October 20, 2012

Regulators, thou shall not lead bankers into temptations, nor distort

Sir, Robert May writes “In finance too, complex ecosystems can be vulnerable”, October 20. The opinions of a zoology professor should be much welcomed since only a diversity of views could help us to avoid regulatory faux pas of such magnitude as the current. That said there are things I do not agree with him and would love to discuss. 

For instance when he writes that” it is hard to believe anyone could have been so beguiled by mathematical elaboration of silly assumptions as to rate grouped triple B mortgages as triple A”, he ignores first that well awarded triple B mortgages can indeed be grouped in such a way that most of those could be rated triple A, and secondly, completely, the power of incentives. 

When regulators offered the banks needing only to hold a meager 1.6 percent of capital against securities rated triple A, we are talking about Churchill´s initial "Madam, would you sleep with me for five million pounds?”, and not his "Would you sleep with me for five pounds?". The Lord´s Prayer prays for “lead us not into temptation”, but irresistible temptation was precisely what the regulators created. 

Then of course Professor May correctly supports the recent calls made by Andy Haldane in favor of simple leverage ratios for banks instead complex Basel styled risk-weighted ratios. 

But, unfortunately, and as Mr. Haldane, he has yet to understand that the most important argument for simple leverage ratios is that the risks that regulators have been and are weighing for, are already weighted for by the banks in terms of interest rates and amounts of exposure, and a weight on a weight, can only end up being too much weight. 

And that over-weighting ,in favor of “The Infallible” and against “The Risky”, is precisely the reason why our banks have become dangerous obese ingesting supposedly absolutely safe assets and anorexic on the for us so nourishing risky assets, like loans to small businesses and entrepreneurs. 

I am sure Professor May would never have done a dumb thing like that, to one of his complex and beloved ecosystems.