October 12, 2011

A market adjusted very risky sovereign debt could be less risky than an AAA-rated sovereign debt.

Sir, Patrick Jenkins, Ralph Atkins, Peter Spiegel and Alex Barker in their “Europe’s banks face 9% capital threshold” write that according to the European Banking Authority’s board of supervisors, “banks should be made to raise their core tier one capital ratios – the key measure of financial strength even after absorbing write-downs on the value of their sovereign debt holdings.” 

Here are two questions: Should the credit rating be the same for a debt acquired at its nominal value of 100% than the credit rating of that same debt for someone who acquired it after for instance it has been discounted in the market for the credit risk to be worth only 50 percent? Or, could not a BBB rated debt acquired at 50 percent be safer than an AAA rated debt valued at 100 percent? 

In answering them, you will understand why the bank regulators have placed us in a hole and why they only keep digging us deeper in it. 

You can have the regulators measuring the risks, not recommended, or you can have the market doing that, but, what you cannot do, under no circumstances is to use and add those both measures simultaneously, and expect to obtain something reasonable.