Is banking regulation unfinished business? You bet, risk weighted capital requirements are still used

Sir, I have not read Tamim Bayoumi’s “Unfinished Business” yet, so for the time being I have to go on what John Authers writes in “A fresh way to learn from the financial crash” October 2.

From what I see the book seems in much like another example of Monday morning quarterbacking. For instance when it states “In early 2007 anyone in Wall Street would have said that naive European banks were the most enthusiastic buyers for dubious debt securities” we must really ask what is meant by qualifying European banks as naïve? These were AAA rated securities, these were the type of securities that their own regulators had just in 2004 with Basel II authorized the to leverage 62.5 times to 1 their capital with.

What we had (and still have) is amazingly naïve bank regulators… who for instance still allow banks to use their own models, as if banks were not interested in generating the largest risk adjusted returns on equity, something that, because of regulators, is nowadays foremost done by minimizing capital requirements.

It also says: “the US widened the collateral that banks could use in repo transactions [this] rule encouraged them to create mortgage-based securities, and “game” rating agencies into giving them undeserved strong ratings”. But that is wrong, or at the most, just a minor cause of the disaster.

Anyone who has taken time as I did to understand what had happened (I passed exams for real estate and mortgage intermediation licenses in the US for that purpose) would be clear on the following. The profit potential in securitization is a direct function of the quality difference between what is put into the securities, and what comes out. To be able to feed the sausage with subprime mortgages yielding 11 percent, and then because of AAA ratings be able to resell these (to Europe) at 6%, was a profit opportunity to big and juicy to miss.

Finally Authers comments: “Meanwhile, models resting on assumptions disproved during the crisis are still in use. There is indeed unfinished business.” Indeed, the risk weighted capital requirements are still used.

Sir, the first of about 50 letters I have written to John Authers since July 2007, more than a decade ago, ended with: “This all is lunacy and we are being set up for even bigger disasters and it must end, before it ends us. We need urgently to punish the regulators, at least on the count of being very naive.”

But clearly someone in FT did not want to hear my arguments, or at least not these coming from me.

@Per Kurowski