May 07, 2009

The marginal authorized leverage was then 125 to 1!

Sir John Gapper in “How banks learnt to play the system” May 7 is slowly identifying the AAA-bomb that set of this crisis. He writes about how regulatory bank equity, by not being real hard cash equity, and how assets, by being minimized through regulatory risk-weighting, made “some investment banks enter this down-turn with capital ratios of 30 times or more.”

But Gapper is not there yet since he seems to forget that in economics as well as in finance, the most important price is not the average but the marginal. If I am allowed to assume what Gapper seems to do that only the 4% equity of tier 1 capital was for real, and consider the fact that loans or investments to corporations and securities that were rated triple-A were risk-weighted at only 20 %, then he should be able to calculate that the marginal authorized leverage for the banks on some operation were 125 to 1... or more, if as Gapper holds, that even the tier 1 capital was partly made up of illusions.

P.S. I just wonder. If I had been a PhD, from a well known university, would I have not been referenced as someone who has warned and argued over this problem over and over again for years? After 258 letter to the Financial Times labelled “subprime banking regulations”? Not including this one.