December 29, 2010

Regulators are quite busy fooling themselves.

Sir in “A smaller role for Wall Street” December 29 you write “Above all, regulators do not want to be fooled again”. Let me assure you that no one fooled the regulators more than they fooled themselves, and, from the looks of Basel III, they still keep on doing that.

June 2010, in Washington D.C. I commented to Lord Adair Turner, the Chairman of the FSA, that he as a regulator was acting like a confused handicap officer on a horse-racetrack, taking away the weights of the good runners (triple-As) and placing these on the bad runners or debutants (small businesses and entrepreneurs), without even informing the bettors and the bookies, and believing this would lead to a fair and good race. This layer of discrimination, slapped on top of the market´s natural adverseness to risk, pushed the banks excessively into AAA land and is affecting quite seriously the real economy.

I also reminded Lord Turner that even from a pure limited regulatory perspective it made no sense, as the only thing capable of posing a systemic threat to the banking system was precisely what was perceived as not risky, by banks and regulators alike. Lord Turner, in an email answered that “Our ability to know ex ante what is low and high risk is clearly limited” and that my “argument certainly poses a challenge which I need to think about”. It would seem he is still thinking about it… or trying to forget the inconvenience.

Though there are free-kicks in football most time the ball is in a much confused play.

Sir, John Kay in “Don´t expect the markets to bend it like Beckham” December 29, correctly points out that in the market it is not really the expertise of the expert that counts but the interaction of the experts, and I would say the myriad of non-experts often believing themselves experts.

This is precisely what the Basel Committee completely ignored when they calibrated the capital requirements based on risk of defaults. They appointed as their experts the credit rating agencies but completely forgot that what really imported were not the ratings as such but the way banks would respond to such ratings and to the resulting capital requirements… in the midst of a confused game.

December 21, 2010

The regulatory “after” is still heading in the same utterly faulty direction as the “before”.

Sir, your FT writers, in “Before and after: how the investment banks had to change shape post-crisis” December 21, write “The new global Basel III capital framework… will force banks to hold more capital against riskier activities”.

Yes, that is so, unfortunately, because what the bank regulators, and your writers, are still incapable of understanding is that since this crisis had absolutely nothing to do with what was considered as riskier bank activities, and for which the banks held more than sufficient capital, and all to do with what was perceived as not risky, and for which the banks were allowed to hold minuscule amounts of capital… we are still being set up for future systemic disasters by exactly the same deeply flawed regulatory paradigm.

Again, for the umpteenth time, first lesson of Bank Regulations 101… it is only what is perceived as not risky that has the potential of creating a systemic disaster.

When will we hear regulators talk about the importance of avoiding giving further incentives to what already has the immense incentive of being perceived as not risky? Please, FT, wake up!

December 17, 2010

The Basel Committee seems really to be digging us deeper in the hole.

Sir I would recommend the reading of Basel III: A global regulatory framework for more resilient banks and banking systems published in December 2010.

If after what this crisis should have taught the regulators this is all they can come up with I can only conclude that our current crop of bank regulators are absolutely insane.

The regulations are so convoluted that there is no chance that any normal banker or regulator would really understand them much less be capable of evaluating these… as they are all supposed to do.

Just as an example I would call your attention to the formula in paragraph 99: A that supposedly calculates the capital requirements to cover for counterparty risk. Also that formula, which I admit that I am not yet 100% sure on how it works, references a table of risk-weights that in seven tranches goes from .7% for an AAA rated, through 3% for a B rated and up to a whopping 18% for a C rated counterparty.

I look at it, over and over again and try to understand how this formula would have stopped the banks from dealing excessively with a triple-A rated counterparty like AIG. In fact, though I cannot swear on it, it would seem that the capital requirements would be even lower than in Basel II.

FT, do you have any reporters with the guts of not admitting they understand something before they truly understand it? If you do, please have them ask the Basel Committee some fundamental questions, I mean so that we try our utmost to avoid it digging us deeper in the hole where they already placed us.

And the current scary story tells only a fraction of the scary possibilities.

Sir the truly frightening figures for bank capital shortfall of €577bn that Brooke Masters and Patrick Jenkins report “Basel reveals liquidity gap for world’s biggest banks” December 17 are even more frightening if one considers that basically no downgrading of credit ratings of sovereigns are included in those calculations.

For instance Spain having recently been downgraded on notch courtesy of the Basel Committees’ Basel II still generates a 0 percent capital requirement… one more downgrade and that could shoot up to 1.6 percent… and then 4… and then 8 percent.

Different planets?

Sir to read  Brooke Masters and Patrick Jenkins  in ”Basel reveals liquidity gap for world’s biggest banks” December 17 mentioning a Basel III capital shortfall of  €577bn in capital for 91 of the world largest banks, and this really before any terminal sovereign debt problem, and at the same time read Ralph Atkins reporting “ECB sends out [only a] €5bn bill for capital increase”, “to restore confidence in the continent’s 12-year monetary union” makes one thing of whether those reporters find themselves on different planets, or that someone is pinning his hopes on the mother of all ambitious leverages.

Again, for the umpteenth time, don’t control for credit risks, it is best handled by the market, without interference.

Sir, Gillian Tett with respect to the “hardwiring” in regulations of the credit rating agencies that is not working writes that “the rub for the regulators … is that “nobody has any clear idea how to create a workable alternative to judge credit risk”, “Rating agencies stuck in a bind as eurozone pressures mount” December 17. That is absolutely wrong and I have hundreds of letters to FT to prove it.

Since the market already clears for credit risk, by means of risk-premiums charged, what regulators should do is absolutely nothing. Anything they would invent, like the risk-weights they imposed, only confuses and muddles the market, and leads to crisis like the current which was provoked by extremely low capital requirements for banks when investing in triple-A rated securities or lending to Greece or Irish banks, because regulators thought these were not risky… even though regulators should have known that it is precisely what is perceived as not risky by regulators and bankers alike, what is always the most risky for the system.

Yesterday I visited the Newseum in Washington and in doing so the question of how journalist silence ideas just because these seem to simple for them and they prefer the complicated convolutions of experts came to my mind. Not once has FT been willing to publish what I like here have argued for years now.

December 16, 2010

Don’t place the responsibility for the banks in hands proven irresponsible

Sir Wolfgang Münchau suggests shifting the responsibility for all systemically relevant banks to the EU, “How a mini fiscal union could end instability”, December 13. Since all European banks have anyhow been mostly ruled by the Basel Committee that seems to make a lot of sense… that is until you realize that what most turned these systemically relevant banks into monstrous systemic risks, were the systemically dangerous regulations of the Basel Committee, and which allowed banks to leverage 62.5 to 1 when investing in triple-A rated securities or lending to Greece or Irish banks. In fact that is when you even start to be tempted about thinking of shifting the responsibility for your banks to the most local of your local authorities.

What a difference a different wording makes

Sir, John Gapper writes “Too often, banks were over-eager to take fees for what they wrongly regarded as low-risk activities that would not absorb regulatory capital”, “Madoff was Wall Street’s problem. December 16. What a strange way of wording it. I would have written “Banks, naturally, like taking fees, especially in those activities that because they are considered as low-risk by the regulators, require the banks to hold only minuscule regulatory capital. What a difference a different wording makes.

There are businessmen in what is rated AAA and then there are all the others

Sir, Mort Zuckerman writes about the need for Obama to bring in more senior business people in order to bridge the current gulf, “Only business can put Obama back on top”, December 16. He is right, but in this respect both Mr Zuckerman and Mr Obama need to remember that there are two quite different types of business people, there are those active in what is rated as AAA and then there are all those who work in the rest of the economy. It is the latter who need urgently to be more present, since listening even more to the former, might only dig Obama’s presidency even deeper into the hole were inept financial regulators have placed the US and much of the world.

December 15, 2010

We have a poor illusion of a committee working on an illusion and us believing their illusions.

Sir, John Kay writes “The notion that a committee can finely calibrate the risk associated with a variety of asset classes, many instruments, and a wide range of institutions on a basis which is at once objective and economic meaningful, is an illusion.”, “Even Middle England should spare a thought for Modigliani-Miller.” December 15. Hear, hear! …that is the sole truth about the Basel Committee for Banking Supervision.

But when on top of that, the Basel Committee also decides that the only risk for which it will calibrate is the truly innocuous risk of default (probably just trying to save itself from the job it should be doing, that of making the defaults run as smooth as possible); and on top of that does it without considering the risk-premiums charged in the market precisely to clear such default risks, then what we end up with is a poor illusion of a committee working on an illusion… and unfortunately a world of politicians, academicians, financial experts, and financial journalists believing in their illusions. Isn´t that a sad state of affairs?

Is a zero capital requirement for banks normal or abnormal?

Sir, Martin Wolf considers the interest rates on US, Germany and UK public debt to be “likely to rise substantially if and when less abnormal conditions arrive”, “Why rising rates are good news” December 15.  I would be interested in hearing whether Martin Wolf considers that among the abnormal conditions is the fact that banks need no capital at all when lending to these governments? To me that discrimination in favor of governments is outrageous and has the odor of communism… but it seems that very few really mind it… not even libertarians… or is it just that libertarians aren´t what they used to be?

December 13, 2010

More than the destination it is the road travelled that counts

Sir, Prof Eric De Keuleneer suggests that “Bank just might have too much equity” December 13. That is oversimplifying it. Banks are required absolutely too little capital, zero to 1.6 percent, when lending to what is perceived as having a low risk of default, and therefore, strictly in relative terms, much too much capital, 8 percent, when lending to what being perceived as riskier, like the small businesses or entrepreneurs who are indispensable to the economy as a whole.

In that respect what should be done is to temporarily reduce the capital requirements for what is perceived as risky, to whom bankers will presumably still not lend excessively to, much less without more careful studies, so as to make the journey to “sufficient bank capital” a less discriminatory venture.

I support of course to De Keuleneer´s recommendation that “the credit rating agencies should be used less and with less authority”; that is an absolute must if we want to return our bankers from that world where they do not need to have an opinion of their own but are satisfied with monitoring the opinions of others.

Reading WikiLeaks in the mirror

Sir it helps to place the WikiLeaks in perspective as well as being real fun to imagining what would be the reactions to many WikiLeaks, if they stated the opposite.

For example, December 9 Silvia Pfeifer reports that a WikiLeak indicated that “Shell knew ´everything’ in Nigerian ministries” What would shareholders and the world think of a “Shell knew nothing”? Would that not really be a newsworthy WikiLeak?

If I was a Nigerian minister, would I prefer doing business with companies willing to do as good a due diligence they possibly can, or would I prefer those who do not? If I decide for the later group would that mean I could let my guard down?

December 10, 2010

Though aspirin might temporarily lessen the pain, we need a cure

Sir, Martin Wolf believes that it is gentler for the society to have artificial low rates and illusory asset values than adjusting to higher interest rates and more real asset values “Why we have to live with low interest rates”, December 10. He is right inasmuch as the sacrifices are spread out over a longer period, but not necessarily in that the accumulated sacrifices will be less… for instance if the sovereign bubble that pays for the lower interest rates bursts, and takes the currencies down.

What we need to be doing is finding ways to really grow out of the mess and that will just not happen while we insist on using capital requirements for banks that, on top of the risk-premiums already charged by the market, add an arbitrary layer of discrimination against perceived risk of default.

For instance at this particular moment hundreds of billions of bank liquidity are painted into the corner of the bank balances which does not require capital, namely the lending to high rated governments, and no matter how much everyone wants it to happen, that liquidity cannot be translated into loans to small businesses or entrepreneurs, because that would require bank capital for which there is currently no real appetite.

It is truly sad to see that though small businesses and entrepreneurs could help us to get out of the doldrums, there are many influential persons who seemingly prefer that to be a task for government bureaucrats alone.

December 08, 2010

Sometimes bad credit ratings are pure bliss.

As a citizen from a country that no matter how bad the credit ratings were they should always have been worse so as to help us to stop our governments from taking on debts, and therefore quite knowledgeable about the bliss that sometimes follows bad news, I cannot but agree with John Kay´s “Learn to love the candid bearer of bad news”.

The fundamental problem with using credit ratings is that if they are 100% right on the dot then a financial transaction based on it would be just but would not provide any party with a profit. In order for credit ratings to generate profit, for a borrower or a lender, for a buyer or a seller, they have to be wrong… and to blindly base your regulations on something that needs to be wrong in order to generate profits does not sound like the wisest thing to do.

PS. You might like to read “The riskiness of country risk” which I published in 2002.

We need also new rules to keep bank regulators alert and on their toes

Sir, Lord Adair Turner the Chairman of the FSA sustains “We need new rules to keep bankers honest” December 8. Though hoping one could keep all bankers honest with rules sounds a bit too optimistic, we all agree… that is of course as long as it does not affect the rational capital allocation function of the banks by making the bankers too risk-adverse

But, what about those rules we need to keep bank regulators alert and on their toes? Given that it was the regulators who allowed the banks to leverage 62.5 to 1 when investing in triple-A rated securities or lending to Greece or Irish banks, a rule like that one which he proposes for incompetent bankers, namely that they will not be “allowed to perform a similar function at a bank, unless…” should equally apply to regulators.

The minimum minimorum I would ask all current regulators to do is to go back to bank regulating school and take course 101 and which teaches that the only risks that pose a real systemic risk are those perceived as low… and most specially when perceived as low by regulators and bankers alike.

Without any disrespect, Lord Turner would also benefit immensely from such a course.

December 06, 2010

Government bureaucrats should not be the sole responsible for generating growth

Sir, Prof Jean Dermine in “Take regulations of bank capital one step at the time”, Letters December 6, lends his support to the Basel Committee´s decision to spread out the capital increases in Basel III over eight years. The problem though is that in the process there will still be many borrowers unduly penalized because lending to them generate larger capital requirements for banks than the lending to others. That is why I am so adamant that while we cannot afford lifting all capital requirements immediately, neither can we afford not lowering them for others.

At this particular moment billions of bank liquidity are already painted into the corner of the bank balances which does not require bank capital, namely the lending to high rated governments, and no matter how much everyone wants it to happen, that liquidity cannot be translated into loans to small businesses or entrepreneurs, because that would require bank capital for which there is currently no real appetite.

Let us allow small businesses and entrepreneurs to help us to get out of the doldrums, let us not place that burden on government bureaucrats alone.