September 27, 2007

There is more to be gained from a debate, even while speaking different tongues

Sir Jennifer Hughes does a very good and spirited defence for accountancy global unification in her “More to be gained from talking in the same tongue”, September 27 but although she is absolutely right in all what she says she is still wrong.

One of the reasons, or perhaps the only reasons why some of us feel happy about having US GAAP and IFRS living side by side is because that helps to sustain a debate among their respective Standard Boards on matters fraught with such intrinsic difficulties as accountancy. No, let us please hope that we will never have to face one solid cohesive block of standards since who knows what they could contain and there would be no one with sufficient strength to oppose it. For a living example of how much we lose out in benefits from diversity let us just consider all the risks that are beginning to surface as a consequence of having relegated so much of the world’s regulatory power over banks to a single single-minded group in Basel.

September 26, 2007

It behoves us all to stand up to the bank regulators

Sir Martin Wolf in “The Fed must weigh inflation against the risk of recession” September 26 mentions “It would be wonderful if those responsible for this most absurd financial crisis could be punished” but for that to happen we need to dare to go to the real bottom of the crisis.

In this respect what most stand out in the Global Financial Stability Report, September 2007, published by the International Monetary Reform is the absolute reluctance by the bank regulators to accept that they, through their regulations, might indeed have been the largest de-facto suppliers of financial systemic risks. The minimum capital requirements imposed by them on banks around the world and their empowerment of the credit rating agencies as the marines in charge of driving out all risks from banking, no matter what, is the true genesis of the problems we now face.

Am I upset? You bet! When reading IMF admonishing the investors with that they “have an obligation and responsibility to understand the dynamics and liquidity risks associated with the products they buy… and they should not assume that the simple letter provided by the rating agencies show equivalent risks as those for hither asset classes” and blithely ignoring that they themselves use those same simple letters interpreted in very simple ways when imposing rules on the banks is frankly shameful.

In November 2004 the Financial Times published a letter of mine titled “Basel is just a mutual admiration club of fire-fighters trying to avoid a bank crisis at any cost”, where I complained that the regulators were so one-track-minded fighting the risks of banking that they blithely ignored all other issues related to the responsibility of banks, such that perhaps some type of financing could be more beneficial to society and therefore merit taking on more risks. Now, they are not only not delivering on the risk elimination front but worse they are even showing a certain willingness of, though in a hole, to dig deeper.

Alan Beattie in “Master of the Universe (Retired)” September 22, when writing about the memoirs of Alan Greenspan “The age of turbulence” references the central bankers with “They would regard themselves as something like the Jedi Council – an ascetic elite who through innate wisdom and arduous training are entrusted with maintaining order”. Be they the wise and the trained the recent experiences still tells us other humble earthlings that if there is any ounce of wisdom within ourselves we now need to stand up to these bank regulators and ask them, or better yet order them to take a better look at their own role in the mess.

Sir, all of us have of course fully supported the independency of the central banks but if they do not have it in them the character to generate sufficient internal criticism and make the debates public then, unfortunately, because of the many dangers from incest, we perhaps need to revisit this whole independency issue.

September 25, 2007

I need to fluoridate

Sir, Michael Skapinker in his “Bottled water and the madness of crowds”, September 25, seems to be searching for the perfect reason why ask the waiter for tap water instead of expensive bottled water. May I suggest “I need to fluoridate”. Unbewits to most of us the use of bottled water has disconnected us from the fluor added to the water in the water taps and so therefore we can already see a whole generation of sophisticated water drinkers ending up with bad teeth. In the US they now almost call it an epidemic.

Regulators, please make the financial flows free to flow again

Sir, when Saskia Scholtes reports that “Moody’s alters its subprime rating model” September 25, we get a glimpse on what is the inherent weakness of any rating system that does its rating from the desk. It is not that the borrowers were subprime that caused the current difficulties since there clearly are many prime mortgages to subprime borrowers, it was that some of those shady operators that always exist in any market exploited the Achilles heel opportunity provided by the credit agencies themselves when they assigned prime ratings to very sub-primely awarded mortgage loans. Anyone should have been able to tell those mortgages were lose-lose propositions if only they have left their desk for just a second to go and have a look.

The above describes perfectly the systemic risks or even the moral hazard that can and will arise from empowering any agent in the market too much and there is no way on earth you can really correct that, and much less so if you insist on doing the ratings by monitoring real life from afar.

I do appreciate the credit ratings efforts and that we should be able to benefit much from their services, but this can only occur if the market is also totally free from not having to use them. Regulators please make the financial flows free again.

September 24, 2007

Caught between moral hazards and moral duties

Sir, Lawrence Summers rightly ask us to “Beware the moral hazard fundamentalist”, September 24, but ends up sounding a bit fundamentalist himself listing the three conditions that if all met makes “a strong case for public action”, namely that there are contagion risks; that it is a liquidity and not a solvency problem; and that it will not cost the taxpayer any money. Very helpful indeed! Under those conditions the moral hazard of not intervening would seem to loom large.

But what if for example the problems were derived from the fact that the regulator through the use of minimum capital requirement rules had ordered or, somewhat softer, induced the financial institutions to dismantle or, somewhat softer, to scale down their own credit risk departments and follow more the criteria of the credit rating agencies, would the authorities in that case not also have a moral duty to help out?

It is who dwells in the houses that really count

Sir, Wolfgang Münchau tells us that “The big economies are only as safe as houses” September 24 where he more than hints in the direction that a substantial part of the economic growth has come from blowing hot air into houses. Be that so and even though I agree much with his article, as someone coming from a country like Venezuela where we are being setback by more than our fair share of political hot air, I feel a duty to clarify the title by reminding that, at the end of the day, the big economies are only as safe as those who dwell in their houses and the institutions that regulate them.

September 21, 2007

Then get rid of those paranoid-schizoid bank regulators too

Sir Richard Taffler and David Tuckett say in their “How a state of mind abets market instability” September 21, that when a “paranoid –schizoid state of mind dominates . . . anxiety that might spell caution is denied . . . doubters are dismissed… responsibility disowned. They then say that “the solution to the financial crises will not easily be found in increased regulation, more transparent information or cuts in interest rates. Rather, it lies in understanding how a market in which a paranoid-schizoid state of mind is encouraged is inherently unstable”.

Absolutely, this is where the analysis has to start and so that we can realize as fast as possible that even though it is hard to accept it the sad truth is that our bank regulators are not only themselves in a paranoid schizoid state of mind but they have with all their actions or silences been the worse encouragers of it. Otherwise you tell me, how can you explain that grown up men have harboured such a belief in that they have found a foolproof way to dominate risk and that they could even go to such length as to appoint some agents, the credit rating agencies, to monitor risks for them, as if such thing a thing would be really possible without creating through the feedback enormous systemic risks.

And this is why we now find ourselves in an extremely sensitive situation because more than getting rid of the worst financial agents, which is what you normally do in a bank crisis, here we might first have to get rid of some bank regulators in order not to mess things up even more. I mean I imagine there cannot be anything worse to stimulate a normal paranoid –schizoid state of mind than the presence of a superior paranoid –schizoid state of mind.

On some dangerous impreciseness

Sir Martin Wolf in “The Bank loses a game of chicken” September 21 mentions that “the banks both created the radioactive securitised obligations and set up special investment vehicles (off-balance sheets banks) that they must now rescue at the expense of lending to everybody else” but this contains some impreciseness that is dangerous when we have to act very clearheaded.

First, yes the banks played a role in designing the securitised obligations but what really gave these the radioactive qualities were the prime ratings given to them by the regulator sponsored credit rating agencies. Second, the setting up of special investment vehicles was much a response to the bank regulations coming out from Basel, a response that as the bank regulators let it pass seemed to have been blessed, officially or by ignorance. Third the rescue at the expense of lending would only be true if bank regulators, as they should, since at this moment they serve no real purpose, do not waive some of their minimum capital requirements and thereby do not force the banks to allocate too much capital to harbour the homecoming lost sons.

As a minimum make sure that no one forces you to trust the existence of gold in California

Sir, Philip Stevens ends his “Modern-day parable of the run on Northern Rock” on September 21 questioning “Why should we trust anyone?” though a far more precise question would be why should we should be forced to trust anyone? Describing how “the squall became a hurricane because the risks of subprime lending had been carefully concealed in the mortgage securitisation market and then scattered to the winds” he should have remembered that what allowed that to happen were the prime ratings awarded to these instruments by the credit rating agencies.
Stevens, the doubter, even mentions almost with sadness that “it is too late, even if we wanted to, to roll back the frontiers of financial innovation” but of course that is not needed when all that is called for is some more scepticism with regard to the gold in California.

Start dismantling any forced use of the credit rating agencies, now! If the markets want their services let them say so but do not have the regulators do their marketing for them.

September 20, 2007

And who pays me?

Sir I deeply appreciated John Gapper’s “Microsoft problem is close to home” September 20 and where he so valiantly gives voice to the for us layman unthinkable possibility that what has been slowing our computers down is not necessarily bad hardware or virus but Señor Windows himself.

Although I confess still being a bit dizzy, if this was to be right, does Gapper think that I could address the European Commission and ask them to share with me some of the money they collected from Microsoft as a partial reimbursement for all my down time?

Alternatively, since Neelie Kroes, the competition commissioner is caught confessing that he “would like Window’s market share to fall from more than 90 percent to nearer 50 percent” and we can safely assume that he assumes this lack of competition lies at the heart of the problem… would it be better for me to sue the Commission instead for not doing their trust-busting job right?

Do we need a product responsibility and liability legislation that is proportional to the market share? At least in those cases were the society itself by awarding intellectual property rights and investing money in their defences creates some of the possible reasons for a high market share?

September 19, 2007

Some of God's greatest gifts are unanswered prayers

Sir we fully understand the plea of Eric Schmidt in “Global privacy standards are needed” September 19, since for a company like Google it must be nightmarish to manage the 50 different approaches to privacy of each state in the US.

Having said that it is not without some fear that we citizens would entrust a global agency with the development of any global privacy standards, and that is not simply because we could be scared that these regulations could turn out to be too relaxed but also because, just as well, they could turn too rigid for our own good. We are yet in the infancy of a global information revolution where access breeds its own needs and so perhaps, before letting bureaucrats lose, it would be nice see the industry come up and agree with some proposals of their own, just to see how they look.

Eric Schmidt himself clearly points to the benefits of self regulation The problems with regulations is that they normally entail choosing a path from where it is later hard to backtrack and as an example let us just look at how the banking regulators empowered the credit rating agencies and now do not really know what to do with them.

Clearly Eric Schmidt has his own commercial needs for regulations and we citizens have ours, and they might not be the same, but perhaps both of us could benefit from thinking about that phrase from a Garth Brooks song that goes ”Some of God's greatest gifts are unanswered prayers”

Unfortunately Northern Rock is not the war, it is just a war incident and on top of it only a minor one.

Sir Martin Wolf in “From a bank run to the nationalization of deposits” September 19 takes a Polaroid photo (if anyone in this digital world remembers what they were) and that tells little of the story. Not only because the events that lead up to this Northern Rock moment have been in the pipeline for a very long time but also because, unfortunately, we are still very far away from where we could be able to discern the end of the story and in fact we should all count our blessings if this all stays as the “Northern Rock” moment. Wolf is of course aware of this when he answers his own question on whether this is the end of the story with “a far from it”

The fact then that Wolf raises so early the questions of whether the disaster could have been prevented, whether the crisis could have been better handled and finally on what to do about it in the future can only be explained in terms of a very human desire of wanting to believe its over, looking to numb those fears that Wolf and so many of us share and that make us “tremble at what may happen”.

Wolf sees the events as an “unwinding of past excesses” sort of like shedding some kilos, while I having been much more sceptical of what has been in the doings see the need to unwind much more than that, among other a bank regulatory system that has placed us on the clear course of fewer and fewer bigger banks, until we hit the very biggest final bank bang. For a brief look ahead, read Saskia Scholtes “Credit turmoil set to benefit big banks”, September 19, where you can read on how central banks are already in despair outsourcing their responsibilities to the banks... while naturally crossing themselves.

Bore where are you?

Well here we are the day after the Fed announced the “what do the fed know that we do not know” 50bp rate cut to which the market responded with their own “what does the market know that the Fed does not know” too large jump in the value of stock and it all just reminds us about the truth of the Chinese curse “may you live in interesting times”. Now let us all please hurry back to the big bore.

Does Observer know the difference?

Sir referring a bit unnecessarily sourly to a man who is supposed to have made his peace with society Observer, Spetember 19, comments on some observations made by Michael Milken on real estate loans but that demonstrates that Observer might not really be so clear about what this subprime mortgage business is all about. Perhaps I could help clarify.

We have some borrowers who qualify as less than top of the heap and have been known as “subprime”. Now to these subprime borrowers you can actually extend very prime quality mortgages but and what has really happened is that you can also be extremely sloppy doing that, and of course it is important to be able to tell the difference. My suggestion is although it becomes a bit lengthy we should really have to refer to our current problem sector as those “subprimely” awarded mortgages to subprime borrowers.

September 18, 2007

Stop them from digging!

Sir, Paul Davies and Gillian Tett in “Moody’s talks of rating reform”, September 18 quote Brian Clarkson, the President and chief operating officer of Moody’s saying “One of the issues we are talking to regulators about is the possibility of creating tools to address liquidity and market issues”. And we can just pray for that the regulators know about the real meaning of “when in a hole, stop digging”.

Once again, I do not have anything against the credit rating agencies refining and improving their mostly already very good products. What I oppose though is that the regulators press the market to use these products, since such a bias will only guarantee the introduction of even more severe systemic risks than those that we have been discovering lately with the sub-primely awarded mortgages to subprime borrowers.

If there’s ever been a confession there you have it.

Sir Brian Clarkson, the President and chief operating officer of Moody’s Investors Service in “Transparency and trust must keep on driving rating agencies” September 18, makes a confession that illustrates exactly the risks of securitization, meaning the packaging the selling and the forgetting of an investment by putting it on someone else’s book, and of the real danger of an excessive systemic reliance in the credit rating agencies criteria. He says” There have been allegations of lax underwriting and misrepresentations in subprime mortgage originations. There is no sure way for a rating analyst who is not involved in the loan origination process to detect such shortcomings.” With such a confession do we need more? Of course if a credit rating agency is to award an AAA rating based on the accumulation of a thousand individual mortgage loans, the least one could expect is a closer examination of some of them through a sampling process.
Nonetheless the real value of the confession lies in showing us how fail prone a system is when we are forced to trust someone, as is much the case with the credit rating agencies

September 17, 2007

There should be limits on how much you can make your opinions heard.

Sir in “Fitch eager to make headlines” September 17, Adam Jones quotes Mr de Lacharriére the owner of Fitch Ratings saying with respect to the possibility of buying Les Echos “that a ratings agency and a financial news provider are complementary since both strive to deliver impeccable information: ‘There is no conflict of interest, we have truly the same objective” May I ask has he ever heard about the reason for separation of powers in any government even though their different branches have the same objectives. On the contrary if I was a bank regulator of those who have empowered the credit rating agency to dictate so much within the financial markets one rule I would make sure of is that these credit rating agencies should have no access to other additional means of imposing what they consider to be their First Amendment protected opinions.

Is the coverage in Business Week influenced by the fact that its parent company, McGraw-Hill, also owns Standard & Poors?

Most probably not but given the real power that has been given to the credit rating agencies that should not even have to be a question we consumers would have to ask ourselves since the regulators should know that it is in their best interest to keep incest as far away as it can?

Is there anything else with sufficient power to stand up to the credit rating agencies going crazy than a free media with the voice to criticize it? Will the criticism be the same if they have the same father? I do not think so and so I would gladly suggest that McGraw-Hill makes up its mind about which part of the business it wants to keep.

September 13, 2007

Do we then need two world banks?

Sir, Krishna Guha and Eoin Callan, September 13, in reference to a report on the role played by the World Banks internal anti-corruption unit, the Department of Institutional Integrity (INT) were told by Paul Volcker, the main responsible for the report, that “his inquiry had ‘reconfirmed’ there was ‘ambivalence’ in the bank as to whether they really want an effective anti-corruption program or not”. Wrong! Having been an Executive Director at the bank (2002-2004) I sincerely believe that an overwhelming majority of the bank staff clearly comes out in favour of more and better anti-corruption efforts but that these do not come into fruition only because part of the management, rightly or not, believe that these could hinder the bank from operating efficiently… at least as they wish for it to operate for whatever reason efficiently.

If we discuss “ambivalence” then perhaps we should also discuss what the report does not touch upon and which frankly I consider being the single most outstandingly ugly blemish on the World Bank’s reputation. Sir, please search out INT on the external website of the World Bank and click on the list of Debarred Firms and Individuals. There you will find, duly named and shamed, a list of names of individuals that one way or another after a due process have been considered to be involved in corruption, but that list does not include the name of one single of those officers of the World Bank that presumably must also have been involved in corruption one way or another. Susanne Folsom the Director of INT, on a Q&A session on that same site mentions, “We’re often asked why we don’t publicly name Bank staff who are terminated for fraud and corruption as well. The Bank’s rules don’t allow such disclosures….” What credibility can you get naming others while not being willing to name your own?

Sir, it might very well be that the “ambivalence” on anti-corruption in the World Bank is insurmountable but if so perhaps what we need is to have two world banks since the world definitely needs one that comes out completely and unabridged against corruption. And mind you I am far from being a zealot on this issue, since life has taught me well that zealousness frequently carries within its own even more dangerous breed of corruption.

Forest destruction is it a threat or is it a reality?

Sir John Aglionby and Fiona Harvey when reporting on September 13 that “Forest nations press for carbon credits to help cut greenhouse gas” mention “that many governments fear rainforest nations could use the threat of destruction of their forest as a bargaining chip in climate change negotiations”. What threat of destruction? They are destroying them now.

I recently told a prominent-save-the-Amazon person that they should, at 7 am each and every morning, put a matchstick to one hectare of pristine Amazon jungle and transmit this on the web and then perhaps the world could easier understand that it needs urgently to create some huge world forest reserves. These reserves could be managed and cared for by hundreds of thousand forest-guard families and who could all be helped to partially improve their lives receiving a small monthly salary from the whole world, financed perhaps through the levy of a special forestry tax of one cent per litre of petrol.

In 2004 while an Executive Director at the World Bank we were asked at the Board to approve a loan to Brazil for “Environmental Sustainability” and I told my colleagues that what we really should be approving was how much each one of all the world countries would have to chip in to help repay that loan, since obviously keeping our most important lung clean could not only be Brazil’s responsibility.

Does burning 365 hectares per year sound awful? Well the same report indicates that only in Indonesia 1.87m of hectares have been lost every year since 2000. Now having said that… please be careful with the matches though.

September 12, 2007

It’s a Baron Münchhausen moment for the US

Sir Martin Wolf in “The policy challenge of rescuing the world economy”, September 12 writes that “Prof Martin Feldstein of Harvard University pointed to a 3.4 per cent year-on-decline in US house prices” and “Prof Robert Shiller of Yale argued that the US house prices might ultimately fall by as much as 50 per cent”. Although oversimplified a division would yield that the recession carries a 15 years potential and since this is clearly unacceptable by all standards, one of the main real challenges is how to get out of the current conditions as fast as possible. Wolf mentions the need for the Chinese authorities to expand their domestic demand so that the burden of external adjustment does not fall unfairly on Europe and though he is right on his European concerns I am not that sure that Chinese domestic demand expansion would really be so helpful at this particular time for the US since China’s demand elasticity towards commodities and mid-range industrial products could be higher than the elasticity to the products offered by the US.

This looks in fact much more like what I would call a Münchhausen moment for the US, and by which I refer to that Baron’s legendary escaping from a swamp by pulling himself up by his own hair. If there was ever a moment to hurriedly correct other weaknesses in the US economy; like for instance by tort reform, health sector reforms, more strict supervisions on how much intellectual property right’s originated monopolies are exploited and the introduction of a tax on petrol consumption and that would help to take away pressures from fiscal and trade deficits while at the same time sending a better long term signal to the US economy, this is it.

Do credit ratings stop capitals from going where they should?

Sir Arturo Cifuentes in “Credit of the big rating agencies under fire”, September 12, explains very well some of the problems that arise from that many market participants do not know what the credit ratings really mean. Also and although Cifuentes does not fully enter into that very delicate terrain of explicitly wondering whether the bank regulators who enforce the use of these ratings know what these mean, he at least dares to ask the question of “Under the current regime, is it safe to determine capital requirements? , and for this he should be commended.

Now, having been very critical of how we have substituted the no matter how technically correct still limited vision of a few credit rating agencies for the real biodiversity of criteria of a free market, the most important question we need to ask about the credit ratings is not so much in reference to the calculation of the capital requirements of the banks, but on how these credit ratings can influence the directions of the capital flows in the world. It is of course bad if banks do not have enough capital but let us remember that it is far worse if capitals do not go where they can best deliver results.

September 10, 2007

It is time to de-regulate the markets

Sir, Wolfgang Münchau in “Stability for the markets is just the start”, September 10 mentions that he is not so convinced of the need to regulate the credit rating agencies since “the smart investors have always known to treat AAA ratings with a pinch of salt”.

Whether the smart investor knows it or not, which also begs the question whether we have a way to divide the financial market into smart and dumb, has nothing to do with the problem. Münchau would do well to read the role of the credit rating agencies in for example the Minimum Capital Requirements by the Basel Committee on Banking Supervision to get a fuller understanding of how much power these First Amendment protected opinion makers really have. Also, although the midst of a crisis might not be the best moment to speak about it, let us not also forget all those who are in real terms hurt by not being more favourably rated. Therefore although I agree completely with Münchau in that we do not need to regulate the credit rating agencies, we absolutely need to de-regulate the financial markets from having to use them.

In Spain there is a saying that goes “We were many and then granny gave birth” and in this respect I feel there are far sufficient forces in the world to drive the financial flows up the mountains towards the same cliffs, so as for they to be further herded on by the credit-rating-boys.

September 08, 2007

On moral hazards

Sir, one prime problem with subprime mortgages is that it is given subprime terms and so, if a lender would agree to write off a 20% of the value of all subprime mortgages and give the current debtor prime terms, it would not be something outrageous to have the government chip in offering some partial payment guarantee on the balance owed, callable only if the loan is delinquent after a cool-it-of period of perhaps two years, and thereby allow the prime terms to be warranted.

That this could imply the moral hazard of allowing some guilty and bad intentioned borrowers to benefit? Absolutely, exactly in the same way that moral hazard exists when bailing out investors. The final question, as always, is just what side of the equation you most need (or want) to benefit, the debtor or the investor.

To do nothing then?... and have the housing market crash, which could of course help some youngster to at last afford buying a house, but make it harder for other youngster to find a job. You see? It is not easy, even for politicians, as life is only about a continuous choice among so many different moral hazards.

September 06, 2007

A Frankenstein blaming the monster!

Sir, FT´s Tobias Buck reports, September6, that Charlie McCreevy, the EU internal market commissioner attacked the credit rating agencies for their role in the subprime mortgage crisis. Yes clearly they did not do their homework but the last ones who have the right to voice criticism against them must be the regulators who empowered these agencies to decide so much.

McCreevy mentions that “credit rating agencies provide ratings that are widely relied upon by investors” but he should do well reading The First Pillar – Minimum Capital Requirements by the Basel Committee on Banking Supervision in order to understand that the investor´s reliance is far from voluntary.

September 05, 2007

Do not forget the mother of all paternalism!

Sir Martin Wolf in “Questions and answers on a sadly predictable debt crisis”, September 5, though he would seem to be qualifying as “paternalistic . . . the abolition . . . of devices that encourage ordinary people to borrow more than they could afford” he does not even get around to mention that mother of all regulatory paternalisms present when investors are forced, stimulated or induced to follow what the credit rating agencies say. A predictable crisis? Yes, just follow the lead of the credit agencies’ exaggerated ratings. A traditional crisis? No way, this is the first ever regulator induced crisis I have seen. Wolf acknowledges “contagion” as a cause; the question that remains though is why he does not want to name the virus bearer, namely the credit rating agencies that with their prime ratings catapulted worse than subprime local mortgages into a global crisis.