Indeed, reforming the credit rating market is an urgent necessity. Indeed, shame on the regulators

Sir, Arturo Cifuentes concludes, “Reforming the credit rating market is an urgent necessity. Shame on the regulators” “Few lessons have been heeded 10 years after Lehman collapse” August 23.

Yes shame on the regulators! But also for some other reasons than those Cifuentes mentions.

Just for a starter, the credit rating agencies would never ever have caused so much damage had their opinions not been leveraged immensely by the risk weighted capital requirements for banks. Imagine, Basel II, 2004, allowed banks to leverage 62.5 times if only a human fallible credit rating agency assigned an asset an AAA rating. 

It should have been crystal clear that with that the regulators were introducing a huge systemic risk in the banking sector. That I mentioned for instance in a letter published by FT in January 2003; and I loudly explained and protested it while an Executive Director in the World Bank during those Basel II preparation days.

In Europe, the EU authorities even overrode the credit rating agencies opinions and assigned Greece a 0% risk weight, which of course doomed it to its current tragic condition. 

Then, let us mention the mother of all regulatory mistakes; for their risk weighted bank capital requirements, initiated in 1988 with Basel I, the regulators used the perceived risk of assets instead of the risks of those assets conditioned on how their risks are perceived? How loony, how sad, what a distortion, what a recipe for disaster was not that? And still, 30 years later, they do not even acknowledge their mistake.

By the way, when Cifuentes denounces that Solvency II, with its myopic risk view, will discourage insurance companies, the natural holders of illiquid assets, to hold these investments, and it will therefore increase the systemic risk by making their portfolios less diversified, I could not agree more.

Sir, you know that for over more than a decade I have written to Financial Times 2.787 letters objecting to the “subprime banking regulations”, this one not included. Galileo could indeed be accused for being obsessed with his theories, but, could those doing their utmost to silence his objections, the inquisitors, not be accused of the same?

PS. Cifuentes mentions “Olivier Blanchard’s 2016 admission that incorporating the financial sector in macro models would be a good idea”, I might have had something to do with that.

PS. Here is somewhat more extensive aide memoire on the mistakes in the risk weighted capital requirements for banks.

@PerKurowski