March 13, 2012

When demand for risk-free bank assets outstrips the supply, banks will load up on Potemkin like risk-free assets.

Sir, David K. Richards in his letter of March 13 “Think again about higher bank credits” blames all bank problem on bad bank assets resulting from “slipshod credit analysis by the rating agencies, by regulators, by securities buyers and by the banker themselves. That is correct but completely ignores that slipshod credit analysis was doomed to happen. 

When the regulators allowed banks to buy triple-A rated securities or lend to “infallible” sovereigns against only 1.6 percent in capital, giving the banks the possibility of leveraging their capital a mindboggling 62.5 to 1, the demand for these assets grew so immense that the market, unable to accommodate that demand with real AAA rated securities or real solvent sovereigns had to, in good old Potemkin style, produce falsely triple –A rated securities and false solvent sovereigns like Greece.