July 25, 2008

Do not blame the sprinklers, blame the sprinkler inspectors and the smoke detectors

Sir Joseph Stiglitz in Fannies and Freddie’s free lunch July 25 holds that “No insurance industry would provide fire insurance without demanding adequate sprinklers; none would leave it to “self regulation”. But that is what we have done with the financial system.” Wrong. Insurance companies would and should provide fire insurance even if there are no sprinklers, as long as the risk premiums are right. What happened was that the financial regulators outsourced the checking of the sprinklers, and the installation of smoke detectors, to the credit rating agencies and these fouled it all up, reporting no smoke when burning and sprinklers where there were none.

Free lunches just for current homeowners?

Sir Joseph Stiglitz in Fannie’s and Freddie’s free lunch July 25 proposal of “converting the home mortgage deductions into a cashable tax credit” begs the question, and what about those who rent and those who would want to see house prices come down so as to be able to afford one on their own? The Home-Owners Church giving out free lunches only to their own destitute and ignoring all others is starting to look like pure discrimination.

July 24, 2008

It is a myth that the financial markets were freed

Sir Paul de Grauwe writes “Cherished myths have fallen victim to economic reality” July 23 and mentions as one of the fallen that the “financial markets have to be freed from the shackles of government control”. This is simply wrong. The current crisis can be directly blamed on the fact that the regulators shackled the banks and many investors to some government appointed few outsourced risk overseers, the credit rating agencies, and these later led the banks, the investors and the regulators over the subprime mortgage precipice. To make it worse, these shackles are still being fully enforced.

July 18, 2008

We all need an insurance against what they are going to think they have discovered in our DNA

Sir in “The fallacy of the ‛choice agenda’”, July 18, Sir Samuel Brittan enters briefly into asking what will happen to health insurance when DNA records come to provide detailed health prognosis. I would answer, just what happens when credit records provide detailed information to lenders, that the borrowers often get bunched together into small groups of misfortunate outcasts that have to take care of each other. For instance, among the subprime we find those who are not able to serve a loan at very high interests, and therefore lose out, and those who by being able to serve their loan de-facto evidence they deserved a lower rate, and therefore also lost, making it truly hard to distinguish a winner.

Since Brittan also correctly states that “insurance is well suited to covering events that are unpredictable at the individual level” let me say that for over a decade I have held that the most important new insurance coverage we all need is that of the risks derived from what they are going to think they have discovered in our DNA.

Could axing an anti-graft watchdog actually reduce graft?

Sir I read the report by Guy Dinmore and Michael Peel titled “Italian premier to axe anti-graft watchdog” July 18 and was of course duly upset. But then I started to think about the figures mentioned and as a yearly budget of 2.5m Euros to fight corruption in Italy seems not to be sufficient it could actually be more honest, and less corrupt, not having a watchdog at all.

It also reminded me of once when at an anti-graft conference I commented that those selling themselves as “anti-corruption experts” sometimes sounded to me as if they could themselves be involved in an extremely subtle form of corruption. I got some strange looks!

What we need to make sure is that any financial crisis results at least from something worthwhile.

Sir John Eatwell and Avinash Persaud, in “Fannie and Freddie, damned by a Faustian bargain” July 18, write the following: “The main cheerleaders for the marketisation of banking were the gnomes of Basel – the centre of international bank regulation. Many regulators thought the “marketization” of banking represented a brave new world, where grizzled, idiosyncratic lending officers were replaced with best-of-breed credit models, policed by third party rating agencies and, where risk was digitised, spread across a large number of investor and traded. But it was a Faustian bargain…. We need to redraw the lines of financial regulation. A critical objective should be to preserve diversity, not create artificial homogeneity in the blind pursuit of common practice.”

Of course as I have been writing and fighting along those lines for over a decade I totally agree with them on this. But when they suggest that regulators need to focus more on the risk capacity of the institutions, primarily their funding structure, there I lose them. The first think we need to focus on is what the real purpose of our financial system should be since currently it seems limited to avoid any type of crisis and that, besides being unrealistic, sounds like a truly pitiful objective.

Since a financial crisis is natural and will happen no matter what, we need to make sure that any financial crisis at least results from something worthwhile.

Politicians and regulators are the same… they only look out for their own interests.

Sir Erik Berglof and Raghuram Rajan in “Progress in emerging markets is being put at risk” July 18, and as a result of the current crisis that gives oxygen to populism, say that “Many of the actions against the financial sector are proposed in the name of the poor, even though the true beneficiaries are the politicians themselves. Absolutely true, but just in the same vein it can be said that most of the current bank regulations are exclusively the result of regulators only wanting to avoid a crisis on their watch, selfishly not caring a jota about the true development needs of the poor and the not so poor.

July 17, 2008

What would the founding fathers say?

Sir Sam Natapoff recounts part of the US financial history in “Finance and the Fed: the battle is not over” July 17. What I would have found really interesting though is to hear him speculate on what the founding fathers would have said about the following issues:

a. The empowerment of the credit rating agencies with the capacity to influence where the capitals should flow, as they currently do through the minimum capital requirements for the banks that are primarily based on the risk ratings.

b. Favouring the government coffers, because when a bank lends money to the government it does not have to put up any capital, something equivalent to an infinite credit multiplier, but if it instead wants to lend to a private, then the shareholders would have to put up 8 dollars or more for each 100 lent.

c. That the savings of the nation are by means of the current regulatory system strongly biased towards financing sectors that can be construed as low risk, such as mortgage lending (ha!) when compared to other more risky but perhaps more nation developing endeavours such as decent job creation or the reduction of climate change risks.

July 16, 2008

The managers of the oil extracting nations simply cannot manage more oil revenues.

Sir Martin Wolf in “A year of living dangerously for the world’s economy” July 16, quotes Daniel Gros of the Centre for European Policy studies on that oil producers (more correctly oil extractors) will leave oil in the ground if the rise in real oil prices is expected to be faster than the return on the alternative assets. Nonsense! Any private company would at current prices be selling oil like crazy to make their shareholders happy. The problem is that there are no real shareholders in many of the oil extracting countries and so even if their citizens, their equivalent of the shareholders, would love to see more oil revenues coming into their pockets, their respective governments have enough trouble managing the huge oil revenues as is.

Why should on earth should Venezuela extract more oil… if all what the government can thing of doing with it is giving it away to London?

What a splendid moment for an America Union!

Sir when reading Martin Wolf’s “A year of living dangerously for the world’s economy” July 16, and seeing him speculate that in terms of government indebtedness the US could soon look like Italy, I cannot help but thinking about what a particularly splendid moment it would be for the announcement of an American Union between the US, Canada and Central America.

Analyzing these countries you see how well they complement each other in economic terms and so the worst thing that could happen for the US now would be to build borders and shrink their GDP numerator just when the check arrives with a high debt denominator.

July 14, 2008

On averages and dark pools

Sir Rupert Macey-Dare´s suggestion to “Upgrade models to blend in pricing information” July 14, which is sort of looking at the difference between how the market prices risk and how the credit rating agencies see is intuitively attractive. That said we have to remember that an exact average does not signify a perfect average and also the fact that if the dark pools where trading occurs in a hidden way and that have been lately so much mentioned really take off then our market price data might not reflect the real market price.

By the way will there be some ownership of the data in the dark pools that will allow for their commercialization at a price? A new line of business? Dark pools of student grades which parent have to pay for to see?

July 11, 2008

Castigate the regulators

Mr Pietro Calice writes that “Sanctions and enforcement rules are needed to regulate the rating agencies”, FT July 11, but what seems most needed are sanctions and enforcement rules to regulate the regulators. How many financial regulators have been fired having been found sleeping on their job after they outsourced the watch out to the rating agencies? None? Yep!

To me there are clearly none more responsible for the current calamities than the regulators that thought up the crazy idea that it is possible to drive risks out of banking forcing the banks to heed the specific opinions of the credit rating agencies and without creating even larger systemic risk.

These regulators though they perhaps should not be sent to jail, should at least be named, shamed and fired… otherwise all talk of accountability is just a farce. If an impossible construction is contracted out who is really guilty when the construction falls?

I guess it is time for your reporter to change location

Sir I am sorry but Benedict Mander completely misses the angle when in “Red tape congests Venezuela’s roaring car trade”, July 11, he describes the governments “new rules that 30 per cent of cars sold from next April must have dual natural gas and petrol tanks” as something extraordinary. I just need to ask what extraordinary measures he believes the Crown would have to take to reign in car sales if it sold petrol at 4 cents of a dollar per litre and if it subsidized the import of new cars by means of an exchange control system.

When a foreign reporter does not see the absolute grotesque in the state giving away petrol at prices below distribution costs, I guess that reporter has been to long in the country and has become blind to its realities. There is supposedly a study that shows that people after having lived long enough close to a railway station do not even hear the trains, because of natural anatomic process of adjustment.

July 10, 2008

Just another case of managers running their personal agenda.

Sir Daniel Gros writes that “it is no mystery that oil supply has not reacted to higher prices. Producers are just waiting for even higher prices tomorrow”, “The China bubble fuelling record oil prices” July 10 and this is far from the whole truth.

The problem lies in that in the many countries where the oil belongs to the State, the current oil revenues exceed their respective governments’ capabilities to use them rationally, and their respective leaders’ most immediate personal needs, and so there is not a lot of incentives for them to produce more.

If on the other hand in all these countries, where the population still suffers many unsatisfied needs, the oil revenue was to be shared out directly to the citizens, the true shareholders, you would see more supply. Again it is all another case where the management run their personal agenda.

Gros quotes King Abdullah of Saudi Arabia that if additional oil were to be found in his country he would advise leaving it in the ground because “with the grace of God our children might have a better use of it” and this he can say only because the current children of his land have no say on it.

July 09, 2008

Give more freedom to the commercial banks

Sir of course I agree with Frank Partnoy in that we need to “Do away with rating-based rules” July 9 (my over 100 letters on the subject to FT should attest to that) but I would not necessarily stop at picking a substitute like the risk assessments made continuously by the market and as Partnoy seems to suggest, but change the whole current system of minimum capital requirements that differentiates among risks and go for flat percentage capital requirements, that could be higher or lower depending on the conditions of the economy.

That way we put the responsibility for taking the financial decision squarely back on the shoulders of the market and the individual bankers by eliminating the almighty excuse impossible to avoid of “I just followed the advice of the credit rating agencies that my bank regulators appointed”.

The traffic signs set up around the world by the credit rating agencies indicating low risks and the minimum capital requirements for the banks hijacked the commercial banks. It is high time to free them since we do indeed need their cooperation in channelling our resources to more productive uses than the building of subprime-mortgages financial pyramids.

As disaster producers, do not underestimate the humans

Sir John Kay tells us to “Forget the meltdown worry about goo and asteroids” July 9 and his arguments goes along the line that the damage humans can cause is modest relative with the damages nature can cause. On the surface it would seem that he has a point but given that humans are no cats and have only one life it does not really matter whether a disaster is capable of killing you once or a million times over.

Also he should not forget the havoc humans create while trying to tame the nature. Just look at the financial sector. Our risk-busters appointed the credit rating agencies to eliminate the risks and what did these do? They concentrated their prime-rating rays too much on a part of the market so that it exploded, bubbled, only later to implode, hopefully in a bunge, but that will foreseeable cause many sufferings, and worldwide, you can’t hide this fact, many onetime deaths.

Whatever, do not make the poor countries trust they can count on the rich ones

Sir Martin Wolf in “Why the obstacles to a deal on climate are mountainous” July 9, repeats frequent arguments of why the costs associated with the reduction of carbon emissions should be borne by high-income countries. Nothing wrong with that except if doing so makes the poor countries actually believe this is going to be so.

Since I am certain that Martin Wolf like me suspects that the possibilities of the high-income countries picking up the tab on this are almost nil, may I suggest that a more productive and honest line of argument would be on the line of the following:

“You poor countries, you better take special notice since in most of the climate change impact studies you seem to be dangerously exposed and since you most probably will not be helped sufficiently by the rest of the world community, you better stop copying the rich countries unsustainable habits, and start cracking on preparing yourself for the worst, on your own. And who knows, there might even be some great hidden benefits in doing so.”

July 08, 2008

We need a new batch of bank regulators

Sir these days the credit rating agencies are getting pounded on, as they should be, for instance as described by Joanne Chung and Michael Mackenzie in “SEC sees conflicts of interest at rating agencies” July 8, but the really frightening issue is how on earth we landed ourselves some bank regulators that trusted so much the credit rating agencies.

No matter what you believe the credit rating agencies they do not even intend to look into the future, they just extend the past into the future, and so they do not even purport their ratings to be correct, and besides that they are manned by humans and therefore bound to err.

But all that did not stopped the regulators from assigning to the credit ratings agencies the role as supreme risk overseers and by doing so reinforcing the beliefs of all those who wanted to believe that the future is manageable. And, like lemmings, the market followed the officially endorsed credit rating agencies over a precipice, and will do so over and over again. Is it not high time to get us a new batch of bank regulators, some that are more knowledgeable of the very basic facts of life?

July 02, 2008

And the lesson number one is....

Sir, Martin Wolf in “The lessons to be learnt from today’s financial crisis” July 2, 2008 quotes the Bank of International Settlements annual report stating “loans of increasingly poor quality have been made and then sold to the gullible and greedy”. Although I find it hard to think of a market that does not use greed as one of its main motors it is really the “gullible” part of it all that really blows my mind.

Who on earth is BIS to talk about gullibility. Was it not the Basel Committee on Banking Supervision that BIS hosts that set up a system based on credit risk assessments and that appointed the credit rating agencies as the supreme risk measurers? If we normal citizens and investors are gullible of anything it has been of believing that the Basel bank regulations had taken care of the problem once and for all, and that the credit rating agencies knew what they were doing.

BIS also mentions “the inherent procyclicality of the financial system” to argue for tighter monetary conditions when credit soars…but not a word about how the risk rating and the consequent “massive re-rating of risk” can send cyclicality soaring to the moon.

No, if there is a first lesson to be learnt it is that central bankers and bank regulators are, no matter how knowledgeable and pompous they act, only humans prone to err, and so it behoves us not give them too much powers, which is what makes them truly scary and dangerous.

PS. A letter on this theme to FT back in 2004.

PS. Here is a current summary of why I know the risk weighted capital requirements for banks, is dangerous nonsense.