I denounce!

Sir I hereby formally denounce that your financial regulators, in following the precepts of the Basel Committee, are causing damage that could prove to be irreparable to your homeland´s economy.

By leveraging the market´s own bias against risk-taking with their own risk-adverseness, they are directly hurting the resilience and the dynamism of the UK economy, as well as its job creating potential, and which as in all other economies is much a direct function of the willingness to take risks. This occurs when, on top of the risk-premiums already charged by the market, they impose capital requirements for banks that are based on an officially perceived risk already known and considered by the market.

The basic capital requirement for banks in Basel II, 8 percent, has proved to be more than sufficient to cover whatever lending or investment exposure the banks had in what was officially perceived as “risky” and the current crisis resulted solely from the extremely low risk-weights that discriminated in favor of the capital returns of lending or investing in what was officially perceived as “not risky”.

In terms of a health-insurance plan, your current financial regulations require that those rated unhealthy, and even though they because of that already pay higher premiums, have to cover for a larger part of the capital requirements of your insurance companies, with the result of then being able to offer even lower premiums to those rated healthy and that already were paying lower premiums. What kind of system is that and what capital reserve cushion will there be if the health-raters miss some symptoms or if a new disease that attack only the healthy strikes?

It is sincerely laughable to read about stress tests performed on banks by bank regulators that have proven not knowing what they do. What is perceived as risky has never ever set off a financial crisis!

You are the Financial Times… do you really not care… how long will you keep a lid on this argument? Do you really think your country will remain strong with your banks regulated by bureaucratic wimps?

FT is unbelievably inconsistent!

Sir suppose that the market, which includes banks, looks at the credit information, which includes credit ratings, and decides that the risk premium of a triple-A rated company should be 1 percent; and then it similarly looks at a company rated BBB and decides that the risk premium there should be 4 percent.

Now if a bank would have to hold 8 percent in capital for all its assets and therefore be able to leverage its capital 12.5 to 1 it would receive 12.5 percent of risk premiums on its capital when lending to a triple-A rated company and 50 percent of risk premium on its capital when lending to a BBB rated company, and it has deemed these risk returns to be equivalent.

But then comes the Basel Committee and in Basel II tells the bank that in the case of triple-A rated companies it can leverage 62.5 to 1 which means that now suddenly the banks receives 62.5 percent of risk premiums on its capital when lending to triple-A rated companies which in this case is, even on a gross basis, more risk premiums than what is obtained when lending to BBB rated companies.

How can you then reward Boldness in Business March 17, and yet not say a word about the distortive risk aversion of current bank regulations? You are being unbelievably inconsistent.

Did the financial crisis originate from anything officially or unofficially perceived as risky? Of course not! They never do.

Did Inside Job do an inside job on The Academy of Motion Picture Arts and Sciences?

Sir, in “Why the public wants its pound of banker’s flesh” March 12, Gillian Tett refers to the Oscar won for best documentary by Inside Job which covers the financial meltdown.

That documentary does not mention even once the Basel Committee for Banking Supervision, that global financial regulator which provided the intellectual back-drop for the more than 60 to 1 bank capital leverages authorized, and which drove the banks into the waters of the triple-A rated securities collateralized with lousily awarded mortgages that detonated the crisis. The only way I can explain that Oscar is by suspecting that the Inside Job did itself an inside job on The Academy of Motion Picture Arts and Sciences.

And by the way I do not care a iota about a pound of banker’s flesh, I would be more than satisfied having the Basel Committee regulators parading down 5th Avenue wearing cones of shame… and of course being banned from regulations forever.

Monothematic regulators are really not interested in interest rate risk

Sir, Gillian Tett asks on March 11 “Have we really learnt lessons of 1994´s sharp rate spikes?” The answer must be NO, foremost because regulators seem not the least interested in that topic.

Current banks regulations are 100 percent based on perceived risk of defaults… and so all other risks… like the interest rate risk Gillian Tett points out, or the risk that our financial system does not perform adequately its capital allocation function that I worry about… or the thousand of unknown risks that I lie around any next corner, are all ignored by these monothematic regulators.

Because of way too optimistic expected returns, pension funds will not be able to deliver.

Sir, Martin Wolf writes “Pension reform makes sense up to a point” March 11 and I hope he takes the opportunity to also look in at the rates of return of pension funds used in actuarial valuations.

As an Executive Director of the World Bank (2002-2004) I continuously held that “It really is not possible for the value of investment funds to grow, forever, at a higher rate than the underlying economy, unless they are just inflating it with air, or unless they are taking a chunk of the growth from someone else. Therefore when we observe how many Social Security System Reforms are based on the underlying assumption that the average pension fund will obtain returns of 5 to 7 percent, in real terms, forever, I have to wonder when we are going to use our knowledge, and inform the world that this is just plain crazy.”

And even after the crisis, the world mostly uses those overly optimistic expected rates of returns in… what cheats they are!

PS. The extract is from my book Voice and Noise of 2006, one of which I also then gave Martin Wolf. Unfortunately Mr. Wolf must not have read it otherwise he would not have perhaps wasted so much valuable opinion space on his macroeconomic-imbalances explanations for this crisis, and would have understood better and earlier the monstrous regulatory imbalances.

PS. Strangely it seems this article by Martin Wolf has disappeared from the web.

FT, dare to look beneath the tip of the iceberg!

Sir, Jennifer Hughes in “Bank dip into tool box for Basel III” March 10, insists, as you all do, on keeping her eyes firm on the tip of the regulatory iceberg, without the slightest concern of what lies beneath. She, as you all do, speak about the minimum equity capital ratio as a percentage of risk-weighted assets while ignoring that if these risk-weights are wrong this has no meaning.

For instance, early this morning Spain was still weighted 0 percent and now, as a result of the two-notch downgrading of its credit rating, suddenly its risk-weight has become 20%; and which means, in Basel II terms, that banks will now need a whopping 1.6 percent in capital when lending to Spain... which means that banks will now be allowed to only leverage their capital a meager 62.5 to 1… poor banks!

You need some warning labels on the transparency pills offered

Sir it is not “when citizens do not know how much the governments are paid” in resource revenues that lies behind the real resource curse… it is much more when governments get paid too much, like more than 5% of GDP, 15% of its exports, or 25% of all tax revenues received from the citizens, “Stop digging deep for the kleptocrats” March 7.

In those cases of evident lack of balance of the societal powers, those transparency pills that the Extractive Industries Transparency Initiative offers, will in the best of cases act as placebos, and it the worst, be feeding on those illusions of a better tomorrow that help maintain petrocrats and oiligarchs in power.

Financial rules must do more for development…anywhere!

As a former Executive Director of the World Bank (2002-2004) I am extremely pleased to see Vincenzo La Via of the World Bank speaking up on the development angle of bank regulations. “Financial rules must do more for development countries” March 7. But, as I have done precisely that, for well over a decade, it might be appropriate to remind the readers that this is not a solely a developing country issue.

Even in developed countries those regulations, by blatantly discriminating against those perceived as more “risky”, are doing just as much harm for the development of their own small businesses and entrepreneurs.

Abundant surrealism is present in the discussions on bank regulations and stress tests

Sir, Patrick Jenkins and Brooke Masters report “Europe’s bank regulator attempts to restore faith” March 7. In it we read again experts opining on the basic percentage of capital requirements indicated by Basel III but not a word is said about the risk-weights which in Basel II diluted the banks required capital into nothing. How surrealistic is that?

Is that because no one wants to acknowledge the fact that European banks, while all the credit rating agencies downgrades are of the outlook for the ratings and not of the ratings themselves, are still allowed to lend, for instance to Spain, against zero capital?

Openness is just a placebo when lifting a real resource-curse

Sir, whenever a government receives in net resource revenues more than 5% of GDP, 15% of its exports, or 25% of all tax revenues received from the citizens, the balance of power has been fundamentally altered and real democracy cannot breath. In these cases the transparency of which George Soros speaks of in “Openness can help lift the curse of resources” March 4, is just a placebo. In fact transparency there amounts to little more than allowing the tortured seeing the pliers that is to be used to extract his fingernails.

That Extractive Industries Transparency Initiative, EITI, and that Soros speaks so highly of is without any doubt well-intentioned, but they have no idea of what the real oil-curse is all about. Anyone who did would not, as EITI does, proclaim the principle: “We affirm that management of natural resource wealth for the benefit of a country’s citizens is in the domain of sovereign governments to be exercised in the interests of their national development.”

That principle supports keeping on concentrating oil-wealth in hands like Gaddafi’s, while the only means of breaking an oil-curse of that size is handing over the oil revenues directly to the citizens. But what would a George Soros or an EITI know about that? … at the end of the day they are not really oil-cursed citizens.

PS. I’m from Venezuela. There the government, by means of oil revenues, has come to receive 97 percent of all national export revenues. In such cases you do not live in a nation, you live in somebody else’s business.

Don´t give microfinance a blanket approval!

Sir in “Dhaka´s spiteful attack on Yunus” March 3, you write “microlenders have small margins in spite of their high interest rates… their loans are cheaper than those provided by traditional money lenders, and free of the social conditions attached to credit in feudal relationship” and I must ask… how on earth do you know that?

As a former Executive Director of the World Bank and very interested in the subject I have closely followed the debate on microfinance, and I have quite often found the need to remark on the fact that most evaluations of the sector are geared to establish the profitability of micro-finance and very little or nothing is said about for instance the rates the micro-borrowers have to pay.

There is much good in microfinance but there is also an enormous amount of hypocrisy, not the least among a crowd of those who make a career and a living out of being microfinance groupies. If you like the concept of microfinance, as I indeed do, then hold it to strict standards and do not give it a blanket approval. (Or otherwise accept it as any other kind of non-holy business).

And of course this has nothing to do with approving or condoning whatever is being done to Mohammed Yunus the founder of Grameen Bank, something of which I know too little about to opine.

Sorry FT… it just seems like the same dumb old banking to me!

Sir in “Brave new banking” March 3 you write that “financial markets were guided less by an invisible hand than by the hands of a blind”. That blind was and is the Basel Committee’s paradigm of capital requirements for banks that discriminate based on perceived risks. You yourself say that “More credit is good when channeled to productive investments” and yet that is not what Basel I, II, or III hold… those regulations hold exclusively that more credit is good when channeled to “not risky” proposals.

Patrick Jenkins, Megan Murphy and Haig Simonian report Oswald Grübel, ex of UBS, saying “If in one part of the world you have an 8 per cent capital requirement, and in another part of the world, 19 per cent… you know where the business is going”. He is absolutely correct, just as is: “If in order to lend to small businesses you need 8 per cent capital requirement, but when lending to triple-A rated securities, or Greece you only need 1.6 per cent … you know where the credit is going”

Sir (please get it!) the 8 percent capital requirement established in Basel 1 and II when lending to what is perceived as risky has proven to be sufficient to cover the losses incurred when banks lend to what is perceived as risky, so there is no need to increase those requirements. What originated this crisis lies exclusively with operations a priori perceived as “not risky”. Before that is realized and fully corrected for, which means eliminating all regulatory discrimination that is layered on top of market discrimination … it just seems like the same dumb old banking to me.

Beware of cuddling up too much with comforting regulatory teddy-bears, they could be poisonous.

Sir, John Kay in “Don’t blame luck when your models misfire” March 2, gets to the core of our problems with the regulatory monopoly of the Basel Committee that has been empowered, God knows how.

The Basel Committee instead of as regulators be highly skeptical about anyone’s ability of perfectly understanding and measuring risks, arrogantly took upon themselves to act as the risk-managers of the world and with their risk-weights which caused the capital requirements for the banks to be absurdly low whenever a triple-A rating was involved, they altered Zero Ground and naturally tempted the bankers to enter into the triple-A rated waters where the sharks of the real economy were waiting for them.

During my days as one of 24 Executive Directors in the World Bank (2002-2004) I repeated over and over the arguments presented by John Kay, but no one wanted to really listen, (just like FT doesn’t want to) since the thought of being able to control for risks sounds so comforting no one wants to give it up… and so the possibilities of finding clientele for the next risk controlling potion introduced are of course boundless.

In such circumstance the best we can do is to try to make certain that the systemic risks of any risk-avoidance scheme to which we want to snuggle up sucking thumbs are not themselves larger than the risks we want to be protected from. Unfortunately there are many who have a vested interest in hiding the fact that they sold us a poisoned regulatory teddy-bear.

It is time we give our banks a purpose different than that of surviving.

Sir, Mort Zuckerman in “How we can get America working again” February 25, as so many do, identifies the lack of jobs as one or perhaps the most serious challenge facing all here, there, and everywhere.

If that is so and our banks are supposed to allocate capitals why do we not throw out those capital requirements for banks based on perceived risk, and which obviously did not serve us well, and adopt capital requirements based on job creation potential as certified by job creation rating agencies?

Asking the pusher for help?

Sir, Martin Wolf holds that “Ireland needs help with its debt” February 23. But when looking at the help Ireland currently gets by way of crazy bank regulations one could also ask, what more help can it need?

Ireland’s credit rating was recently downgraded to A- and which means that banks are still allowed to leverage their capital more than 60 to 1 when lending to Ireland, while in comparison they are limited to about 12 to 1 when lending to a small business or an entrepreneur. And, before March 2009 the banks because of Ireland’s AA or better ratings, needed no capital at all when lending to it.

Without doubt what most caused the over-indebtedness that set off the current crisis was the minuscule capital required by the regulators of banks whenever these entered into operations connected with prime credit ratings. That Mr. Wolf can insist in that “the big failure was the behaviour of private lenders and borrowers”, without also referring to the out the “out-of-control” bank regulators who acted as the pushers of debt, is just amazing.

PS. When Ireland gets downgraded to B, then the risk-weight applied will instead of 20% be 50% which means that all banks need to post 2.5 percent in additional capital on all their exposure to Ireland… and that is why Ireland has not been downgraded to B.

A lottery for the rich!!!

Sir, Peter Orzag the former director at the US office of Management and Budget recently wrote about the role of lotteries in raising savings… and I presume implicitly, the fiscal revenues, “Taking a chance can be a better way to save”, February 17.

One of the criticisms he referred to was that these lotteries were usually a regressive form of tax since it mostly attracted the poor who had the most to gain from it. Today when reading Kara Scanell, Justin Baer and Haig Simonian reporting "US arrests Swiss banker in tax probe” they make reference to an amnesty programme for US individuals who would be granted leniency in exchange for their co-operation… and I could not refrain from thinking about a lottery that could interest the richer segments of the lottery market.

When democracy dies in the cradle

Sir, Arvind Subramanian is absolutely correct arguing that democratic forces stand no chance against the economic rents of a State, “Arab spring will not see an economic bloom”, February 22.

As an oil-cursed citizen (Venezuela) and therefore an expert on the issue let me assure you that societies where citizens are not paying directly for most of their government expenses, and are mostly positioned as receivers of government favors, there is absolutely no chance to develop a functional democracy. The most one can do is to hope for an illuminated oil-dictator, in the sad certainty that sooner or later one will have to suffer a truly dysfunctional one.

If for instance in Iraq oil revenues were shared out directly in cash to citizens the political dynamics there would have been different, and real democracy could have had a chance to be empowered. As is they are just waiting for the next petro-autocrat, and who could then perhaps even count on an oil production that doubles the highest under Sadam Hussein´s regime.

By the way even taxes can produce a tax-curse, if these are not transparent enough. Currently the UK taxman perceives through taxes on petrol consumption more per barrel of oil than those who give up that non-renewable for ever… and few UK motorists are really aware of how much they pay in these taxes.

Martin Wolf and the rest of us baby-boomers might soon be invited to visit an “ättestupa”

Sir, Martin Wolf looks to explain “Why the world´s youth is in a revolting state of mind” February 19. He fails to sufficiently transmit the seriousness of the issue something that you might understand better when reading reports about the millions after millions of young men in the Middle East who because of a lack of job opportunities will not ever have the means required to start a family.

Wolf would do well placing all the demographic challenges the world faces in the perspective of the fact that the only objective for our banks their regulators have set, is for the banks not to fail. Perhaps the regulators have been appointed by the baby-boomers with the instructions of making sure their assets are safe while they are still around, in the best “après nous le deluge” style.

No! Our youth deserves our banks perform their capital allocation function freely and without regulatory interference. Otherwise we older, Martin Wolf included, might with reason be invited by the youth to take a walk to the nearest “ättestupa”… meaning those cliffs from which according to a Scandinavian myth the elders threw themselves down when they no longer were useful. But perhaps it is that Mr. Wolf is counting on himself being lucky enough to find himself among those with “resource wealth to buy off their young”

Current banking regulations is a venomous potion for smal businesses

Sir, Vince Cable the UK Secretary of state for business, in “Private recovery is the only potion for growth” February 18, worries about “growth being undermined by costly, limited bank finance for smaller business”

Excuse me! Does the UK Secretary of state for business not know that limiting and making more expensive the finance for smaller businesses is a direct consequence of the subprime banking regulations that so odiously and regressively discriminates against perceived risks?

Does the UK Secretary of state for business not know that while banks are required to hold important levels of capital against lending to the small businesses, it needs to hold basically no capital at all when lending to the government?

What the UK Secretary of state for business should be doing is to protest the venomous regulatory potion that attempts against real private recovery… and not leave that to Sir John Vickers’ banking commission, which does probably not care one iota about small businesses.

About lights and regulations

Sir in “Regulating finance” February 18 you refer to “But the light is here”.

A fixed lamppost giving light is regulation, a regulator illuminating with a lantern where he thinks bank should go (like allowing for a 62.5 to 1 leverage whenever there was a AAA rating involved) that’s pure intervention. When will you grasp the difference between those lights?

We share John Kay´s miseries

Sir what John Kay describes in “Public projects obscured by private finances” February 16, is very much what happened in many developing countries when we were subjected to the privatization crusade of our utilities and infrastructure.

Instead of the good project engineers, we were told we would get to run the operations efficiently, we were assaulted by financial engineers searching for how to squeeze out the most of what de-facto were most often safe monopolies, and that should ordinary have been financed at very low rates by orphans and widows. And, the cleverer these wizards structured the projects, the more they could pay upfront for the rights of executing them, and so the happier were our authorities too.

And now we are stuck with it, having to find consolation reading John Kay and seeing that at least our miseries are shared. The saddest part though is that it has so unnecessarily given the private sector a bad name. Looking at how doomed-to-fail these projects often were structured makes one suspect that it could almost have been done so on purpose.

The “exceptionally low costs of borrowing” are not for everyone.

Sir, Martin Wolf in “A strategy for growth that dares to be radical” February 11 speaks of “using the current exceptionally low costs of borrowing as an opportunity to promote a much enlarged programme of investments in infrastructure”. Since those “exceptionally low costs of borrowing” for the government are partially the result of bank regulations that allow for minimal capitals when lending to the government, compared to quite high capital requirements when lending to small business or entrepreneurs, why not just level the field a bit and allow the private sector to help out?

Martin Wolf would do well walking down main¬-street asking those borrowers perceived as riskier by the credit rating agencies, or so small that they are not even perceived, whether their borrowing costs are exceptionally low. In relative terms, they are exceptionally high.

A proposal for strengthening the sustainability of the dollar as an international reserve currency

Sir I refer to the recent discussions on international reserve currencies.

There are only two possibilities for an international reserve currency, it is either backed by something physical or it is backed by some sort of metaphysical faith. In the latter case it would be really hard to envision an international organization being able to substitute for a nation in generating the required faith, since that would really have to mean it becomes stronger than any country. I ask, except for in some global citizen´s dreams, when will the IMF or even the United Nations mean more than, for instance, the USA? The SDR´s recently being much re-discussed are based on a predetermined mix of some countries, and as an average, it all finally depends on the how the individual members of the basket do.

And so the fact is that, for the time being, the world has deposited its faith in the USA, which on its currency declares in its turn having deposited its faith in God. And that´s it! While the music plays, as someone recently spoke about a different situation, you have to keep dancing, no matter how untenable it all can seem to be… that is of course unless you want to try to create chaos by decree.

Meanwhile if there is anything we could do, that is to discuss how the faith in the currency of a country could be better harbored, so as not to provoke some of the difficulties for the trusted country, which could provoke the world losing its trust in it earlier than necessary.

In this respect I believe that the most important part to achieve more sustainability is to make a clear distinction between the long term faith in a country and its economy, and the short term faith in its government, perhaps with a sort of a Chinese wall.

Since even the safest harbor can become dangerously overcrowded the US should think of having the Fed collecting a toll from anyone wanting to anchor in their safe-dollar harbor, and not pass along that toll to the US government by means of lower interest rates on its debt, and as is currently the result. That safe-haven toll would align much better the incentives, especially for the US citizens, because no citizen would like to have his government´s finances subsidized by foreign interests. It would in fact be an effective way to combat the safe-haven resource curse.

There would be no problem in having the Fed later sharing the revenues of the toll with the government but those revenues would then be seen as being generated by the strength of the nation and not by the strength of the government.

The IMF and the World Bank did not listen then… and, unfortunately, they still do not listen enough

Sir Alan Beattie in “Watchdog says IMF missed crisis risks” February 10 makes reference to ignored warnings such as those delivered in 2005 by Raghuram Rajan, the then chief economist of the fund, and which mentioned the threat of widespread financial instability.

Mr Rajan was far from being alone in that. I myself, as an Executive Director of the World Bank, in a formal statement at the Board in 2004 said: “We believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”

No one wanted to listen then… the real problem though is that most still don’t. (And this would include also FT)

Perhaps it is the regulator we need to bring home

Sir, Robert W. Jenkins in a letter titled “Call the bankers’ bluff in this cat and mouse game” makes some good comments about the implied threat from bankers moving to “greener pastures”, if regulations home get to be too tough.

Mr. Jenkins should not forget though that part of the problem is that the regulators themselves moved out, to Basel, from where, with their risk-weights which determines the capital a bank needs to have in order to back up its different assets, they manage the risks of our banks, in splendid isolation. Perhaps it is the regulator we should call back home, if only for an urgent reality check.

The regulators should regulate against unforeseen risks, not manage the foreseen.

Sir, you say that “Some crisis may be inherently unpredictable. Being aware of what we do not know should encourage a policy of taking precautions even when we see no danger” “The IMG goes to the confessional” February 10. Precisely, and that should be the role of the regulators.

Compare that with what the Basel Committee currently does, which is to act as a financial risk manager for the world, allocating risk-weights that determine the capital requirements for banks based on exactly the same information already available to all bankers, namely the credit ratings. To leverage the perceptions imbedded in the credit ratings as the Basel Committee does, is not an act of futility, it is, as proven, an irresponsible and dangerous act with serious consequences.

And please do not accept the argument that these were unforeseen consequences. The Financial Times in January 2003, long before Basel II was approved, published a letter that I wrote which concluded in “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds.”

Mr Issa, then do something about it!

Sir, Darrell Issa writes that “assuming government can allocate resources and spur growth more effectively than market forces is a mistake America must never allow to happen again” “Obama´s Keynesian failures must never be repeated” February 8. He might not be aware that America and much of the world has hardwired such an assumption into their financial regulations.


When a bank is required to have 8 percent capital when lending to a small business or an entrepreneur, but does not need any capital at all when lending to the government, it is precisely that the government can put the savings of the nation at better use what you are assuming. And the US Congress recently passed 2000 plus pages of financial regulatory reform without showing the slightest intention of reneging on such an assumption.

For the umpteenth time, the current system of capital requirements for banks concocted at the Basel Committee is stealth communism.

The regulator was the noisiest!

Sir, Justin Baer in “Noise of the financial herd will drown out risk concerns? February 5 writes that the crisis exposed flaws in the way Wall Street measures and limits risks. That might be, but let us never forget that the biggest flaws of them all were those present in the bank regulations of Basel II, which allowed banks to leverage their capital 60 times and more just because a triple-A rating was involved in the operation, like in the case of most of those collateralized debt obligations referred to in the article.

If there was a margin of 1 percent in the operation, then the returns on capital could be catapulted into over 60 percent a year. Talk about real noise!

To avoid risks, take risks.

Sir, Paul Collier in “Forget Plan B. It’s Plan A+ that Britain needs” February 4, leaves all stimuli to be done to the Government; suggesting to constrain the market’s nervousness with some deft now you see it now you don’t magic.

What about opening space for the private sector, by for instance reducing some of the capital requirements for banks when lending to what is perceived as risky, and that has obviously had nothing to do with this financial crisis. Getting rid of the odious and regressive regulatory discrimination of what is perceived as risky is the least risky way to proceed.

To keep on risk-weighing UK public debt at zero percent, while risk-weighing an unrated UK small business at 100%, is a sure recipe for disaster.

Those at the nucleus may not even know they´re there.

Sir, John Kay writes that “Those at the nucleus may not have the best view” February 2. Indeed, but that is so much worse, when those at the nucleus are not even conscious they´re there.

For instance the Basel Committee which with such hubris took upon itself to act like the risk-managers of the world, assigning the risk-weights that determines how much capital the banks need to hold for different assets, according to their credit ratings, is not even aware of that by doing so it determined Ground Zero for other risk-managers; and continue therefore to complain about the ability of bankers.

Our future is (hopefully) not this!

Sir, Martin Wolf titles his article assessing the financial crisis “How the crisis catapulted us into the future” February 2. I am not so sure of that since it seems that in many important aspects, our past has just catch up on us, and we´re still stuck in it. Let me explain.

This crisis was caused by regulators, who with hubris took upon themselves to play the role as the supreme risk-manager of the world, and created an unstable ground zero for the rest of risk-managers, by authorizing for instance banks to leverage over 60 times their capital, just because a triple-A rating was involved.

Prominent names, like Martin Wolf, have not yet even begun to question the wisdom of that… and surely (hopefully) our future should have no room for such regulatory meddling and distortion of the markets.

Why don´t regulators stop helping the banks from doing what they do not want them to do?

Sir, Philip Stephens refers to Christine Lagarde, the French Finance minister as saying that banks should “contribute properly to economic recovery, to curb bonuses and to bolster their own capital”, “Critics will shut up when the banks pay up” February 1.

I wonder why the “formidable” Lagarde does not simply request the Basel Committee to eliminate those capital requirements for banks that so discriminate in favor of what is perceived as having a low risk of default; allowing for 60 to 1 and even higher bank leverages when triple-A ratings are involved? That is what has hindered and hinders the banks from allocating capitals more efficiently in order to create a more sustainable economic recovery; that is what has allowed and allows generating the huge bank profits which breeds huge bonuses; that is why the banks have been able and are able to grow too-big-to-fail with little capital.

The era of regulatory distortions should draw to a close

Sir, Richard Dobbs and Michael Spence write “The era of cheap capital draws to a close” February 1. Given the current losses, would not this era, in these terms, be more accurately defined by calling it the era of “capital cost postponements”?

Also, given that if banks had been limited to more traditional leverages, we would never had seen the credit expansion that occurred, was it really cheaper capital we saw or was it not an era of regulatory distortions?

It was arbitrary regulatory discrimination which caused bank credits to be relatively very cheap for anything that could dress itself up to be perceived as low risk, as bank equity could then leverage more than 60 to 1, and relatively much more expensive for what could not do so, and for which bank leverage was kept to a 12 to 1. That is what pushed the world into financing houses in the US and other “safe” places and away from infrastructure and machinery and other “unsafe” ventures.

If there is anything we should ask for now, that is for the financial regulators to immediately stop acting with such hubris as the risk-managers of the world.

For markets to work the regulator needs to act as a regulator and not as a risk-manager

Sir, “Time finally to make banks safe” you correctly write on February 1, yet you fail to understand that for market discipline to be restored, it is imperative that regulators keep their hands out of the markets, instead of, with their capital requirements for banks based on perceived risk of default and as risk-weighted by the regulator, acting with incredible hubris as the self appointed risk-manager of the world.

In other words you can order whatever basic capital requirement you want for banks… 9 percent or 100 percent… but that will not mean anything if you then water down some of these capital requirements by applying minuscule risk-weights. In fact the higher the basic capital requirements for banks are, the higher will the distortions produced by different risk-weights be.

The regulators set “Ground Zero” for most of the risk management of banks… and we need that “Ground Zero” not to be a distorted reflection of their arbitrary and regressive regulatory risk-adverse bias.

Ps. Truly I do not understand what little Per Kurowski might have done to FT, for FT to decide they prefer to shut him up, before having his opinions heard.

And the Oscar for lax risk management should go to… The Bank Regulators!

Sir Tom Braithwaite in “Financial crisis report to blame Wall Street” January 26, reports that “The Financial Crisis Inquiry Commission will on Thursday blame unchecked Wall Street excess for much of the 2008 turmoil, highlighting lax risk management …and insufficient regulation”

I am not fully sure of the reasons the “Republican commissioners refused to endorse the report”, they usually are too Fannie Mae focused, but in my mind the report is fundamentally wrong. If anyone has to receive an Oscar for lax risk management that has to be the Basel Committee who with incredible hubris took upon themselves the role as risk-managers of the world, by means of their capital requirements for banks based on risks and that allowed among others for an insane bank leverage of over 60 to 1 just because a credit rating agency had perceived something to be a triple-A… in a world where we know for a fact that there is an absolute scarcity of true sustainable triple-As.

Since what was clearly pure lousy regulation is classified in the report as “insufficient regulation” then that may indeed be part of the agenda of those who want to regulate us more, and now even want to take care of pro-cyclicality and systemic risk; stubbornly refusing to acknowledge that they as regulators and governments are most to blame for pro-cyclicality and systemic risk. If there was an Oscar for the most intrusive and distorting regulations, that would be well-earned by the bank-regulators too.

How should then bank regulators be paid?

Sir, I fully agree with the wisdom of deferring the payment of bonuses to bankers in order to establish that the reasons for earning them were real and not purely a mirage “Paying bankers to be prudent” January 24.

That said the title seems to indicate you believe that the bankers, as a group, were imprudent. That fits poorly with the fact that what caused the current crisis was not excessive lending or investments in what was perceived as risky but excessive lending and investments in what was perceived as not risky.

If you really want to talk about imprudence then take a look at the financial regulators who indulging in the mother of all regulatory hubris assumed the role of risk-managers of the world, and if a triple-A rating was involved in the operation authorized the banks to leverage 62.5 to 1. The outrageous bank bonuses that we have seen are mostly the result of the outrageous profits resulting from these outrageously authorized bank leverages. I ask, how should then regulators be paid?

It is not the capital requirements that are wrong it is the risk-weights that have gone bananas

Sir, Anat Admati asks for higher equity requirements for banks “Force banks to put America´s first”, January 20. She is correct about that goal but wrong about how to reach it. The reason why banks have too little capital is not that the basic capital requirements are low; but that the arbitrary risk-weights which the regulators playing risk-managers assign to those risks perceived as low are obnoxiously low… especially when considering that it is precisely what is considered to have a low risk which poses the highest systemic risk. A society will not disappear because of the risk their children will turn all into risky bungee jumpers, but it could disappear because of the risk that they all pick the wrong subject to specialize in at the risk-free university.

The basic capital requirement under Basel II was 8 percent… but the risk-weight for lending to Irish banks or Greece, for instance, was only 20% which effectively diluted the previous decent 8 percent to an indecent 1.6 percent

PS. I later discovered that the risk weight of Greece was in fact an insane 0%

A case for capital requirements for banks based on corporate organization and management´s stake

We outsiders, we taxpayers, we do not run the risks of the clients of a bank we run the risk of how the bank is managed. Therefore, much more than being concerned with the credit ratings of the clients of a bank, we need to concern ourselves with how the bankers of that bank react to those credit ratings.

In this respect John Kay´s “How trust in finance was carried off by the carpetbaggers” January 19, makes a splendid case for having bank capital requirements for banks depend on such aspects as to how much of the risks of the bank are shared by the management of the bank. As an example, for a bank operating as a full partnership or a mutual, the capital requirements could be 6 percent of all assets, while for a fully public bank 12 percent, with the in-betweens covered proportionally.

The perceived risks are never as dangerous as those not perceived

Sir, according to what Tom Braithwaite reports Tim Geithner has embraced humility concluding that it is not possible “to make a judgment about what’s systemic and what’s not until you know the nature of the shock”, “Geithner queried risk concept” January 14.

Let us hope he can now used that as an intellectual bridge to understand why it is useless and dangerous having the regulators arrogantly playing sophisticated risk managers with their capital requirements based on perceived risks when we know that all bank crisis are caused by risks that have not been perceived.

Just the same old pound locks!

Sir, Gillian Tett in “Stand by for new ways to control hot money bubbles”, January 14, refers to instruments like special levies on banks foreign exchange positions. These instruments are far from new and have very often been used all over the world as pound-locks in order to guard for the asymmetries in the size of flows between the small lakes of small countries and the big global oceans.

For a time free market zealots were against even these pound-locks but most of us knew it was just a question of time before they were going to be used again. And by the way the zealots never realized that capital requirements for banks based on perceived risk were a hundred times more intrusive and distorting than these transparent levies and pound locks… just look at the tsunami into the triple-A rated waters they produced.

What would though be thought provoking, interesting and new would be to see the big oceans needing protection from the flows from the small lakes.

Bank regulators and FT should also heed Aristotle

Sir, on January 13 Martin Sandbu explained very well “Why Aristotle is the banker’s best friend” though besides the bankers he should have included their regulators. I say this because in all the current banking regulations originating from the Basel Committee there is not one single word about the purpose of the banks, as all that regulators expect from them is that they do not fail.

When on the theme of “granting impunity to lazy thinkers” he should also consider the responsibility of a paper like the Financial Times… as the way it has decided to silence opinions like the previous, and other, and “not engage in reasoning”, because seemingly it rubs some of its associates the wrong way, would not have been something approved by Aristotle.

Oh if bank regulators had only stuck to the dress code of bankers

Sir, John Kay directs his “A smart business is dressed in principles not rules” January 12, to the people in Basel dealing with the regulations of banks… and I cannot but reflect on how the current crisis would have been avoided if regulators had stuck to regulating the dress code of bankers.  Instead they went ahead and arrogantly discriminated among perceived risks with their capital requirements for banks, gladly ignoring that bank crisis always occur as a consequence of risks that have not been perceived.

And where are the smart principles for regulating regulations?

Sir, John Kay directs his “A smart business is dressed in principles not rules” January 12, to the people in Basel dealing with the regulations of banks. To that I would indeed add the following:

Bankers, as a principle or as rule, should believe they can master quite adequately default risks. Who wants to deal with a banker who does not?

The regulators, as a principle, and as a rule, should always answer the bankers “No you can’t… and besides there are so many other risks to be considered than just avoiding defaults”

It is bad enough when regulators fall for the sales pitch of bankers, but so much worse when regulators arrogantly decide what is the risk that should be regulated and try themselves to be the masters of that risk, with or without the help of credit rating agencies.

Currently the regulators who failed conquering simple risks of defaults are now tackling more God-like events like pro-cyclicality. God help us! Where are the smart principles for regulating regulations?

The bank crisis and the Basel Committee banking regulations explained to a golfer

Once there was a golf Club with a somewhat narrow golf course and where, even though the members were very careful, sometimes the hooking or slicing of the golf balls into adjacent holes, caused some serious accidents.

The Club’s Board was ordered to find a solution. To that effect the elected members of the Board consulted with some Experts and asked for recommendations. The Experts told the Board “most of the slicing and hooking is the product of bad players and so, if you want to solve this problem, you need to get rid of them”. Knowing this idea would not be received with much enthusiasm, and could in fact pose a direct threat to their reelection as members of the Board, they all decided to immediately delegate the “how” to a Committee of Experts.

The Committee of Experts decided that they needed to appoint some Golf-Player Rating Agencies (GPRAs) to rate the real quality of the players and thereafter created a parallel handicap adjustment requirement that effectively eliminated the bad players… without these even noticing it. According to their ratings, the AAA rated players had their normal handicap increased by 5 strokes, while the players rated B- or worse had their normal handicaps officially reduced by 5 strokes.

It worked! Though, just initially… Since having to play with a very low handicap was pure hell for a bad player, most of the bad players rapidly decided to change clubs and, as a result, the Club gained immense recognition for having the best players and being the safest club in the country… and the Committee of Experts was wildly acclaimed for having true experts. We will never ever have more accidents in our Club… was the Board’s self congratulatory message at the year’s end… four years ago.

But life is life, even among golfers, even in a golf club… and so the membership of the Club started changing. For instance, many great golfing has-beens around the country were attracted by a system that so clearly could help to pro-cyclically prolong their golf-life, just like many never-able-to-be-good players were also attracted by the possibility of joining a club renowned for having exclusively good golf players… and so they all started to read up and converse with the GPRAs about what was necessary in order to be conveniently rated.

There was such an avalanche of enquiries that the GPRAs got confused and overworked and started to make mistakes… to such an extent that the Club rapidly became overcrowded with dubiously rated golf-players. This would, of course, not have meant anything in the old days, but, since everyone had been duly informed that the accidents had been forever eliminated and that therefore there was no need for being careful… the accident rate shot up and rapidly turned, three years ago, into a pandemic disaster that threatens even the survival of the Club… and aggravated by the fact that the beginners and the decent-bad players, those who really are the heart and soul and economical support of a golf club, want nothing to do with a club that has a handicap system that so harshly discriminates against them, and have therefore joined other clubs.

But, golfing friends, the saddest part of this story is that since the logic of “getting rid of bad players and allowing only good players” sounds so very attractive and so very logical, the Board has not even today understood what they did wrong and so they insist on using exactly the same Committee of Experts to come up with better solutions. And the Committee of Experts is currently studying only refinements of their original handicap adjustment requirement formulas because, as “experts”, they cannot under any circumstances acknowledge that they were so fundamentally wrong.

And, unfortunately, the local media is not sufficiently "without fear and without favour" to dare to really fundamentally question the wisdom of the local Club´s Board or of the Committee of Experts.

Regulators are quite busy fooling themselves.

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

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

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

Though there are free-kicks in football most time the ball is in a much confused play.

Sir, John Kay in “Don´t expect the markets to bend it like Beckham” December 29, correctly points out that in the market it is not really the expertise of the expert that counts but the interaction of the experts, and I would say the myriad of non-experts often believing themselves experts.

This is precisely what the Basel Committee completely ignored when they calibrated the capital requirements based on risk of defaults. They appointed as their experts the credit rating agencies but completely forgot that what really imported were not the ratings as such but the way banks would respond to such ratings and to the resulting capital requirements… in the midst of a confused game.

The regulatory “after” is still heading in the same utterly faulty direction as the “before”.

Sir, your FT writers, in “Before and after: how the investment banks had to change shape post-crisis” December 21, write “The new global Basel III capital framework… will force banks to hold more capital against riskier activities”.

Yes, that is so, unfortunately, because what the bank regulators, and your writers, are still incapable of understanding is that since this crisis had absolutely nothing to do with what was considered as riskier bank activities, and for which the banks held more than sufficient capital, and all to do with what was perceived as not risky, and for which the banks were allowed to hold minuscule amounts of capital… we are still being set up for future systemic disasters by exactly the same deeply flawed regulatory paradigm.

Again, for the umpteenth time, first lesson of Bank Regulations 101… it is only what is perceived as not risky that has the potential of creating a systemic disaster.

When will we hear regulators talk about the importance of avoiding giving further incentives to what already has the immense incentive of being perceived as not risky? Please, FT, wake up!

The Basel Committee seems really to be digging us deeper in the hole.

Sir I would recommend the reading of Basel III: A global regulatory framework for more resilient banks and banking systems published in December 2010. http://www.bis.org/publ/bcbs189.pdf

If after what this crisis should have taught the regulators this is all they can come up with I can only conclude that our current crop of bank regulators are absolutely insane.

The regulations are so convoluted that there is no chance that any normal banker or regulator would really understand them much less be capable of evaluating these… as they are all supposed to do.

Just as an example I would call your attention to the formula in paragraph 99: A that supposedly calculates the capital requirements to cover for counterparty risk. Also that formula, which I admit that I am not yet 100% sure on how it works, references a table of risk-weights that in seven tranches goes from .7% for an AAA rated, through 3% for a B rated and up to a whopping 18% for a C rated counterparty.

I look at it, over and over again and try to understand how this formula would have stopped the banks from dealing excessively with a triple-A rated counterparty like AIG. In fact, though I cannot swear on it, it would seem that the capital requirements would be even lower than in Basel II.

FT, do you have any reporters with the guts of not admitting they understand something before they truly understand it? If you do, please have them ask the Basel Committee some fundamental questions, I mean so that we try our utmost to avoid it digging us deeper in the hole where they already placed us.

And the current scary story tells only a fraction of the scary possibilities.

Sir the truly frightening figures for bank capital shortfall of €577bn that Brooke Masters and Patrick Jenkins report “Basel reveals liquidity gap for world’s biggest banks” December 17 are even more frightening if one considers that basically no downgrading of credit ratings of sovereigns are included in those calculations.

For instance Spain having recently been downgraded on notch courtesy of the Basel Committees’ Basel II still generates a 0 percent capital requirement… one more downgrade and that could shoot up to 1.6 percent… and then 4… and then 8 percent.

Different planets?

Sir to read  Brooke Masters and Patrick Jenkins  in ”Basel reveals liquidity gap for world’s biggest banks” December 17 mentioning a Basel III capital shortfall of  €577bn in capital for 91 of the world largest banks, and this really before any terminal sovereign debt problem, and at the same time read Ralph Atkins reporting “ECB sends out [only a] €5bn bill for capital increase”, “to restore confidence in the continent’s 12-year monetary union” makes one thing of whether those reporters find themselves on different planets, or that someone is pinning his hopes on the mother of all ambitious leverages.

Again, for the umpteenth time, don’t control for credit risks, it is best handled by the market, without interference.

Sir, Gillian Tett with respect to the “hardwiring” in regulations of the credit rating agencies that is not working writes that “the rub for the regulators … is that “nobody has any clear idea how to create a workable alternative to judge credit risk”, “Rating agencies stuck in a bind as eurozone pressures mount” December 17. That is absolutely wrong and I have hundreds of letters to FT to prove it.

Since the market already clears for credit risk, by means of risk-premiums charged, what regulators should do is absolutely nothing. Anything they would invent, like the risk-weights they imposed, only confuses and muddles the market, and leads to crisis like the current which was provoked by extremely low capital requirements for banks when investing in triple-A rated securities or lending to Greece or Irish banks, because regulators thought these were not risky… even though regulators should have known that it is precisely what is perceived as not risky by regulators and bankers alike, what is always the most risky for the system.

Yesterday I visited the Newseum in Washington and in doing so the question of how journalist silence ideas just because these seem to simple for them and they prefer the complicated convolutions of experts came to my mind. Not once has FT been willing to publish what I like here have argued for years now.

Don’t place the responsibility for the banks in hands proven irresponsible

Sir Wolfgang Münchau suggests shifting the responsibility for all systemically relevant banks to the EU, “How a mini fiscal union could end instability”, December 13. Since all European banks have anyhow been mostly ruled by the Basel Committee that seems to make a lot of sense… that is until you realize that what most turned these systemically relevant banks into monstrous systemic risks, were the systemically dangerous regulations of the Basel Committee, and which allowed banks to leverage 62.5 to 1 when investing in triple-A rated securities or lending to Greece or Irish banks. In fact that is when you even start to be tempted about thinking of shifting the responsibility for your banks to the most local of your local authorities.

What a difference a different wording makes

Sir, John Gapper writes “Too often, banks were over-eager to take fees for what they wrongly regarded as low-risk activities that would not absorb regulatory capital”, “Madoff was Wall Street’s problem. December 16. What a strange way of wording it. I would have written “Banks, naturally, like taking fees, especially in those activities that because they are considered as low-risk by the regulators, require the banks to hold only minuscule regulatory capital. What a difference a different wording makes.

There are businessmen in what is rated AAA and then there are all the others

Sir, Mort Zuckerman writes about the need for Obama to bring in more senior business people in order to bridge the current gulf, “Only business can put Obama back on top”, December 16. He is right, but in this respect both Mr Zuckerman and Mr Obama need to remember that there are two quite different types of business people, there are those active in what is rated as AAA and then there are all those who work in the rest of the economy. It is the latter who need urgently to be more present, since listening even more to the former, might only dig Obama’s presidency even deeper into the hole were inept financial regulators have placed the US and much of the world.

We have a poor illusion of a committee working on an illusion and us believing their illusions.

Sir, John Kay writes “The notion that a committee can finely calibrate the risk associated with a variety of asset classes, many instruments, and a wide range of institutions on a basis which is at once objective and economic meaningful, is an illusion.”, “Even Middle England should spare a thought for Modigliani-Miller.” December 15. Hear, hear! …that is the sole truth about the Basel Committee for Banking Supervision.

But when on top of that, the Basel Committee also decides that the only risk for which it will calibrate is the truly innocuous risk of default (probably just trying to save itself from the job it should be doing, that of making the defaults run as smooth as possible); and on top of that does it without considering the risk-premiums charged in the market precisely to clear such default risks, then what we end up with is a poor illusion of a committee working on an illusion… and unfortunately a world of politicians, academicians, financial experts, and financial journalists believing in their illusions. Isn´t that a sad state of affairs?

Is a zero capital requirement for banks normal or abnormal?

Sir, Martin Wolf considers the interest rates on US, Germany and UK public debt to be “likely to rise substantially if and when less abnormal conditions arrive”, “Why rising rates are good news” December 15.  I would be interested in hearing whether Martin Wolf considers that among the abnormal conditions is the fact that banks need no capital at all when lending to these governments? To me that discrimination in favor of governments is outrageous and has the odor of communism… but it seems that very few really mind it… not even libertarians… or is it just that libertarians aren´t what they used to be?

More than the destination it is the road travelled that counts

Sir, Prof Eric De Keuleneer suggests that “Bank just might have too much equity” December 13. That is oversimplifying it. Banks are required absolutely too little capital, zero to 1.6 percent, when lending to what is perceived as having a low risk of default, and therefore, strictly in relative terms, much too much capital, 8 percent, when lending to what being perceived as riskier, like the small businesses or entrepreneurs who are indispensable to the economy as a whole.

In that respect what should be done is to temporarily reduce the capital requirements for what is perceived as risky, to whom bankers will presumably still not lend excessively to, much less without more careful studies, so as to make the journey to “sufficient bank capital” a less discriminatory venture.

I support of course to De Keuleneer´s recommendation that “the credit rating agencies should be used less and with less authority”; that is an absolute must if we want to return our bankers from that world where they do not need to have an opinion of their own but are satisfied with monitoring the opinions of others.

Reading WikiLeaks in the mirror

Sir it helps to place the WikiLeaks in perspective as well as being real fun to imagining what would be the reactions to many WikiLeaks, if they stated the opposite.

For example, December 9 Silvia Pfeifer reports that a WikiLeak indicated that “Shell knew ´everything’ in Nigerian ministries” What would shareholders and the world think of a “Shell knew nothing”? Would that not really be a newsworthy WikiLeak?

If I was a Nigerian minister, would I prefer doing business with companies willing to do as good a due diligence they possibly can, or would I prefer those who do not? If I decide for the later group would that mean I could let my guard down?

Though aspirin might temporarily lessen the pain, we need a cure

Sir, Martin Wolf believes that it is gentler for the society to have artificial low rates and illusory asset values than adjusting to higher interest rates and more real asset values “Why we have to live with low interest rates”, December 10. He is right inasmuch as the sacrifices are spread out over a longer period, but not necessarily in that the accumulated sacrifices will be less… for instance if the sovereign bubble that pays for the lower interest rates bursts, and takes the currencies down.

What we need to be doing is finding ways to really grow out of the mess and that will just not happen while we insist on using capital requirements for banks that, on top of the risk-premiums already charged by the market, add an arbitrary layer of discrimination against perceived risk of default.

For instance at this particular moment hundreds of billions of bank liquidity are painted into the corner of the bank balances which does not require capital, namely the lending to high rated governments, and no matter how much everyone wants it to happen, that liquidity cannot be translated into loans to small businesses or entrepreneurs, because that would require bank capital for which there is currently no real appetite.

It is truly sad to see that though small businesses and entrepreneurs could help us to get out of the doldrums, there are many influential persons who seemingly prefer that to be a task for government bureaucrats alone.

Sometimes bad credit ratings are pure bliss.

As a citizen from a country that no matter how bad the credit ratings were they should always have been worse so as to help us to stop our governments from taking on debts, and therefore quite knowledgeable about the bliss that sometimes follows bad news, I cannot but agree with John Kay´s “Learn to love the candid bearer of bad news”.

The fundamental problem with using credit ratings is that if they are 100% right on the dot then a financial transaction based on it would be just but would not provide any party with a profit. In order for credit ratings to generate profit, for a borrower or a lender, for a buyer or a seller, they have to be wrong… and to blindly base your regulations on something that needs to be wrong in order to generate profits does not sound like the wisest thing to do.

PS. You might like to read “The riskiness of country risk” which I published in 2002.

http://unsustainabledebtsustainability.blogspot.com/2002/09/riskiness-of-country-risk.html

We need also new rules to keep bank regulators alert and on their toes

Sir, Lord Adair Turner the Chairman of the FSA sustains “We need new rules to keep bankers honest” December 8. Though hoping one could keep all bankers honest with rules sounds a bit too optimistic, we all agree… that is of course as long as it does not affect the rational capital allocation function of the banks by making the bankers too risk-adverse

But, what about those rules we need to keep bank regulators alert and on their toes? Given that it was the regulators who allowed the banks to leverage 62.5 to 1 when investing in triple-A rated securities or lending to Greece or Irish banks, a rule like that one which he proposes for incompetent bankers, namely that they will not be “allowed to perform a similar function at a bank, unless…” should equally apply to regulators.

The minimum minimorum I would ask all current regulators to do is to go back to bank regulating school and take course 101 and which teaches that the only risks that pose a real systemic risk are those perceived as low… and most specially when perceived as low by regulators and bankers alike.

Without any disrespect, Lord Turner would also benefit immensely from such a course.

Government bureaucrats should not be the sole responsible for generating growth

Sir, Prof Jean Dermine in “Take regulations of bank capital one step at the time”, Letters December 6, lends his support to the Basel Committee´s decision to spread out the capital increases in Basel III over eight years. The problem though is that in the process there will still be many borrowers unduly penalized because lending to them generate larger capital requirements for banks than the lending to others. That is why I am so adamant that while we cannot afford lifting all capital requirements immediately, neither can we afford not lowering them for others.


At this particular moment billions of bank liquidity are already painted into the corner of the bank balances which does not require bank capital, namely the lending to high rated governments, and no matter how much everyone wants it to happen, that liquidity cannot be translated into loans to small businesses or entrepreneurs, because that would require bank capital for which there is currently no real appetite.

Let us allow small businesses and entrepreneurs to help us to get out of the doldrums, let us not place that burden on government bureaucrats alone.

The regulators never believed in the Efficient Financial Markets Hypothesis.

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

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

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

We need to start by fixing our banking infrastructure

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

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

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

I strongly object to Basel I, II and III.

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

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

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

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

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

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

A day at the races

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

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

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

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

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

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

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

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

If only the Basel Committee had known more about behaviouralism

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

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

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

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

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

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

Forget about regulating bonuses, regulate the regulators instead.

Vikram Pandit might need to go back to banking school

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

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

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

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

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

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

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

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

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

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

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

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

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

Gold-bugs are preferable to house-bugs

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

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

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

Finally some real heavy-weight support!

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

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

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

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

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

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

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

Are the banks now to set their own capital requirements?

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

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

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