in order to compensate for such unsettling behaviour.

The world has a serious shortage of elites.

Sir at long last we might now be starting to debate what should have been debated all the time namely how to ensure true accountability and true good governance that ensures that our human endeavors lead us to a better tomorrow instead of having us all sign up as baby-boomers on a Après nous le déluge.

Jessica Einhorn in “Corporate governance without a hint of systemic surveillance” begins putting her finger on important pieces of said debate pointing out that “few corporate managers today are permitted the luxury of thinking about long-term returns for their ever changing cast of investors”, “that regulatory activist… have special interests and they do act to further them through initiatives in corporate governance” and “that we need to hold our public officials accountable for thinking through systemic issues”.

Could the glue that help us overcome the above mentioned challenges be found anywhere else than in an enlightened elite of families capable of including all humans as heirs? I do not think so!

Do not tax Gekko-style risk-taking.

Sir Gillian Tett writes about “That secret desire for burst of Gekko-style risk-taking” March 20 and that must lie very close to the heart of anyone looking for a speedy recovery.

May I suggest she reads the following table derived from the Minimum Capital Requirements for the Banks issued by the Basel Committee under the Standardized Approach in order to cover for Credit Risk:

Rating of the ......Required Bank...... Allowed
Corporation ......Equity $100 Loan ...Leverage

AAA to AA- ..........$ 1.60 ....................62.5/1
A+ to A- ...............$ 4.00 ....................25.0/1
BBB+ BB- .............$ 8.00 ....................12.5/1
Below BB- ............$14.00 ...................8.33/1

From it she should be able to conclude that the regulators have imposed, on the core of our financial system, the commercial banks, a de-facto tax based on a loosely defined “default risk” and as measured by the credit rating agencies.

When as now bank equity is scarce and very expensive this de-facto tax on risk, which is charged on top of whatever the market commands for assuming higher risks, is extremely high. So, if you want Gekko-style risk taking? Start by not imposing special taxes on it.

The Turner report is not even close to being a watershed.

Sir I have tried to figure the why of Martin Wolf´s “Why the Turner report is a watershed for finance” March 20, but I can´t. A regulatory watershed implies some fundamental change in the basic paradigms used, and this is definitely not it.

As an example the Turner Review holds that “Credit ratings have played a valuable role since (i) good investment practice should seek diversification across a wide spread of investments; and (ii) it is impossible for all but the very largest investing institutions to perform independent analysis of a large number of issuing institutions” which only makes us ask: Have they not seen enough of that what matters is not the diversification within one institution but within the whole system? Have they not seen enough of the how expensive the too-big-to-fail are so as to insist in giving the larger institutions special rights?

But perhaps Martin Wolf illustrates best the shortcomings of the report when he writes “if everybody believes in the same (faulty) risk models, the system will become far more dangerous than any individual player appreciates”. Did you notice that “(faulty)”? Well that means that Martin Wolf, like the report, still believes that the risk models can be right and that if we all follow them we will find financial Nirvana.

Wolf also stands firm and refuses to understand that a credit rating is simply the result of a model that analyzes one type of risk, and that these simple one dimensional published result created more havoc than all the other sophisticated financial models put together and that without the AAAs would have remained stacked away as unsellable nerdy creations.

Long live the diversifications of views that can only be present in a free market!... though that does not mean of course that we not do have to get rid of the regulatory naiveté that actually reigns and that allows a bank to leverage itself 62.5 to 1 times, as long as it lends to corporations rated AAA or AA- by some very few eyes.

PS. “A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind."

Europe, hand over two chairs, immediately, no discussions

Sir Trevor Manuel in his commendable, timely and important “Let fairness triumph over corporate profit” March 17, asks several “Can we…?” and to these our only answer can be “yes, we have no choice”. That is if we want to live in a reasonably peaceful world that is if we want to have a chance to adjust to the environmental and energy related dangers that lurk around the corner.

This article, like last week’s Luiz Inácio Lula da Silva’s “The future of human beings is what matters”, evidences clearly why Europe needs to surrender to the rest of the world at least two of the chairs it occupies at the World Bank and the IMF. Immediately! No discussions!

That said I would have preferred to see Trevor Manuel’s article titled as “Let reason triumph over corporate greed” and I have an inkling that so would he.

Whistleblowers of the world unite!

“Managers need to listen before disaster strikes” writes Michael Skapinker March 17. Everyone agrees none argue against it and still it is almost impossible to achieve most often because what management and others would qualify as disaster varies dramatically. Sometimes the only real disaster is the pure possibility of a disaster being acknowledged.

But what can we do? Let me have a go at it. Since a corporate climate that is unreceptive to whistle blowers could hide a time bomb credit rating agencies should never be able to give more that a B- to any company that does not achieve some minimum results in a yearly secret internal ballot held on various governance issues.

That could help some managers to start listening.

There is exactly where the going forwards must begin

Sir Tony Jackson really shows he got his priorities right with his “Proper or improper, banks need society’s control” March 16. This is exactly the type of issues that should be exhaustedly discussed before you sit down and start to try to regulate the activities of the banks.

It is exactly the total lack of a reference to what the purpose of the banks should be that allowed the regulators to build up regulation systems almost exclusively based on the concept of minimum capital requirements based on perceived risks, as if that is all that risk is all about, as if avoiding defaults is the only objective for our banks.

Jackson’s article deserved an op-ed place and I sure hope he manages to start a discussion on the simple basics before hiding in the opacity of the sophistications.

FT, please don’t give up on the market.

Sir if you believe that a super-regulator is capable to control systemic risk without generating new and even worse systemic risk it is clear that you must have already given up on the market and also that you have not learned one iota from this crisis, “Why the US needs a super-regulator” March 12.

If you really think that such a regulatory could perform miracles in a market “with extreme complexity” would it then not be better for it to take over the regulatory functions in the UK, Europe or even the rest of the world?

Who do you think these regulatory authorities really are? How come you are so completely sure they’re angels?

Cheap money? Cheap credit? Humbug!

Sir, Chrystia Freeland in “The audacity for help” March 12, mentions “the era of cheap money” and “the end of cheap credit” May I suggest that the existence of an era of cheap money and cheap credit has just been a big bluff, promoted to make money on expensive credit, and that consumer credit is partially responsible for accentuating economic differences in the US and in most of the world.

When a consumer buys something at a rate that exceeds the rate of inflation and pays more than the risk free rate he is in fact impoverishing himself ,and would have been better off postponing any consumption and purchases he does not absolutely need.

Look just at the current reality. The US treasury pays about .01% on its short term debt and a US citizen has to pay at least 1,690 basis points more, at least 17% on his credit card. Who except a credit card salesman or credit card company shareholder, could even dream of calling that cheap money or cheap credit?

You want to see some of the wealth differentials reduced? Then teach the consumer about the worth of bargaining their purchases paying cash.

Doing a little sleeping with the enemy, aren’t we?

Though it is clear that the faulty ratings issued by the credit rating generated more real losses than what 50 Madoffs could have done it is amazing to see FT giving so much voice to the President of Standard & Poor’s to defend his business model “Re-evaluating and rebuilding a more useful rating system”, March 12, while silencing so much of the fundamental criticism against the creation of an oligopoly in the market of risk information, namely the systemic risks that this in itself generates. Doing a little sleeping with the enemy aren’t we?

You too FT

Sir in “The consequence of bad economics” you accuse our leaders of intellectual failure and blame their “unwillingness to see (or their wilful ignorance of) what markets need in order to produce good outcomes for society. I accuse FT of the same.

You say “People were not unaware of risks, but... The great mistake was to rely merely on self-interest in as imperfect and as important a market as the financial sector” and I have held for years, and in hundreds of letters to you, that it was exactly the reliance on self-interest that was missing in many of our regulations.

The minimum capital requirements for the banks which in the case of private corporations sometimes allowed for a 62 to 1 leverage, plus the official appointment of some external credit rating nannies, all in a globalized world slush away with funds, induced and facilitated some few reckless market participants to sell to the world a monstrously explosive systemic risk composed exclusively by perceived low risk AAA investments, and which all blew up. FT has mostly preferred to ignore these facts.

I agree though with your conclusions, “This was not a failure of markets... but the intellectual and moral failure of those who were in charge of it”... FT included, of course.

Complete truths are the best compasses

Sir as usual Gillian Tett has written a good article in “Lost through destructive creation” March 10. Having said that let me express two complaints. The first one is that when she writes “the banks were making such fat profits they had little incentives in questioning their models” one gets the impression that all or at least most of the banks were involved in the production of opaque assets and that is simply not true, the real culprits, they were few.

What also disappoints is the unwillingness of Tett to connect the dots between the opacity of the innovative financial instruments and their immense marketability. That is not merely explained by the fact that these instruments were awarded AAA ratings because for that to matter the credit rating agencies had to be invested with enormous amounts of credibility, and this is what the financial regulators erroneously supplied them with.

If we are more willing to bare all things as they really are and assign the responsibilities where they should really be then we might discover that we are in fact not that lost.

Muito obrigado!

Sir we should all give thanks to Luiz Inácio Lula da Silva reminding us that “The future of human beings is what matters” March 10. In days like these it is so easy to lose sight of the real priorities.

And the truths are the needed seeds for its reconstruction

Sir Martin Wolf gets to set the tone in the series on “The future of capitalism” and titles his opening article “Seeds of its own destruction” March 9. I object that for reasons I cannot explain he leaves out what some of us consider the fundamental causes for this crisis.

Wolf writes about “frenetic financial innovations”, “innovative financial systems” and of “how little banks understood of the risks they were supposed to manage” without even mentioning the fact that the Basel Committee ,with their minimum capital requirements for the banks, innovated to such an extent that banks were duly authorized to leverage their capital for instance in the case of corporations rated AAA and AA- to a never before heard astonishing level of 62 to 1; and that it was these capital requirements that gave way to the mother of all the regulatory arbitrage booms.

Also when Wolf writes on how “huge capital flows…largely ended up in a small number of high-income countries and particularly in the US” among other he suggests the US government programs but finds no place at all for the credit rating agencies. Wolf does simply not want to accept that the big explosion in the growth of the subprime mortgage market had very little to do with a FHA or a Fannie Mae and all to do with the excessively empowered credit rating agencies stamping their AAA sign on securities fabricated on Wall Street. Wolf simply refuses to ask himself why for instance Europe financed more subprime mortgages in the US than the US itself.

The current crisis is a remarkable fertile ground for all type of other-agenda-pushing and I have already heard arguments attributing it to Israel/Palestine, genetically modified seeds, increased narcotic production in Afghanistan, the military control of the political apparatus of the world and other similar mindless arguments. The only way we can avoid this crisis from degenerating into something even worse is to defend the truth and the whole truth about it.

Let’s be clear about the true origin of the financial “snake-oil”.

Sir Robert Shiller in “A failure to control the animal spirits” March 9,  completely ignores that the “snake oil” the financial world bought was produced almost exclusively by the financial regulators, those who held that banks could leverage their equity 62 to 1 when they gave credit to corporations determined to be AAA or AA- by their official default risk surveyors the credit rating agencies.

Shiller writes that “It was part of a story that all investments in securitized mortgages were safe because those smart people were buying them”. He is wrong! It was part of the story that those securitized mortgages were safe because they “are AAA and, if the credit rating agencies are good enough for Basel, they’re good enough for you”

AIG was only an addict and the Basel Committee its pusher

Sir, Henny Sender in “AIG saga shows how dangerous credit default swaps can be”, March 8, writes interestingly about the “regulatory capital forbearance” trades but without mentioning a word about the financial regulators who created such markets.

If she would take her time to read the current minimum capital requirements for banks she would find that if a bank lends to a sovereign country rated AAA it can have as much leverage it wants, there are no limits. If a bank lends to a corporation rated AAA or AA- it is authorized by the Basel regulations to have a 62 to 1 leverage. If it lends to a corporation that is not rated or one that has only received a BB- the banks are authorized to leverage their capital 12 or 8 times respectively.

Understanding this extraordinary range of authorized bank equity leverage, from limitless to 8 times, all of it depending on the criteria the credit rating agencies... where would AIG have been without the concept of an AAA? ... she could have but reached one conclusion, namely that AIG was an addict and that the Basel Committee was its pusher.

Yes, it has indeed a lot to do with the battle among generations.

Sir, John Authers is correct bringing in the baby boomers in the equation that explains the current crisis “Why baby boomers will put their faith in bonds”. March 7. 

I have in many letters to FT pointed out the problems with the generational transition between the baby boomers and those who will follow them. The latter have no incentives of buying their retirement roofs at the high prices houses have reached, nor to start investing for their retirement at a Dow at the 14.000 level.

Now the battle among the generations has started for real. The baby boomers are opening asking for stimulus spending to bail them out. It is very difficult to see the upcoming generation capitulating early, and pay the taxes that are needed to support that spending from transitioning into inflation.

A UK financed overnight?

Sir John Authers in “The Short View” March 6 writes about the Bank of England’s plan to buy long dated gilts…which will make money cheaper by reducing the rates on long bonds. That might be what happens with the marginal rate but not necessarily what happens with the average rate.

In fact what is being done is reducing the current interest rate cost of the public debt of the UK by reducing its average maturity and which could prove to be very costly tomorrow, like many Americans who entered into adjustable rate mortgages could attest.

It is indeed the Bank of England taking the short view. Let us see what happens when markets wake up and finds England financed overnight.

But Hank had company.

Sir John Gapper in “Too long in the spaceship, Hank” March 5, mentions that AIG´s “biggest money-spinner was regulatory arbitrage”. Exactly!

Before Basel banks and financial institutions always engaged in some regulatory arbitrage but it was mostly harmless. It was when the Basel Committee concocted a system of minimum capital requirements based on what they perceived as risk, and as measured by their risk sentries the credit rating agencies, that the real regulatory arbitrage business took off globally and turned into the extreme systemic danger it has proven itself to be.

And so if a Hank has been too long in a spaceship so has his fellow bank regulators.

I will gladly trade you one Basel Committee for a hundred of offshore financial centres.

Sir Avinash Persaud is absolutely right when he writes “Look for onshore, not offshore scapegoats”. The damage produced by the onshore enclave we know as the Basel Committee and all its regulatory derivatives, has caused hundredfold more misery than all offshore financial centres put together.

This does of course not imply that I would not like to trade away the financial centres too.

Revamp completely the minimum capital requirements for the banks

Sir (as you probably must gather from my hundreds of letters to you on the subject and that you decided to ignore for reasons of your own) I totally agree with John Stroughair in that “Rating agency system stifles innovation and competition” March 5. The fact though is that the reason that we even have to discuss the issue of the credit rating opining are minimum capital requirements for the banks issued by Basel which stifles something worse risk taking and promotes something really bad, the reliance on others.

Currently if a corporation is rated AAA to AA- a bank needs to hold only 1.60 dollars for each 100 of lending, which signifies an astonishing 62 to 1 of authorized leverage. But in the case of a corporation rated below BB- the banks need to hold 12 dollars for each 100 of lending, 7.5 times more than in the case of an AAA, notwithstanding the fact that the bank will most certainly be more careful when it comes to lending to a below BB- corporation than to a AAA.

The difference of 10.40 dollars of required equity, especially in times when bank equity is so scarce and expensive, is a de-facto regulatory tax on risk, levied on top of what the market requires for accepting risks and which stifles anything that smells innovation and which often implies more perceived risk.

In this respect it is not only the credit rating agencies we need to get rid of but also of the current malfunctioning system of minimum capital requirements based exclusively on the limited concept of default risks. Just as an example, is not the risk of the default of our planet because of climate change much worse?

A bit of navel-gazing, haven’t we?

Sir Paul Keating is absolutely right in saying that “Global financial confidence, once destroyed, requires myriad positive events and a heavy convergence of them to counter ambient pessimism and gloom”, “A chance to remake the global financial system”, March 5.

But then Keating lists issues, like better IMF governance, which is of course a very laudable thing to do, I support it completely, that in my opinion are almost irrelevant to the confidence of markets and perhaps even to most of the official actors.

For example when he mentions “the government of China has no intention of dealing with its surpluses by letting its real exchange rate redirect national resources, especially when such action risks putting it into the hand of the IMF” I would argue that the voting rights at the IMF, at this particular moment, is one of the very last real concerns of China.

Also whether the G20 structure “is truly dynamic” or the old Breton Woods arrangements are reformed sounds currently as some pure and unashamed navel-gazing.

Since it was the G10 that by means of endorsing the concoctions of the Basel Committee empowered the credit rating agencies so much that the whole world followed their AAA signs over the subprime precipice, I cannot honestly see how the markets would regain confidence in any sustainable way from a concentration of bureaucratic powers in a G20.

Does Keaton really believe a G20 success spells recovery? Is he long or short on G20 derivatives?

Pushing for a green recovery requires also reducing the conflicting market signals.

Sir Joseph Stiglitz and Nicholas Stern write “Providing a strong, stable carbon price is the single policy action that is likely to have the biggest effect in improving economic efficiency and tackling climate change”. Since it is always harder to bailout from a financial crisis than from a climate change crisis, although I come from an oil country I agree. “Obama’s chance to lead the green recovery”, March 3.

But these green market signals would be more effective were we capable of reducing some of the competing signals, for instance those present in one of the most important drivers of world capital namely the minimum capital requirements for the banks as defined by Basel.

Currently for a bank to make a 100 dollar loan to a corporation the banks currently need to have an equity that ranges from a minimum of 1.6 dollars to 12 dollars, a whooping 7.5 times the minimum, which depends on the risk assessments produced by the credit rating agencies.

Since bank equity is scarce, and expensive, especially now, this means that besides what the market would normally be charging for assuming a high perceived risk, the regulators have imposed an additional de-facto tax on risk. This would be great if “default risk of a corporation” was all that mattered. But what about the default risk of our planet? What if most investments in projects destined to fight the risk of climate change presented more risk than projects that increased the risk of climate change?

What if the securitized finance of car purchase financing gets an AAA rating while the project to install a solar panel only achieves a rate below BB-? Is it logical then that the financing of a solar panel needs 7.5 times more bank equity? I don’t think so!

The credit rating agencies were not just innocent bystanders

Sir, Vickie Tillman, Executive Vice-President of Standard & Poor Ratings Services, in “Rating firms do not capture risk in one measure”, March 2, writes, “credit ratings are opinions about future default risk and do not address the many other risks that have affected debt securities in recent months and accounted for the bulk of losses reported by financial institutions … policymakers should review regulations that may inadvertently encourage undue reliance on ratings. If rating opinions are used as benchmarks of creditworthiness – which, incidentally we have never encouraged – other benchmarks and factors should be considered as well.”

Does this mean that I have wrongfully been accusing these poor credit rating agencies, that they are only innocent bystanders and that they have nothing to do with this crisis that is going to result in so much misery for the world? Of course not!

Granted, the primary responsibility lies with the regulators who enabled the regulatory framework that incited this crisis and then with those investment bankers who took advantage of the system failures but in no way should we allow the credit rating agencies to go free of any historic guilt; as we should neither allow those financial newspapers that still have the gall calling the credit rating agencies “indispensable” something that even the credit rating agencies would not dare to do, to wash their hands.

And now what?

And now what?

And now what is society to tell all those who entered into private social security schemes all over the world? Sorry chaps you should not have risked it on your own!

To sell the whole concept of one generation after the other always finding initial final market conditions favourable enough so as to in guarantee them that, in the long run, their older days will be taken cared of, is almost fraudulent.

In this respect I very much share with Peter L. Bernstein that “the possibility the long run has run away is one of the few pieces of good news. “In the long run, we are searching for answers” February 26.

At last we now can go back and discuss on more objective grounds the real differences between pay as you go social security plans based on solidarity between generations and the everyone-is-on-his-own type of private insurance schemes sold lately.

But would they listen?

Martin Wolf suggests “What Obama should tell the leaders of the Group of 20”, February 25 and it all sounds so extremely intelligent and rational. Problem is though that the chances of obtaining a rational responses to rational requests are very slim in a world where there has been so little capacity to respond to any threat of something that could occur more than a week ahead, and in a world where so many promises, like that of .7% of GNP to foreign assistance are continuously and shamelessly broken by most.

In this respect if I was Obama, which I am of course not, lucky you, I would start by asking... how can we make sure that the upcoming summit will not be a waste of time since we clearly have no time to waste?

As a bare minimum, before flying over the pond, I would request the Europeans to deposit at least half of their voting rights in the International Monetary Fund, in the same escrow account where I on behalf of the US would also be depositing its own half of the voting rights, also before flying over the pond, and so as to be able to proceed down the road of international cooperation in a much more credible and expedient way. Wasting even a second of the summit on the voting right issue should just not be an option.

Also if I was Obama, and Martin Wolf, I would stop from dividing the world between surplus and deficit countries since that division helps very little when trying to foment a spirit of international cooperation when clearly all the countries are hurting.

Credit rating agencies...indispensable? Absolute nonsense!

Sir although you finally admit to the lead role the credit rating agencies played in causing this crisis you still hold that we can’t live without them and describe their services as “indispensable” “Quo vaditis, raters?” February 23. Absolute nonsense! Of course we can live without them.

There are millions of credit rating agents performing their daily function in what we all know as the market but the problem is that the importance of their diversified judgements were diminished when the regulatory authorities assigned oligopoly powers in the risk information market.

The credit rating agencies have been around for many decades but it was not until the Basel Committee sent out the message that “if they are good enough for us they should be good for you” that they were empowered to do so much damage.

Sir think of what could have happened to a financial world without officially endorsed credit rating agencies and what really happened where trillions of dollars followed their AAA’s into the subprime swamp lands. If you have any sense you must come to the conclusion that what is indispensable is to immediately strip them from their powers.

Do you sincerely believe that we can make the credit ratings to perform so good that nothing of this or even a worse crisis can’t happen. Do you not know that the biggest risks lurch in what is perceived as the safest waters?

For all your experience and reputation you seem quite unwise and perhaps even incapable of learning. Or is it that you have an undisclosed conflict of interest with the credit rating agencies?

If interest rates fell, borrowings would still jump.

Sir Martin Wolf writes “When interest rates fell in the early 80’s, borrowing jumped. The chances of igniting a surge in borrowing now are close to zero”, “Japanese lesson for a world of balance-sheet deflation” February 18.

He is wrong the world has not changed that much, if the interest rates fell borrowings would still jump. The problem Wolf has is that he is looking only at the Federal Reserve’s intervention rate which is close to zero and cannot fall much more, and not at the rates that really do matter, for example the interest rates on credit cards. The interest rate on a credit card in the US for someone like me that has a substantial credit line available and has never defaulted on any payment is currently 17%.

With a rate of 17% low inflation expectations, for now at least, and cash being king, I would have to be an absolute nut to borrow even if I most fervently wanted to help stimulate the economy.

In order to reform regulations we need first to reform the regulators.

Sir John Dizard is calling the bluff of the regulators in “The inside story of reforms is that there is no story” February 17. Well done! Now in order to have a chance to make truly worthwhile reforms there are two things that must happen.

First we need a totally new crop of regulators, most especially in the headquarters of the Basel Committee as those currently there have dug themselves so deep in their framework they have no earthly chance of getting out of it. As an example they cannot even visualize a world without “trustworthy” credit rating agencies when we all know well that no one but God should be given so much trust.

Second there must be some type of accountability. For instance the thousands of licensed professionals involved in generating those masses of lousy mortgages to the subprime sector should, as a bare minimum, have their license revoked for five years.

Sorry, if I am a party pooper

Sir Mohamed El-Erian finds a silver lining for our current crisis in that “As the risks become clearer, a greater degree of international policy co-ordination may emerge”, “Era of policy activism opens door to global co-ordination” February 17.

I am sorry if I am something of a party pooper but may I remind him that this crisis was caused precisely by the international policy co-ordination in banking regulations that took place in Basel. Without the Basel Committee we would most certainly have had other bank crisis but none as systemic and severe as the current one.

Will the world trust the American taxpayer?

Sir Mohamed El-Erian in respect to the Federal Reserve being “prepared” to buy Treasury bonds asks “Will the world be comfortable with two US public agencies offsetting operations that ultimately must be supported by someone else?”, “Era of policy activism opens door to global co-ordination” February 17.

That is either a slightly coward or a too kind way to phrase the issue since that “someone else”, when push comes to shove, is no one else but the American taxpayer.

The US dollar instead of “In God we Trust” should state “In the American taxpayer we trust and thereafter in God’s will”. What will the markets do when they realize the real picking order?

“Tea with FT” is your External Devil’s Advocate

Sir in “Sounding off” February 13 you speak about the importance for an institution of a “Devil’s Advocate appointed to challenge and probe its assumptions and evidence”. This is exactly the role of a blog like “Tea with FT”.

In your case you have censored and tried to have the whistleblower fired by stopping from publishing his letters, suddenly, most probably because the feathers of some journalistic Prima-Donna were ruffled. The beauty in this case though is that even if the FT establishment wants the Devil’s advocate to disappear, he still hangs in there, on the web.

Does a Devil’s Advocate always have to be right? Absolutely not! That is not his role.

Can a Devil’s Advocate be advocating too often and therefore only be accepted if he limits himself to one letter a month? Of course not! That would be plain silly.

But a Devil’s Advocate can surely not appoint himself? Why not? Do you prefer the management or the Prima-Donnas appointing him?

Cheers

The debate has been sequestered by the machos and the wimps.

Sir Samuel Brittan seems to divide us economic debater between the machos, those who hold that this is no time for hesitance, better too much stimulus than to little and that we should forget about how we are going to pay for it all; and the wimps those, who urge more caution. In my case I confess that I often find myself among the latter, though mostly as a reaction to the runaway machismo of the machos. “Economic dominoes are still falling” February 13.

The truth, which as usual lies somewhere in the middle, is that we all should be very careful machos, and by which I imply we should stimulate a lot but make sure that every cent of stimulus counts.

In this respect (once again) I wish to point out that there are other issues that need to be looked at, such as the interest rates charged on credit cards.

To stimulate consumption placing compromises of a trillions of dollar on the shoulder of future generations of tax payers while at the same time allowing credit card companies to charge 17% interest rates in an economy where inflationary expectations are low, has nothing to do with machos or wimps, only with plain stupidity.

I am therefore proposing that the US government and the Congress should limit the interest rates that can be charged on credit cards to something like 5% and perhaps, for a year, as a partial compensation, pay the creditors an additional 3% on any balance financed. That stimulus cost would amount to a meager 30 billion dollars, per each trillion of credit card debt.

Doing it would put real money in the pockets of the real consumers and simultaneous work at solving the next wave of toxic assets soon to hit the markets.

Balloons explode, don’t they?

It is amazing that so soon after having witnessed what disasters comes from having empowered credit agencies to put up their AAA signs showing the roads to no risk-lands Arvind Subramanian and John Williamson dare to recommend setting up zones for asset prices. “Dear I don’t think we should buy our house here because it has a 343 bubble rating. Perhaps I should look for a job in Toledo?”, “Put the puritans in charge of the punchbowl”, February 12.

There is nothing wrong for a central banker to keep an eye on assets prices such as houses to decide on monetary policies but if he wants to make any official use of it he should first make sure he does not own a house so as to be free of any conflict of interest but, more importantly, he needs to remember that bubbles, even though they might hurt when they explode, have a role to play in taking human and economic development forward.

A world without bubbles gets to be closer to a world without illusions.

Limit and subsidize credit card rates

I heard Geithner in the Congress and I read Martin Wolf’s “Why Obama’s new Tarp will fail to rescue the banks” February 11 and it is clear that they and most of us have entered into a quite unproductive phase of the debate, where we are all threading muddy waters not getting anywhere.

We should all take a break, from discussing solely about banks, and discuss those other participants of the economy we know as the consumers.

The US consumers face incredibly and unexplainably high rates on their credit cards, like 17% if in current status and 26% if in default.

Why does not the US government not limit those rates to 4 and 6% respectively and as an incentive offer to pay the creditor a 3% compensation on any balance financed over the next year? That would only cost a meagre 30 billion dollars per trillion of credit card debt.

Doing that would put real money in the pockets of the real consumers and simultaneous work at solving the next wave of toxic assets soon to hit the markets.

After such fresh air we might take up our current discussion with new energies.

The scary cognitive dissonance of the Basel Committee

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

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

A KeynesKeynesKeynes economic plan?

Sir Benn Steil is both correct and timely with his “Keynes and the triumph of hope over economics” February 6. But, just as well, he could have titled it “Keynes and the triumph of the shortcut over the real way”.

When we ser how many use Keynes to back up any call for stimulus, no matter how big, without even looking at what is going on at street level, like the enormous interest rates currently charge by the credit card companies to finance and refinance, it only reminds us how the credit ratings got their AAA ratings so wrong.

Do not dangerously overcrowd the safe-havens.

Sir Willem Buiter in “The ‘submerging market’ crisis”, February 6, proposes that the US and UK Treasuries should cover the Fed and the Bank of England for the credit risks they take on when they purchase private securities. This is one good way of looking at it.

I would prefer the Fed and the Bank of England charging their respective Treasuries with a commission on all public debt issued. This way the Treasuries would know better that the benefits derived from safe-havens considerations is really not for them to keep; and also that it costs a bundle to keep ever more crowded safe-harbors safe.

That the markets trust Treasuries has more to do with the lack of alternative ports during a very difficult storm than with any intrinsic trust in the harbor chiefs. The governments need to humbly accept that before they and we are left with nothing.

The world needs a Davos meeting without financiers

I just received a letter from one of those big banks that has recently received billions of dollars in official assistance. It informs me that if I finance my purchases with my credit card, where I have ample credit available since I repay all my consumptions monthly, my interest rate will be 17% and, if I enter into any default, 26%. This all in a country where there are no inflation expectations; the government is paying zero rate on its short term borrowings and contemplates a close to a trillion dollar stimulus package; and everyone wants the consumers to spend more to get the economy from falling. For a consumer to finance the anticipation of any purchases with these interest rates would be an act of extreme irresponsibility.

And then I read Martin Wolf’s “Why Davos man is waiting for Obama to save him” February 4, and though it seems such an utterly sensible article that recommends “focus all attention on reversing the collapse on demand now... employ overwhelming force. The time for ‘shock and awe’ in economic policymaking is now”; it only makes me reflect on how much we need a Davos type meeting where the financial sector is not invited and where one could freely dare to ask questions such as... why should we stimulate the economy before making sure that all the new green sprouts are not going to be devoured by some of the players in the financial sector?... and how could we get a finance sector that serves our needs too?

Anything you can rate I can rate better!

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

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

Is George Soros long on oil from Texas?

Sir George Soros in “The game changer” January 29, instead for advocating for a tax on the gas at the pump so that the gas is used less and other energy sources can compete better, he argues for an outright protectionist duty on oil “to keep the domestic price above, say, $70 per barrel.” Is George Soros long on oil from Texas?

Governments and politicians should feel much less smug.

Sir Martin Wolf shows us to be between a rock and a hard place in “Why dealing with the huge debt overhanging is so difficult” January 28. On one hand “liquidation” and bankruptcies would result in a depression and so “that option must be insane” but if, central banks are aggressive enough, we would “relapse into inflation [which] would be a huge policy failure”.

What are we to do? Just the realization of where we find ourselves is a better place to start. That way at least we will have a chance to avoid the push to spend and stimulate massively and fast, no matter how, and begin to behave more rationally in terms of the implementation so as to get the most effective stimulus of sustainable growth out of every cent of new public debt invested; and in terms of thinking about the taxes that will be needed to pay for it all.

But to have any chance to get it right we also need governments and politicians to stop feeling so smug about the current interest levels and to think that markets are brimming with confidence in their actions. If we disregard what markets are paying in premiums for access to a temporary safe haven in the midst of an initial confusion, many sovereign public debts might have already surpassed their long term sustainable levels.

Money, money, and money.

Sir Jeffrey Sachs is absolutely right when in “The Tarp is a fiscal straitjacket”, January 28, he urges for a “sound medium-term fiscal framework”. Since the markets quite often even when such a framework is spelled out do not believe in it, they have their statistically valid reasons for that, can you imagine how spooked they could get when asked by the stimulators to join a spending crusade without even hearing a word on taxes?

Indeed, since taxes seem to have reached a real low point in terms of credibility, having lost so much of their real progressiveness over the years, the first thing to do is to make a careful inventory of the supplies and to figure out how to get them to the troops, in time. As Prince Montecuccoli taught “To wage war, you need first of all money; second, you need money, and third, you also need money.”

What freewheeling?

Sir Gillian Tett in “Bankers and bureaucrats seek a new philosophy” January 28, she mentions that “Western Governments… know they cannot return to the type of freewheeling world seen earlier this decade. What freewheeling is she speaking about? As far as I can see the current crisis is the direct consequence of the financial capitals having been concentrated so as to travel overly relaxed on some rigid AAA-tracks which led them over a precipice. I am absolutely sure that if capitals had really been freewheeling nothing like this sort of horrendous systemic crisis would have occurred.

Desperation is indeed a bad counsel

Sir Peter Boone and Simon Johnson make a proposal for how to re-privatise the de-facto nationalized banks by means of the government receiving and selling warrants which would allow new private equity and shareholders to step in at a more reasonable fiscal cost. To save the banks we must stand up to the bankers, January 27.

That could be, though I remember that one of the reason for the successful Chilean recovery after their bank crisis was that the old shareholders were given a repurchase option, at a price that compensated the government of which I believe many have already been executed.

What I do take exception from is when they express that one of the problems is that the banks would refuse to sell their assets and so “the regulators need to apply without forbearance their existing rules and principles for the marking to market of all illiquid assets. The law must be used against accountants and bank executives who deviate from the rules on capital requirement.” Are they going berserk? Desperation is clearly a bad counsel. Their intention sounds like forcing everyone who owes more on a house than what it is worth to have to walk away from it even if he is willing to stay. Besides, what does market value really signify when markets do not exist?

Actually the truth is that to save our banks we must first stand up to our financial regulators and who are, without doubt, the first to blame for this crisis.

The government needs to provide venture capital for new banks.

Sir George Soros discusses “The right and wrong way to bail out the banks” January 23, as if bailing out the banks was our problem. We need to bail out our economy and if doing so we happen to bail-out the banks, great, if not hard luck.

At this moment we have a regulatory system for the banks that by means of the minimum capital requirements prioritizes risk avoidance. What we need instead is a regulatory system that helps us assure that the banks prioritize what is most needed.

In this respect, with government funds, I would create many new banks, with a fix capital requirement for any credit, for instance 6 per cent, and I would nominate a series of management groups to run these banks giving them the incentive of a generous purchase option for the bank in a couple of years, and asking for a secured indemnity in case of any particularly irresponsible act committed by any of these manager.

Also if these banks want to buy “toxic assets”, because they believe it is in their interest to do so, the better.

Sir I guess that it most probably must have been a very long time since George Soros walked down any Main Street.

The rating agencies credibility is not a result of any market

Sir Paul De Grauwe is right suggesting to alert the investors with a label that says “Warning: rating agencies can do you harm” January 23; as you know I have been advocating precisely that for years. But, when De Grauwe expresses surprise that the rating agencies are still around, even after having failed so miserably, he forgets that who put them in power and keep them there were the financial regulators and not the market. As long as “if they’re good enough for the Basel Committee they’re good enough for you” reigns, the markets cannot free themselves from these dangerous agents of systemic risk.

http://teawithft.blogspot.com/2007/08/we-need-to-attach-warning-message-to.html

Geithner could be heading onto the wrong direction.

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

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

It might neither be time for an international symphony orchestra

Sir you hold that a global financial crisis requires global co-operation and therefore it is “Not a time for a one man-band” January 22. But, whether we are able to stimulate the right kind of projects that will serve sustainable growth, or hand out the most efficient tax-rebates that produce the most suitable demand that will all, at the end of the day, no matter how much international cooperation there is, depend almost exclusively on the very local capacity to implement. Of course it cannot be a one-man band; it has to be a very well rehearsed local symphony orchestra.

I cannot refrain from reminding you again that I bet my last shirt on that we would all have been better off without that international cooperation called the Basel Committee. Of course “no country will escape this storm on its own” but that is no valid reason to jump all in the same life-boat. That each country while implementing their own rescue plans needs to consider the international implications carefully, that is a totally different question.

Having considered the Financial Times a defender of free financial markets, by which, just in case, I do not mean unregulated markets, I find it somewhat bewildering to see it championing global financial central planning. Should we not better reserve that for the fight against climate change?

The nuclear bridge

A letter that was not published by FT

Sir, whether sturdy or weak, safe or dangerous, short or long, no matter how we look at it the nuclear energy is the best and perhaps even the only bridge available to take us from a carbon driven to a clean renewable energy driven world. 

In this respect I do not harbor any of the concerns that Oleg Deripaska expresses about the current drop in oil prices or the financial crisis delaying the development of a nuclear response to the world’s energy, as long as we can convince regulators that it is high time for them to roll up their sleeves and work 24-7-365 to speed up without running of course, whatever due diligence procedures are needed, “A nuclear response to our energy problems” January 22.

If you ask me what would be one of the best stimulus packages we could come up with, dollar for dollar that would be to double or triple the budgets of entities such as the U.S. Nuclear Regulatory Commission… and then crack the whip.

Mr Jouyet cannot have the cake and eat it too

Sir as reported by Paul J Davies in “France demands stronger ratings supervision” January 22, it looks like Mr Jean-Pierre Jouyet, the French regulator strives to have the cake and eat it too. On one hand he wants to increase the supervision of the credit rating agencies and so which presumably would make them more “trustworthy” for all to follow and on the other hand he “wants to see the role of agencies in the financial system reduced.” He needs to make up his mind. May I suggest he concentrates on the latter alternative as the first would only risk digging ourselves deeper into the hole we’re in.

Let us pray it is not too late.

Sir Peter Thal Larsen reports January 21 that the “UK regulator helps to ease the pressure” lowering the capital requirements for banks when at the “low point of the cycle”. Not a minute too late.

Requiring higher capital when already awarded credits are being discovered to be more risky than previously thought, and allowing lower capital when credits could be perceived to be less risky, is one of the fundamental ways how the financial regulators that were responsible for the Basel framework created and leveraged new cyclicality for the world to suffer. Shame on them!

Listening to their “we did not know” is just the reason we do know that bank regulations must not be allowed to remain an exclusive and reserved affair for bank regulators.

Let our bankers become bankers again.

Sir Mohamed El-Erian says “We have to bring the banking sector back to life” January 21, because “Banks play an important role in any economy…efficiently channelling funds to productive uses”, and I believe he is even more right than he is aware of.

For years I have been arguing that our banks need to rescue the role they should play in the economy and which they lost when they were ordered by means of the minimum capital requirements based exclusively on risks, imposed on them by the regulatory authorities in Basel, to be risk-adverse entities and basically automated arbitrators trying to capture whatever spread existed between what the market was requiring in interest rates and what it should charge in accordance to the credit rating agencies opinions on the inherent risks.

Yes, now, more than ever, we need our bankers to become bankers again, and to regain the capacity of looking their clients in their eyes so as to explore on behalf of the society all the avenues that exist for the creation of decent jobs and sustainable economic growth. It is absolutely not too “late to stop banks becoming utilities”; for the simple reason that we cannot afford to let them.

Obama has more than enough on his own plate

Sir Martin Wolf is right blaming an absolutely excessive consumption gap between deficit countries led by the US and surplus countries led by China for the ongoing implosion, now when the music stopped, and that therefore it is not only the US’s responsibility to provide the fixes, “Why President Obama must mend a sick world economy”, January 21.

I would go even one step further. When Wolf mentions that “much of the expansion is expected to come from the US Federal Budget” we should not, even for a second, “leave aside the question of whether this will work”, knowing, as Wolf says, that the “US cannot run fiscal deficits of 10 per cent of GDP indefinitely.” In this sick world economy, one of the few healthy spots that remains is the dollar, curiously the representative of the leading deficit country, and to keep the dollar healthy should be one of Obama’s prime responsibilities.

Anyhow anyone that stops looking at yesterdays statistics and walks the main streets, in real time, will soon come to the conclusion that whatever “good” the fiscal expansion might bring to the USA, pardoning financial losses, reducing excess inventories, financing private savings, making the local adjustments easier, a sustainable USA expansion does not carry sufficient punch to assist in keeping up any significant consumption disequilibrium, and so the adjustments now going on in the surplus countries must, unfortunately, be absolutely brutal. That though cannot be Obama’s prime concern; he has enough on his own plate. In other words, the world cannot afford the US drowning while trying uselessly to save it. “Healer heal thyself”, comes more readily to my mind.

Finally, Wolf rightly mentions that “more of the world’s surplus capital needs to flow into investments in emerging countries” but for that to happen the financial system requires two reforms that have to take place in Basel. First to take away the power of agencies to set up AAA directions signs and that will by sheer inertia always tend to guide capital to status quo economies; and second to eliminate the current formula of minimum capital requirements for banks based on risks and that places an additional tax burden on those risks that are more prevalent in emerging markets. Those two reforms are in my mind more important and urgent than the also much needed IMF governance reforms that Wolf focuses his attention on.

How do we get better regulations with the same not-accountable regulators?

Sir Frank Partnoy holds that “It is ironic that credit rating agencies still retain such power. They were a significant cause of the crisis. They helped fire the fatal bullet by giving unreasonably high credit ratings to ´super senior´ tranches of subprime mortgage-backed collateralised debt obligations. It is astonishing that their views would matter to anyone at this late date. Yet government regulations continue to rely on ratings.”, “Prepare to bury the fatally wounded big banks” January 19.

Indeed it is ironic, even outright disgraceful, and the only explanation for it must be found in the total lack of accountability of the financial regulators. These regulators are now conveniently shielding themselves behind all those calls for more regulations, and which become so hard to explain if one is forced to accept the fact that there is such thing as bad regulators.

Eurozone prayers!

Sir Wolfgang Münchau describes the Eurozone as resilient enough to handle a sovereign debt crisis scenario thinking that “a full-fiscal union would be more probable than a break-up”, “What if´ becomes the default question”, January 19. Unfortunately, when he argues that “if Germany, for example had such an incentive to leave, it would almost certainly forgo that perceived economic benefit and stay for political reasons” he enters the land of hopeful wishing. How does Münchau manage to ignore that “perceived economic benefit” represents precisely one of the strongest political reasons?

From the beginning I have always thought of Europe going into a monetary union without being a true political union as quite an adventurous proposition but, to have an economic crisis to lay the ground for a political reunion, sounds much more like believing in miracles. Anyhow, I agree, let us pray for a miracle.

In taxes we need to start from scratch.

Sir I certainly appreciate Clive Crook’s “Four fixes for America’s fiscal fiasco” January 19, since the very first thing that came to my mind in this crisis was a… how are we now going to pay for it all? … especially since taxes have lost so much credibility around the world that they are even described more and more solely in terms of growth inhibitors.

In order to regain their credibility the taxes have to be of a progressive nature; they have to stop being overly targeted at the salaries in the formal economies; and they have to be aligned with new global realities. The only way to achieve a tax system that fulfils those criteria is by means of a sincere non-partisan cooperation that is allowed to reconstruct the whole tax systems… from scratch. In the US as in many other countries there is no way of making much sense out of the existent voluminous and confusing tax-codes.

How we now wish the regulators had let things be!

Sir no one would contradict Chris Giles’s opinion that “Regulation is small price for protection from another crunch” January 17, the question is though… what kind of protection? … could we not make it worse?

In this respect, to all those who believe that the more intrusive these regulations are the better, let me remind them that not long ago our financial regulators made a choice between the following options:

a. To leave things as they were, with the same capital requirements for banks on all credits, which if 8% meant a maximum 12.5:1 leverage; allowing the banks to keep taking their own credit decisions without having to look over their shoulder at what the credit rating agencies opined or,

b. To impose on the banks a formula of minimum capital requirements based on “risk”, as the regulators understood risk to be, and which for instance for corporations with a AAA ratings required only 1.6% of capital which allowed for these credits a 62.5:1 leverage; and forcing the banks to heed the opinions of the credit rating agencies sending out the message of “if these official risk-surveyors are good enough for the bank regulators then they are good enough for the banks”.

The regulators, sadly, unwisely, chose option b…how we now wish they had not changed a thing!

It is not a question of stimulus against public investments.

Sir Joseph Stiglitz pleads “Do not squander America’s stimulus on tax cuts” January 16 preferring the investment in infrastructure. The issue is wrongly phrased, it is not a question of either or.

If stimulus one needs to make certain that these go to those who provide the most effective demand creation in sustainable sectors; if infrastructure these have to create employment in the short term and serve as support for long term sustainable growth.

But, whatever alternative is chosen, there is a need to follow sound implementation principles. For instance, in infrastructure projects and in order to guarantee ownership, these should be proposed by the States municipalities or even private corporations; for transparency these should be approved by a public committee after a brief evaluation of the projects on what they offer in terms of jobs and sustainable growth; and, finally, for accountability, the projects should only receive the funds in strict pre-specified terms and conditions, cash on delivery.

Whatever, but please pull out the aching tooth fast!

Sir, Martin Wolf is absolutely right when he indicates that the window of opportunity for the USA to be able to sort out all that it needs in order to reassume economic growth of a hopefully more sustainable kind, before they hit the roof of unacceptably high levels of debt, is short, “Why Obama’s plan is still inadequate and incomplete” January 14. I would hold it to be very short.

It reminds me of a letter that I wrote to the Editor and that you published in August 2006 on “The long term benefits of a hard landing” and where I argued “that the gradualism of it all could create the most accumulated pain.”

The letter said “Why not try to go for a big immediate adjustment and get it over with? …. This is what the circle of life is all about and all the recent dabbling in topics such as debt sustainability just ignores the value of pruning or even, when urgently needed, of a timely amputation… Yes, a collapse would ensue and we have to help the sufferer, but the morning after perhaps we could all breathe more easily and perhaps all those who, in the current housing boom could not afford to jump on the bandwagon, would then be able to do so, and take us on a new ride, towards a new housing boom, in a couple of decades.”

The Fed Reserve needs many strong helping hands in order to prevent a dollar rout

Sir Mansoor Mohi-uddin gives us a “Five point plan for Fed Reserve to help prevent a dollar rout” January 13 and we do appreciate the intentions, especially since for the time being the undisputable role of the dollar in the international system represents much of the stability there is left in it, and we shiver to think what would happen if that pillar would yield.

That other countries will go down the route of quantitative easing and therefore “there will once again be no major alternative to the dollar as the world’s reserve currency” is, in any such scenario, of little consolation.

But the defence of the dollar is not solely a Fed responsibility. Sooner or later the market, in these days when the only thing it hears are on tax-rebates and stimulate-until-you-drop plans, will expect some indications as to how the American tax payer intends to help to pay for it all. Much as it hurts me since I come from an oil producing country an announcement of a dollar plus new tax per gallon of gas in the US would do a lot more to prevent a dollar rout than all the squirming of the Fed Reserve put together.

Send out the dogs!

Sir Aline van Duyn does very right reminding us that “Messy question of toxic assets still needs an urgent answer” January 9. There must be without any doubt some value in those assets and besides, in these circumstances of uncertainty, even knowing for sure they’re worthless could have some value.

I remember having heard about the possibility of the US government empowering some financial experts to go out and hunt down the value of the toxic assets and paying them a percentage of the bounty. What happened with such a splendid idea… too republican?

Do you belong to an unkown sect of Austrian economists?

Sir in “A plan to spend – and to pay it back” January 9 you admonish that “Congress should not commit themselves to fiscal consolidation too soon”. Are you joking? Don’t you know Congress is composed by politicians?

Also I cannot understand why you egg on the announcement of even larger stimulus packages knowing that these will come, in due time, if there is room for them. Could it be that you belong to a sect of extreme Austrians economists that want Obama to spell out the real figure so that the markets are spooked right away from believing the dollar is a safe haven?

Indeed what would Keynes be saying?

Sir we must be grateful for Peter Clarke’s very enjoyable “In the long run we are all dependent on Keynes” January 8, not the least for the timely reminder that “the General Theory had advocated regulating economy through investment, not consumption”.

It would be interesting to speculate about whether Keynes would have repeated his “I was the only non-Keynesian there” if witnessing how his name is now used to support the build-up of US public debt in order to create bailouts and stimulus packages to save the world from a monstrous depression, given the extremely high stake of said debt becoming so unsustainably large to cause the mother of all meltdowns.

Between the opinions of Vaclav Klaus and Kevin Rudd I am all for the first

Sir Kevin Rudd the Australian prime minister holds that “Leaders must act together to solve the crisis” January 8, because “Fragmented responses could yield to policies that run the risk of accelerating rather than ameliorating the crisis”. This is a bad argument since there is very little to assure us that a coordinated official response would not do exactly the same.

For someone like myself who for years now have fought the efforts of regulators to impose a coordinated global oversight on risks by using some few credit rating agencies it is clear that I prefer the much humbler attitude in reference to the value of government interferences expressed yesterday by the President of the European Union Vaclav Klaus in “Do not tie the markets – free them”.

The US, sooner or later, has to start paying for what it consumes.

Martin Wolf in for “Choices made in 2009 will shape our destiny” January 7, describes very accurately our starting point saying that “relying on vast US fiscal deficits and expansion of central bank credit is a temporary – albeit necessary- … will not deliver a durable return to growth. Fundamental changes are needed”. Wolf also points out the problem of the “persistent external and internal imbalances in the US and the world” that result from the US and a number of other chronic deficit countries” having “structurally deficient capacity to produce tradable goods and services.

Unfortunately, after such a clear diagnosis, Wolf proceeds hinting at the need of even higher fiscal deficits without giving much clues as of to what those required fundamental changes could be; and so let me then suggest one truly fundamental change, that of the US starting to pay for its own spending spree instead of having the world finance it.

One aspect conspicuously absent in the discussions is the need for the US to come up with a new generation of taxes that are appropriate to the current conditions and that work in a globalized setting. One type of these taxes, namely a tax on gas, has at least started to be discussed in Washington.

Absent the willingness of the US to pick up the bill for their own consumption, they might buy themselves some time if China buys up a million of houses in the USA so as to get some more real backing for their dollar investments; and which by the way would also be a great alternative for China to get the US economy going again for the benefit of their own business model.

As I see history playing out its ironic hand housing finance created a perfect storm which forced everyone into the safe harbour of the US treasuries, until it got so crowded there that everyone started swimming again to the house-wrecks.

Viva the President of the European Union!

Sir though I do not agree with his laisser faire attitude towards the climate change I must express my deepest thanks to Vaclav Klaus for giving reason a voice and blaming the “immodest and overconfident politicians playing with the market” for the current economic crisis, “Do not tie the markets – free them” January 7.

His words remind me of those uttered by the Joker (in the name of the free market) in the movie The Dark Knight, 2008. “You know, they're schemers. Schemers trying to control their worlds. I'm not a schemer. I try to show the schemers how pathetic their attempts to control things really are. It's the schemers that put you where you are. I just did what I do best. I took your little plan and I turned it on itself. Look what I did to this city with a few…” collateralized debt obligations.When I think of a small group of bureaucratic finance nerds in Basel thinking themselves capable of exorcizing risks out of banking, for ever, by cooking up silly formulas of minimum capital requirements for banks based on some vaguely defined risks of default; and thereafter creating a risk information oligopoly empowering the credit rating agencies and which doomed, sooner or later, the world to be guided over a precipice of systemic risks; like what happened with the lousily awarded mortgages to the subprime sector, I cannot but shiver when I hear about giving even more advanced powers to the schemers.

Still… all we need is love!

Sir you argue that “bereft of ideas even after a cataclysm for capitalism that there is a need for “Reinventing the European left” January 6.

In a world where everyone now needs to take some time out and refocus, even you, is it not a bit arrogant to single out just one party as being in need of reinvention?

Also, does “All we need is reinvention” really substitute for that old “All we need is love”… I don’t think so.

No sir, it is not the individual citizens responsibility to help the society to spend itself out of the mess.

Sir you write “Saving the savers is not the priority” January 6 and, in that, you are right. But then you go on saying “This is surely the right time to encourage people to spend, spend, spend” and, unless you are yourself doing that and giving exactly the same advice to your own children, this is a shameful thing to say.

Yes it would be lovely if all consumers by magic fully recovered their confidence in the economy but while the economy is not showing a clear direction of where it is going the individual responsibility of a citizen that a country could be proud of, is to save, save, save… even if not for any other purpose than to have the money to pay, pay, pay for all the taxes that will come.

Franchising is also a valid way of de-leveraging

Sir I read with interest Jonathan Birchall’s report “Borders hopes new chief can improve its story” January 6.

These mega chains, like Borders with 1,000 stores in the US, and that must have driven out of business a lot of small bookstores are clearly a result of an era where financial leverage was king. Perhaps the tide is now turning and so perhaps one financial value creating way of de-leveraging for a Border is to franchise out their operations to 1,000 individual franchise owners. One would at least hope this alternative is considered before there are further store consolidations that could leave us buyers and consumers with no leverage at all.

No way!

Sir Andrew Large as a former financial regulator should be ashamed of his “Central banks must be the debt watchdogs” January 6 by which he wants to dig us even deeper into the hole we’re in.

He wants to construe “the necessary architecture and instruments to produce a more effective response to the build up of systemic pressure” ignoring that this itself could lead up to other systemic risks just as the regulators appointment of the credit rating agencies as their risk watchers led most of the market to focus on what these gorillas were doing and therefore never seeing all that was happening around them.

Let me be absolutely clear central bankers are incapable of scrutinizing systemic risks since that would require them to start scrutinizing themselves as the biggest source of systemic risk.

And what if China buys a million houses in the USA?

Sir David Hale follows a quite plausible story line in his “There is only one alternative to the dollar” January 6 but he arrives to the wrong conclusion. Clearly if the confidence in the dollar drops demand for gold could go up but it is really hard seeing gold reassuming in today’s world its traditional role in backing currencies and many other developments, no matter how crazy, might be in store for us.

For instance what if China decides to buy one million of the actual stock of American houses to better guarantee their somehow shaky dollar exposure and to prop up the US housing market that was a main pillar in a business model that seemed to be working quite well for them?

The original sin was ignoring the purpose of our banks

Sir, John Plender titling the “Originative sin: the future of banking” January 5, has the late John Kenneth Galbraith opining that “finance and innovation were fundamentally incompatible”. What Plender implies is wrong. If anything can be labelled as the original sin it is not the financial innovations but the fact that for some decades now there has been little or no discussion of what is the purpose of our financial system and most especially that of our banks. Of course we expect the banks to be safe mattresses for our savings but that is far from all they are supposed to do and clearly, any financial innovation, should be evaluated with a reference to its purpose.

Just the same Galbraith, in “Money: Whence it came, where it went” (1975), addresses the function of banks in the creation of wealth by speculating on the fact that one of the basic fundamentals of the accelerated growth experienced in the western and south-western parts of the United States during the past century was the existence of an aggressive banking sector working in a relatively unregulated environment. Galbraith mentions that banks opened and closed doors and bankruptcies were frequent, but as a consequence of agile and flexible credit policies, even the banks that failed left a wake of development in their passing. May I ask… what wake of development has the financial sector left lately?

We left the regulation of our banks in the hands of a regulator who only had the safe-mattress purpose on their agenda and that is why the saddest part of this current crisis is the little sustainable development the last boom-bust cycle has produced. All the recent bank regulations created in Basel were oriented towards the goal of avoiding individual banks to fail while completely ignoring the much larger risks that banks would fail to do what we truly expect them to do.

In 2003, during a World Bank risk management - Basel II workshop, I said: “Be careful, when looking for ways of avoiding a bank crisis, you could be inadvertently slowing development. I’ve been sitting here for most of these five days without being able to detect a single formula or word indicating that growth and credits are also a function of bank regulations”

Austrian surgery or Keynesian chemotherapy?

No Sir FT should not get away answering “Is your recession really necessary? January 2009 by painting a simplistic picture of some evil Austrian forces wanting to castigate the world by dragging down the economy into the doldrums of a severe and disciplining recession and an enlightened Englishman who understood that “in a crisis, demand would not necessarily fall back to the sustainable level”. What is happening is much too serious for that.

Our current alternatives are more like having to choose between Austrian surgery and Keynesian chemotherapy. Only as an example I would much prefer to cut out all the financial fatty tissue that was created like by magic when the subprime mortgages moved up to the Triple-A world, than use a general chemotherapy that can leave us so weak with masses of public debt and that could have us fall into a final coma.

Having said that, before any type of intervention, the patient needs to recover the will to live and that depends on us being able to explain to him in a credible way the full extent of his illness and its treatment. As an economic doctor I would start telling the patient about the sacrifices he will have to make, for instance the higher taxes he will have to pay, because the whole story of stimulus packages, tax rebates and expecting rational behaviour modification from the same financial regulators that got us into this mess, sounds too much of a tall tale to inspire any sort of confidence.

If I was Obama I would in the first 100 minutes of my presidency use my political capital to announce a one dollar per gallon of gas tax. That would absolutely sting a lot but that would also help the patient to believe that there is a rational way out and that someone is willing to go down that path.

Certainty is a source of much worse systemic risks than uncertainty

Sir Sheila Dow in “A strong argument for pluralism in economic reasoning” January 2, writes “Predictions in times of particular uncertainty can shift dramatically… with serious consequences”. She is right but let us not forget that times of particular certainty like those when everyone from the regulators, the sophisticated investors and the small investors believed in the credit rating agencies generate even worse systemic risks.

If we cannot guarantee pluralism let us at least combat monism