September 27, 2008

Why does the Financial Times ignore the only legitimate children of the latest interventions?

Sir “In praise of free markets” September 27, you do not even mention that the financial markets are not free at all since they have to follow or are induced to follow the criteria of a few credit rating agencies that for all practical purposes are just outsourced government agents.

Also saying that “subprime mortgages grew because the subprime mortgage sector was dominated by Fannie Mae and Freddie Mac” blithely ignores the fact that it is indeed possible to provide the subprime sector with excellent mortgages, and which has been done for many decades, and hides the truth that what went wrong was that extremely lousy awarded mortgages were given wings to travel all over the globe because the credit rating agencies blessed them with their AAA.

You talk of the “child of other interventions” but you do not even mention the only two formally recognized legitimate children of the latest interventions and that are present in the current regulations from Basel namely the minimum capital requirements imposed on the banks based on a vaguely defined concept of risk and, of course the use of the credit rating agencies.

Why does the Financial Times ignore these children? Are you not free?

September 26, 2008

To restore confidence in banks you need first to restore the banks self-confidence

Sir in “Need for action on the banking panic” September 26, you open with a “Banks are not to be trusted” and you mention that this is the view of the public and policymakers, and that something needs to be done. You then propose very sensible steps, all with which I fully agree, but you leave out the vital task of rebuilding the self confidence of the banks, and that was effectively lost when the regulators declared the banks not trustworthy and imposed on them the credit rating agencies as the risk measuring experts.

My first action as a regulator would be to tell the markets…

“Hold it there, those that really got us all into trouble were the credit rating agencies and we are very sorry we empowered them so much. Therefore, effective immediately we suspend all the regulations that assign a formal role to the credit rating agencies. Truth be said, admittedly late, we do believe that the banks are more capable if they have all the authority to decide on their own what is best for them.”

September 23, 2008

There is a cultural war looming on the financial front

Sir Gillian Tett writes that the “Era of leverage is over” September 23 but sort of mulls over the fact that leverage is not an absolute financial value but only another dimension of risk, since a zero leveraged investment in something risky could be more risky than a 100:1 leveraged investment in something less risky. The problem, as always, is who is to determine the risk.

When Gillian Tett mentions that “Basel Two capital rules will now force banks to hold more capital against esoteric assets” it is a great moment to remind ourselves how extraordinary little esoteric those lousily awarded mortgages to the subprime sector really were.

In the US there is a lot of talk about a cultural war breaking out on the political front but the stage is also set for a cultural war on the financial front; between those who believe that markets should be allowed to freely determine risks and those who believe in soviet-styled-central-planning and feel that, even having to face the current disaster, this is best left in the hands of official risk-kommissars, which is what the outsourced credit rating agencies really are.

September 22, 2008

If only we knew where Münchau’s 100bn of losses where

Sir Wolfgang Münchau does a great job reducing a 62.000bn market size of Credit Default Swaps down to “possible losses [that] might be below 100bn.” “Defaults will test a fair-weather construction” September 22.

Though I believe he is entirely right in his assumptions, the journey there is fraught with dangers that could attempt against reaching such a favourable outcome, like “offsetting claims in the other direction” is not easy when so many counter-parties are immersed in confusions of their own, and no one seems capable to answer…Where are those damn 100bn?

Have a nice cuppa tea.

Sir Gillian Tett gives the best and most timely advice I have yet heard in these days of financial turbulence… “have a nice cup of tea”, “Calm must prevail in war of psychology” September 22, good for her. If Paulson could benefit from reading up on the Swedish model of handling a bank crisis he would also do well by mustering a very British stiff upper lip.
P.S. Living in the US I am fed up though with the word “prevail”

September 20, 2008

But bad information was leveraged even more, sort of a million to one

Sir, John Plender writes in Capital in convulsion about “toxic assets” and that “allowing investment banks to be leveraged to the tune of 30:1 is like Russian roulette with five out of the six chambers loaded”, September 20. Yes, but let us not ignore that most of the toxicity has less to do with the assets as such and more with the lack of understanding of them; and that it was the financial regulators that leveraged, sort of a million to one, the impact of bad information flows, and effectively turned the credit rating agencies into single chambered guns loaded with nuclear devices.

September 19, 2008

And… what about the folly of a generation of Editors who did not question sufficiently?

Sir, you are the Financial Times, and in “Central banks: a survival guide” September 19, you dare, without blushing, refer to the “follies of a generation of irresponsible financiers”? Where does that leave you? Did you “without fear and without favour” ask, timely, the questions that needed to be asked? Like, is it not an arrogant folly to believe risks can be measured, so completely that thereafter you can place our global financial risk surveillance in the hands of some few credit rating agencies without concentrating the risks?

When I started my it was because I felt that the Financial Times “also need some checks-and-balances, of those that do not always have to be approved by the Editor”. I had no idea how right I was… though when I was told that in order for my letters to be published I should not send too many, I started to suspect it.

Sir, the current generation of financiers are not more or less responsible than past generations of financiers… they just got swooped up in some the crazy and uncontested notions of their times. In the words of Albert Einstein “It is harder to crack a prejudice than an atom”.

Take it easy on global rules…some global leveraging has already been too much!

Sir Philip Stephens in “After the crash: why global capitalism needs global rules” September 19, mentions that “mistakes of recent years have not been so much about the absence of regulation, but a failure to act. The central bankers and the regulators were simply asleep on the job”. I do not think Stephen is really aware of how right he is.

The regulators overregulated the imposition of sentries on the financial markets, the credit rating agencies, to watch out for risks and with that everyone went to sleep; markets, regulators and at the end even the sentries.

And so when designing next round of global rules it would be helpful to do so with the humility that comes from accepting that in the initial efforts of generating a good global financial public-goods, such as the use of the credit rating agencies, they seem actually to have produced a public-bad. If a subprime mortgage is awarded in an irresponsible way, you want to keep it local; you do not want to give them AAA wings to fly.

Worse than the admiration of the golden calf is the mutual admiration between the golden calves.

Sir David Bodanis in “How we were all blinded by the golden calf”, September 19, says “Raise an institution such as the unfettered financial world to the role of an idol and you are not critical of anything it does.” He is right though I would have to add that even more blinding than that is the mutual admiration between the golden calves.

Suffice to look at how all our financial regulators belong to the same club, with all the members having exactly the same set of mind and priorities in life namely “whatever… except for a bank-default, on my watch”; and where even those who are supposed to provide regulators with oversight overwhelmingly belong to the same club.

How is a club of mutual admiration born? One way is to create a debate forum reserved for “the world’s most influential economists” and then make sure that you never analyze why the members of the group did not help to influence in averting disasters like the current financial crisis.

It was the regulators that initiated the fetishisation of the credit rating agencies

Sir Paul J. Davies in “The false of security at the heart of the credit crunch” September 19 relates how Peter Fisher, a former undersecretary for domestic finance at the US Treasury explains that it was the financial systems extreme “reliance on the supremacy of secured asset based lending” or the “fetishisation of collateral” that made a necessity out of the credit ratings agencies, because a “credit rating is the bare minimum that can be taken in lieu of any real inquiry into a borrower’s cash flow”.

Absolutely not! First, there is nothing wrong with secured asset based lending if the value or cash flow generated by those assets has been correctly assessed. Second, a credit rating, if done right, should of course include a real inquiry into the borrower’s cash flow. The fetishisation of the credit rating agencies occurred primarily because the regulatory authorities declared the credit ratings so correct that they could be used, for instance, to determine the minimum capital requirements of the banks. And, lets be frank, if the regulators believed that much in the credit rating agencies, how could you really expect stop that kind of blind-faith from permeating the rest of the market?

Let us make good and permanent use of our disorientation.

Sir Gillian Tett writes that “Gridlock and panic follow loss of compass” September 19 and wants to know “how to end the disorientation”. As I see it though our current problems derives more from the regulators having imposed too much orientation believing themselves and making the markets to believe that a financial risk compass was just like any other compass.

In this respect we should perhaps welcome our disorientation and use it to diminish dramatically the role of the credit rating agencies, so that we do not follow them next time around over a precipice even more dangerous than that of the lousily awarded subprime mortgages.

September 18, 2008

The risks never gone are now coming back with vengeance.

Sir Roger Altman in “Modern history greatest regulatory failure” September 18 ascribes this to the extraordinary leverage that some institutions took on and the development of a huge financial system outside the normal banking network.

He is right in the secondary causes but the origin of the whole leisured and blasé attitude to risks of the market that allowed for leverage to happen had its origin in the crazy notion that you can have some credit rating agencies correctly measuring risks without creating systemic risks; and the push for a system outside of banking was a direct result of the regulatory arbitrage that arose when the regulators imposed on banks minimum capital requirements based on risks.

Everyone were busy congratulating each other they had beat the risks and so everyone relaxed… and there you have it, the risks never gone are now coming back with vengeance.

September 17, 2008

Martin Wolf (even when told) does not discern the gorilla in the room

Sir Martin Wolf writes about “a shift in the psychology of supervision away from the presumption that institutions know what they are doing”, “The end of lightly regulated finance has come far closer”, September 17. It is further proof on how many can’t see the gorilla in the room, even when told.

If a father tells his son “you can go anywhere you want as long as you take your governess with you” is he being a trusting father? No! Just like the current regulatory system that obliges the financial sector to take the credit rating agencies with them wherever they go cannot be regarded as a liberal letting the sector free to roam.

The credit rating agencies were the governess and the gorilla in the financial sector. The investors who were all very strongly signalled by the regulators to heed their opinions, let down their guard and went where the credit agencies told them there was no risk to go, for instance into the land of the securities collateralized with lousily issued subprime mortgages.

Martin Wolf refers to John Kay opining “regulators cannot successfully second guess the decisions of huge institutions staffed by better paid and more highly motivated people than themselves”. That is exactly what the regulators were doing when they outsourced risk assessments to credit rating agencies and imposed them on the markets.

In a letter to the Editor of the Financial Times published May 11, 2003 I said “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds". To me my comment illustrated what should be a natural concern for financial regulators expected foremost to be wise… but they did not seem to care. To me my comment illustrated what should be a natural concern for all influential economists and financial experts… but no one of them said a word. How come?

In being able to answer that question, forthrightly, lies the way out of our current financial predicaments and our only chance for not ending up someplace even worse... which is always a possibility.

All financial literature is crowded with the concept of a “risk-free rate”, google it, and though it is accepted as only a theoretical construction, think about what just those two words, “risk-free”, could be doing to inflate our regulatory egos and instincts.

Accountability, for all!

Sir I find it strange to say the least that a professor of economics at Harvard University and a former chief economist of the International Monetary Fund can write an article as “America will need a $1,000bn bail-out”, September 17, from such a detached observer’s point of view, as if he had absolutely nothing whatsoever to do with the current mess.

Where was Kenneth Rogoff when a world needed to be told that, as a financial regulator, you just do not go out and decide that risk can be measured, and outsource that measurement to a few credit rating agencies, and tell the banks they have to raise capital in accordance to what those few credit ratings opine, and then think that nothing systemic would come out of that?

Accountability Professor! You too!

September 11, 2008

What U.S. risk is FT exactly referring to?

Yesterday, September 10 FT had on its first page a report signed by Krishna Guha Michael Mackenzie and Nicole Bullock that spoke about “the cost of insuring against a US default crept higher” and referencing a price for insuring that “implied that the US was more likely to default on its obligation than” several other countries.

Today, September 11, John Gapper in “Take this weekend off, Hank” apparently also finds a need to mention “that credit rating agencies had to declare to the investors that the Fannie and Freddie bail-out would not affect the country’s triple A sovereign rating.”

Given that US debt is issued in dollars, what exactly does this U.S credit risk insurance that you are talking of cover? The risk that they will run out of paper and ink at the US Bureau of Engraving and Printing?

September 10, 2008

But then where were the world’s most influential economists?

Sir Martin Wolf asks of the US government to “spare us homilies on the sacred role of free financial markets for a long time” and with sarcasm refers to financial geniuses that transmuted simple assets into assets so non-transparent that the market ultimately imploded”, “America’s housing solution is not a good one to follow” September 10.

It leaves me asking where were all the “world’s most influential economists” when they were needed to alert that allowing the financial regulators to impose the credit rating agencies on the markets so much made them far from free and was plain crazy since “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds”? The last quote is from a letter published in FT on May 11, 2003 and written by someone unfortunately not sufficiently influential, namely me.

September 05, 2008

But at least now we know that skies can indeed fall!

Sir Martin Wolf's laudable exercise in citizen responsibility "Why the sky may not be falling", September 5, asks whether, besides Gordon Brown, "anybody else believe the business cycle could be eliminated?" The answer, unfortunately, is yes.

All those financial regulators who empowered credit rating agencies to act as traffic cops directing the flows of funds flashing their risk signs; and believed the tall tale that the risks could be diluted in the global oceans or managed by those able to do so, also believed implicitly that the business cycles could be eliminated and that the sky could not fall.

September 03, 2008

Donors should cap aid concentration in Africa… and everywhere

Sir, coming from an oil cursed country (Venezuela) and knowing too much about having to live with governments that are made wealthy independently from their citizens, I absolutely agree with the general concept that Adrian Wood expresses in “How donors should cap aid in Africa” September 3, though I cannot understand why he makes a specific exclusion in the calculations of the revenues from oil and minerals.

If we are to have sustainable democracies, where governments are accountable to their citizen, then a rule that caps all the revenue that the State obtains, whether from aid, oil or whatever not paid directly to it through non-coercive means by their own citizens, to a certain percentage of GDP, for example 5 percent, and otherwise obliges that all aid (and hopefully oil revenues too) is distributed directly to the citizens would seem like a much better alternative.

You should not impose a limit on how much help donors want to give, not with the many needs at hand, nor at how much a citizen could receive, not with the many needs at hand, and I do not know of any such limit that has helped a developed country to develop, but, you sure could help to impose limits on how to avoid to concentrate the aid given and received in too few gubernatorial hands. Please go ahead!