June 26, 2008

The bank directors have the mother of all the good excuses.

Sir Francesco Guerrera and Peter Thal Larsen wrote a full pager on June 26, 2008 titled “Gone by the Board?” on why the directors of big banks failed to spot the credit risk. Though it is not my intention or role to defend bank directors I must in all honesty say that they completely left out the most important argument the directors could use in their defence.

Just think about a knowledgeable and a responsible director’s chances to convince his fellow directors that the securities backed with subprime mortgages and rated prime by the credit rating agencies and appointed to such a task by the bank regulators themselves were not prime as he had heard rumours that the mortgages were not awarded with the same usual care. None? I would say so.

If you want a board to act you have to let it act and not let them believe that the credit rating agencies are doing the job for them.

June 25, 2008

But the citizens of the oil exporting countries would love to consume…if given a chance.

Sir Martin Wolf says in “How to manage the world economy through two crises” June 25 that the ongoing transfer of wealth from oil-importing countries to oil-exporting countries… from those who spend to those inclined to save… will curb the rise of global demand” and he is right, but it should not have to be that way. The reason for him being right is that the wealth transfers goes into sovereign funds or other government pockets and not to the citizens of the oil-exporting countries who would also gladly step up their consumption.

Today, in Venezuela, I am publishing a fictitious letter from Arnold Schwarzenegger in which he offers to buy on a rolling five years average price 2 million of oil barrels per day to satisfy the needs of his constituency and take the worst volatility out of the market. To stimulate Venezuela entering into such a country he is offering to pay an equal share of the proceeds, to each one of the 26 million citizens of Venezuela, in the currency and in the individual account each one of them would like.


June 23, 2008

Indeed moderation needs to be sustained…but it better be the right kind.

Sir Stephen Cechetti wrote “We need to sustain the great moderation”, June 23, 2008 and I initially thought he meant a “from-now-on”. To my big surprise, reading it I then saw that he refers to the period 1985 to 2005 when the $500bn in home mortgages grew to $9,500bn, signifying debts of about 7 months of the current GDP, and of which $7,500bn was used for securities, as the “moderation” that with some minor tweaking, needs to be sustained.

On what planet does he live? As I see it the most important result of that boom was to make the USA even more energy dependent, in the midts of an environmental threath, and luring many babyboomers to anticipate their current consumption.

Can you imagine how much better the US would have been off if those $9,000bn had gone to infrastructure investments that prepared the US for the new realities?

But of course that could never have happened when the bank regulators all they care about is to stop the banks from defaulting… no matter where the rest of the country ends up.

Indeed moderation needs to be sustained…but it better be the right kind.

June 20, 2008

The real conundrum is… what is the purpose of the banks?

Reading “The conundrum of financial stability” June 20 we get the impression you have been boxed up with those bank regulators for whom everything in life circles around stability, on their watch. You discuss the problem of the central banks having the dual responsibility of macroeconomic and financial stability, but forget that out there, in the real world, stability itself is not enough, we want and we need more.

How the financial systems could help to create decent jobs and avert real threats such as those from arising from climate changes, are issues much more important to discuss than just how banks can avoid to default but, unfortunately, almost by definition, central bankers are not at all interested in those themes, and much less now when having convinced us that they need independence they have been granted their own full stability, given that we cannot fire them.

June 11, 2008

Angela Merkel, helps us understand, thanks! And now credit rating agency Del Sur!

Sir the world at large needs to show Angela Merkel much gratitude for when she says “I think that in the medium term Europe will need a working ratings agency because the robust currency system of the euro has not yet secured sufficient influence over the rules governing the financial markets” June 11, she is in fact daring to lay bare the fault in the whole fundamentals for the use of the credit rating agencies, namely that these agencies could, objectively, without bias, and presumably without mistakes, measure risk.

Not so, whether through bias or through mistakes they are as humans to err and with their signalling lead us in the wrong directions or even over precipices.

I can already hear a hugo chávez call for a credit rating agency Del Sur!

But foremost we need a new direction for our growth

Sir Martin Wolf writes that “Sustaining growth is the 21st century’s big challenge” June 11 but as the article is set in the perspective of the environmental and energy limitations that the world now faces and that Jeffrey Sachs has written a book on a better title would have been “Re-direction growth so as to make it sustainable is the 21st century’s big challenge”.

Now how do you do that? First of all by measuring growth in terms that makes more sense. That a dollar used to buy the family’s third car in a developed country should count as much as the dollar used to pay for the vaccine for a child in Africa does somehow not seem to give us the right compass bearing we need.

June 10, 2008

Why can’t you have sensible long term contracts in oil?

Just the sheer possibility of losing a tenure based on no particular fault of their own, could do wonders for the educational system, infusing it with a minimum required dose of uncertainty, and thereby allowing tenured professors to at least to understand the concept of anxiety.

Sir in “Double, or quit?” June 10, you say that “Volatile prices get in the way of sensible medium-term contracts to produce or deliver oil-intensive goods and services” June 10 and you are right but why on earth you cannot extrapolate that into the need for sensible medium-term or even long term contracts for oil itself, to bring down that uncertainty that hinders more investment is indeed very hard to understand.

June 09, 2008

We need to avoid monopolies or oligopolies in the market of risk-appraisals.

Sir it is indeed comforting to read the president and chief executive of the Federal Reserve Bank of New York Timothy Geithner admit that “Regulation can distort incentives in ways that make the system less safe”; but also disappointing that in his Op-Ed “We can reduce risk in the financial system”, June 9, there is not a word about how the appointment by the regulators of the credit rating agencies as their delegated risk surveyors, reduced the incentives for the rest of the markets to do their own risk appraisals.

We need to avoid monopolies or oligopolies in the market of risk-appraisals.

Sir it is indeed comforting to read the president and chief executive of the Federal Reserve Bank of New York admit that "Regulation can distort incentives in ways that make the system less safe" but also disappointing that in his Op-Ed "We can reduce risk in the financial system" June 9 there is not a word about how the appointment by the regulators of the credit rating agencies as their delegated risk surveyors, reduced the incentives for the rest of the markets to do their own risk appraisals.

June 06, 2008

We need to establish a worthier purpose for our banks than just avoiding a default

Sir Ken Lewis the Chairman of Bank of America in “Markets alone will not lead to a green future” June 6 says that “the private sector needs a stable and predictable regulatory environment with a bias towards clean energy and the green economy”. By doing so, perhaps unwittingly, he points out the major failure of our current bank regulations, which is that they are biased exclusively towards eliminating the risk of bank defaults, as if that is the only risk with the banks for the society. In fact the risk of the banks not doing their part in the development of the society is much more serious than the risk of having to go through a bank crisis.

In this respect instead of applying minimum bank capital regulations base solely on risks of default, most often as measured by the credit rating agencies, we need to give more purpose to banking, perhaps by starting to think in terms of units of risk of defaults per environmental hazard avoided or per decent job created.

More confidence requires more distrust

Sir Robert Jenkins writes that “Confidence is what we need, not more alchemy” June 6, but let us not forget that it was an excess of confidence, by the regulators in the capacity of the credit rating agencies, that caused much of this turmoil. In this sense we could reach the somewhat peculiar conclusion that confidence building must also include distrust building.

June 05, 2008

Free the banks from the chaperones and get the party going!

Sir Charles Goodhart´s and Avinash Persaud´s “A party popper’s guide to financial stability” June 5 reads like the desperation of a garage fixer to fix something with whatever epoxy he can lay his hand on.

I have myself often proposed a progressive tax on banks, based on the-bigger-you-are-the-more-it-will-hurt-if-you-fall-on-me principle but, what on earth do they mean by taxing the growth rate of bank assets, which is what raising capital requirements mean? That slow growing banks can just sit back and trade growth allotments, like if bank assets were carbon type contaminants?

No instead of worrying so much about the possible hangovers why do they not worry more about making the party better. The current risk adverseness implied in the minimum capital requirements based on risk and as measured by the credit rating agencies, have the markets playing boring and unproductive minuets, like consumer finance dressed up as “risk free” securitizations.

The world is clamouring for decent jobs, and if the banks are to help us create them, they need to be given more freedom and responsibility. In that sense, set the capital requirements for banks at a fixed percentage of assets and get the chaperones out of their hair, so that we can get more of that risky salsa that when if times comes for a hangover, makes it at least more bearable... since the party was great!

June 02, 2008

Should not all banking be sustainable?

Sir Lawrence Summers, June 2, gives his “Six principles for a new regulatory order” for the financial system and the next day you publish a full section on “Sustainable Banking” and there is absolutely no connect between them. Should not the ordinary financial sector and its commercial banks also be sustainable?

Ever since the Basel Accord the only thing in the agenda of bank regulators has been to avoid bank defaults and that cannot simply be all the purpose there is to banking. What a big irony that FT and IFC the private sector arm of the World Bank Group can find the need to mention sustainability and even award prizes to banks based on something that does not even appear in Basel I or Basel II or even in the thoughts of bank regulators.

In just the same vein we now read that “World Bank calls for microfinance rules” June 3 saying that “lenders making small loans to poor people in developing countries should be subject to regulation to prevent abusive practices” and we need to ask, does that not apply to lenders making big loans to rich people in developed countries?

The new regulatory order should correct the faults of the old one

Sir Lawrence Summers lists us “Six principles for a new regulatory order” June 2 and I wish to make the following comments. Though I do agree on that the risk of allowing institutions to determine capital levels based on their own risk models neither do I think it is up for the regulators to intrude artificially with their own subjective rulings. As is the differentiated minimum capital requirements based on credit ratings is imposing an arbitrary layer of risk adverseness on top of the market’s own with quite possibly long term dangerous results as society needs risk-taking in order to develop.

With respect to the need of avoiding that the failure of “an individual institution is not itself a source of systemic risk” there would seem to be no other route than placing limits on the size of the institution, perhaps based on a progressive the-bigger-you-are-the-more-it-will-hurt-if-you-default-on-us tax.

Finally there is a fundamental principle that Summers misses, that of avoiding the risk of the market relying too much upon other, such as the credit rating agencies. The least acknowledged lesson learned from the current sub-prime turmoil is that it would not have happened were it not for the credit rating agencies having been too much empowered by the regulators and a new regulatory order that is build without naming the faults of the previous one has little chance to become better.