April 29, 2009

In this crisis, many wish for the cloak of invisibility.

Sir there is no way you could understand what happened in this financial crisis if you do not read what Basel II contains. It is not only that the banks now have to make up for the many write downs after all the losses they incurred but that they will also have to make up for all the undercapitalization that Basel allowed for.
When the bank lend to a company or invests in a security that has managed to get a triple A-rating Basel II has authorized this exposure to be risk-weighted at only 20% which means that 500 of it will count as only 100 which (500 exposure divided by 8 in capital requirement) results in a leverage of 62.5 to 1.
And so Martin Wolf in “Fixing bankrupt financial systems is just the beginning” April 29, should also have acknowledged to begin with the need of “fixing” the intellectually bankrupt regulators who came up with such insane regulatory permissiveness just because they trusted the credit rating agencies so much.
Is it really surprising that now “investors burned by more sophisticated risk-adjusted ratios increasingly trust... the ratio of common equity to total assets’? Of course not, though the real question that needs an answer is how the regulators could have been so naive and gullible to design these ratios and then go to sleep believing in them?
Clearly the IMF, a staunch supporter and marketer of the Basel regulations, would prefer the world to ignore this whole issue… but why should a Financial Times that proudly champions a “without fear and without favour” also do so?

The regulators they authorized a leverage of 62.5 to 1!
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Am I obsessed? You bet! You should be too!

April 27, 2009

How could AIG have resisted?

Sir, though Eric Dinallo is right in saying that “Marriage not dating, is the key to healthy regulation” April 27, it is at the same time extremely worrisome to read how he, the New York insurance superintendent, still seems to believe that what brought AIG down was the lack of regulations.

What brought AIG down was that its credit rating of AAA became dangerously super-empowered, when the financial regulators decided that any risk that AIG offered to cover transmitted to the underlying securities a permit for the banks to leverage these 62.5 to 1. I ask. What kind of corporation could have resisted the temptation of not waving that magic AAA wand too much?

April 26, 2009

The dollar is the whole world’s s.o.b.

The last of my 15 letters that the Financial Times published before I was silenced was the following dated October 4, 2006 and which said the following.

“Sir, Martin Wolf’s “America could slow us down” (September 27) somehow ignores the possibility that just as the Americans did when they accepted the “In God we trust” printed on their bills as an act of faith when the dollar abandoned its convertibility into gold, the world is now willing to live with an “In America we trust”, at least while there is such a world shortage of better alternatives. If this is so, one could argue that we have still far to travel on the roads of the American current account deficit currently used by the world to dollarize since the fact is that, if you want to lay your hand on a dollar, you have to sell or give something for it. Frightening? Yes, but is not the world itself a frightening place that needs many acts of faith in order to make life bearable?”

Today, after all what we now know, and seeing the world still placing so much trust in the dollar I would probably want to rephrase it by paraphrasing Roosevelt saying “The whole world knows the dollar is an s.o.b but (at least for the time being) the dollar is the whole world’s s.o.b.”

April 25, 2009

Who is then going to be the bad cop?

Sir, the world needs a good cop and a bad cop, but can really do without a wishy-washy cop. Listening, during the spring meetings in Washington of the World Bank and International Monetary Fund, to the intents of the Fund to recast itself as a good cop, the big question is... who is now going to play the bad cop?

Come on, you just robbed hugo chávez of Bush... are you now going to take the Fund away from him too? What popular enemies that can be exploited will he be left with?

April 24, 2009

We deserve something different than the current crop of regulators

Sir Timothy Geithner in “We must keep at the process of repair and reform” April 24 mentions that “the Financial Stability Forum, renamed the Financial Stability Board (FSB) and expanded to include all of the G20 nations, should be given greater responsibility for the stability of the international financial system. And that is the problem with the current crop of regulators. Who told them that the only thing we look for is stability? We want a well functioning financial sector with a much more meaningful purpose that stability.

Look at what the search for stability and lowering of risks with the minimum capital requirements designed by the Basel Committee and the appointment of the credit rating agencies as the risk sentries of the world has taken us? The Basel Committee and the members of FSB all come from exactly the same regulatory incestuous gene-pool. We deserve better results, and this can only be achieved by a new and much more diversified set of regulators.

April 23, 2009


Sir William Cohan’s “Clever wheezes will not mend the banks” April 23 touches on one of the hardest questions to answer… namely should we mark to market in a crisis like this?

Without the mark-to-market we can never be that sure we already reached a bottom, but with the mark to market, we might reach an even deeper bottom.

From Basel II into Solvency II… has the European Parliament lost it?

As reported by Nikki Tait and Paul J Davies, April 23, not only do the higher risks have to pay higher insurance rates because the market so demands it, but now they have to be additionally penalized in order to compensate for the higher capital requirements for higher risks that will be imposed on the European insurers by the European Parliament; as a result of something called “Solvency II” and which sounds and reads frightfully similar to Basel II.

Do they never learn? Now again, what will result from all this is increasing the incentives for disguising as being of lower-risks and for having the regulators go to sleep in the belief that all has been taken care of. Who is going to measure the risks? The insurance risk rating agencies? Start praying!

April 22, 2009

The regulators changed the odds at the casino... surreptitiously

John Kay in “How economics lost sight of the real world” April 22, writes that “grossly imperfect information have led us to where we are today” and he is more right than he knows.

On June 26, 2004 Ministers and central bankers from the G10 endorsed the publication of the International Convergence of Capital Measurement and Capital Standards: a Revised Framework. Those regulations authorized banks to have a leverage of 62.5 to 1 if they lent to corporations to which human fallible credit rating agencies had awarded AAA-ratings. With that the regulators send out the message, loud and clear, that risks could be measured with much more preciseness than previously thought possible and that there were agents capable of doing so.

And the regulators also naively ignored that the measurement of risks would itself alter the realities of risks, and so those regulations amounted to something like fooling around with the odds at the casino without informing the players. Markets that wanted to play it safe, on black or red, were unknowingly lured into placing their bets on a number.

Those regulations contained in sum the most dysfunctional financial regulatory innovation in history and no one said a word. Shame on the tenured professors, the think-tanks, the press and all the others the society counts on to keep it informed.

April 20, 2009

The regulatory innovations are the ones to blame, not the financial.

Ben Bernanke in his most recent speech, April 17, 2009 said “Where does financial innovation come from? In the United States in recent decades, three particularly important sources of innovation have been financial deregulation, public policies toward credit markets, and broader technological change. I'll talk briefly about each of these sources.”
As for the public policies Bernanke mentions the Community Reinvestment Act of 1977 (CRA) and the government-sponsored enterprises, Fannie Mae and Freddie Mac. Nowhere does Bernanke mention the greatest source for the financial innovations that proved disastrous, namely the regulatory innovations that were put in place during the very last decade. Could it be because he also is among the ones to blame?
The regulators in Basel innovated as regulators never innovated before, and thought they could control for default risk, and therefore allowed incredible leverages as long as the default risks of borrowers were perceived as low or non-existing by the official risk sentries the credit rating agencies. After that the regulators being so sure about the value of their innovations went to sleep… but that is of course nothing new or innovative.
At the end of the day the simple truth is that the costs of regulatory innovations far exceeded the costs of financial innovations, and that the benefit from financial innovations far exceeded the benefits from regulatory innovations. Try to live with it FT!

April 17, 2009

The value of the CDS depend a lot on who contracts them

Sir Henny Sender in “CDS derivatives are blamed for role in bankruptcy filings” April 17 reports on how this type of instrument changes the behavior of creditors. One way I have found useful explaining the pro and con of the CDS is with a simile to life insurance.

Supposed Henny Sender took out a life insurance for a million quid to take care of her loved ones in case anything would happen to her. That should be a quite good responsible and tranquilizing thing to do. Now imagine instead that many of Henny Sender’s extended family and friends and even some total strangers took out million quid life insurance policies on her. Not so tranquiliz, baning eh?

April 16, 2009

You need to stress-test the American taxpayer first

Sir in “America’s fate is not in its hands” April 16, you mention the stress tests of the financial sector. Much more important than that would be to stress-test the American taxpayer.

What the US dollar bill really should state is “In the American Taxpayer We Trust” and so the more pragmatic Americans have printed the “In God We Trust” on it.

There is no way that the current American generation, having been brought up as the consumers of last resort in the world, would now turn around and accept to be the world’s taxpayers of last resort… at least not with the current taxes and any stress-test of them would show you that.

The US government should be much more conscious of this before launching itself on a fiscal spending stimulus binge which, if allowed by the markets, will build up its public debt to a totally unsustainable level.

That said I believe the market is going to say NO much earlier than that, since one thing is to be searching for a safe temporary haven and another quite different to be trapped in a permanent home.

And that is why, before the US Dollar loses its AAA rating, that the US, and the world, should work hard in developing a totally new generation of taxes that can be perceived as legitimate, that are aligned with the new global realities, and that interfere as little as possible with the functioning of a competitive economy.

April 15, 2009

What bedevilled the world was the belief in certainty.

Sir Edmund Phelps writes that “Uncertainty bedevils the best system” April 15 and though I agree of course with that uncertainty is part of any system, what has really bedevilled us lately has been the belief in certainty. In this respect Mr. Phelps would do well reading the basic first pillar of the bank regulatory system that emanated from the Basel Committee and in the minimum capital requirements for the banks he would find that the regulators formally authorized an astonishing 62.5 to 1 leverage if banks lent to corporations rated AAA to AA- by some human fallible credit rating agencies.

If there ever was a dysfunctional, naive and gullible regulatory system that arrogantly believed it had the risks under control, this was it. Our current problem is that the same regulators that came up with this are still in charge of regulating.

Do not just blame some financial oligarchs but follow the profits instead

Sir Martin Wolf is right in that “Cutting back financial capitalism is America’s big test” April 15, but this has much less to do with cutting back powers of a “financial oligarchy” as argued with an unhealthy dose of populism by the previous IMF chief economist who-said-nothing-then Simon Johnson, and much more with cutting back on the use of some dubious non-market instruments that have helped to tilt the market too much in favour of the financial sector. Follow the profits!

The financial sector first lent to risky clients and then waved that magic wand of the credit rating agencies, which allowed them to generate immense profits reselling those same loans as having much less risks. What on earth does this has to do with oligarchs? It seems much more the fault of lousy regulators (among which we find the IMF) who empowered the credibility of risk surveying so much that even they fell for it and authorized an astonishing 62.5 to 1 leverage for banks when they lent to corporations rated AAA to AA-.

The financing of the consumer and home buyer in the USA lives and dies with the use of some non-transparent credit scores and which allows charging many consumers much higher interest rates in order to compensate for those that should never have been given credit in the first place. What on earth does this has to do with oligarchs? It is a basic fault of the US society that has allowed itself get trapped in a position where sometimes American parents give more importance to their children credit scores than to their school grades.

April 12, 2009

There is nothing so risky than what is seen as risk-free

The basic capital requirement for the banks established by the Basel Committee is 8% which results in a 12.5 to leverage. But since assets are then risk weighted, for instance at 20% in the case of loans to corporations rated AAA or AA-, the officially permitted bank leverage can increase to 62.5 to 1.

AIG’s whole business model was based on exploiting its supposedly risks free AAA rating which was precisely what led it to take on unimaginable risks. Since most investors in fact abhor risk and naturally go for anything perceived as having less risk we now, courtesy of the Basel Committee are seeing how the losses incurred in supposedly risk free investments are many times the losses incurred in what supposedly was risky.

The sole concept that risk-free investment opportunities can be determined makes the “first pillar” of our current bank regulations fundamentally flawed. Instead of acknowledging this problem the running wild and free regulators seem intent to dig us even deeper in the hole we’re in thinking themselves also capable of determining what the systemic risks are. Please, will someone save us from this lunacy?

PS. That FT, after so many letters I have written about this and well into the second year of the deepest financial crisis has yet not once picked up on this issue and much less mentioned the truly astonishing 62.5 to 1 leverage that is still allowed, makes me sadly conclude that there is a fundamental flaw in FT too.

April 08, 2009

What we have is a genetically modified Black Swan

Sir if you throw a coin, betting on head or tail, and then suddenly it lands on its side then that is a real and natural Black Swan event. But, if you alter the coin in such a way that it must land on its side, more sooner than later, then when that happens can no longer be referred to as a real and natural Black Swan since it is a manmade event. At best we could perhaps refer to it as a genetically modified Black Swan.

The current financial crisis would not have happened had the regulators not empowered some few credit rating agencies as their official risk surveyors and these had not with their AAA signs guided the risk adverse herds of capital in an absolutely wrong direction.

In this respect it is truly surprising that Nassim Nicholas Taleb, a scholar on Black Swans, does not include among his “Ten principles for a Black Swan-proof world”, April 8, the importance of not forcing or stimulating the world to follow the opinions of just a few.

April 07, 2009

A chance for many bankers to be much better bankers

Sir my eldest daughter works for a large Canadian bank and so I have a vested interest in Gillian Tett’s “A chance for banker to refocus their talents” April 7. I have another take on this issue.

If there is one thing to be learned from this crisis is that the world is much better off with hundreds of thousands of credit analysts that get to know and truly understand their clients, look them in their eyes, decide and shake their hands, knowing that though they will be personally accountable for their mistakes they will not risk bringing down the world, as some very few high paid credit analysts in the only three credit rating agencies did.

That these good credit analyst won’t make as much money as their supercharged predecessors is clear but they will have the possibility of earning a decent salary in an interesting and worthy carrier instead of just stupidly staring into their monitors looking at what the credit rating agencies opine.

Understanding how the banks dismantled their credit analysis departments as a consequence of the regulations that emanated from Basel helps you to understand the immense potential for recreating the jobs that were.

PS. Though I have a couple of other individual articles that I favour it is clear that based on the full production Gillian Tett deserves the title of Journalist of the Year. Bravo! That said, as an anthropologist she had perhaps an unfair advantage in these times.

April 03, 2009

The sincerity of the authorities matter more than their commitment to stability.

Sir Martin Wolf in “Credibility is key to policy success” April 3, writes that “a central bank’s unconventional monetary operations are reversible” but says little on the issue that the distributional effects for the citizens of such operations are most probably not reversible at all.

At this moment for many private persons and entities any “quantitative easing” dilutes effectively the current value of their cash, with no guarantee of reversal, making it thereby a very non-transparent tax, and so countermeasures will be taken by the market, for sure.

Keeping up any government’s credibility while it plays hidden games under the table is not an easy trick, for any magician. This is not so much about the “sincerity of the authorities’ commitment to stability” as it is about authorities’ general sincerity.

The worst part though might be that “quantitative easing” makes it also difficult for the government to be sincere with itself as it really does know what the market would look like in the absence of such easing, just like a company cannot be really sure of the price of their shares during a stock-repurchase plan.

April 02, 2009

The value of our cash is diluted in an ocean of cash, which effectively makes of “quantitative easing” just another tax.

Sir Krishna Guha in “Easing by world’s central banks take a variety of forms” April 2, mentions that “Expanding the money supply creates relatively little inflation risk in the short term. But this could change when the crisis turns.”

The above is right of course but let us not forget that however we dress it up “easing” signifies an easing only for those whose instruments are being bought, whether it is the government or the holders of the distressed securities. For the rest of us it just signifies that the real value of our cash gets to be diluted in the ocean of cash produced by the “quantitative easing”, which effectively makes of it just another tax, though a much less transparent one.

What we foremost need are capital requirements that cover for the risks that what is rated AAA is not really AAA.

Sir in Chris Giles’ “Harmony is main item on the agenda” April 2 mentions “Banks will be required to hold more capital in future and everyone agrees that capital requirements (for financial institutions) need to become stricter in good times to provide a greater cushion for downturns”. That is of course right yet it behoves all of us to remember that our current predicament had much less to do with “good times” and much more with having incurred in vanilla type plain old fashioned bad investments. In this respect the first thing to do, whether for good times or bad, is to place some capital requirements to cover for the risk that what is rated AAA is not AAA.


Sir Just on word comes to mind when reading your pre G20 summit reports April 2... Eerie!

It feels like sitting in a cellar waiting for the hurricane to come or pass knowing that your cellar is utterly inappropriate for such an event.

To reduce the too many cars it might be better to eliminate some infrastructure, like some roads.

Sir you use as an illustration for Mathew Green’s report on lacking infrastructure a photo from Lagos from which one could conclude that it is not infrastructure that is lacking but the cars that are too abundant, “Crisis puts the brakes on”, April 2. Have this financial crisis already made us forget the energy and climate change crisis?