May 28, 2010

Very soon the vultures will descend on some European sovereign bond markets

Sir Gillian Tett writes about future haircuts on Greek and other sovereign debt that “will continue to poison the bond markets, “Bondholders jittery over who will bear Greek losses” May 28.

Yes, there will surely be a lot more of it in line but let me assure her that already many bondholders are de-facto taking their share of hair cutting by way of the markets, as interest rates for these borrowers is shooting up, and, if nothing is done, sooner or later the vultures, those who have been preying on other lesser markets might descend in full force on Europe.

There is little anyone can actually do against a market that has discovered something as being unsustainable, and so the decision the European governments have to make now is more about who they wish to encounter on the other side of the negotiation table... the traditional bondholders or the vultures?

When is real Armageddon more likely to occur, when we are impacted or when we discover that we are going to be impacted?

May 26, 2010

It was the financial regulator who upset the delicate balance between grasshoppers and ants.

Sir Martin Wolf ends “The grasshoppers and the ants – a contemporary fable” May 26, as all fables should end, namely with a moral, in this case being “If you want to accumulate enduring wealth, do not lend to grasshoppers”. Now since that moral cannot in any way classify as a new moral, the question that begs an answer is how come it was so utterly ignored. Let me explain why.

Our financial regulators, fed up with so many bank failures, got together in something they named the Basel Committee and there, in an incestuous petit committee, decided that it did not any longer really matter whether the banks were lending to grasshoppers or ants, as long as they were lending to those who were most certain to repay. And, in order to make sure that their new regulations were duly carried out they empowered some few human fallible credit rating agencies to decide who were most likely to repay… and created monstrously huge incentives for the banks, in terms of ridiculously low capital requirements, to lend to those deemed absolutely safe by the risk-commissars.

And the risk-commissars, grateful for the opportunity to perform a very profitable service, set out by rating their masters, the most reputable sovereigns, as having no risks… crowning them with their AAAs. And then all sort of crazy things started to happen and which brought total confusion to the markets.

The banks began leveraging up lending to sovereigns and other “risk-free” client, and though this should have resulted in the credit ratings of the banks being cut, the risk commissars measured the willingness of sovereigns to assist the banks if need be, and deeming it to be good kept the ratings of the banks; which then could further lend to super-safe-grasshoppers and super-safe-ants alike. But, unfortunately, since there is a natural scarcity of super-safes, as a good regulator should have known, and there was such an extraordinarily demand for these, the market, being what it is, began supplying some fake subprime super-safes... until the forgery was discovered, much too late.

But, meanwhile, since the lending to all of the small ants, those who in their beginnings of course pose higher risk of default were kept under the thumb of much more conservative capital requirements, it also upset the very delicate world balance between grasshoppers and ants, ending in the current disaster of having too many grasshoppers per ant.

May 21, 2010

Are capital and liquidity rules for the banks out of the domain of the US Congress?

Sir in “Tsunami of regulation batters banks”, May 21, Brooke Masters reports “The Basel Committee on Banking Supervision is aiming to adopt new capital and liquidity rules by the end of the year.”

Given that the current capital rules, which unjustifiably favors the good credit risk ratings already favored by the markets, created the stampede after triple-A rated securities that detonated the current financial crisis, this must surely be one of the most important part of the financial regulatory reform.

Can then anyone explain to me why the Basel Committee is not mentioned even once in the 1336 pages long reform bill presented to the US Senate or in the 1776 pages long H.R. 4173 financial regulatory Act approved by the House of Representatives?

May 20, 2010

More than about who sets the basic capital requirements for banks a sensible regulatory reform needs to worry about who sets the risk-weights.

Sir Howard Davies and David Green are correct suggesting that the setting of the capital requirements for banks should be placed in the hands of the monetary policy committee or whoever else sets the interest rate policy, as they are tools for a similar purpose, “Final touches for sensible regulatory reform” May 20. Currently that basic capital requirement decision is not even in the UK, having been delegated to the Basel Committee and which, for no special reason at all, seems to have carved out in stone an unmovable 8 percent.

But Davies and Green, much more than about the basic capital requirements, should worry about who takes the decisions on the risk-weights. It is those weights which really explain why, from mid 2000 until December 2009, the banks could lend to Greece with only 1.6 percent capital, while if they lent to any unrated UK entrepreneur they needed 8 percent in equity. This was because the Basel Committee, in Basel II, with precious little and quite dubious explanation, assigned a 20 percent risk weight for sovereigns rated A+ to A and corporate rated AAA to AA, while giving a 100 percent risk weight to any unrated clients. This arbitrary risk discrimination imposed on top of how the market already discriminates based on risk is the fundamental cause of this crisis, as it among others caused the stampede after triple-A rated investments.

May 19, 2010

Where did the regulators get their risk weights from?

Sir John Kay extends “A royal invitation to raise the debate on finance” May 19. Knowing that the value of those commissions lies primarily in how the questions are phrased, since quite often the questions are too general or too many, which tends to obscure the answers, let me suggest one single line of question.

Current capital requirements for banks were established at 8 percent, adjusted for risk-weights. A loan to a small business is risk-weighted at 100%, and the bank needs to hold 8 percent in capital when lending to it. But since a loan to a corporation rated AAA, or to a country like Greece, which until quite recently was rated A, would be risk-weighted at 20% and so then only 1.6 percent in capital would suffice when lending.

So ask the commission… where did the regulators get those 100% or 20% risk-weights from?

We know that the Basel Committee has published for example “An Explanatory Note on the Basel II IRB Risk Weight Functions” but reading the paper only reinforces the urgent need of introducing outsiders to this close circle of regulatory insiders, who are now circling their wagons defending themselves, so successfully that they allowed to dig us even deeper in the hole they placed us in.

The Explanatory Note, prepared in July 2005, states that the risk-weights were developed with a “confidence level of 99.9%, meaning a bank is expected to suffer losses that their capital on average once in a thousand years” How come that confidence level did not last for two years? Who authorized that confidence level? I for one know perfectly well that, if the world would regulate their banks under the assumption that they would fail only once every thousand years… it might as well be dead and buried.

May 17, 2010

It is low capital requirements that generate the type of yield of which great bonuses are made of

Sir Tony Jackson writes that the reason why “banks are up to their eyebrows in dodgy sovereign debt” is they have “fasten to instruments with investment-grade rating and junk-grade yields”, “Politics remains the biggest barrier to bank regulations” May 17. At this point of the crisis it is astonishing how wrong Jackson can be. Where has he been?

These sovereign debts did not pay junk-grade yields they paid relative low rates but these rates were made especially attractive for the banks because these were required to hold very low capital requirements against them.

For example a bank holding debt of Greece, between mid 2000 and December 2009, needed only to have 1.6 percent in capital… which allowed it a 62.5 to one leverage. Take any small margin and multiply it 62.5 times and you will get the type of yields of which great bonuses are made of.

It is not politics but the Basel Committee, who remains the biggest barrier to rational bank regulation.

May 15, 2010

We need to decrease the credibility asymmetry that exists in the credit information market

Sir I refer to The Lex Column writing about the religion credit rating agencies bring to the markets, with their implied aura of infallibility May 15.

One of the problems with credit ratings is that they are never sufficiently publicly debated, unless when it is too late, and when that happens then it is mostly the case of a small questioner against the mother of all father authorities in the markets.

Too often have I heard bankers ask me “Per, how on earth do you think I could convince my colleagues on the Board that the credit rating agencies were getting it so extraordinarily wrong that we should exit from what seemed to be an extraordinarily good business for us?”

In our efforts to solve the asymmetry in information we have increased the asymmetry of the credibility with respect to financial information, making it now almost impossible for divergent opinions to nudge the markets on the margin, and being only considered when the causes for the divergence become much too apparent, which is of course then much too late.

The first thing that should happen is that the credit rating agencies should be required to post, real time, all the questions and answers received with respect to every particular ratings, so to allow the market to express their viewpoints and to allow configure the necessary opinion majorities that could force the credit rating agencies to revise what they are doing.

If that Bank Director friend of mine could have referred to a public online forum where those same suspicions were uttered by others, then he would stand a much better chance of being heard.

May 14, 2010

But the regulatory geeks never passed calculus!

Sir Gillian Tett in “Risks posed by get-rich geeks are not just a flash in the pan” May 14 is right on the dot when she writes that “it all seemed so mind-numbingly geeky and dull to ordinary mortals and very few journalists, politicians, or even regulators, had much interest asking the right questions”

In 2003, at the World Bank, in a brief speech I gave to some assembled risk-manager-regulators I told them “…we can already begin to see how Basel II is forcing bank regulators to make a real professional quantum leap. As I see it, you will have a lot of homework in the next years, brushing up on your calculus—almost a career change.”

Clearly they did not pass calculus, but nor should they have had to, because if regulations are not comprehended by the weakest of the team, they are just too complicated. My problem in my relation on the subject of the very subprime financial regulations with the journalists of the Financial Times is exactly that, because very few of them, if anyone, has found the necessary calm and tranquility to sit down and read Basel II, so as to even begin to understand what absurd paradigm the regulatory geeks want us to follow.

The conventionals scorched the earth but still reign!

Sir again Martin Wolf in “The economic legacy of Mr Brown” May 14 refers to a “light touch” [financial] regulatory regime. I object, never before has there been such a heavy handed intervention as when the regulators created huge incentives, by means of ridiculous low capital requirements, to lend to anything related to a triple-A, and in effect subsidizing risk adverseness to such an extent that markets followed fake-triple-As into disaster.

Also Martin Wolf repeats several times the correct assessment that one of Mr. Brown’s faults was to follow too much the conventional wisdom. Not only do I find it difficult to put what happened in relation to any “wisdom” but I also believe it would have been more elegant for Wolf to acknowledge that, from his own high pedestal in the Financial Times, he himself has been an important feeder of those conventions.

The worst though is that, with or without Mr Brown, the conventionals still reign... suffices to see how the Financial Stability Board is digging us even deeper in the hole.

Mr. Padoa-Schioppa, you helped to pick out "the intelligent", so now you better live with them

Sir it is somewhat hard to comment Tommaso Padoa-Schioppa’s “The euro remains on the right side of history” May 14, because it includes so much of that glorious babble that I produce when I have had a glass of wine too many. That said let me remind Padoa-Schioppa that when he describes those enemies who besiege his euro and refers to “targets selected by the intelligence of three credit rating agencies” he should do well remembering that he himself was among those empowering these credit rating agencies and innocently believing them to be so intelligent that you could structure your whole financial regulations around them.

I am also left with a lingering doubt, is he suggesting that the omnipotent nations-state of Europe should be replaced by an even more omnipotent union. Mind you I am all for EU, as long as it is subservient to the citizens… since deal-making Maastricht bureaucrats can be just as obnoxious as deal-making Westphalia kings.

May 12, 2010

The Champions of the Basel Committee

Sir there is not one regulator capable to stand up and with a straight face look us into our eyes and tell us why a Sovereign rated A to A+, like Greece was from mid 2000 to late 2009, were risk-weighted 20% which allowed banks to lend it with a capital requirement of only 1.6 percent in equity meaning being able to leverage 62.5 to 1, while the small business in our neighborhood was risk-weighted 100%, meaning for banks, 8 percent in equity and 12.5 to 1 in leverage.

But luckily for those regulators, they will never be asked those questions, as long as they can count on Champions like Martin Wolf, Paul de Grauwe, and so many others, insisting on blaming just the private financial sector, “Governments up the stakes in their fight with markets”, May 12. How long will it take to hear a proposal to define all European sovereigns as de-jure rated AAA, so that they can be risk-weighted at zero percent, so that banks do not require any capital at all when lending to them, so that their leverage can be infinite?

May 07, 2010

They´re just plain dumb

Sir Arvind Subramanian is absolutely right when in “Greek deal lets banks profit from immoral hazards” May 7, states the case that there has to be a debt restructuring that includes a lot of hair-cutting to turn Greece´s economy into something reasonably viable, something reasonably livable.

But then he goes into a lot of convolutions trying to explain why the parties in charge do not understand it, but leaves out the most simple and the most normal human possibility, that of them being plain dumb.

I mean anyone who has allowed banks to stock up on Greek and alike debt by authorizing them a 62.5 times to one leverage can´t be anything but plain dumb… and we the dumber allowing them to do so.

The best is to name every single investor as super-duper sophisticated.

Sir Gillian Tett in suggest a new intermediate level of financial sophistication, college level perhaps, to handle the protection of those investors who might find themselves in the no man land of in between, “Sophisticated investor debate takes on a new dimension” May 7. I do not agree one category suffices the “super duper sophisticated”. Give each investor notice they have been considered to belong to this category and let the investors take it from there in the knowledge that when push comes to shove they are on their own.

And in the debate about bankers´ fiduciary duty the best way is for them to declare, in each operation, on behalf of whom they act, whether the buyer, the vendor or just themselves, which is also in their right, and then hold them strictly to that. What is worse is misrepresentation or lack of representation.

We had a monstrously dumb and stupid, government failure

Sir, Samuel Brittan in “A credo for a revived capitalism” May 7 reminds us that we need to discuss more about “government failure”. He is absolutely right.

In October 2004, as an Executive Director of the World Bank, I who am not an investment banker, nor a financial regulator, presented at the Board a written statement were I opined: “We believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”

And long before that and during my whole term as an ED I repeated, as much as I could, bordering on annoying, that the ratings issued by the credit agencies were just a new breed of systemic error to be propagated at modern speeds… and that we should not follow the money but follow the triple-As.

The real question now is what keeps the world from listening when the innocent child screams out “the emperor is naked”?

Look at the European governments, accepting the dictates of the Basel Committee and allowing their banks a 62.5 to one leverage when stocking up on Greek debts and alike… if that is just not a monstrously dumb and stupid government failure, what is?

May 06, 2010

They hold too many Greek bonds, courtesy of the communists in the Basel Committee

Sir Gillian Tett, in “Grim echoes of Wall Street crisis as investors face mental Rubicon” May 6, asks “How many Greek bonds do German banks hold? The simple answer is too many! It could not be any other way with regulators who have allowed banks to leverage their capital 62.5 times to one in the case of bonds rated like those of Greece, and only 12.5 times to one when lending to small businesses and entrepreneurs.

Don’t you get it? For all practical purposes these regulators in Basel are nothing but disguised communists.

May 05, 2010

Respectfully, may I express a doubt?

Sir in your “The case for change” May 4 you write that the Financial Times stands for a “liberal agenda: a small state...” May I respectfully doubt it?

No one that stands for a small state can agree that if his deposit in the local bank is loaned out by the bank to a small business the banks needs to hold eight percent in capital, but if his bank lends instead that money to the government it needs to hold no capital at all.

About this I have written you many letters during many years but you keep on ignoring the issue.

May 04, 2010

Basel Committee, why don´t you just shut up!

Sir who do these Basel Committee regulators really think they are bullying us around with an arrogant “the banks should be sensible and realise that it might backfire if they protest too much”? as reported by Brooke Masters, May 4.

They themselves are the ones who thought everything would be fine and dandy if they just had some few credit rating agencies determine default risks and then gave the banks great incentives, by means of different capital requirements, to follow those credit risk opinions. They themselves are the ones who believing in the abundance of safe triple-A rated lending and investments, caused the world to stampede and fall over the subprime mortgages. They themselves should shut up, because rarely has the world seen such a gullible naive and outright stupid bunch of regulators.

Now the banks, in the midst of a crisis, need to build up the equity they do not have precisely because the Basel Committee did not require them to have; precisely when we the most the banks to lend. The regulators, instead of bullying banks, should busy themselves day and night finding ways for severely capital stretched banks to be able to lend to those small businesses and entrepreneurs who have had to pay the cost of higher capital requirements but who had absolutely nothing to do in generating this crisis.

And just in case, for the record, I am no banker, only a citizen, very upset with the fact that in the 347 pages of the regulations known as Basel II, there is not one single word that describes the purpose of those regulations. Basel Committee why do you not start defining a purpose for what you are doing? Is that too much to ask?

May 03, 2010

Europe, please, do not risk the EU to save the Euro!

Sir you are aware that I have been thinking that a Greek (and some other) defaults is the most logical way out of an unsustainable illogical situation, and so of course I agree with what Wolfgang Münchau on that “Europe’s choice is to integrate or disintegrate” May 3, though much more than he knows.

You see for me I am not so worried about the Eurozone but more so about the EU, since trying to save the Euro signifies seriously endangering the EU, and that is something much worse.

That´s why the markets are schizo!

Sir Tony Jackson could just the same have titled his “Caught between business as usual and more aftershocks” May 3, with “Caught between wanting to make money and wanting to salvage as much as possible”. The problem as we know is that both wishes requires entirely different strategies, which is why the markets are schizophrenic.

May 01, 2010

The Euro or the EU?

Sir Alan Beattie is right deriving “Lessons for the Greek crisis from Philip II of Spain” May 1. Greece is of course much better of keeping all the help they can get for the morning after than for the night before… especially when in this the night before, though very late, it is so hard to discern any morning light.

Only a speedy restructuring of Greece´s debt can avoid having to choose between the Euro and the EU.

Financial Times is equally a promoter of “metaphysical presumptions”

Sir your ‘Faith in numbers” May 1 is truly odious in the way you arrogantly and ironically joke about religious beliefs while blithely ignoring how much you yourself have been helping to give credence to bank regulations that seem to be just the same or even more based on “metaphysical presumptions”.

Or what would you call having the capital requirements for our banks based on some opinions of the credit rating agencies and as arbitrarily weighted by the high priests of the Basel Committee? If that is not pure purposeless mumbo-jumbo or hocus-pocus, what is?