Default risk-weights and purpose-weights are used to establish capital requirements for banks in Venezuela.

Sir on July 29, in Venezuela, the financial regulator, Sudeban, issued a normative by which the risk weights used to establish the capital requirements of the banks were lowered to 50%, when banks lend to agriculture, micro-credits, manufacturing, tourism and housing. As far as I know this is the first time when these default risk-weights and which resulted from the Basel Committee regulations, are also weighted by the purpose of the loan.

The way it is done Venezuela seems to lack a lot of transparency and it could further confuse the risk allocation mechanism of the markets (though in Venezuela that mechanism has already almost been extinguished) but, clearly, a more direct connection between risk and purpose in lending is urgently needed.

In this respect the Venezuelan regulator is indeed poking a finger in the eye of the Basel regulator who does not care one iota about the purpose of the banks and only worry about default risks and, to top it up, have now little to show for all his concerns.

I can indeed visualize a system where the finance ministry issues “purpose-weights” and the financial regulator “risk-weights” and then the final weight applicable to the capital requirements of the banks are a resultant of the previous two.

Does this all sound like interfering too much? Absolutely, but since this already happens when applying arbitrary “risk weights” you could also look at this as a correction of the current interference.

Stop subsidizing status-quo and taxing development.

Sir Mario Monti in “Watchdogs of the world, unite!” July 29, makes a powerful case for the need of strong antitrust enforcement to keep market competition alive, capitalize on “creative destruction” and minimize “destructive conservation”.

In the same vein I would also request the competition agencies to look into the anti-competition implications imbedded in the capital requirements for banks, by which borrowers who can dress themselves up as having a “low default risk”, when compared to the “higher default risks”, are subsidized by the cost savings that are produced by some extremely low capital requirements. That signifies a subsidy for status-quo (the known) and a tax on development (the unknown). This exaggerated conservative risk-adverseness has already taken us over the cliff of the subprime mortgages… with nothing to show for it.

Systemic risk, here, there and everywhere

Sir when you in “At your own risk” July 28, write about forecasts as “self-fulfilling prophecies” you are precisely describing a systemic risk in regulations. Systemic risk does not only signify a part of the system that becomes so large as to endanger the system, as that concept seems to have been exclusively interpreted lately, but it also includes the risk of introducing a threat to the system, a virus... like the concept of forcing upon the banks the use of credit rating agencies.

Now when you lecture University presidents about how the “public’s intellectual virtues – curiosity about other fields, aversion to dogma could do the discipline some good”, instead of “public” you could use “readers” and apply it to yourself. The ease, by which on a whim you exclude the opinions of some of your readers like me, shows you share the same problem.

What if I would send you an exclusive and mindboggling story? Would you have to let it go? Have you hijacked yourself? That is sure a systemic risk? Don’t you agree?

The credit rating agencies made mistakes, the regulators showed lack of judgment

Sir Arturo Cifuentes concludes “Time to start rating the full influence of bond graders”, July 28,“Leaving [the credit markets] at the mercy of the [credit rating agencies] that showed so much bad judgment in what was supposed to be their core competence seems like a terrible idea.” I must correct him. The credit rating agencies just made mistakes instead it was the regulators who, by giving the agencies the powers, showed a total lack of judgment.

Is Mr Robert Picciotto a closet central planner?

Sir Robert Picciotto a Council Member of The United Kingdom Evaluation Society in a letter titled “Competition will not cure rating industry ills” July 27, writes: “Objective evaluation is a quintessential public good that is unlikely to be generated by the market”.

I sure hope Mr Picciotto is defending a business interest of his own, because the alternative would make him an extremely fanatical and dangerous central planner. How can he write such nonsense precisely in the midst of an economic crisis that resulted directly from the global bad risk information that was requested by those financial regulators who believe that our financial markets should be guided by some very few experts?

“Objective evaluation”? Hah! They have not even agreed what exact risk is to be evaluated or for what purpose exactly.

Let the government charge for the protection racket services it already provides.

Sir your “Vice of necessity” July 25, where you start hinting at legalizing drugs so as to raise the taxes fighting this crisis needs, opens up our eyes to a lot of unexploited taxing opportunities.

Among these: charging for the protection services already provided to intellectual property right holders; imposing a special tax on government created monopolies and oligopolies such as those of the credit rating agencies; and finally a big special tax on all bonuses derived from capitalizing all those splendid arbitrage opportunities that the financial regulators provide.

Alternatively of course, and like what you seem suggesting, is to get out of protection racket altogether so that much of the illicit and informal economies that most probably are still growing at healthy rates, can join the rest of the economy and be taxed as all of us.

What does not seem logical though is to remain in the wishy-washy middle ground.

The investors know very well what is going on.

Sir Gillian Tett in “Investors are floundering in post-traumatic syndrome” July 24, writes that “the number fretting about inflation is similar to those concerned about deflation – with almost no one sitting on the fence”. No wonder, to be sitting on the fence presupposes governments know what they are doing and if they did why are we in this crisis to begin with?

Personally I am convinced we will fall over to the inflation side because the public debt will become unsustainable; there are other bottlenecks like oil out there; and I do not see sufficient political will to stop the printing press from working overtime.

What I do not agree is when Gillian Tett says that “investors lack the intellectual framework to make sense of what is going on”, they know perfectly well that it is the governments and the regulators who lack the intellectual framework to make sense of what is going on, as evidenced by the lack of efforts to ascertain we will not have a new cull of subprime financial regulators in Basel.

What are we doing to save ourselves from subprime financial regulators in Basel?

Sir Prof Lawrence J. White in “No monopoly on credit wisdom” July 24 writes “Credit wisdom is not located solely in Moody’s Standard & Poor’s and Fitch”. He is of course absolutely right, though the real question are: Should not our financial regulators have known that before they sent the market on a wild and crazy AAA chase guided by just three credit rating agencies? How unwise can we allow our financial regulators to be?

Frankly we did not need this crisis to know that and let me remind you that on January, 12, 2003, the Financial Times published a letter I wrote and that ended with “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.”

What are we doing in order to save ourselves from a new cull of subprime financial regulators in Basel? Not much, if anything at all.

FT is at long last very close to getting it, come on just one more push!

Sir about six years and 300 letters of mine later you are finally asking to “cut back the credit rating agencies quasi-public authority” Raters berated, July 23. A bit slow, and thick, but, nonetheless, well done!

Having said that when you refer to the EU’s recent directive on capital ratios I see you are still harbouring some confusion. Let me try to explain it again… letter 301?

The regulators arbitrarily imposed distortions in the financial markets when they decided, for instance, that in order to lend to a non-rated borrower a bank needed 8 percent in equity while for a triple-A rated only 1.6 percent is required. Even if the EU now rules that the banks cannot, no matter what, leverage themselves over some maximum figure, but leave otherwise intact the current structure of minimum capital requirements then, on the margin, all the distortions remain. You see in finance and in so many other things in life it is the marginal decision that counts.

By the way… is a job in a triple-A rated company more worth to defend than a job in a B- company? The regulators in Basel seem to think so.

The too few to follow is more dangerous than the too big to fail

Sir I refer to John Gapper’s “Squeeze the leviathans of finance” July 23. I go way back fighting the “too big to fail”, even when they were thought of being “too smart and expert to fail”, but let me assure you that a thousand small banks following one credit rating agency are still much more dangerous than the too large to fail with thousands of analysts.

And by the way the problem with the Basel minimum capital requirements is not so much that banks end up holding little capital but that these regulations discriminate among borrowers and who therefore go through all strange convolutions to dress up in AAAs.

Mark to market the government’s bail-out efforts

Sir Jonathan Guthrie in reference to the bailout of General Motors writes that if he was a US taxpayer “I would tell Fritz that I wanted my $50bn back”, “An industry running on romance alone” July 23. And he is fully in his right to demand that… but only after he had paid his share of the tax of course.

Perhaps what the US should do is to turn around and give a 50% tax credit for anyone willing to pay 100% of face value for whatever the government has received from GM in return for that assistance and then let these papers trade to see what the market considers them to be worth.

Problem though is that government would never dare themselves to be marked to market that way.

Shear madness or superb lobbying?

Sir as Joanna Chung and Aline van Duyn reports in “US rating agencies escape overhaul” July 22, the financial regulators seem intent to have the financial world and the banks to keep on following the opinions of the credit rating agencies as if nothing has happened. Is this the result of shear madness or superb lobbying?

R.E.S.P.E.C.T.

Sir, in “An exit will have to come, but not yet” July 20, by reducing us to some “sick” jokers worrying about inflation when there is so much “excess capacity and high and rising unemployment” you show utter disrespect to those of us who do worry about inflation resulting from hitting serious energy, public debt and climate change bottlenecks. 

I would say, whoever wrote this editorial must be a baby-boomer, living up to the motto “Après moi, le déluge”.

That said, on the theme of quantitative easing, let me remind you that just as a company repurchasing its own shares, its main problem is that while doing so, it really does not know how much the market values its shares.

Let the bankers earn their bonuses, through competition

Sir David Blake goes overboard titling “Why banking’s bonus culture should be defended” July 18. Yes, regulators should not try to micromanage the bonuses but “defend the culture”? No, what is evidenced by the extraordinary gross earnings available for bonuses is that the banks are not operating in a sufficient competitive environment, and much so because of the regulators.

It is the trading of non-transparent instruments in non-transparent markets; and the profitable arbitration of the risk weights concocted by the regulators that help to create those gargantuan gross earnings that need to be distributed. How the bankers and the shareholders then share the almost loot, well that is entirely their business.

We might have been better off with no regulation whatsoever, but while they regulate let the regulators respond to investors, borrowers, and taxpayers for those mind-boggling bonuses paid out to the bankers, or those mind-boggling shareholder value of banks that we have seen the last decade.

How do you get seignorage out of security?

Sir, in “Cheer up, Britain”, July 18, you describe how the UK is a safe place to live. Since in the market of safe havens there are many niches what the UK now needs is to find out how to get the most seigniorage out of that kind of security.

Taxation through reverse mortgages?

Sir in “Adapting to mediocre prospects” July 17 Martin Wolf writes “Let the cash-poor but land rich borrow their tax payments from the government and demand repayment on death”. Is Martin Wolf trying out as a modern Sheriff of Nottingham proposing the taxation through reverse mortgages?

Why does Mr. Wolf not go after the cash-rich to begin with? What does Mr. Wolf have especially against landowners? Why does Mr. Wolf for instance not go after all those intellectual property owners who are granted monopoly rights and protection by the state without paying anything special for that?

Safer does not mean less risk

Sir Martin Wolf in “Adapting to mediocre prospects” July 17 writes that the UK “must start by making finance safer”. Has he not learned anything? It was exactly doing this that the regulators, with their minimum capital requirements based on risk and the appointment of official risk surveyors, the credit rating agencies, led the world massively into the safest assets, houses, the safest country, the USA and the safest instruments, the triple-A rated securities.

If you want to get out of this crisis, even settling for mediocre objectives, the financial world has to learn to embrace the right risks and learn to avoid the unsafe safeness

Beware wasting scarce resources on green placebos

Sir I refer to your “Winds of change” July 16. For every dollar spent fighting climate change with green placebos such as hybrid cars, photovoltaic solar panels and sometimes even wind-energy, we have one dollar less in resources to fight climate change for real. This fact, quite astonishingly, often seems to matter the least to those for whom fighting climate change seems to matter the most.

We are climbing a ladder made of whipped cream

Sir Martin Wolf writes “After the storm comes a hard climb” July 15, and the title is indeed optimistic as it seems to imply as a first Hurrah! that we already hit bottom and as the second that we have got ourselves a good ladder. I am not at all sure the first Hurrah is true, let’s pray it is, but what I do know is that the ladder we are currently using is not solid enough for any sustainable growth. I would say the current ladder looks and feels like made out of whipped cream, and most probably is.

The remittances immense economic importance is rewarded with minimum political relevance

Sir in reference to your “Survival lessons for developing countries” July 15 and that discusses
the vital economic importance of remittances for developing nations I would like to contrast that to their almost non-existent political importance.

For instance, in the case of Honduras the remittances signify 25% of the GDP of Honduras. If we assume that the migrant workers remit 20% of what they earn we can then calculate that their gross earnings represents 122% of Honduras GDP. And so, if we divide the 122% by the net 75.5% GDP that was produced domestically, in Honduras, then we have that the Honduran migrant workers outside Honduras produce a bit more than 1.6 times what is produced in Honduras.

In other words it is the Honduras migrant workers that with immense sacrifices carry their poor homeland on their shoulder but yet no one asks their opinions in relation to the recent events in Honduras. Shame on the Hondurans back home, the minimum one could in such circumstances expect is that the migrant workers had at least 30 percent of the seats in the Honduras Congress.

The same Basel induced temptations keep plaguing the banks

Sir since it was the extremely low capital requirements that were authorized for banks whenever the risk perceived by the credit rating agencies was non-existent that started the stampede into subprime land, John Plender is absolutely right when he writes “Banks let off the hook as flawed model is preserved” July 15. It does not matter much if you increase the minimum capital requirement averages if, on the margin, you keep on interfering in the same arbitrary way in the risk allocation mechanisms of the market.

Today, the banks are still authorized to leverage themselves 62.5 to 1 on the loans they give to corporate borrowers rated AAA to AA- or need to capital requirements at all when lending to sovereigns rated AAA to AA- and so, today, all the temptations to head off in the wrong direction are still there.

A mystic crusade against debt?

Sir, there is too much debt because debt has been given huge fiscal incentives; that banks have in some circumstances been authorized to have extraordinarily high leverages; that consumer debt pushers have been able to act freely with an impudence that any drug dealer or casino owner would kill for; and that markets followed faulty risk rating signals that indicated some borrowers were risk-free no matter how much debt they contracted.

And there is nothing “mystic” with that, as the almost embarrassing manifest of Nassim Nicholas Taleb and Mark Spitznagel “Time to tackle the real evil: too much debt” July 14 would seem to indicate. The authors call for economic demystification by calling for a mystic crusade against debt.

I have professionally been involved with many debt to equity conversion operations and of course they are often very useful but let´s face it, at the end of the day, a loss is a loss is a loss, whether you are holding debt or equity, just that the latter usually allows you to bluff yourself a little longer.

“Small children small problems big children big problems”

Sir John Kay in “Our banks are beyond the control of mere mortals” July 8 discussing the qualifications of those in charge of our financial institutions concludes that “we would be wiser to look for a simpler world, more resilient to human error and the inevitable misjudgements”. I guess anyone except those puritans who expect our bankers to be from another world would tend to agree with that.

Nonetheless given that the world is not simple and that we should perhaps not want it to be simple either, the best we can hope for is first for no one to accumulate so much power that the results of any inevitable misjudgment will bring the system done; and second that the resilience to human errors does not hide the human errors while they are still small. In other words exactly what the very unwise regulators did when they invested so much regulatory power in the three amigos, the credit rating agencies.

Narrow banks could lead to a narrow future.

Sir Prof Sol Picciotto on “How to create narrow banks with purpose” July 3, suggests requiring from “any bank that benefits from state support to engage only in classes of transactions that have received regulatory clearance”. Sound great but what kind of transactions of those who got the banks into problems did not have regulatory clearance and of these which would not have received regulatory clearance? Those with AAA ratings?

We continue trapped in the belief that there was some sort of excessive risk taking that got us into this crisis while in fact what happened was that the financial world was authorized to engage into an excessive risk-aversion and that turned out so bad when the officially appointed risk-surveyors failed.

We continue trapped in the belief that there was some sort of excessive risk taking that got us into this crisis while in fact what happened was that the financial world was authorized to engage into an excessive risk-aversion that turned out bad when the risk-surveyors failed.

If we want a better world then let the banks be banks but if all we want is to desperately conserve then I guess we have to go for “narrow banks”.

Just don´t pay Harvard cash-up-front!

Sir Lucy Kellaway answering “Am I mad to invest in a Harvard course in a downturn?” July 2, does not tackle the real madness of it which is the way that the course would seem to be contracted with terms of $ 60.000 cash-up-front.

I would suggest a better offer to Harvard would be $3.000 up front to cover for your marginal costs and then 20% of any additional earning produced by the graduate during the next 5 years, even if that comes to be much more than $60.000. I mean that would make the so much recently discussed incentive structures better.

The Constitution of Honduras contains some strange things.

Sir I refer to your reports on the current situation in Honduras. Are you aware that one of the articles in the Constitution of Honduras actually states that you will “lose your conditions as a citizen if inciting, promoting or supporting continuance or the re-election of the President.” This, though sounding a bit crazy, could be indicative of that the whole issue of a re-election, towards which Manuel Zelaya was undoubtedly striving, is more of an existential issue in Honduras, and which if so would oblige us as a minimum to look much more carefully into what is really happening there.

Should there be an automatic sentence of the co-responsible?

Sir John Gapper is right when describing the sentencing of Bernard Madoff as “both necessary and rare” July 2. That said justice was not totally served. Had there not been a SEC you can be sure that the people who lost their money with Madoff might have lost even more money, in many other ways, but would certainly not have lost that same way with Madoff. Therefore perhaps all regulators involved should receive an automatic sentence for co-responsibility. One percent? One and a half years?

The too few credit rating agencies opinions to follow are a larger source of systemic risk than the “too big to fail”

Sir, with respect to the “too big to fail” at a workshop on risk management in the World Bank in 2003 I told the financial regulators that “knowing that the larger they are the harder they fall on us, if I were a regulator, I would be thinking on a progressive tax on size” I can therefore evidence having stood up against the big while they were still believed invincible and few dared to do so. 

That said it is clear that this crisis, though it did hit some of the big especially bad, was not caused by these banks but by the “too few credit rating agencies opinions to follow” that were imposed on the system by the financial regulators. 

But as we can read from Martin Wolf’s “The cautious approach to fixing banks will not work” July 1, slowly and surely we are getting to the truth. Martin Wolf now informs us that the median leverage of commercial banks in Europe in 2007 was 45 to 1 and of course it is “insane”, anyone knows that, so the real question becomes why did not anyone, including Martin Wolf, say so? 

The answer lies in the risk weighting of the assets that was done and in this aspect Wolf still has something to learn. When he says “the required bank capital must also not be risk-weighted on the basis of bank models, which are not to be trusted” he blithely ignores that the bank models has little to do with that because the essential parts of the risk-weighting is derived from the arbitrarily rules on minimum capital requirements concocted by the regulators and from the opinions of the appointed supreme risk surveyors.

PS. Incentives matter. The escape valves of risk weighted bank capital (equity) requirements, cause banks’ risk models to be more about equity-minimizing/leverage-maximizing, than about analyzing bank assets’ true risks. That’s life!

There is regulatory financial protectionism of what is seemed as having a lower risk

Sir John Plender writes “Protectionism is coming at us from all directions” July 1 but fails to mention that financial protectionism that has been around for just a couple of years and that discriminates among lenders. On top of what the market charges for risks an unrated borrower has to pay for the cost of the bank having to put up 8 percent in capital while a triple A rated company gets away with the cost of only 1.6 percent. And then we ask why do inequalities grow?

Has this financial protectionism served us well? Absolutely not! I have even read Nobel-prize winning economist who though standing in front the monumental losses derived from financing the safest assets, houses, in the supposedly safest country, the US, and in instruments that carried the best credit ratings, still describe our current crisis as having originated by excessive risk taking. Ridiculous, they are either intellectually lazy or they have no idea of what they are talking about. It should be crystal clear that this crisis resulted from of an excessively misguided risk-adverseness and which got a tremendous boost from the regulators protecting what should not be protected.

Since it was an excessive risk-aversion that caused the crisis there is nothing wrong with a little more of risk-taking.

Sir the commissioner of Japan’s Financial Services Agency Takafumi Sato warns that “Tightening capital rules could increase risk-taking” July 1. Given that the current minimum capital requirements concocted in Basel authorize a marginal leverage of bank equity of 62.5 to 1 if the borrower has an AAA to an AA- rating it is hard to even comprehend what increased risk taking he refers to.

Excessive risk taking was not the problem. It was the excessive risk-aversion of the regulators that created an amazing regulatory bias in favour of what was perceived as being of little risk which brought this crisis upon us. In this respect we might in fact need some increased risk-taking.

This crisis did not originate from risky Argentinean railway projects but from investing in the safest assets, houses, in the safest country, the US, in securities rated AAA. Do you call that excessive risk taking?

Madoff got a sentence of 54.900 days. Should not the regulators spend one day in the slammer just for the sake of justice, just to help us restore some minimum accountability?

For a good obituary you need a good life

Sir Anil Kashyap in “A sound funeral plan can prolong a bank’s life” June 30 writes about “the rapid resolution plan” that systemically important financial companies, according to the financial regulatory reform proposed by the Obama administration, would have to file indicating what arrangements they have made for their demise. It sounds so right and so utterly responsible (even Angela Dorothea Merkel would be expected to endorse that) but, do we not really need more a little mission statement about what they are going to do while living? I mean we still keep on worrying so much of keeping the costs of the funeral down instead of making certain that the life has been worth it. In the financial regulatory reform, where do they discuss the purpose of the banks?

The possibilities of a “rapid resolution plan” to be of any use depends also much on what disaster hit you. For instance what is the “rapid resolution plan” for a bank if all the credit rating agencies turn out to be wrong (again? Suing the regulators for forcing the banks to heed so much the opinions of these risk surveyors?

It was not the faith based financial institutions who caused it but the “too few to follow”

Sir we know with absolute certainty that had not the regulators empowered some “too few to follow”, the credit rating agencies, and created some perverse incentives that interfered with the risk allocation mechanism of the market, the minimum capital requirements for banks, we could have had another type of crisis, but definitely not this one. In this respect Michael Mackenzie is as right as he can be to argue “It’s a stretch to blame hedge funds for banks collapse”, June 27, and mind you I am not a great fan of these what I call “faith based financial institutions” that charge outlandish fees for their services and keep you mostly in the dark.

And blaming derivatives when the originals, the mortgages to the subprime sector in the US were so badly awarded is just like the robber pointing with his finger down the street and loudly shouting “there he runs that s.o.b!

This particular efficient market hypotheses was murdered and I am not buying any efficient regulator hypotheses

Sir James Montier observes that “The efficient market theory is as dead as Python’s parrot” June 25. After duly goggling what he meant by that, I agree, but only as to the death of this particular parrot and not to the extinction of its whole specie. You see our current efficient market parrot did not die of natural causes it was murdered. Murdered by some scheming banking regulators in Basel who decided that one of the lead actors of the market, the banks, had to swallow a pill of arbitrarily set of capital requirements based on vaguely defined risk and as measured by some external credit rating agencies. It proved to be just too venomous.

Montier could be suffering a state of shock like when he writes “new research shows that career risk and business risk are the prime drivers of most professional investors” as if that was something new, as if we really wanted or expected that to be different; or when he writes “there isn’t a scrap of evidence to suggest that we can actually see the future at all” like even if it were true we should not try to do our best to look into the future. Then again anyone capable of describing the current regulatory approach as “the markets know best” has either no idea of what he is talking about (I am always suspicious of anyone that uses many quotations) or is pursuing a completely different agenda. Just in case I rather go searching after any other efficient market hypotheses or even use the current carcass to clone a new one than to buy myself an efficient regulator hypothesis.

Don’t just pick on the fallen bankers.

Sir it is clear as Martin Wolf writes “Reform of regulation has to start by altering incentives” June 24. That said it is hard to understand exactly what incentives Wolf is referring to since most of the problem he describes are an intrinsic part of the realities of banking and therefore, if he just wishes to eliminate banks and go for safe mattresses instead, then he should perhaps say so.

The incentives I most worry about are those arbitrary incentives created by the regulators in Basel and that state among others that if a bank lends to a corporation without a credit rating it can leverage its capital 12 to 1 but if lending to a corporation that has managed to obtain a credit rating of AAA to AA- then it is allowed to go for an incredible leverage of 62.5 to 1… and as if the good risks needed additional subsidies.

Talk about incentives to pursue the AAAs! With incentives like these no wonder many of the AAAs weren’t for real. Like many, Wolf also expresses concern about the “too big to fail banks”. Had he participated in the few debates prior to the approval of Basel II in June 2004, he would have known that this was exactly one of the major concerns and that unfortunately was finally brushed aside.

We know that the bankers are down for counting so it is understandably tempting to pick on them but please let us first and foremost go after on the truly horrendous regulatory incentives which perhaps are also easier to correct.

Wolfgang Kuhn… you are absolutely right

Sir I cannot but subscribe completely to Wolfgang Kuhn’s letter of June 24 “Don’t ridicule Germany for its aversion to debt” and if only I was able to get hold of Mr. Kuhn, and so permitted, I would be glad to post it in my own Tea with FT blog.

We need warning signs placed on academics

Sir Devesh Kapur is perfectly right pointing a finger at academics for their not having been able to produce anything useful that could have helped to avoid the current crisis. Never have so many of those who were supposed to perform societal oversight done (and still do) so little. “Academics have more to declare than their genius” June 24.

But the real fundamental problem is not necessarily with the academics per se but more with those of them who venture into public life selling or allowing themselves to be sold as experts. Academician should be the first to know that at least in social sciences there are no real experts, just as there are no credit rating agencies that can guarantee a consistently good result. Therefore academics should at least come with a warning sign that reads “Believing an academic to be an expert could be extremely dangerous for the health of your portfolio.”

Private schools compete quite well with public schools

Sir John Kay’s “How a television monopoly ended in mediocrity” July 24, though quite interesting with his book production analogy fails to make a case for his final statement that “A license-fee BBC is now the main obstacle to quality television in a competitive market.” It is not a bit like saying that public schools impede private schools to prosper?

The Fed has a conflict of interest if overseeing systemic risk.

Sir Frederic Mishkin in “Why all regulatory roads lead to the Fed” June 23 fails to mention the most important reason why the Fed should not be the systemic regulator, namely that as a regulator it is also a producer of systemic risks and has therefore a clear conflict of interest.

The current crisis occurred, primarily, because of those so poorly crafted minimum capital requirements for banks that originated in the Basel Committee and that created immense incentives for anything that could get hold of an AAA rating, such as AIG and the securities collateralized with subprime mortgages. The sole fact that most still speak of “excessive risk taking” while the truth is that the problems derived from risk adverse investors taking refuge in instruments that had been faultily classified as risk-free, is just an example of that peer solidarity among regulators that creates opacity and puts the world on a wild-goose chase it cannot really afford.

I would prefer to outsource any systemic risk vigilance to a totally independent entity, perhaps, given its global implications, even one paid and supervised by the United Nations, than having that function placed in the hands of regulators and that as far as this type of risk I trust even less than I would trust a Wall Street firm.

A minimalistic comment

Sir Peter Tasker’s “Japan serves up valuable minimalist lessons” June 22, reads so true and feels so timely.

Let us avoid subtle muddle

Sir I have participated for many years in the debate on the regulations for banks coming out of Basel but, in order to have an even fuller understanding of what happened, I recently completed all the requirements to be a mortgage loan officer and a real-estate salesman in the state of Maryland. From what I have been able to gather Clive Crook, and many with him, is wrong when he slips by some questions that seem to attribute much of the subprime crisis to Fannie Mae and Freddie Mac, “A thin outline of regulatory reform” June 22.

There might be other real problems with these “government sponsored entities” but the subprime avalanche was created by mortgage originators that managed to channel unbelievably lousy awarded mortgages into Wall Street created securities which had managed to hustle up AAA credit ratings, so much that even Fannie Mae and Freddie Mac fell into the trap of buying up some of this securities, as investors.

There might be other real problems with these “government sponsored entities” and there is a lot of pent up criticism of these by conservatives, and much of it might be valid, but creating regulatory reform in hard times like this is not made easier by subtle muddle being thrown into the debate.

In his article Clive Crook also asks “what would better regulation of the [credit rating] agencies look like? To this I would have to reply by asking? Why would we need better regulation that could make the credit rating agencies even more dangerous? Why do we not just take away the official powers they have had since only June 2004?

We must learn to celebrate pruning.

Sir you are absolutely right when in “Central bankers strike back” June 20 you remind that “Banks too large to fail... is only one source of systemic risk” Indeed the opinions of the rating agencies and that the regulators incentivized the markets to follow produced much more real losses than all the too large to fail as a group.

And you are also absolutely right also mentioning that “it is even more important to make it possible for even the largest ones to fail. Indeed we must learn to celebrate pruning. In May 2003 while being an Executive Director at the World Bank I told a workshop of some hundred regulators from all over the world that “A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation.”

We need at least one urgent change in the financial rule book.

Sir it matters little how you arbitrate a game if the rules in the rulebook don´t make sense and therefore, in matters of financial regulations, the Obama administration is right concentrating on what you title “Redesigning the financial rulebook”, June 18, before “rebuilding the regulatory structure”. I just hope they really change that truly crazy rule of the minimum capital requirements for banks that the Basel Committee concocted.

How would you arbitrate a game of hockey if depending on how some external consultants perceived the strength of the players to be each player had to carry different protective gears? The strong AAA players would have less protection, exposing them to additional risks, while the poor BB- weaklings would have to carry more protection weighing them down even further. And, if a hockey reporter how would describe the team? The protective-gear weighted strength of it?

The taxman must do better than create a cartel

Sir, Matti Vanhanen is clearly being responsible with his “Europe will need to raise taxes in harmony” June 17 and he should be lauded for not ignoring the need for higher taxes to pay for the mess, and so that we do not have to pay it all through inflation. 

Having said that though, as a taxpayer, I would beg that the search for new, better and more credible taxes, adjusted to the realities of a global economy, should be the driving force of increased fiscal revenues, and not the creation of a global taxmen cartel… or do we also need a global coalition of taxpaying citizens?

Does Soros want to eliminate private banks?

Sir I try to find something new and important in George Soros “My three steps to financial reform” June 17, but frankly the only think I find, though it is indeed surprising, is when Soros argues that “banks should not be allowed to speculate for their own account with other people’s money”. Is he now making a case for abolishing private banks?

The world needs to reach a sustainable bottom.

Martin Wolf sums it up very well when he ends “How today’s global recession tracks the great depression” with “The race to full recovery is likely to be long hard and uncertain” June 17. To this I would just add that the length of that recovery will depend a lot on those who by panicking impede the world economy from regaining a strong foothold from where it can work itself up.

The remedy for the creative industries is already in their name.

Sir Stephen Garrett writes that “Piracy is threatening the survival of creative industries” June 15 because governments have not been cooperative enough blocking piracy on the web. But, since there are many that hold that the creative industries are themselves a major threat to creativity that might not be entirely such a bad thing. That some jobs are lost while the adjustments to the new world order are made? Could be, but there’s were real creativity comes in. Anyhow no one would dare to order the wheels off the luggage in order to safeguard the jobs of porters… or would they?

But there is a minimum minimorum reform that the US health sector needs for a starter.

Sir, being a foreigner living in the US I have thanks God not needed to get too acquainted with its so heatedly debated health sector; and I pray it stays that way. In this respect I cannot really comment much on Clive Crook’s “Medicare for all may be the best cure” June 15, but yet I feel the need to point out something that to me seems to go against any sense of justice, which is that as I have witnessed, the uninsured are often required to pay many times the price insurance companies pay for exactly the same medicine or treatment.

If beer companies compete that is good for beer drinkers and does not affect those who do not drink beer. But in the case of health services it is obvious that many of the cost reductions negotiated by the competing insurance companies, end up expected to be recovered from those uninsured.

If it was in my hand (perhaps it's good that’s not the case) I would put up a prohibition to charge anyone more than 5% to max 20% over the minimum price offered to any insurance company… and then take  health reforms from there. Not doing so forces millions of uninsured who could pay reasonable fees to either swamp free service emergency rooms, or being financially abused.

Is not cost-discrimination against the uninsured a much worse discrimination than many of those other discriminations being protested so loudly? 

Who could have thought the Financial Times would come to this?

The Basel Committee concocted some minimum capital requirements for banks based on risk assessments made by the credit rating agencies which establish for instance that if a bank lends money to a corporation with no rating it requires 8 percent of equity but if it lends to a corporation with an AAA to AA- rating then it only needs 1.6% of capital.

The above set in motion forces that over only some 3 years helped to channel around two trillion dollars, some 100 years worth of World Bank lending, to finance badly awarded mortgages to the subprime housing sector in the US just because these managed to dress up as AAA and which detonated the current crisis.

Sir given that among the seven recommendations for better financial regulations you make in “Last chance saloon”, June 15 , you do not mention that the regulators should stop interfering arbitrarily in the risk allocation mechanism of the market I guess you are alright with it. Who could have thought the Financial Times would come to this?

Please, regulators, more humility.

Sir Emil Henry could not be more right when begging everyone to be very careful on the issue of whether and how a systemic risk regulator SSR could monitor financial institutions, “Daunting decisions on a new risk regulator”, June 11.

The truth is that regulating for systemic risk could be the most dangerous way of creating systemic risk. To understand the above suffices to look at the minimum capital requirements for banks concocted by the Basel Committee and that amount to a direct arbitrary intervention in the markets risk allocation mechanism and that can be shown having been the number one driver of the current crisis.

In “Against the Gods Peter L. Bernstein (1996) writes that the boundary between the modern times and the past is the mastery of risk, since for those who believe that was in God’s hands, risk management, probability, and statistics, must have seemed quite irrelevant. Today, when seeing so much risk managing, I cannot but speculate on whether we are not leaving out God’s hand, just a little bit too much.

Martin Wolf’s savings are not much different from China’s or Germany’s

Sir Martin Wolf referring to the surpluses of countries China and Germany writes “they cannot have both safe foreign assets and huge surpluses”. Why not? It is obvious that persistent surpluses do create special difficulties but these are faced by all investor, even Mr Wolf if he runs a surplus. “It is in Beijing’s interests to lend Geithner a hand” June 10.

In fact had it not been for the misguidance produced by the credit rating agencies or the regulators intervening in the risk allocation process of the market by way of the minimum capital requirements for banks, the system could have kept on working for a very long time until other factors would have become important on the margin.

For instance, just a couple of years ago many were analyzing what would happen to China when they ran out of their labour surplus and salaries were not any longer so competitive. Sadly now we won’t know this for quite some time.

Wolf considers “China’s decision to accumulate roughly $2.000bn in foreign currency reserves... a blunder” What did he himself do? Spent it all? Kept it in pounds? Did he also blunder?

You, oil dictators, give us our (f……) oil revenues.

Sir Martin Sandbu and Nicolas Shaxson in “Give the people their resources wealth” June 5 write that “improved transparency, has hardly empowered ordinary citizens”. Of course not, with respect to oil revenues improved transparency is more like allowing the tortured to also be able to see when they extract their fingernails.

There are many places where citizens are finally waking up to the fact that the principle of that very well intentioned Extractive Industries Transparency Initiative and that states “We affirm that management of natural resource wealth for the benefit of a country’s citizens is in the domain of sovereign governments to be exercised in the interests of their national development”, is just plain wrong.

And if there is truly one single thing the US should regret in the US is not having taken the opportunity to promote oil revenue sharing of the citizens in Iraq. Trying to sow democracy in a land where oil resources are centralized would be laughable but for its tragic implications.

In Venezuela I have over the last two years published at least 40 articles on the subject of why we need to wrestle away the oil check-book from the Hugo Chavezes of this world, and I am currently trying to form a global coalition of oil cursed citizens, to see if we can help each other since, at the end of the day, there is no such thing as an oil-cursed politicians, oil-cursed governments or oil cursed policymakers, on the contrary they are all most often shining examples of oil blessings... there are only oil-cursed citizens.

Unfortunately, since we citizens do not have the oil revenues yet, few want to help us, they prefer helping the dictators to become more saloon respectful dictators, but I guess that’s life on the oil curse lane.

http://theoilcurse.blogspot.com/

Hurrah! We managed to get out of the garage!

Sir Martin Wolf sounds like someone who taking a very long car trip reassures his wife with a “Honey we´re doing fine” after being able to manoeuvre out of his garage, “Rising government bond rates prove policy is working” June 3. There are thousands of treacherous miles left to drive in a used car that does not seem too trustworthy and we have recently been given evidence that we can’t even trust the GPS or the petrol meter or for that matter the mechanics or the traffic signs.

Does Wolf need an example of one of the trolls awaiting him round the bend? If a bank lends to a car company then the government requires it to have 8 percent of bank equity but if it lends to the government so that the government can lend to the car company then it is not required to have any equity at all.

Does Martin Wolf really have any idea of where the 10 year US bond rate would be without the quantitative easing of the Fed or the subsidies implied in the zero capital requirement for the banks when they hold such paper? I don’t think so, and so even for a fierce anti-deflationist like him it is much too early to shout out any type of Hurrah!

“Sharp tightening, but not yet”… that is indeed the battle cry of the baby-boomers “Après nous le deluge”

But we still trust many proven fools.

Sir Luke Johnson in “Rough diamonds dazzle as entrepreneurs” May 27 vents the frustration many of us share with him when he says “I hope we never again trust overpaid fools who think they know best thanks to bogus theories”. Unfortunately, we will... just as we still trust the regulators in Basel with their bogus theories that they can control banks through capital requirements that depend on risk assessments made by third parties... just as we still allow our regulators to allow our banks to lend our deposits to the government without any capital requirement whatsoever.

Yes, let’s put a damper on size!

Sir John Kay is of course right in “Why ‘too big to fail’ is too much for us to take.” May 27.

In May 2003 at a Risk Management Workshop for Regulators at the World Bank, as an Executive Director, I said: “A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.

Knowing that the larger they are, the harder they fall, if I were regulator, I would be thinking about a progressive tax on size.”

There is a zero capital requirement for banks on AAA public debt

Sir, some define systemic risk simply as the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, but, that is in fact more the result of the systemic risks that originates from the interdependencies and the failures of the system itself.

John Taylor, in “Exploding debt threatens America” May 27, writes that he believes the debt projected level of US debt to be systemic. Yes indeed, the debt could be so large that it could bring us an awful inflation but, what really propels it as a systemic risk, is not so much its size but the fact that the current minimum capital requirements for banks, in the case of public debts rated triple-A, is an astonishing zero. This not only subsidizes the growth of public debt but also leaves the system totally unprotected.

This type of systemic risk led us to the precipice of the badly awarded mortgages to the subprime sector ,just as it will help to lead us to the precipice of governments too much in debt.

Regulations are systemic risks.

Yes Sir you are absolutely right when in “Regulation Time”, May 26, you say “This crisis was born of gambles with systemic stability, not of weak investor protection”. In fact it was by trying to overprotect banks and investors from risks, by means of minimum capital requirements for banks that rewarded risk adverseness and the naming of some few credit rating agencies as the world’s official risk surveyors, that the regulators gambled away the systemic stability.

In order for current regulations to stand a chance of being corrected the first thing that has to happen, is for the regulators to acknowledge that regulations are by themselves a prime source of systemic risks.

Should used bank salesmen be trusted?

Sir Henny Sender “This year’s model for cash raising – the GMAC way” May 23, begs the question whether we should trust the used bank salesmen; a question that is difficult to answer when it is so hard to assess what’s under the hood of a bank, especially now when their assets are disclosed in “risk-weighted” terms.

GMAC is reported to have $173.bn of risk weighted assets, but taking away the impact of the weights, the real nominal asset exposure could easily be ten times that amount. For $173bn of risk-weighted assets an additional need of $11.5bn sounds “so reasonable”, but then it could just all be a mirage produced by that dangerous cocktail of faulty credit ratings and arbitrarily imposed risk-weights and that have hit and obscured the financial sector ever since Basel II got going.

The fact though is that while in Germany the sales of new cars are subsidized by a payment to scrap old used cars, in the US it is the financiers of used cars that are receiving government support and that sort of reflects quite different workout strategies.

The safe-haven is always in the eyes of the beholder

Sir you conclude “Dollar worries” May 23 with “currency traders are pricing in the tail risk that the US will be forced to resort to the printing press”. Sir whether forced or not the fact is that with the Fed’s quantitative easing they are already using the printing press, a lot.

Do you have any idea where the rates would be if it had not been for the quantitative easing? It sure puts a big question mark when it needs to recur to quantitative easing in order to sell itself as a safe-haven. The greatest mistake made by the US government and Congress in their current handling of the crisis is that they might have taken the world’s wish for a temporary safe-haven as a wish for a permanent home.

Behind our backs bank regulators in Basel decided that lending to a triple-A rated government required zero bank equity while lending to an ordinary non-rated private company required 8 percent... and the governments loved it... wouldn’t they? The markets though requires x percent return for lending 100 to triple-A rated governments and y percent return for lending exactly the same 100 to a non-rated private company all without any reference to capital requirements.

Therefore though you can subsidize governments and temporarily confuse the market by means of arbitrary regulations in the long term you cannot simply instruct markets to behave as if a dollar lent to the government is any different than a dollar lent to a private company. Having then to reduce the current implicit subsidy to the governments contained in the minimum requirements for banks will also put further pressure to increase the interest rates on public debt... just when the world seems least to afford it.

The gorilla is there in the room roaring and pounding his chest... let’s pray we’ll never have to pay him off, informally, over the counter, with some gold coins.

Go City of London go!

Sir what caused this crisis, as I have so repeatedly written to you about over the years, were the regulators in Basel executing the mother of all interferences in the risk allocation process of the markets. 

Not only did they appoint the credit rating agencies as Thee Official Risk Surveyors but they also empowered them by concocting minimum capital requirements for banks that covered an incredible range from 8.3 to 1 to 62.5 to 1 with all of it depending on the ratings. 

In this respect when Martin Wolf in “Why Britain has to curb finance” May 22, refers to UK regulators having “an influence on the world economy out of proportion to the country’s size” he is either too parochial or he still completely misunderstands what has happened. 

Also a sheer reference to a “light touch” in the context of financial regulations would be almost laughable if not for the sad and serious consequences of the very heavy handed and truly relevant regulations that from Basel hit the world, London included.

Frankly the UK cannot afford to curb anything, less it wants to be left out completely. And the Financial Times should be the first to know that. 

Go City of London go!

Could there be value to be unlocked in the one-year ownership of shares clause?

Sir you are so right in that the recent minimalistic step taken by the SEC to allow the true owners, the shareholders, to name who should be at the Board of their companies was “A much needed victory”, May 22.

What I cannot comprehend though is how the SEC can get away with the one year of ownership criteria... how on earth does one year of ownership change ownership? Could there now be an opportunity to sell the shares but keep them in your name, so as to offer the one year ownership on record? I mean in this severe crisis one has to look under every stone for any value to be unlocked.

But let the markets’ see more with their own eyes

Sir as you must know by now I full heartedly agree with William Poole’s proposal of introducing more market discipline for banks by forcing them to issue substantial amounts of long term subordinated notes “A market solution to secure the future of banks” May 21.

That is of course as long as some of that fog that comes from having the assets reported as seen through the eyes of the credit rating agencies and risk-weighted arbitrarily by the regulators is dissipated. As is everyone, regulators included, might keep on focusing on the wrong exposure where a real 40 to 1 leverage is reported as only a 10 to 1 assets to capital leverage. Let the markets have a better look at what’s really in the banks… otherwise we will just have the blind leading the blind.

Are some doing their best for the market not to regain confidence?

Sir Martin Wolf in “This crisis is a moment, but may not be a defining one” May 20, writes “The willingness to trust the free play of market forces in finance has been damaged.” Of course, how could it be otherwise, when even the Financial Times (notwithstanding my over 200 letters on the subject) refuses to describe in detail the amazing interference with the risk allocation processes in the financial markets made by the bank regulators in Basel.

Through their minimum capital requirements for the banks the regulators allowed for a 62.5 to 1 leverages (and that in some cases can even reach 179 to 1) and all based on the credit rating agencies’ triple-As. How on earth could the free play of market forces in finance stand a chance to correctly handle that?

If you really want the market to regain confidence then you have to explain what really happened.

Rasputins versus Oligarchs

Sir John Kay in “Beware the bail-out kings and backbench barons”, May 20, refers to “Simon Johnson’s comparison of corporate financiers with Russian oligarchs”. Kay should not forget though that Simon Johnson, as a former chief economist at the International Monetary Fund, is part of that regulatory technocracy which played God and interfered with the risk allocation processes in the financial markets, in the most amazing way, by allowing for a 62.5 to 1 leverages (that in some cases can even reach 179 to 1) all based on some credit rating agencies awarding their triple-As... and helped to cause this mess.

In this respect the Rasputins have now a clear and vested interest in blaming the oligarchs in order to protect themselves. John Kay rightly says “We need to reassert the notion that roles of authority are positions of responsibility rather than declarations of personal merit and routes to personal enrichment.” And that should apply equally to bankers and regulators.

Please, may we have a small but growing capital charge on governments?

Sir if your bank lends your government 100 pounds then it is not required to have any equity but, if it lends that amount to your unrated neighbour, then it has to put up 8 pounds in equity. That might sound very reasonable to you I do not know your neighbour, but be sure that in the long term it will just mean we will all end up more and more entangled in the web of the government.

In this respect when we read Aline van Duyn and Francesco Guerrera report in “Geithner plan fuels cost fears”, May 19, that “companies face capital charges against hedges” one wonders when they will start imposing some capital charges on what seem runaway governments. A small increasing capital charge on anything to do with governments is probably an essential element to help stimulate the banks into lending more to the private sector again.

Just for the record

Sir in “Taming derivatives” May 19, you write about “a jungle where companies such as AIG were able to use derivatives to avoid capital requirements”. Just for the record, that was never the real problem with AIG. The problem with AIG was that because of its AAA rating it overextended itself by selling immense amounts of derivatives that allowed others to avoid capital requirements.

How long do you intend to play this charade?

Sir day after day, week after week, month after month, year after year the Financial Times indicates the currency rate of Venezuela 2.1473 Bolívar Fuerte per Dollar and provides the additional vital footnote of “New Venezuelan Bolívar Fuerte introduced on Jan 1st 2008. Currency redenominated by 1000.”

Are you not aware that this currency rate in that it does not by far reflect the FX rate that applies to the whole Venezuelan economy is totally fictitious. That is has been fixed there since February 2003 and that those not favoured by having the government receive their Bolivar Fuerte in order to convert them into dollars, need currently to use at least 3 times as many Bolívar Fuerte to get a dollar.

For how long does FT play along in this charade of the Venezuelan government? If you want to put an end to it I suppose you have two alternatives the first to simultaneously publish an estimate of the rate in the unofficial market, which would provide your readers with more information, and the second not to publish any rate at all.

This crisis is indeed far from being a pure failure of markets

Sir Leszek Balcerowicz writes “This has not been a pure failure of markets” May 14 and the most extraordinary thing about it is that there is a real need for his article.

If a bank regulator decided that the minimum capital requirements for the banks depended on how much some few specially designated fashion experts fancied the colour of the tie that the borrower´s chief executive officer wore; and that capital requirements so determined could then vary between a high of 12% of the loan and a low of 0.56% would you call this a free market? Of course not, not even if instead of the colour of ties what was used were the ratings of some vaguely defined credit-default risks.

But, if even Martin Wolf, the chief economics commentator of the Financial Times, almost two years into the crisis, can still write about “why free-market capitalism went off the rails” and that the “era of financial liberalisation has ended”, “Seed of its own destruction” May 12, when one could very well argue that free-market capitalism was actually placed on rails heading over cliffs, then clearly Balcerowicz’ article is still much needed and appreciated. Clearly those from Poland have a clearer or at least more recent concept of what state dirigisme really means.

Risk is risk is risk!

Sir David Walker with “America’s triple A rating is at risk” May 13 gives new evidence on how dangerously the world has got itself trapped by some erroneous concepts about risk. Of course, America’s triple-A rating is always at risk, there is no absolute quality or anything inherently permanent with a credit rating, this no matter how much the financial regulators want us to think so.

That the US, and the dollar are in trouble, that there can be no doubt about, but the truth is that the US and the dollar could still remain for a very long time the most de-facto triple-A in the world, because, at the end of the day, risk is always relative, except of course, when we really reach the end of the day.

Now on the rest of David Walker’s message I could not agree more. Last year, during the annual meeting of the World Bank and the IMF, I went around asking “how are we going to pay for it all?”, and proposing a new generation of taxes, such as taxing income from protected intellectual property rights, only to be met with a “what is he talking about?”

The bottle that now matters is the one containing bank equity.

Sir Tony Jackson in “Is the liquidity bottle half-full or half empty” May 11 writes “If the banks can only hold Treasuries rather than private securities... The less the scope, too, for securitisation- the vital form of lending that has yet to recover”.

In other circumstances looking at the Treasury versus private securities from a liquidity angle might be correct but, at this particular injunction, the bottleneck for the banks is equity and not liquidity.

In this respect let me remind you that the minimum capital requirements concocted by the Basel Committee holds that in contrast to claims on private assets that do require holding some equity, although in some cases ridiculously small, claims on sovereigns rated AAA to AA- do not, as they are given a 0% risk weight.

As food for thought just think about what are fore-bankers would have thought of making a zero-reserve when lending to a Crown. But of course, a zero equity requirement is what the Basel Committee had to stipulate in order for the finance ministers in their AAA or AA- countries to cheer them on. Now if a sovereign were to be down-rated to A+ to A- then the risk weight goes up to 20% and if that would happen they would either have to change the minimum capital requirement or face the mother of all demand for bank equity.

Unfortunately Tett misses what turned a snowball into an avalanche

Sir another great chapter by Gillian Tett though again she misses the most fundamental point. If it had only been the loss in the market value of the “super-seniors” that had to be covered with new equity, that could have been manageable, but the fact was that as the risk ratings of the whole exposure to super-seniors were down-graded then like rubbing salt on the wounds they had to find additional equity to cover for higher capital requirements.

Assume that Citibank had one of those super-seniors rated AAA and that according to paragraph 615 of the Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework - Comprehensive Version of June 2006 carried a risk weight of only 7%.

This meant that a $1430 investment was going to show up as only $100 in risk-weighted assets, which in fact believe it or not, signified an authorized leverage of (1430/8) of 179 to 1, and therefore required only $8 in equity (8% of 100).

If the market value of those $1430 then fell 2 percent to $1401 the bank would first have to register a $28 loss but if that “super-senior” was also concurrently down-rated to an “awful” A, then the new risk weight applied was 20 percent which signified that the risk-weighted assets increased to $280 (20% of $1401); and therefore requires $48 in additional equity ($280 times the 8 percent equity minus the $8 of previous equity).

And so we not only have $28 in mark-to-market losses that must be covered but the bank has also to find additional equity of $48 to cover for the higher equity requirements... and so the bank is induced to sell those super-seniors but for which there is now not a market since buyers have been scared off by a credit rating downgrade... and so down and down it goes... not so much because of the intrinsic quality of the super-seniors but because of the minimum capital requirements for the banks

The above describes the most vicious part of the current vicious circle in the bank sector and the Basel Committee is fully responsible for it. Never ever has the financial regulators and the financial experts been so gullible and naive like when they believed that “risk-weighted assets” were correctly risk-weighted assets.

By the way when reading the recent stress tests prepared for the largest 19 bank holdings in the US the possibility of this misconception still being in existence is what frightens me the most.

What a stress!

Sir now 19 large bank holdings companies (BHCs) have been told what to should do in order to hang around and so they should at least be a little bit less stressed... but what should we do with these stress-test results?

First it hard for us to interpret the results of the stress test because they all refer to risk-weighted assets” and this we know that no matter its pompous name this does not mean anything absolute. Not only are the weights completely arbitrary, like for instance 20% for triple-A rated assets, but also those weighing, the credit rating agencies, have clearly shown themselves not to be the most very trustworthy risk surveyors. It also makes any comparisons between BHCs impossible since the differences between the risk-weighted assets could be larger than between apples and oranges.

But second and most importantly the stress test does not include any type of recommendation. Do we want to strengthen the weaker BHCs so that these survive or are we looking to show who are weak so that we can strengthen the stronger to make sure that some of the BHC survive? Why do we not put all our money in the group outside the BHCs? What a stress!

You pay for what you paint!

Sir Benedict Mander in “Venezuela’s state oil company gears up for a $2bn bond issue” May 8, quotes experts with “expected to be a two year zero-coupon bond yielding about 16 per cent” and that it “will not affect the yields on existing PDVSA or sovereign debt – one of the best performers in emerging markets this year”. It is hard to understand how they would get away with that.

That said PDVSA with all the richness that it controls, if it was well run, should have to pay only some basis points more than the risk free rate and so, in order for your readers to understand better what is going on, perhaps you should have translated what was painted on the PDVSA oil tanks in the photo. It says "Fatherland Socialism or Death"… hence 16 percent.

The Global Coalition of Oil-Cursed Citizens

The hedge funds were just the regulators’ hobby.

Sir Gillian Tett “writes that the bank follies went unnoticed for so long partly because many regulators spent the last decade obsessed with hedge funds.” “Some effects of an unhealthy fixation on hedge funds”, May 7. Though close, she does not really get there.

What happened was that regulators invented some risk weights and then got themselves some risk surveyors, the credit rating agencies, and produced the line of “risk weighted assets” by which they thought their job regulating banks was all done... and so, to find something to occupy their now fulltime spare-time with they started to pick on the hedge funds.

Do not undercut in any way the disciplinarian role of the market

Sir as an Executive Director at the World Bank 2002-2004 and as member of its Audit Committee I remember as one of my biggest frustrations continuously warning about counterparty risks and always ending up being answered along the lines of... “What counterparty risks? Don’t you know that a triple-A is a triple-A is a triple-A?”

This is why I take strong exception when Matthew Richardson and Nouriel Roubini in “Insolvent banks should feel market discipline”, May 7, though correctly advocating more of Schumpeterian creative destruction, are surprisingly lenient in the case of counterparty risk. They even write “But unlike with Lehman, the government can stand behind any counterparty transaction”. No!

What is counterparty risk? The risk that for example the insurance company you have insured yourself with cannot pay up when it should. This risk is clearly not a risk that an ordinary citizen should have to bear but for the financial system’s overall health it is an absolute must that all the qualified institutional participants bear with the full consequences of it.

In fact, in case they have not read it, current third pillar of the otherwise so discredited bank regulations from Basel – named the market discipline, “aims to encourage market discipline by developing a set of disclosure requirements which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposures, risk assessment processes, and hence the capital adequacy of the institution.” And that of course means the evaluation and the taking of counterparty risks.

And by the way, just as the markets would benefit from more creative destruction, let me also remind you that so would our financial regulators

The marginal authorized leverage was then 125 to 1!

Sir John Gapper in “How banks learnt to play the system” May 7 is slowly identifying the AAA-bomb that set of this crisis. He writes about how regulatory bank equity, by not being real hard cash equity, and how assets, by being minimized through regulatory risk-weighting, made “some investment banks enter this down-turn with capital ratios of 30 times or more.”

But Gapper is not there yet since he seems to forget that in economics as well as in finance, the most important price is not the average but the marginal. If I am allowed to assume what Gapper seems to do that only the 4% equity of tier 1 capital was for real, and consider the fact that loans or investments to corporations and securities that were rated triple-A were risk-weighted at only 20 %, then he should be able to calculate that the marginal authorized leverage for the banks on some operation were 125 to 1... or more, if as Gapper holds, that even the tier 1 capital was partly made up of illusions.

P.S. I just wonder. If I had been a PhD, from a well known university, would I have not been referenced as someone who has warned and argued over this problem over and over again for years? After 258 letter to the Financial Times labelled “subprime banking regulations”? Not including this one.

We need liquidation and inflation and growth

Sir, Martin Wolf in “Central banks must target inflation” May 6 writes: “for clearing up the mess and designing a new approach to monetary policy... we have three alternatives: liquidation, inflation; or growth”, though he knows, of course, that we need all of them all: liquidation so that we stand on firm ground; inflation to grease the wheels; and a lot of hard and clever work at growth. 

Wolf also considers the possibility that our children “in despair...will even embrace... the absurdity of gold”. I do share Wolf’s feeling since they, and we, deserve more than that; in fact one of the most worrisome aspects of this crisis is how often one finds oneself on the side of those gold-bugs one has always considered being somewhat nuts. 

Now, what I do not agree with Wolf is when he writes of “inflation targeting”, as a holy gray, since one of the problem could be that the inflation was not adequately targeted. 

In a letter published by FT in May 2006 I wrote “inflation as they, our monetary authorities know it, is just obtained by looking at a basket of limited consumer goods chosen by bureaucrats and that although they might be highly relevant to the many have-nots, are highly irrelevant to measure the real loss of value of money. For instance, who on earth has decided for that the increase in the price of houses is not inflation? And so what should perhaps be argued is that really our monetary authorities have not been so successful fighting inflation as they claim they have been.” 

And then of course we have the financial regulations, and that Wolf does not even want to mention. Would a runner be a bad runner just because someone trips him up and he falls? In just the same way must a monetary policy be wrong, just because some financial regulations, risk weighted bank capital requirements, went haywire?

China would collapse too if it loses faith in the dollar.

Sir Andy Xie is of course right saying that “If China loses faith the dollar will collapse” May 5 but he should also remember that because of the Ying-Yang relation between China and the US, if so happens, China would also collapse. We are all riding on an illusion where we need to feel sorry for him who gets off to early and sorry for him who gets off to late…never before with respect to currencies have the “In God we trust” seemed so appropriate.

Do not save us from the embarrassment... it was sheer stupidity!

Sir John Kay in “A boom based on little more than a bezzle”, May 5, with all this talking of “embezzlement or “febezzlemnt”... is he trying to console us? The embarrassing truth is that the crisis originated from sheer stupidity, that of trusting too much the triple-As that never were. If anyone febezzled themselves that was the Basel Committee when it came up with such nonsense as believing they could and should drive out risks from banking, and that the credit rating agencies were just the right ones do to it for them.

Just pay for what you want and you have a slightly better chance of getting it.

Sir John Coates makes quite a disservice by giving a way too simplistic version on the problems with rewarding the much needed risk-taking in “Time to tackle this culture of rewarding the risk-takers” May 5. He sets us up to choose between the hare and the tortoise forgetting completely that the hare can produce tortoise results and vice versa. Those tortoises that have only been able to produce the $20 million in profits the first 4 years can be those giving us the $500 loss in the fifth year.

There is really nothing like a perfect incentive plan though for an investor who is looking for a five year return he should clearly be better off paying an incentive based on the five years results as easy as that. Diversity is also good... if the whole world starts looking for five year results that will be just as bad as the current one year structures... you see humans, and especially traders, they do adapt.

Which bring us to the most important part of all... knowing what the incentives are. Coates refers to the traders but perhaps more important yet is to refer to the trader’s bosses.

Iceland: Financial System Stability Assessment—an Update completed August 2008.

Sir may I invite you to read: “The update to the Financial System Stability Assessment on Iceland"

It was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on August 19, 2008 and provided background information to the staff report on the 2008 Article IV consultation discussions with Iceland, which was discussed by the Executive Board on September 10, 2008, prior to the recent Board discussion on a Stand-By Arrangement for Iceland.”

It makes fascinating reading, especially in these times when the regulators now want to tackle systemic risks while ignoring that their regulations are in fact the prime source of systemic risk.

In it, dated a month before the crisis exploded at the end of September 2008, we can among other read the following: “The banking system’s reported financial indicators are above minimum regulatory requirements and stress tests suggest that the system is resilient. Bank capital averaged almost 13 percent of risk-weighted assets between 2003 and 2006, dropped to 12 percent in 2007 and to approximately 11 percent in the first half of 2008, but remain above the 8 percent minimum. Liquidity ratios are likewise above minimum levels. Notwithstanding the positive indicators, vulnerabilities are high and increasing, reflecting the deteriorating financial environment”

To me once again, this just proves that no one had the faintest idea of what the “risk-weighted assets” really meant and, if they did, they had no will to question the significance of risk-weighting.

Instead of allowing the sceptics to have a voice the regulators forcefully correlated the financial markets to some few credit rating agencies.

Sir from “Genesis of the debt disaster” May 2, an extract from “Fool’s Gold: How Unrestrained Greed Corrupted a Dream, Shattered Global Markets and unleashed a Catastrophe” it is clear that Gillian Tett has written a great book that starts going to the root of the issues. It is sad though to think that a great reporter like her might now have become useless by correlating herself to what she wrote in her own book. (The same way another opinion-maker has correlated himself to explaining all in terms of the economic imbalance among surplus and deficit countries.)

Tett does indeed tell us a lot about one of the seeds of the debt disaster but, as someone who has recently even acquired a license as a mortgage loan officer in the US in order to better understand what happened, I believe that it was really the environment that mattered for that seed to bloom into something really bad. More detailed information on the amounts of mortgages awarded to the subprime sector and that were securitized on year by year or even better month by month basis is useful to understand it all and I hope Gillian Tett has provided that in her book.

My explanations for the crisis is much simpler. In synthesis, the financial regulators in Basel correlated the world to the opinions of just three credit rating agencies… and with that they weakened or even displaced from the market the voice of all the many healthy sceptics like Terri Duhon and Krishna Varikooty and the reduced the market weight of more careful individual investors.

The International Convergence of Capital Measurement and Capital Standards in July 1988, even though the minimum capital requirements there are based on risk, they do not even mention the credit rating agencies and the risk weight for all claims on the private sector is 100% and they therefore require the 8% of capital.

By contrast the International Convergence of Capital Measurement and Capital Standards of June 2006 1988 is all about the credit ratings… and for instance the corporations that are rated AAA to AA- are risk-weighted at 20% and so do only generate a capital requirement of 1.6%. And, from that moment on the road to “fool’s gold” was determined to go thru the credit rating agencies.

The safe-haven must recycle its waters.

Sir you write of the need to “Reopen the taps of global finance” May 1, but that must surely be the responsibility of the current borrower of last resort, the USA.

Ricardo Hausmann, during the spring meetings of the World Bank, at a conference titled “Latin America and the Global Crisis: Towards a Rapid Regional Recovery” argued that the US should take on debt and relend to the world. Hausmann, coming from an oil rich country must have remembered that this was exactly what the oil countries did during the 1974-79 oil bonanza when foreign bankers virtually forced credits on them… and the oil exporting countries recycled and imported and recycled and imported... until.

But is this politically viable? Perhaps not, but even so there are major troubles brewing down the line.

First the US, as the safe-haven par excellence, cannot expect to crowd out the rest of the world from the financial markets, for a lengthier period, without its own waters becoming stale or even having the rest of the world starting to think in terms of sabotaging that safe-haven.

Second if the US, in order to reflate its own economy and which might also help to stop the world from deflating too much, for a while, does so by investing only in its own back-yard, then the returns from those overcrowded back-yards will not be sufficient to repay what will be owed, and so the US taxpayer will start to seriously object having to become the taxpayer of last resort…and with that, again, waive bye, bye to the sweet dollar safe-haven.

Let us not forget that in truth the dollar bill should have imprinted on it “In the American Tax Payer We Trust” but that the US Mint, more pragmatic, more marketing minded and much wiser preferred the much more fundamental “In God We Trust”.

In this crisis, many wish for the cloak of invisibility.

Sir there is no way you could understand what happened in this financial crisis if you do not read what Basel II contains. It is not only that the banks now have to make up for the many write downs after all the losses they incurred but that they will also have to make up for all the undercapitalization that Basel allowed for.

When the bank lend to a company or invests in a security that has managed to get a triple A-rating Basel II has authorized this exposure to be risk-weighted at only 20% which means that 500 of it will count as only 100 which (500 exposure divided by 8 in capital requirement) results in a leverage of 62.5 to 1.

And so Martin Wolf in “Fixing bankrupt financial systems is just the beginning” April 29, should also have acknowledged to begin with the need of “fixing” the intellectually bankrupt regulators who came up with such insane regulatory permissiveness just because they trusted the credit rating agencies so much.

Is it really surprising that now “investors burned by more sophisticated risk-adjusted ratios increasingly trust... the ratio of common equity to total assets’? Of course not, though the real question that needs an answer is how the regulators could have been so naive and gullible to design these ratios and then go to sleep believing in them?

Clearly the IMF, a staunch supporter and marketer of the Basel regulations, would prefer the world to ignore this whole issue… but why should a Financial Times that proudly champions a “without fear and without favour” also do so?

The regulators they authorized a leverage of 62.5 to 1!
Uploaded by PerKurowski

Am I obsessed? You bet! You should be too!

How could AIG have resisted?

Sir, though Eric Dinallo is right in saying that “Marriage not dating, is the key to healthy regulation” April 27, it is at the same time extremely worrisome to read how he, the New York insurance superintendent, still seems to believe that what brought AIG down was the lack of regulations.

What brought AIG down was that its credit rating of AAA became dangerously super-empowered, when the financial regulators decided that any risk that AIG offered to cover transmitted to the underlying securities a permit for the banks to leverage these 62.5 to 1. I ask. What kind of corporation could have resisted the temptation of not waving that magic AAA wand too much?

The dollar is the whole world’s s.o.b.

The last of my 15 letters that the Financial Times published before I was silenced was the following dated October 4, 2006 and which said the following.

“Sir, Martin Wolf’s “America could slow us down” (September 27) somehow ignores the possibility that just as the Americans did when they accepted the “In God we trust” printed on their bills as an act of faith when the dollar abandoned its convertibility into gold, the world is now willing to live with an “In America we trust”, at least while there is such a world shortage of better alternatives. If this is so, one could argue that we have still far to travel on the roads of the American current account deficit currently used by the world to dollarize since the fact is that, if you want to lay your hand on a dollar, you have to sell or give something for it. Frightening? Yes, but is not the world itself a frightening place that needs many acts of faith in order to make life bearable?”

Today, after all what we now know, and seeing the world still placing so much trust in the dollar I would probably want to rephrase it by paraphrasing Roosevelt saying “The whole world knows the dollar is an s.o.b but (at least for the time being) the dollar is the whole world’s s.o.b.”

Who is then going to be the bad cop?

Sir, the world needs a good cop and a bad cop, but can really do without a wishy-washy cop. Listening, during the spring meetings in Washington of the World Bank and International Monetary Fund, to the intents of the Fund to recast itself as a good cop, the big question is... who is now going to play the bad cop?

Come on, you just robbed hugo chávez of Bush... are you now going to take the Fund away from him too? What popular enemies that can be exploited will he be left with?

We deserve something different than the current crop of regulators

Sir Timothy Geithner in “We must keep at the process of repair and reform” April 24 mentions that “the Financial Stability Forum, renamed the Financial Stability Board (FSB) and expanded to include all of the G20 nations, should be given greater responsibility for the stability of the international financial system. And that is the problem with the current crop of regulators. Who told them that the only thing we look for is stability? We want a well functioning financial sector with a much more meaningful purpose that stability.

Look at what the search for stability and lowering of risks with the minimum capital requirements designed by the Basel Committee and the appointment of the credit rating agencies as the risk sentries of the world has taken us? The Basel Committee and the members of FSB all come from exactly the same regulatory incestuous gene-pool. We deserve better results, and this can only be achieved by a new and much more diversified set of regulators.

Mark-to-market?

Sir William Cohan’s “Clever wheezes will not mend the banks” April 23 touches on one of the hardest questions to answer… namely should we mark to market in a crisis like this?

Without the mark-to-market we can never be that sure we already reached a bottom, but with the mark to market, we might reach an even deeper bottom.

From Basel II into Solvency II… has the European Parliament lost it?

As reported by Nikki Tait and Paul J Davies, April 23, not only do the higher risks have to pay higher insurance rates because the market so demands it, but now they have to be additionally penalized in order to compensate for the higher capital requirements for higher risks that will be imposed on the European insurers by the European Parliament; as a result of something called “Solvency II” and which sounds and reads frightfully similar to Basel II.

Do they never learn? Now again, what will result from all this is increasing the incentives for disguising as being of lower-risks and for having the regulators go to sleep in the belief that all has been taken care of. Who is going to measure the risks? The insurance risk rating agencies? Start praying!

The regulators changed the odds at the casino... surreptitiously

Sir, John Kay in “How economics lost sight of the real world” April 22, writes that “grossly imperfect information have led us to where we are today”. He is more right than he knows.

On June 26, 2004 Ministers and central bankers from the G10 endorsed the publication of the International Convergence of Capital Measurement and Capital Standards: a Revised Framework. Those regulations authorized banks to have a leverage of 62.5 to 1 if they lent to corporations to which human fallible credit rating agencies had awarded AAA-ratings. With that the regulators send out the message, loud and clear, that risks could be measured with much more preciseness than previously thought possible and that there were agents capable of doing so.

And the regulators also naively ignored that the measurement of risks would itself alter the realities of risks, and so those regulations amounted to something like fooling around with the odds at the casino without informing the players. Markets that wanted to play it safe, on black or red, were unknowingly lured into placing their bets on a number.

Those regulations contained in sum the most dysfunctional financial regulatory innovation in history and no one said a word. Shame on the tenured professors, the think-tanks, the press and all the others the society counts on to keep it informed.

P.S. https://subprimeregulations.blogspot.com/2012/12/the-basel-ii-roulette-manipulation.html

The regulatory innovations are the ones to blame, not the financial.

Ben Bernanke in his most recent speech, April 17, 2009 said “Where does financial innovation come from? In the United States in recent decades, three particularly important sources of innovation have been financial deregulation, public policies toward credit markets, and broader technological change. I'll talk briefly about each of these sources.”

As for the public policies Bernanke mentions the Community Reinvestment Act of 1977 (CRA) and the government-sponsored enterprises, Fannie Mae and Freddie Mac. Nowhere does Bernanke mention the greatest source for the financial innovations that proved disastrous, namely the regulatory innovations that were put in place during the very last decade. Could it be because he also is among the ones to blame?

The regulators in Basel innovated as regulators never innovated before, and thought they could control for default risk, and therefore allowed incredible leverages as long as the default risks of borrowers were perceived as low or non-existing by the official risk sentries the credit rating agencies. After that the regulators being so sure about the value of their innovations went to sleep… but that is of course nothing new or innovative.

At the end of the day the simple truth is that the costs of regulatory innovations far exceeded the costs of financial innovations, and that the benefit from financial innovations far exceeded the benefits from regulatory innovations. Try to live with it FT!

The value of the CDS depend a lot on who contracts them

Sir Henny Sender in “CDS derivatives are blamed for role in bankruptcy filings” April 17 reports on how this type of instrument changes the behavior of creditors. One way I have found useful explaining the pro and con of the CDS is with a simile to life insurance.

Supposed Henny Sender took out a life insurance for a million quid to take care of her loved ones in case anything would happen to her. That should be a quite good responsible and tranquilizing thing to do. Now imagine instead that many of Henny Sender’s extended family and friends and even some total strangers took out million quid life insurance policies on her. Not so tranquiliz, baning eh?