October 28, 2009

Is there no cost in avoiding bubbles?

Sir though I agree with much of Martin Wolf’s “How mistaken ideas helped to bring the economy down” October 28, I have serious difficulties on understanding how one should be implementing the bubble-busting. Are the regulators now going to appoint bubble-measurers? Are we going to have these assets bubble-meters being showed off in Times Square?

Much the same way it sounded so utterly reasonable to have the credit rating agencies influence how much equity banks should have, and look where it led us, this reasoning assumes that a bubble is a bubble and that there are no risks derived from pre-announcing that a bubble will not happen. And what if the prime motor of development is the belief in the possibilities of the next bubble? If we eliminate ex-ante the possibility of a bubble will some then just stay in bed while other countries with no qualms about crisis go forward?

If there is something truly lacking in the current discussion on regulatory reform is the appreciation of the good things that come with risk-taking and now, the good things that come from bubbles.

Me, I would love the world to keep on taking risks- and blowing bubbles even at the cost of suffering huge setbacks as long as that takes us forward. Because of this, more than worrying about where the next precipice might be, I would try to make much more certain we are heading in the right direction. Others, on the contrary, seem to be satisfied with what they have achieved and settle for keeping it.

The regulators did indeed cause this crisis, with their faulty regulations

When in 2002 I arrived from Venezuela, where I had never been assaulted, to Washington DC, in less than 48 hours I was thrown to the floor at handgun point and robbed of my wallet. When I asked the police officer who had helped me to my feet “is this not supposed to be a safe area? he answered “yes, you are right, and that is why these bad figures need to come here to steal”.

If the police had told some neighbourhoods in London that just because they were safer they could lower the guard and leave the doors open and some disaster had ensued, it would surely have been blamed. But this is exactly what the bank regulators did when they authorized the banks to a 62.5 to 1 leverage as long as they were lending or investing in AAA safe areas.

So therefore when John Kay in “Too big to fail’ is too dumb to keep” argues that “the claim that regulators caused the crisis is a ludicrous as the crime due to the indolence of the police” he just shows he has no idea of what happened. 99 percent or more of those losses that detonated this crisis can be traced to this regulatory naïveté. Just for a starter the AAAs of AIG would not have the same value.

The problem we have is that so many are trying to use this crisis to push their particular agenda, which often requires a blatant disrespect for what really happened. Mr John Kay, a true baby-boomer, in the “Après mois le deluge” sense, wants us now to have narrow banks which refuse to underwrite risk-taking, as if society can prosper with non-risk taking banks.

And, by the way, since I am one of the very few who has spoken out loud and publicly against the “too big to fail” before the “too big” started to seem as failures, this is by no means a defence of them.

October 24, 2009

We must urgently, temporarily, lower the capital requirements for BB+ and below.

Sir John Dizard’s “The real reasons why banks are remaining reticent on lending” October 24 marks, from what I have seen and not withstanding my hundred of letters on the subject, the first time that anyone in the Financial Times gets involved with the real fundamental flaw of our current bank regulations, namely how it discriminates among different risk categories.

Welcome FT, better late than never!

Dizzard writes “The banks still want to lend but the desired business is now triple B or better [which in essence requires a capital of four percent]… Unfortunately, even using 2007 standards and data, perhaps half of their book was double B and below [which requires 8 percent in capital]”

And that is why, knowing for sure that those most able to create jobs and provide for fiscally sustainable growth are the entrepreneurs who usually live in the BB+ and below area, I have been on my knees begging for the temporarily lowering of the capital requirements on these loans to only 4 percent; while the banks are busy rebuilding their capitals in order to take care of all the perceived low-risks that turned into real high risks.

We would not want to crowd out our possibly savors in order to provide room in the lifeboat for those who got us in the mess, would we?

October 23, 2009

The FSA got to be kidding

Sir Brooke Masters reported in “UK regulator sees growth in banks capital having extra capital” October 23, reports on the recent Financial Services Authority Discussion Paper on the Turner Review Conference and I could not find where the FSA said such thing. Nonetheless it might very well be so, in the very long run, but the road there is extremely difficult, and even the FSA warns that “too rapid increases in capital requirements will harmfully constrain lending to the real economy which is likely to have negative implications for the capital position of firms”.

But what saddens me most is that the only consolation for the real economy the FSA identifies is when following the previous quote they say “Capital enhancement through restraining cash bonus payments and unnecessarily high dividends will not have this harmful effect. Capital enhancement achieved by these means will contribute to whole system stability and confidence by speeding the pace at which exceptional government and central bank support measures can be withdrawn”.

Do they really mean that the real economy is now in the hands of reduced banker bonuses and reduced bank dividends? They’ve got to be kidding.

If there is anything that the real economy really needs now is for an immediate reduction in the capital requirements for the banks when lending to BB+ or below rated clients, there where the real economy normally lives, at least while the banks are rebuilding their capitals to cover for all those AAA rated operations for which the regulators only required 1.6 percent in capital.

Come on FSA, understand it, the banks are not are not even supposed to be into AAA rated operations… that should be the exclusive territory of widows and orphans.

October 22, 2009

Temporarily, we need lower bank capital requirements for the old “high risk”

Sir in your “Testing times for bank regulators” October 22 you argue that “rather than having regulators carve up institution and police an arbitrary border between ‘safe’ and ‘unsafe’ activities, setting higher capital requirements allows the banks to find their own way through”. With that, may I say at long last, you are addressing the worst fault in the current Basel bank regulations, namely the fact that regulators have totally arbitrarily mingled with risk.

Now, on the way to higher capital requirements we must not forget that there are many borrowers that already pay the price of higher capital requirements and these, even though they might be the most important borrowers in terms of recovering from this crisis, will, as bank equity is scarce and expensive, now run a serious risk to be crowded out by all those other operations that previously enjoyed very low capital requirements.

Therefore, and even if it sounds a bit shocking, we need to temporarily lower the capital requirements for all which, perceived as riskier, already has higher capital requirements. In other words, while making adjustments for that “low risk” that turned out risky do not kill those high-risk who are not at fault and whose energy we now need more than ever.

October 21, 2009

Serious intentions or just a one night stand?

Sir Jonathan Wheatley and Alan Beattie in “Brazil taxes foreign portfolio flows in bid to stem exchange rate rise”, October 21, make a reference to the Chilean capital controls, and it is important to understand that these were of quite different nature than Brazil’s tax.

Chile’s capital controls, intelligently, wanted to make certain that the foreign investments flows wanting to go in into Chile, as pretenders, had serious long term intentions, and were not just looking for any one night affairs. It was therefore based primarily on freezing the use of funds for one year, so as to assure a proper courting.

Compared to that, Brazil’s 2 percent tax, just raises the price of having an affair in Brazil. And what is 2 percent in these days of hedge-funds fees if the signorina is beautiful?

Il Cuckoo Supremo

Sir Martin Wolf in “How to manage the gigantic financial cuckoo in our nest” October 21 fails to mention the cuckoo-est cuckoo in our financial nest, the financial regulators, those caretakers who came up with the idea that the best therapy for calming down the patients was to have them play safe games, assigning these lower capital requirements, which altered the normal routine of the asylum and started that crazy and finally so devastating race in search of some AAAs.

Let the financial franchise owner charge the operators a percentage of their earnings.

Sir Martin Wolf in “How to manage the gigantic financial cuckoo in our nest” October 21 mentions “a ‘windfall tax’ or special curbs on bonuses” but perhaps the starting point should be a ‘windfall tax’ on bonuses. The current real owner of the financial sector franchise, the government, should have the right to extract a windfall fee from those operating individual franchises, if that helps to improve operations and strengthen the public image of the whole franchise. That said one needs to be careful the tax does by means of netting, does not castigate those investing in the franchises, especially when you want to attract more capital to them.

October 16, 2009

Is Jacques de Larosière befuddled or just lobbying?

Sir Jacques de Larosière´s “Financial regulators must take care over capital” October 16, is either a perfect example of how trapped the regulators are in their own groupthink, or a simple lobbying effort on behalf of some European banks.

Larosière starts by rightly declaring “History shows that economic recovery essentially depends on the existence of a strong and risk-taking financial system” but then speaks out in favour of higher capital requirements for banks the higher the risks as “it is the quality of the assets of a bank that matters more than its leverage”; and writes that “imposing a non-risk based leverage ratio could entail serious negative, albeit unintended consequences.”

Well the market already charges for risk though interest spreads and so any additional risk-adjustment, for instance by means of different capital requirements, amounts to an arbitrary intervention by the regulators in favour of what they might consider low risk and quality, but which might have absolutely nothing to do with what the economy really needs.

If we want an example of how “serious negative, albeit unintended consequences” that regulatory mingling with risks could have, it suffices to look at the current crisis with its low capital requirements for the huge exposures to “non-risk” AAA rated operations. And besides, the “quality” of a financial asset is not a function of risk, but a function of its risk-reward relation.

If we are to have banks capable of taking the risks the economy needs to recover, then the first thing we need is for the regulators to stop from arbitrarily interfering with the risk allocation mechanisms of the market. If this signifies special transition problems for the European banks, as Larosière indicates it could, let us solve that by other means than defending and conserving the worst element of our current financial regulations.

October 14, 2009

We´re stuck in an unsafe to be dollar safe-haven, most probably waiting for the Dollar II.

Sir Martin Wolf writes that “The rumours of the dollar´s death are much exaggerated” October 14, but the discussions have really been about who could take over some of the dollar´s job so that it would not die of a heart attack. And the dollar´s job is not an easy one, as it has the USA suffering from the curse of exporting safe-haven permits, which creates few jobs of that sort the world likes to qualify as “real sustainable” jobs, while importing products produced by real jobs abroad.

Will the dollar suffer the agony of a slow death or fade away like a soldier? Not likely, once the rumour of the safe-haven is having become dangerously overcrowded starts, death will be swift. Strangely though, as things currently stand, the most likely heir of the dollar would be the Dollar II.

October 12, 2009

The US suffers from the safe-haven curse

Though both Roger Altman “How to avoid greenback grief”, and Wolfgang Münchau “The case for a weaker dollar” October 12, are very right in their comments they are, for the time being, sorry to say, somewhat irrelevant.

The US is currently suffering from a safe-haven curse, which has the world buying dollars not really because of monetary parameters but more as parking permits to what they perceive is one of the few safe havens to whether out the storm. All of us who come from resource cursed nations, in my case Venezuela, know how difficult it is living with a curse, not least the fact that even though we know those resources are finite, and investors will wake up one morning suddenly thinking the dollar safe-haven to be unsafely overcrowded, there is little to be done until that happens. Just like no one stopped until they had chopped down the last tree on Easter Island.

But, having said that, let us not forget that, on the positive side, once the curse is lifted, a lot of new opportunities arise and so we do not necessarily have to be so pessimistic about the future of the US.

On a separate issue I would also recommend Mr. Altman that he performs a stress test on the willingness of the US tax payer to pay for the current public debt being contracted; he might find it even weaker than the current outlook for US consumer spending.

When in doubt just announce a Nobel Peace Price Objective

Sir personally I am convinced that Obama got the Nobel Prize for Peace by default since the committee could not really find someone else. That said I would not suggest for Obama to return the prize as Clive Crook does in “It is too early to land Obama – or to be disappointed” October 12, as that would be an unnecessary slap in the face of the Norwegians who must find themselves going through much pains anyhow trying to come up with a worthy winner each year. May I suggest to them the following alternative?

Those years when they do not find thee natural candidate why do they not declare an objective and that if accomplished would automatically give right to a Nobel Peace Prize sort of placing the carrot more explicitly before any possible candidates. As is it is not really sufficiently clear whether Obama got it for past or future achievements.

We need more responsible regulators too

Sir Paul Myners writes “Regulators can limit risky activities by making them less profitable, by requiring increased capital...” “We need more responsible corporate ownership” October 12.

A better way to phrase the above in view of our recent disastrous experiences would be “Regulators should not incentivize less risky activities, making them more profitable, by requiring less capital”. And so it is clear we need more responsible regulators too, those who know that tinkering with risks is a risky affair.

October 09, 2009

Slow the dance but do not impose the tune

Sir Chrystia Freeland ends “Investors had little choice but to keep dancing” October 9 asking for “a more powerful regulator to be established with the authority and courage to slow down the music for everyone” and this absolutely correct. But in doing so we need to avoid by all means that the regulator chooses the tune to which the markets should dance.

I say so because the current crisis resulted from the Basel bank regulator wanting the market to dance slower and, using capital requirements based on risk, induced it to take up some slow low risk waltzes instead of fast polkas or emotionally laden tangos and which led the markets into the arms of the dangerous AAAs.

By the way there are still two dance halls open and that many feel should be closed but which proves something impossible to do while the music plays. One is the dollar, where investors all know that one morning they will wake up find the safe-haven unsafely overcrowded, and a murderous panic for the exit will ensue, and the other is the public debt here and there and almost everywhere. Who is making the preparations for when these other two dance halls close down?

Most will not even wake up to the ‘silo curse’

Sir when Gillian Tett writes “Waking up to the ‘silo curse’ is far from the end of the problem” October 9 she is absolutely correct since the worse “silo curse” is the one we all carry in our own minds and which keeps channelling our minds towards the answers we feel comfortable with. For most the real problem is that they will never even wake up to it. And, among them, are many regulators.

October 08, 2009

Mme Christine Lagarde, the crisis demands we think things over more carefully, from scratch!

Sir who would disagree with Mme Christine Lagarde´s call that “The crisis demands we finish what we started” October 8, that is of course as long as it does not mean finishing us off completely.

Strangely enough, when Mme Lagarde rightly focuses on the issue of cutting unemployment, the first concrete results she points out is “150 tax information exchange agreements have been signed and the number of tax havens has been drastically reduced.” There is nothing wrong with fighting tax evasion but, what it has to do with job creation beats me, unless she is referring solely to the creation of jobs for public servants. The funds hanging around the tax-havens are not sipping cocktails on the beach but creating jobs somewhere.

Also in the same vein no one would disagree with her when she writes “we need to make sure that requiring banks to hold more and better capital does not hinder their ability to lend to individual and companies” but how can she then say in a congratulatory tone that “The Basel II framework for banking capital has now been accepted by all and the heads of states have committed to applying it to the most important financial centres by 2011.”? Is she totally unaware of that the Basel II framework sabotages the risk-taking needed to create jobs? And that many of us consider the Basel II framework as the main explanation for this crisis?

No Mme Christine Lagarde, the crisis, what it really demands, is that we think things over more much more carefully, from scratch and without being stuck in the past.

Risk avoidance is an extremely risky business

Sir surprised I read Mr. Stuart M Turnbull´s and Mr. Lee M. Wakeman’s whishing that “the rating agencies published and kept current, term structures of survival probabilities [so that] investors would be able to compare directly the risk of default for various maturities across corporate and municipal bond markets”, “Investors value accuracy ahead of stability” October 8.

Since presumably the whole market, and not only these two gentlemen would have access to this information, have they not given a thought to what this would do to the risk-weighted returns they would receive? I will tell them. They would be condemned to absolute mediocre return rates, as the intermediaries will previously have sucked out any arbitrage profits there are… that is until the day the credit ratings get it wrong again, as they, being humanly fallible are doomed to, and that day they lose it all unless, they are again bailed out by their grandchildren picking up the tax tab.

Yes, the investor values accuracy and stability, but they also value the possibility of some special returns, just for them. If these two gentlemen believe there is even a remote possibility of regulating a financial market so that it will be just and fait to everyone, when all the rest is not just and fair, then they clearly belong among all the other naïve and gullible financial regulators out there.

October 07, 2009

Bumpy roads indeed!

Sir Martin Wolf writes that “Big bumps lie ahead on the road to recovery and reform” October 7. Though I sort of agree, on most, for me the biggest real bump for recovery is that of not knowing yet what kind of growth is sustainable, given the two bottlenecks of oil and climate change. Some countries could resume growing as if these constraints do not exist, but that might very well not take us where we want to go. Yes, we want to stimulate the world, but we also want it to take off in the right direction.

Then of course we have the problem with the monetary system, most particularly for the US, the exporter of the currency the world most trusts in lieu of other alternatives, and that therefore has to live with the safe-haven curse. All of us who come from resource cursed nations know there are serious difficulties living with a curse, not the least the fact that those resources are finite, and though we know that one morning investors might wake up finding the safe-haven unsafely overcrowded, there is little to be done until that happens. Just like they could not stop until they had chopped down the last tree on Easter Island.

But where I might disagree completely with Wolf is when he quotes Andrew Smithers arguing to “force banks to raise the needed capital and if they cannot, let government provide it” if with this he implies he believes public bank capital is the same as private bank capital. What we most need in term of reforms is to eliminate any bureaucratic interference with the risk and capital-allocation mechanism of the market, like those of the minimum capital requirements for banks based on perceived risk of default. What is most needed, especially in the “comfy” countries, is for a banking sector willing to take risks on those few willing to take risks.

October 06, 2009

UK adopts a marker put down by Argentina

Last year Argentina´s Cristina Kirchner nationalized 10 private pension funds arguing it was “necessary to protect retirees in the global financial crisis” We know different, she needed the money to feed the government coffers.

And so today when Brooke Masters and Patrick Jenkins report on the UK regulator announcing rules that “could require UK banks to increase their holdings of high-quality government bonds” we cannot but reflect over how in this small world you never really know who influences who. “FSA puts down a global marker” October 6.

October 05, 2009

Timothy Geithner should start by increasing the capital requirements for banks when lending to the government.

Sir Krishna Guha in “Bankers´ pleas on rules rebuffed , October 5, reports that Timothy Geithner said of the banks “These are the institutions that told the world and told the shareholders and told their creditors and told their customers they knew how to manage risk and that they were better at this than their supervisors were ever going to be”.

Does Mr. Geithner really believe that the supervisors will ever be better at managing risks than the banks? Is he suffering from amnesia? Has he already forgotten that it was the minimal capital requirements which the regulators authorized the banks to have whenever the regulator´s own outsourced credit risk supervisors, the credit rating agencies, awarded their AAAs which detonated the crisis?

Of course regulatory overkill is a risk for a recovery which urgently needs risk-taking to awaken. Nonetheless if Mr. Geithner needs to show himself off as a real regulatory macho man why does he not increase the capital requirement for banks when lending to his own government?… it is currently zero!

Or does Mr Geithner also believe that public bureaucrats are better at taking investment decisions than their private counterparts?

AAAs proved more dangerous than “junk”

Of course real disasters are more prone to be found in sectors perceived as less risky than those thought as more risky, if only because when entering the latter we are all more careful.

Having said that though reading Michael Milken, who was known as the Junk Bond King, telling the world now that “investors will lose more money on AAA credits than on any other rating category”, is a wonderful reminder of how little we really know about risk and cosmic order, and it should hopefully help to humble some regulators.

As for me, in the title of his article “Prosperity rests on human and social capital”, October 5 I would have loved for Milken to also have included in the title “and the willingness to take risks”; so as to help make clear that we are running risks when allowing our bank regulators to impose special taxes on perceived risk.

October 02, 2009

More stars for a more stable triple A?

Sir when the president of Standard & Poor’s, Deven Sharma writes that the credit “ratings should not be used for purposes for which they were never designed”, like “hardwiring” prudential regulations around them, we can only ask… why did he wait so long to say that? Investors require consistency when it comes to credit ratings” October 2.

And when Sharma mentions the investment institutions want “credit ratings to be relatively stable” and that he intends to satisfy such demand by an “initial lower rating” of any security “more prone to a sharp downgrade in periods of economic stress”, we can only think of a chef developing some ratings a la carte, in order to earn more stars on some Michelin guide.

October 01, 2009

Should Snow White have known the apple was toxic?

Sir in “Shining a light on bank´s deep hole” October 1, you write about “bad bets on risky assets”. What risky assets do you refer to? To those AAA rated securities that carried so little risk that the regulators only required the banks to hold 1.6 percent equity against them?

When Snow White was offered the apple, was she supposed to have known Queen Regulator´s helpers, the credit rating agencies, had poisoned the apple?

Please free us from imprudent risk-aversion and give us some prudent risk-taking.

Published in FT's / Martin Wolf's Economist Forum October 1, 2009  (The link is gone)

There is not one single reason to believe the world would be a better place because our financial regulators provide additional incentives to those who, perceived as having a lower risk of default, are already favored by lower interest rates, or punish further those who, perceived as more risky, are already punished by higher interest rates. In fact the opposite is most likely truer.

According to the bank regulations of the Basel Committee, the global standards setters for much of the world, if a bank lends to an unrated corporation then it must hold 8 percent in equity but, if lending to an AAA rated client, then only 1.6 percent will suffice. The difference between 1.6 and 8 percent, 400 percent, given the high costs of bank equity, carries a substantial cost that increases the premiums on risk; something which also confuses the markets risk allocation mechanism. And, by the way, you better sit down; the capital requirement for lending to governments is quite often zero!

The debate of the current financial crisis ignores what really hit us. We still hear the most influential experts, Nobel Prize winners included, repeating over and over again the mantra of “excessive risk-taking”. How can they be so blind? This crisis did not detonate from financing “risky projects”, but from financing the safest of assets, houses and mortgages, in the supposedly safest of countries, the US, and using instruments rated AAA, which are supposed to carry no risk. 

This crisis resulted from some misguided and imprudent risk-aversion policies put in place by regulators by means of capital requirements for banks based on risk and the empowerment of the credit rating agencies, and who with their rating signs caused herds of capital to stampede over a subprime precipice. If we do not want to understand and accept this, how are we supposed to move out of this crisis and into a better future, something which, as human history has proved again and again, always requires prudent and sometimes even a dose of imprudent risk-taking?

I have been writing about this issue for a long time, to little or no avail, since the current financial regulatory system is founded upon an almost unbreakable paradigm created by regulators who are not at all interested in the big-scheme of things but who furiously concentrate on trying to live out their own small bedroom fantasies, that of a world without any bank failure... and as if a world without bank failures has to do with a better world. Actually, the more frequent bank failures are, the smaller the risk of a systemic crisis like the current. 

If you need evidence for the above, read the 347 pages of the bank regulations known as Basel II, where you will not find a single phrase that has anything to do with establishing the purpose for our banks. Regulators, when regulating, should you not start by doing just that?

In January 2003 the Financial Times published a letter were I wrote “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds.” But, even though it were the mistakes of the credit rating agencies which detonated the crisis, and which were doomed to happen, the most important part to understand, and the hardest one to accept, is that the systemic errors for the world at large would occur even if the credit rating agencies had got their ratings absolutely right. 

Between 2002 and 2004, as an Executive Director at the World Bank, I did what I could to remind this development bank that risk is the oxygen of all development, but I was never really heard. The World Bank, forced to harmonize with Mr. Stability, the IMF, had been effectively silenced. Today, when there are renewed puritan screams against “risks” I hope that the World Bank finally comes to grip with its role and turns into a Champion of prudent risk-taking. The world needs it. Just as an intellectual exercise think of how much better off our children and grandchildren could be, had the trillions that were wasted on a useless housing boom in the US, been lost instead financing projects which adapt and mitigate for climate change?

As a note, in terms familiar to the development community, current financial regulations, by favouring the “lower-risk” that resides more easily in the rich and developed countries, and castigating the “higher-risk” more prone to be part of the poor and the developing world, helps to increase the inequalities and therefore the world’s Gini coefficient.

Dear baby-boomers, there is a world out there that needs a whole lot of risk-taking in order to stand a chance of a better future; a world which does not want to lay down and die in tranquility, just yet.

PS January 2016: What already exists is usually perceived as safer than what is to come; and so regulators have de facto imposed higher capital requirements for banks when financing the future than when refinancing the past.

PS Here is a still growing list of the mistakes with the risk weighted capital requirements for banks