February 29, 2008

Nothing but BIG!

Sir February 29 David Wright0n reports that AIG announced “almost $15bn of writedowns and losses related to subprime mortgage exposures” but that according to Martin Sullivan, the chief executive, “AIG had the ability to absorb the current volatility while committing the resources to grow and take advantage of the opportunities”.

Sir I must admit to feeling frightened by these expressions of nothing but sheer bigness.

February 28, 2008

Don’t just blame Basel II, Basel I where it started is also to blame

Sir Harold Benink and George Kaufman wrote that “Turmoil reveals the inadequacy of Basel II” February 28 and I disagree. Basel II has not even been fully implemented yet and what the turmoil really reveals is that Basel I is also inadequate.

Among other Benink and Kaufman recommends more discipline in the oversight by the markets but mention as a problem the lack of incentives for professional investors to use information in an optimal way. Of course they are right. What is the sustainable incentive in a system that no matter what the bank could think of a credit it is still the credit rating agency that calls the shots? The way out of this conundrum that I have been proposing for quite a while now is to include the minimum capital requirements calculated as current with the help of the credit rating agencies as a footnote and impose on the banks a minimum percentage of capital to assets requirement, for instance 8 percent.

Doing so would free us not only from the regulatory arbitrage that has stimulated banks to hide risks in other places but also from that systemic risk produced by the credit rating agencies and that has entities like the monolines sweating out ways of how to respond to crazy ultimatums type “you got five days to find capital or I downgrade you and you’re history”, something especially painful considering that if the credit rating agencies had done their job correctly in the first place the monolines would never have been in their current predicament.

PS. Update December 2012. When I wrote this comment I was not aware of how much of Basel II had been implemented in Europe and I had also since 1997 been expressing concerns about Basel I. 

February 27, 2008

Sovereign funds are not really that sovereign

Sir John Kay when arguing “Sovereign wealth investment is a force for stability” February 27 says “the lesson of history is that the problems are for the investor not the investee” and that “Investments across borders binds us together by creating actors with much to lose from political tension”. Both arguments clearly point to the fact that when push comes to shove, once committed to an investment, sovereign wealth funds are not really that sovereign.

These days the International Monetary Fund is drafting good conduct rules for the Sovereign Wealth Funds. I wonder if they should take the opportunity to include some good conduct rules about how the countries receiving the investments should behave… or would that infringe too much on someone’s sovereignty? There are arbitrage procedures to settle investor against country dispute but, do these apply in country against country cases?

The bank regulatory system risks turning itself into a Polish cavalry

Sir it is when Martin Wolf expresses concern over how the financial system works that he really makes it clear “Why Washington’s rescue cannot end the crisis story” February 27.

This is no ordinary crisis that requires an ordinary cavalry led by a John Wayne to rescue some poor pioneers from being scalped by the Indians. No, this is a much more serious affair that starts with having to question some of Wayne’s adjutants, the credit rating agencies, about their role in seducing capital inflows from foreigners to a non-existent El Dorado, by telling stories about great ratings around the world’s market-fires.

And so, to really end this crisis we need to revise the overall fundaments of the current regulatory system because if not, next time, our valiant John Wayne could end up commandeering something like the last charge of the polish cavalry against enemies much more dangerous than some yelling Sioux.

February 26, 2008

They have not even imagined how right they are

Sir having for more than thirty years argued about the dangers for the bathtubs of a small economies to lie completely open next to the global financial oceans exposed to their tsunamis I could not but fully agree with the general direction of Dani Rodrik’s and Arvind Subramanian’s “Why we need to curb global flows of capital” February 26.

Having said that I would much rather use the term “slow” than “curb” because it is the speed of how the financial resources move that causes the most damages.

But let me put forward a much more important comment. When the authors say that one should not be “too optimistic about the potential of prudential regulation to stem excessive risk-taking” they are more right than they have imagined in their wildest dreams or wildest hypothesis. In fact, it was precisely the running away from the risks, forced upon the financial market by the regulators through their minimum capital requirements for the banks and that was based exclusively on risk-assessments carried out by the regulator’s own outsourced risk overseers, the credit rating agencies that set us up to all what is currently happening.

February 25, 2008

Help the subprime´s go prime

Sir for a holder of a house mortgage the worth of it depends on the credit-worthiness of the debtor. For instance a thousand dollars paid each month servicing a mortgage during 15 years, when discounted at 11 percent per year, because the borrower is deemed “risky”, is worth only 88.000 dollars today, but exactly the same monthly one thousand dollars when discounted at only 6 percent because the borrower is deemed creditworthy, is worth 118.500…35 percent more! Herein lies one of the real problems of the subprime debtors… not only do they have less money but the little money they have is also worth less.

Lawrence Summers in “America needs a way to stem foreclosures”, February 25 speaks about the need for the creditor, when they “accept a write-down in the value to their claims, to retain an interest in the future appreciation if the homes on which they have mortgages”. This might be correct from an economist’s long term point of view but unfortunately bears little or no relevance to our mark-to-market accounting rules that do not look at future house values. Instead, was the creditor, when accepting a write-down, to obtain an additional guarantee that improves the rating of the mortgage, then the creditor could immediately cash in this on his balance sheet.

It is amazing how little money up-front can go a long way solving long term problems. If you want to go down memory lane, a similar principle was used behind the “Brady bonds” issued in the 80s to help developing countries manage their debts. Is it not time for some similar creativity to help your own citizens?

February 24, 2008

Sorry music industry, the ball is completely in your park

Sir in “The ISP police” February 23 it is when you say “The music industry meanwhile, must help itself and offer cheap, accessible downloads to expand the legal online market” that you get to the inescapable truth about the piracy of music at the internet.

For bad and for worse, the internet signifies and immense technological breakthrough and that has the power of changing society even more than music, something which as a true music lover it pains me to say.

We can not therefore hold back the society from fully exploiting the potential of the internet just in order to accommodate to the collection of music copyrights; much less can we afford to criminalize the hundred of millions of persons that are de facto and de jure infringing on copy rights; much less can we afford to dedicate scarce resources in the pursuit of these crimes when there are so many worse threats calling for our attention; much less can we afford to create in the music market another booming market opportunity for the entrepreneurs of illegal activities.

And so, sorry music industry, the ball, or in this case the song, is completely in your park

Recognizing you don’t either have a clue is a good place to start

Sir in your “Dangerous animals in the banking zoo” February 23 you suggest that the banks need traders with trading mentality in order to supervise the traders. This might indeed help to reduce some operational risks but, unless you have managed to tame those supervising traders into non-trader bankers the question then becomes who will supervise them.

Exactly the same fundamental approach as you are suggesting led the regulators to appoint the credit rating agencies as the knowledgeable risk overseers and see how far that has taken us. The credit rating agencies have now become themselves our largest systemic risk creator running around correcting their mistakes, downgrading here and there and placing ultimatums like “raise your capital in 48 hours or I will downgrade you”.

No, why do we not try something of the old traditional sensible stuff like not getting involved in something we do not fully understand and place through the banks professionals with sufficient moral standing to admit to that fact when it is true.

Come to think about it why does not FT give a good example and spell out that it does not understand it at all either, before suggesting we dig ourselves deeper in a trading hole.

February 22, 2008

Sounds like a lot of butterfly wing flapping!

Sir Marc Chandler in his “This is the rainy day Japan’s reserves are meant for” February 22 suggests that Japan should give $242bn of their reserves to the Japanese so as to boost the internal demand. Great idea! Pity though that bringing home $242bn while the sun is not really shining on the US economy sounds a fraction more than a butterfly flapping its wings and will cause some other effects to the economy of the world.

The credit rating agencies are private public servants.

Sir Jean-Louis Beffa and Xavier Ragot in “The fall of a financial model” February 22, describe the “present standard model of financial capitalism” as “mainly based on the self-regulation of the financial sector, which alone assesses the risks produced by its financial innovations”. Sorry, in what world do they live?

Currently the most important risk assessments are not provided internally by the financial sector but forced upon it by those outsourced risk-measure government bureaucrats we all know as the credit rating agencies. The fact that these agents are private does not make them less public servants

Careful with the systemic risks of supremacy

Sir Gillian Tett is at her most insightful self when she recurs to the background in anthropology to analyze the financial sector as she does in “CDO buffs who schmooze could resolve a financial mess” February 22.

Now if only she drew more on that background when drawing her conclusions then all would be great, since as she goes into a trance of supremacy founded expectancies wishing for schmoozing geeks or geeky schmoozers, we start to shiver thinking of an even worse generation of systemic errors than those that the credit rating agents are already providing the financial sector. No, humanities best and only hope might be that geeks and schmoozers don’t fusion into one.

February 20, 2008

A proposal for a reasonable regulatory forbearance

Sir Martin Wolf in “America’s economy risks the mother of all meltdowns” February 20 quotes Nouriel Roubini mentioning as one of the reasons that the Fed finds it so hard to head the danger off is that “regulators cannot find a good middle way between transparency over losses and regulatory forbearance”. I do not agree. It might not be perfect but a good way to start doing that would be to give the banks a longer time to adjust their capital requirements to the down ratings produced by the credit rating agencies on credits that should never have received good credit ratings to begin with.

I mean what is the need to compound the misery of the banks by forcing them to raise new capital immediately? To do so amounts almost to extortion that could only cause banks having to raise unnecessary expensive capital; which would do no one but some vultures any good. It is like the doctor suddenly informing a person that he has gained hundred pounds over the last two years and forcing him to shed that weight before next Tuesday. A scalpel?

If I were a bank president I would be raving mad with the regulators. First they tell me I have to raise capital in accordance with what their outsourced credit rating agents tell me and then when these go madly wrong they make me pay for it immediately.

Think tanks are also to be blamed for their lack of thinking

Sir Desmond Lachman from the American Enterprise Institute writes that “Greenspan will have to be called to account for regulatory failings and his interest rate policy” February 20. That might very well be so but others must also recognize their failings in the process. For instance not alerting to the abominable systemic risks that could be created by investing so much power over the financial markets into the hands of the credit rating agencies is more than proof that very little thinking occurred in the think tanks.

February 19, 2008

How the Financial Times got duped

If the Bank of England had decided to appoint some bureaucrat to rate credits for the purpose of deciding how much capital the banks needed to set aside in order to be allowed to give any credit I am sure the Financial Times would be up in arms screaming something about a bloody central planning. But by outsourcing these exact same functions to the private credit rating agencies, the central planners managed to dupe the Financial Times into believing that this was indeed the voice of the market.

In the letter from Michael Djordjevich “The lessons of the sad demise of bond insurance” February 19, we read “Rating agencies that held the key to the future of this industry accepted this concept of intertwining two basically incompatible risks”. I wonder what it will take for a Financial Times to realize that a bureaucrat is still a bureaucrat and a human is still a human prone to human error no matter if he is in public or private employment.

Sir, please help us to get the central planning monopolies that the outsourced credit rating agencies really are out of the financial world. In just a few years the credit rating agencies have managed to turn themselves into one of the biggest systemic risk the world faces.

February 16, 2008

FT should take care not to become a pink pamphlet

Sir with Ingram Pinn’s caricature “Olympic Spirit” February 16, which could easily have appeared in an extremist pamphlet, FT has let us down.

To even imply that the US qualifies to compete in the world league of torture (in this case waterboard) is to completely lose the perspective and play right into the hands of those foes of the US and of the rest of us who would love that to be so. I do fear this “without favour” of yours!

February 15, 2008

Assign to the diasporas a chair at the World Bank

Sir Michael Fullilove in “The world must adapt to diasporas” February 15, holds out that the “world would profit from developing an understanding…of diasporas issues” and I could not agree more.

As a former Executive Director at the World Bank (2002-2004) I believe that instead of wasting our time reshuffling the votes among geographically bound my-own-backyard interests, we need to assign one of the chairs at the board of the World Bank to the working emigrants community (and another one to the multinationals).

In 2007 the emigrant workers of El Salvador remitted to their homeland 3.7 billion dollars which, if this amount represents fifteen percent of their earnings means that their gross income was around 24.7 billion dollar. The official GDP of El Salvador, if we reduce it by the amount of the remittances, is then only 14.8 billion dollars. Now, you tell me ¿where is really El Salvador? Should not the Salvadorian diasporas have 50% of the seats on the Legislative Assembly of El Salvador?

Doing the same operation as above for the whole world we calculated that the Gross Diaspora Product is greater than that of the GDP of India, perhaps even China’s, and so why should not the diasporas sit at the executive board of a World Bank in globalized times?

February 13, 2008

Does FT have a conflict of interest?

In your editorial “Subprime chains” February 13, when writing about the wrong incentives that led to the current crisis; even asking for “regulation that increases the average size and stability of brokers”, as if size of a brokerage firm has anything to do with the accumulated stability of a market (if anything the contrary), you do not even mention the fact that had it not been for the good ratings given to the subprime mortgages backed securities by the credit rating agencies neither banks or brokers would have had neither the tools or the incentives to create any subprime mortgage mess.

I know that McGraw-Hill owns Standard & Poor’s. Does FT have a similar conflict of interest that could cloud its “Without fear and without doubt” with relation to the credit rating agencies?

An explanation yes, but not an excuse for the cowards

Sir John Kay is right when in “Bankers, like gangs, just get carried away” February 13, he puts the bank bosses role in perspective by arguing that “the gang leader, despite his apparently unquestioned authority, is frequently the prisoner of the gang members.” This applies to so many different realities, like one could currently even say that a hugo chávez is a prisoner of the hugo chávez gang. Let us remember though that this could serve as an explanation but never as an excuse.

The fact that it might be easier to pinpoint guilt on a Jérome Kerviel does not really mean that he is more guilty that all his superiors who delve in matters that are much harder to understand; since the not understanding a iota but not being man enough to be able to say so is what mostly lies behind this current financial turmoil.

February 12, 2008

FT seems not to want to see the forest because of the trees.

Sir your editorial “Ratings reform” February 12 shows that you like others quite stubbornly do not really want see the forest because of the trees.

You write it is ”meaningless to say that the ratings agencies were wrong in hindsight – the question is whether they made responsible use of the data they had in 2006 or early 2007”. Hold it there! This is not a question of given points for performance or style in a high jump contest. The credit ratings were empowered by the regulators to impose on the market their criteria not because they were going to responsibly use any specific methodology but because they were supposed to be right! If they cannot be right...who cares about whether they act responsibly or not... we do not need them...in fact the more credible they are the more the dangers that we will follow them where we should not.

Yes I do blame the credit rating agencies, who should as a bare minimum inspected a sample of the subprime mortgages offered as a collateral to see if they even belonged to the same universe of data they had before taking them as a good guarantee, but, much more do I blame the regulators who empowered the credit rating agencies to begin with and thereby set us up to extremely dangerous systemic risks.

February 10, 2008

Stripe the credit rating agencies´ powers

Sir “Ratings agencies move to restore the credibility” by Saskia Scholtes, February 7 and “Rating agencies face struggle to make the grade” by Michael Mackenzie, February 9 are but two of thousand of articles that refer to how the credit rating agencies will try to make amend and become better.

Unfortunately, our real underlying structural problem goes into the complete opposite direction. The more the few we have empowered to tell us about where to go get better at it, the more likely we all are to follow them where we should not go.

Allow for credit rating agencies, they are useful, but please stripe them from their artificial powers.

Would shorting England be acceptable?

Sir Christopher Caldwell concludes his “Why Kerviel is so unsettling” February 9, saying “The problem is not the rise of the super-empowered individual. It is that the super-empowered individual tends more and more to be an amoral individual.” He is right of course but how did we get here?

We have currently a system that allows for the creation of all kinds of amoral vested interests…like making profits out of an increased mortgage default rate, something not much different from having allowed Englishman to short England and created a group of nationals with a transparent and legal vested interest in Hitler winning the war.

Also when Caldwell refers to “What is striking here is the contrast between the mediocrity of the trader and the scale of the catastrophe” this is really peanuts when compared to the contrast between the super-sophistication of the financial wizards and the credit rating experts and the scale of our current catastrophe.

Unsettling indeed is how we settle to focus on Kerviel as our convenient scapegoat. Hang Kerviel we’re innocent!

February 08, 2008

Installing fire detectors at the insurers against fire

Sir William Gross is most probably right in that “Rescuing monolines is not a long term solution” February 8, but it might be an expeditious short term approach to buy us some time to find a solution or at least lower the temperature of an overheated financial system.

That the whole issue is tremendously confusing there could be no doubt. It all sounds like having to help the insurance company that covers your home against the risk of fire, to pay for the installation of fire detectors in their offices, so that they do not burn up and leave you standing alone on your yet unburned but still at risk of a fire property.

Narrow banks just reflect narrow minds

Sir, as the confusion that reigns in the financial world grows more people will hang their hopes on the alternative of “Narrow banking” which by restricting some banks to hold only liquid and safe government bonds is supposed to provide us a super-duper safe bank.

Let me sincerely doubt that just because we already show so much faith in governments and politicians accepting their currency based on their implicit well behaviour we are to be much safer by depositing those funds back with the same governments and politicians.

In the current bank regulations that emanated from Basel little is spoken about the almost conspiratorial subsidies to public debt that have been created by requiring so little bank capital to be held against it and that thereby also signals that the public debt does not carry risks. With such behaviours how surprised should we be seeing the current levels of public debt growing and growing… until the true reality of risk catches up?

What happens to the environment is indeed a risk that finance ministers should talk more about

Sir the finance ministers from the US the UK and Japan speak with one voice when in “Financial bridge from dirty to clean” February 8, they say that without a global investment framework built on market incentives the global deployment of clean energy technologies is going to be very difficult but they also note that not doing so will be very risky for us all.

Well this is exactly the sort of real societal risks that were ignored by financial regulators when they designed the minimum capital requirements for banks based on a very narrow definition of risk namely that of a default. If a default occurs because someone was trying to help the planet it would seem like something more acceptable to the society if there were no default but the bank was financing the purchase of a new car that will produce more carbon.

It is not that I am saying that banks should take stupid risks in environmental protection projects…but neither should finance ministers through their regulations create non-transparent subsidies for what just the credit rating agencies believe are low risk projects while ignoring all other risks faced by humanity.

If a bank lends a AAA corporate client a 100 dollars the bank need 1.6 dollars in capital if it lends to riskier below BB- reacted environmental project the bank needs 12 dollars in capital. Is this what the minister’s mean with market incentives?

February 07, 2008

Basel II just keeps digging the hole of Basel I

Sir, Charles Freeland a Former Deputy Secretary-General of the Basel Committee on Banking Supervision considers “Basel II a big improvement on outdated model” February 7, and the outdated model he refers to is Basel I which has been in place for only about ten years.

I do not think it of Basel II as an improvement but jut as a further digging ourselves into a very dangerous hole. Now, instead of going back to the freedom of the markets, besides keeping on using the outsourced bureaucrats of the credit rating agencies to measure risk (Basel I) we are with Basel II also allowing some big banks to do their own internal risk modelling, and this even when we have recently witnessed how much intrinsic risk these models create by themselves and how bad they can really be. This is all plain crazy!

I would much prefer setting an 8 percent minimum capital requirement on all the credits (including those to the public sector) and assist the market producing the information it needs to take it from there.

And, just to make certain we do not put all the eggs in the same basket, I would start thinking about a progressive tax on the size of the banks. “The bigger you are the more it will hurt if you fall on me and so the higher must the insurance premium I charge you be”

February 06, 2008

But why should we keep the financial sector caged?

Sir Martin Wolf explaining “Why it is so hard to keep the financial sector caged” February 6, gives us ground to ask… are we supposed to cage the financial sector?

Besides offering a safe passage for our savings is not the financial sector also there to assist the society in the generation of decent jobs and the distribution of opportunities?

We have for soon two decades been led by the bank regulators into a risk-adverse frame of mind that carries with it significant other risks.

I hold that instead of minimizing risks, which one could do at least on paper by not taking any risks; and instead of focusing only on the possible crisis event, we need a much more holistic view and that at least starts by measuring the full results of the boom-bust cycle to see if, on the whole, it was worthwhile for the society at large, and most specially for future generations.

The Financial Times has teamed up with the International Finance Corporation (IFC) which is part of the World Bank Group to offer "The Sustainable Bank of the Year Award” and where it recognizes "the bank that has shown excellence in creating environmental, social and financial value across its operations." It is a great idea but why not take that opportunity to reflect upon that none of those worthy goals receive any incentive from the regulator, who's only concern in life is lessening the risks.

Not to risk anything for nothing is much worse than to risk all for something. Let us never forget that risk is the oxygen of development and that “No woman no cry” was not written for us to stop crying.

The irony of it all is that the regulator in all their risk/adverseness also created those new sources of systemic risks that have acted as detonator for our current turmoil; namely the empowerment of the credit rating agencies as their outsourced bureaucrats in charge of measuring the risks; and whom the markets blindly followed into subprime quick-sand laden swamps.

February 05, 2008

Harmonizing also carries its risk

Sir Francisco González is most probably a great banker and I suppose he can tell us a lot of “What banks can learn from this credit crisis” February 5. Unfortunately both he, as a banker, and just as the regulators are, find themselves to close to the trees to see the full forest.

For instance when Gonzalez speaks in favour of more harmonization it sounds oh so sweet, but I shiver, because history has told us that humans run almost the same risks of harmonizing around good ideas than around bad; and so the expected result of it all is less volatility…until a very big bang. Exactly the same way we got into our current mess…credit rating agencies were doing well, we left down our guard, and to the floor we went, knocked down with some really crazy prime rated subprime mortgages.

As I see it the only financial regulations that really works is to install the continuous questioning of it all, and to but your eggs in as many baskets as possible; even though a Mr González running a super-basket may not particularly like it.

González consoles us with “the good news is that the crisis has exploded during a phase of robust global economic growth and before it could produce long-lasting damage”. Yes, let us all pray that he is indeed right, but never without forgetting that this could just as easily have happened under much more dire circumstances.

Clarity about what?

Sir Michael Mackenzie and Stacy Marie Ishmael report that “Moody’s offers to change debt rating system” basically substituting a number up to 21 for their current letters, presumably to increase clarity. Clarity about what? Risks? In that case the more confusing the reporting system perhaps the less prone it is to transmit the sense of clarity and exactness that does not exist. In this the current system is more adequately confusing.

February 04, 2008

FT Sustainable Banking Awards

The Financial Times and IFC have teamed up to create the following competition.

"The Emerging Markets Sustainable Bank of the Year Award recognizes the emerging markets bank that has shown excellence in creating environmental, social and financial value across its operations."

Sounds great but, if creating environmental, social and financial value across its operation is as I gather the promoters believe a worthwhile goal, then why do they not ask the regulators to send clearer signals about it to the banks in the emerging nations.

From what we can observe the regulators are currently signalling minimum capital requirements based exclusively on the reduction of risks as perceived by those outsourced risk surveyors we know as the credit rating agencies.

But if you want to give incentives so as to obtain the results the promoters seem to wish, then you might be better of sending clearer signals than those of a competition. For instance why do you not set up minimum capital requirements based on the rating of environmental, social and financial value creation? And, if you do, why not throw in something about job creation too, which also seems something quite worthwhile for the banks to do.

That is if course unless all what is meant when referring to sustainable is solely the sustainability of the banks themselves.

Don’t blame Basel II, it’s Basel I that got us here!

Sir, you are publishing many letters, like for instance on February 4, that blame Basel II for our current financial turmoil. Not true. The genesis of it all lies squarely with the original Basel Accord and its first implementation, Basel I. That is when our regulators decided to enforce a system of minimum capital requirements on the banks and to empower the bureaucrats of the credit rating agencies as their outsourced risk surveyors.

The whole Basel affair is just another example of the dictatorship of information and knowledge that places all the decision in hands of specialists whom in this case, with the usual arrogance of specialists, thought they could control risk and completely ignored that there is nothing as risky as the risk you believe you have under control.

What do we learn from this all? The same old lesson! Listen to the experts but do not, under any circumstances, give them power to control it all, as that will, by virtue of incestuous degeneration, put in force uncontrollable and very dangerous forces.

February 02, 2008

Should we freeze the ratings too?

Sir Aline van Duyn in “Stakes in the ratings game are being rapidly raised” February 2, describes very well the consequences of our financial regulators having empowered financial Frankensteins to tell the world about where the risks were. How do we now rein them in?
Perhaps having thought about interest rate freezing it could also behove us to take a closer look at the freezing of ratings? I mean what useful purpose could it serve getting all the bad news simultaneously when we can’t really digest them rationally? Especially since they are in fact really old news since they should never have gotten their good ratings to begin.