Wednesday, November 4, 2009
Wednesday, October 28, 2009
Bubble talk!
I am getting a bit nervous with all this bubble talk.
How are they intent to do their bubble-busting? Are the regulators now going to appoint bubble-measurers? Are we going to have these assets bubble-meters being showed off in Times Square? What instruments to puncture them are going to be used? Talk about value of inside information!
Much the same way it sounded so utterly reasonable to have the credit rating agencies influence how much equity banks should have, and look where it led us. This reasoning just like it assumed that a risk of default was a risk of default, assumes that a bubble is a bubble, and that there are no risks derived from pre-announcing that a bubble will not happen.
And what if the prime motor of development is the belief in the possibilities of the next bubble? If we ex-ante eliminate the possibility of a real bubble, how many will just stay in bed while other countries, those with no qualms about a crisis because for them any status quo is worse, will go forward?
If there is something truly lacking in the current discussion on regulatory reform that is the consideration of the good things that come with risk-taking and now, the good things that come from bubbles.
Me, I really would love the world to keep on taking risks and blowing bubbles, even at the cost of suffering huge setbacks, as long as that takes us forward. Because of this, more than worrying about where the next precipice might be, I would try to make more certain that we are heading in the right direction.
Others, baby-boomers and wimps, on the contrary, seem to be satisfied with what they have achieved and are happy settling for just keeping it.
This is a great opportunity for developing countries to catch up... I can already see the billboards “Have bubbles, willing to party, for real, no adult supervision, foreign investors welcome!” While the developed countries set up theirs, on Wall Street, announcing “Welcome... guaranteed no bubbles!”
Real capital might be coward... but it sure loves bubbles.
How are they intent to do their bubble-busting? Are the regulators now going to appoint bubble-measurers? Are we going to have these assets bubble-meters being showed off in Times Square? What instruments to puncture them are going to be used? Talk about value of inside information!
Much the same way it sounded so utterly reasonable to have the credit rating agencies influence how much equity banks should have, and look where it led us. This reasoning just like it assumed that a risk of default was a risk of default, assumes that a bubble is a bubble, and that there are no risks derived from pre-announcing that a bubble will not happen.
And what if the prime motor of development is the belief in the possibilities of the next bubble? If we ex-ante eliminate the possibility of a real bubble, how many will just stay in bed while other countries, those with no qualms about a crisis because for them any status quo is worse, will go forward?
If there is something truly lacking in the current discussion on regulatory reform that is the consideration of the good things that come with risk-taking and now, the good things that come from bubbles.
Me, I really would love the world to keep on taking risks and blowing bubbles, even at the cost of suffering huge setbacks, as long as that takes us forward. Because of this, more than worrying about where the next precipice might be, I would try to make more certain that we are heading in the right direction.
Others, baby-boomers and wimps, on the contrary, seem to be satisfied with what they have achieved and are happy settling for just keeping it.
This is a great opportunity for developing countries to catch up... I can already see the billboards “Have bubbles, willing to party, for real, no adult supervision, foreign investors welcome!” While the developed countries set up theirs, on Wall Street, announcing “Welcome... guaranteed no bubbles!”
Real capital might be coward... but it sure loves bubbles.
Saturday, October 24, 2009
My voice and noise on the regulatory reform of banks
I will keep here, at the top of http://www.subprimeregulations.blogspot.com/, my most recent version of my proposal on how to reform the regulations of our banks. Since I am just a citizen working on his own I would appreciate any comment or editing suggestion and which you can send to my email perkurowski@gmail.com
My voice and noise on the regulatory reform of banks
Introduction
It is we the people who are supposed to be able to invest our savings in low-risk-operations. It is them the bankers, those who are supposed to be the professionals, whom we should count on to identify those risky risk-taking entrepreneurs most capable of restoring fiscally sustainable growth and create decent jobs, and then take the risk of lending to them.
Why then has the regulator been so set on having the banks avoiding ordinary banking risks, and have instead create incentives for our banks to finance those already rated AAA and who should not even need the help of a bank? In truth, the AAAs should be the almost exclusive territory of widows and orphans.
The bank regulatory framework which emanated from Basel and which promoted a highly imprudent risk-aversion in our banks, instead of a prudent risk-taking, represents a failure of immense proportions and it needs to be stopped, right now.
The following are some suggestions on that route and I call on anyone who knows the value of living in a “land of braves” to help to stop the arbitrary taxes on risks imposed on our banks by the Basel wimps.
We should temporarily lower the capital requirements for what is perceived as high risk.
The first, and basically only pillar of the Basel regulations, the minimum capital requirements, establishes that when a bank has an asset that carries an AAA rating it is required to hold 1.6 percent equity while, if it lends to an unrated entrepreneur it needs 8 percent. The difference of 6.4 percent, especially when bank equity is scarce and expensive, represents effectively a high and totally arbitrary regulatory tax on perceived risk; and which has to be added on to what the market already charges in premiums for risk.
Therefore and while we are increasing the extraordinary low capital requirements for the “low-risk” operations, which have proven to be so dangerous, we must, in order to avoid that "high-risk" borrowers are unduly crowded out from bank lending, substantially reduce the capital requirements for all those operations that are deemed more risky, in essence those rated BB+ or below. As an initial level I suggest 4 percent.This is real counter-cyclicality.
Once the banks have achieved a level of 4 percent (tier-one) capital for all of their assets (including government) and once out of the woods of this crisis, we must rebuild the capital base of the banks to a level ranging between 8 and 12 percent, for all assets, government included, cash excepted, a level that could fluctuate depending on where we find ourselves in the economic cycle.
Can the banks currently handle a 4 percent in capital requirements when lending to a risky entrepreneur? Yes, I am absolutely sure that a shell-shocked banking sector will behave prudently with what is perceived as “high-risk”. In fact since what normally produces certain carelessness are those loans and investments perceived as being less-risky, one could build a case for arguing that it is the “lower-risks” that should have higher capital requirements.
Since I am aware that the above sounds somewhat strange in the midst of the knee-jerk rule tightening reactions that a crisis always produces let me remind you that the first wave of bank losses sustained in this crisis from lending or investing in what required 8 percent of capital were only a fraction of those first wave losses sustained in “safe” 1.6 percent endeavors.
By the way, arguing in the first place that the losses that arose in connections to the safest assets, houses and mortgages, in the safest of the countries, the USA; and in the safest instruments, rated AAA, has anything to do with excessive risk-taking, seems to me somehow to include a dose of intellectual dishonesty.
Suppose a person entered a modern building and took an elevator that was supposed to be duly checked and then died in an accident because some inspectors did not do their job… would you call that excessive risk-taking? Of course not!
Purpose of the banks
The 347 pages of Basel II regulations contains not one single phrase, much less a paragraph that has anything to do with establishing the purpose of our banks http://bit.ly/1wj8V
Therefore we must require from the bank regulators to define the purpose for our banks, because without doing so, how can they regulate and how can we be sure they are taking the banks to where we want them to go? Let me below give you a hint
What’s in it for humanity for the banks to finance the AAA rated? Nothing! The real or fake AAAs are already more than strong enough, and so who we really need for our banks to support are those with BB+ or below ratings in order for these to have the chance of becoming the real AAAs of tomorrow. What the banks are supposed to do is to help society to evaluate the BB+ or below rated in order to generate new winners, while creating the lowest possible contingency risks for having to bail out the depositors if the banks fail in their mission.
Governments
Currently when a bank lends or invests in paper of the government there are no capital requirements. This amounts to an outright discrimination in favor of the government and against the citizen. I do not see how see how this could have been in the minds of any founding fathers.
Over a period of time we should reach a point where the capital requirements for banks when lending to the government, are the same to those when lending to an ordinary unrated citizen.
Credit rating agencies.
In January 2003 the Financial Times published a letter I wrote that included
“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”
And of course if we insist on blindly following the opinions of the credit rating agencies, as has been the case, we are sooner or later doomed to be back to the point where this crisis started.
But, what need is there to have the credit rating agencies pointing out the directions with 100 percent accuracy, if we should not be going to the place we are going? None! We cannot afford to channel scarce funds, by means of very low capital requirements for what is perceived as “low-risk”… into financing something, if that something is useless… like perhaps building a huge inventory of coffins. at zero percent interest rates.
And so, referring to the previous point, we should not waste a single second by reforming the credit rating agencies, when by reforming what really needs to be reformed, namely eliminating the regulations that discriminate based on risk of defaults, the problem of humanly faulty credit rating agencies will be solved on its own.
"Too big to fail."
In February 2000, in the Daily Journal of Caracas, in an article title “Kafka and global banking” I wrote:
"… thank God we still have several banks to work with". Imagine if we would have had to discuss the issue with an official of the One and Only World Bank (OOWB). Without a doubt this would present us with a future full of horrendous Kafkaesque possibilities. With every day that passes we have fewer and fewer banking institutions worldwide with which to work. This trend has been marketed as one of the seven wonders of globalization.”
Also in May 2003 in a risk management workshop for regulators at the World Bank I held
“There is a thesis that holds that the old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, was much wiser than today’s no burning at all, that only allows for the buildup of more incendiary materials, thereby guaranteeing disaster and scorched earth, when fire finally breaks out, as it does, sooner or later.
Therefore 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.”
But, having said all that, I equally believe firmly in that we are not well served by rushing to solve this particular problem, especially while we have much more urgent matters at hand, such as getting out of the woods.
And neither should we break up large banks while we still have regulations in place that breed and support large banks… does that not seem logical?
If there is one alternative that should definitely be explored is that of using a Non Operating Holding Company (NOHC) under which to separate the different activities of the typical huge bank of today and which I have seen proposed by OECD in their "The Financial Crisis: Reform and Exit Stategies". I find this route to be a very sensible and not too traumatic alternative and, if it would prove not to be working, we would at least already have it cut up in more digestible pieces.
Therefore my suggestion on the "Too Big To Fail" issue would be to give the largest banks some basic separation guidelines and ask them to come back for a proposal on how they would wish to set up their NOHC, if so required, and then take it from there.
On derivatives
Just get a central clearing house for anything that seems to taking on the form of a mass market and let all the rest be, stating of course, very loud and very clear, your caveat emptor and your caveat venditor.
Derivatives which cover real original risks are never as dangerous as derivatives designed to exploit arbitrary differences of a regulatory system.
The reason is that in real derivatives, for each seller taking the risk of being a seller, you always find a buyer taking the same sized opposite risk as a buyer… and all they have to do is being sure that the other counterpart has the means to pay out if he has to.
But, when derivatives are entered into in order to exploit a regulatory arbitrage, you find sellers and buyers more like partners eagerly sharing a free prize, and which often means they will let down their guards somewhat on each other´s respective counterparty risk.
Example: If a bank has an exposure to a an A- client then it needs a 4 percent equity but if it bought a CDS from a AAA rated insurance company (AIG) then it can get away with only 1.6 percent of capital. The saved difference of the costs of 2.4 percent of expensive bank equity, and which of course has nothing to do with real risks, can then be shared between a bank and an AIG.
When and if, as is here proposed, one eliminates the differences in capital requirements for banks based on risk, there are no longer incentives for this type of bastard derivatives…problem solved!
Systemic Risk
How are those who came up with the minimum capital requirements and enforced the use of credit rating, and thereby introduced so much systemic risk in the financial system, now going to control for systemic risk? They now mostly take systemic risk means to be institutions that are so large and important so as to create a risk for the system… that is just one of many systemic risks.
Bailouts
One thing is to bail out depositors for some fixed amount. But to think about the possibility of bailing out institutions because they might constitute a systemic risk is a totally different ballgame. That could be an open checkbook to disaster. As a government you should never want to have a pre-authorization to bailout a financial institution because then you are supposed to do so, or at least it is harder to say no.
My voice and noise on the regulatory reform of banks
Introduction
It is we the people who are supposed to be able to invest our savings in low-risk-operations. It is them the bankers, those who are supposed to be the professionals, whom we should count on to identify those risky risk-taking entrepreneurs most capable of restoring fiscally sustainable growth and create decent jobs, and then take the risk of lending to them.
Why then has the regulator been so set on having the banks avoiding ordinary banking risks, and have instead create incentives for our banks to finance those already rated AAA and who should not even need the help of a bank? In truth, the AAAs should be the almost exclusive territory of widows and orphans.
The bank regulatory framework which emanated from Basel and which promoted a highly imprudent risk-aversion in our banks, instead of a prudent risk-taking, represents a failure of immense proportions and it needs to be stopped, right now.
The following are some suggestions on that route and I call on anyone who knows the value of living in a “land of braves” to help to stop the arbitrary taxes on risks imposed on our banks by the Basel wimps.
We should temporarily lower the capital requirements for what is perceived as high risk.
The first, and basically only pillar of the Basel regulations, the minimum capital requirements, establishes that when a bank has an asset that carries an AAA rating it is required to hold 1.6 percent equity while, if it lends to an unrated entrepreneur it needs 8 percent. The difference of 6.4 percent, especially when bank equity is scarce and expensive, represents effectively a high and totally arbitrary regulatory tax on perceived risk; and which has to be added on to what the market already charges in premiums for risk.
Therefore and while we are increasing the extraordinary low capital requirements for the “low-risk” operations, which have proven to be so dangerous, we must, in order to avoid that "high-risk" borrowers are unduly crowded out from bank lending, substantially reduce the capital requirements for all those operations that are deemed more risky, in essence those rated BB+ or below. As an initial level I suggest 4 percent.This is real counter-cyclicality.
Once the banks have achieved a level of 4 percent (tier-one) capital for all of their assets (including government) and once out of the woods of this crisis, we must rebuild the capital base of the banks to a level ranging between 8 and 12 percent, for all assets, government included, cash excepted, a level that could fluctuate depending on where we find ourselves in the economic cycle.
Can the banks currently handle a 4 percent in capital requirements when lending to a risky entrepreneur? Yes, I am absolutely sure that a shell-shocked banking sector will behave prudently with what is perceived as “high-risk”. In fact since what normally produces certain carelessness are those loans and investments perceived as being less-risky, one could build a case for arguing that it is the “lower-risks” that should have higher capital requirements.
Since I am aware that the above sounds somewhat strange in the midst of the knee-jerk rule tightening reactions that a crisis always produces let me remind you that the first wave of bank losses sustained in this crisis from lending or investing in what required 8 percent of capital were only a fraction of those first wave losses sustained in “safe” 1.6 percent endeavors.
By the way, arguing in the first place that the losses that arose in connections to the safest assets, houses and mortgages, in the safest of the countries, the USA; and in the safest instruments, rated AAA, has anything to do with excessive risk-taking, seems to me somehow to include a dose of intellectual dishonesty.
Suppose a person entered a modern building and took an elevator that was supposed to be duly checked and then died in an accident because some inspectors did not do their job… would you call that excessive risk-taking? Of course not!
Purpose of the banks
The 347 pages of Basel II regulations contains not one single phrase, much less a paragraph that has anything to do with establishing the purpose of our banks http://bit.ly/1wj8V
Therefore we must require from the bank regulators to define the purpose for our banks, because without doing so, how can they regulate and how can we be sure they are taking the banks to where we want them to go? Let me below give you a hint
What’s in it for humanity for the banks to finance the AAA rated? Nothing! The real or fake AAAs are already more than strong enough, and so who we really need for our banks to support are those with BB+ or below ratings in order for these to have the chance of becoming the real AAAs of tomorrow. What the banks are supposed to do is to help society to evaluate the BB+ or below rated in order to generate new winners, while creating the lowest possible contingency risks for having to bail out the depositors if the banks fail in their mission.
Governments
Currently when a bank lends or invests in paper of the government there are no capital requirements. This amounts to an outright discrimination in favor of the government and against the citizen. I do not see how see how this could have been in the minds of any founding fathers.
Over a period of time we should reach a point where the capital requirements for banks when lending to the government, are the same to those when lending to an ordinary unrated citizen.
Credit rating agencies.
In January 2003 the Financial Times published a letter I wrote that included
“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”
And of course if we insist on blindly following the opinions of the credit rating agencies, as has been the case, we are sooner or later doomed to be back to the point where this crisis started.
But, what need is there to have the credit rating agencies pointing out the directions with 100 percent accuracy, if we should not be going to the place we are going? None! We cannot afford to channel scarce funds, by means of very low capital requirements for what is perceived as “low-risk”… into financing something, if that something is useless… like perhaps building a huge inventory of coffins. at zero percent interest rates.
And so, referring to the previous point, we should not waste a single second by reforming the credit rating agencies, when by reforming what really needs to be reformed, namely eliminating the regulations that discriminate based on risk of defaults, the problem of humanly faulty credit rating agencies will be solved on its own.
"Too big to fail."
In February 2000, in the Daily Journal of Caracas, in an article title “Kafka and global banking” I wrote:
"… thank God we still have several banks to work with". Imagine if we would have had to discuss the issue with an official of the One and Only World Bank (OOWB). Without a doubt this would present us with a future full of horrendous Kafkaesque possibilities. With every day that passes we have fewer and fewer banking institutions worldwide with which to work. This trend has been marketed as one of the seven wonders of globalization.”
Also in May 2003 in a risk management workshop for regulators at the World Bank I held
“There is a thesis that holds that the old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, was much wiser than today’s no burning at all, that only allows for the buildup of more incendiary materials, thereby guaranteeing disaster and scorched earth, when fire finally breaks out, as it does, sooner or later.
Therefore 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.”
But, having said all that, I equally believe firmly in that we are not well served by rushing to solve this particular problem, especially while we have much more urgent matters at hand, such as getting out of the woods.
And neither should we break up large banks while we still have regulations in place that breed and support large banks… does that not seem logical?
If there is one alternative that should definitely be explored is that of using a Non Operating Holding Company (NOHC) under which to separate the different activities of the typical huge bank of today and which I have seen proposed by OECD in their "The Financial Crisis: Reform and Exit Stategies". I find this route to be a very sensible and not too traumatic alternative and, if it would prove not to be working, we would at least already have it cut up in more digestible pieces.
Therefore my suggestion on the "Too Big To Fail" issue would be to give the largest banks some basic separation guidelines and ask them to come back for a proposal on how they would wish to set up their NOHC, if so required, and then take it from there.
On derivatives
Just get a central clearing house for anything that seems to taking on the form of a mass market and let all the rest be, stating of course, very loud and very clear, your caveat emptor and your caveat venditor.
Derivatives which cover real original risks are never as dangerous as derivatives designed to exploit arbitrary differences of a regulatory system.
The reason is that in real derivatives, for each seller taking the risk of being a seller, you always find a buyer taking the same sized opposite risk as a buyer… and all they have to do is being sure that the other counterpart has the means to pay out if he has to.
But, when derivatives are entered into in order to exploit a regulatory arbitrage, you find sellers and buyers more like partners eagerly sharing a free prize, and which often means they will let down their guards somewhat on each other´s respective counterparty risk.
Example: If a bank has an exposure to a an A- client then it needs a 4 percent equity but if it bought a CDS from a AAA rated insurance company (AIG) then it can get away with only 1.6 percent of capital. The saved difference of the costs of 2.4 percent of expensive bank equity, and which of course has nothing to do with real risks, can then be shared between a bank and an AIG.
When and if, as is here proposed, one eliminates the differences in capital requirements for banks based on risk, there are no longer incentives for this type of bastard derivatives…problem solved!
Systemic Risk
How are those who came up with the minimum capital requirements and enforced the use of credit rating, and thereby introduced so much systemic risk in the financial system, now going to control for systemic risk? They now mostly take systemic risk means to be institutions that are so large and important so as to create a risk for the system… that is just one of many systemic risks.
Bailouts
One thing is to bail out depositors for some fixed amount. But to think about the possibility of bailing out institutions because they might constitute a systemic risk is a totally different ballgame. That could be an open checkbook to disaster. As a government you should never want to have a pre-authorization to bailout a financial institution because then you are supposed to do so, or at least it is harder to say no.
We must measure and act during the full cycle.
If we are going to get the best out of our banks we have to stop measuring them only at their worst. We need to look at the full boom bust cycle since there are some busts where all the pains of a crisis are more than compensated with all achieved during the preceding boom, while at the same time there could also be booms that are so unproductive booms that no lack of a crisis pays for them.
Final Note:
I have been a financial advisor all my life never a regulator but when I started hearing about what the Basel Committee was up to I had to raise my voice. The surprise of my life is that still, two years into the crisis, the issue of the dangerous arbitrary risk aversion the Basel regulations were introducing in our financial system is not yet even discussed
Here is the link to the very first article I wrote on the subject in 1997
http://subprimeregulations.blogspot.com/1997/06/puritanism-in-banking.html
If you want to see more you can find it in: http://www.subprimeregulations.blogspot.com/ or in http://financefordevelopment.blogspot.com/ and in the more than 330 letters that I sent to the Financial Times on this issue and that can all be found in http://teawithft.blogspot.com/ searching under the label of subprime banking regulations.
And you can also find a fun conspiracy theory of it all in: http://www.theaaa-bomb.blogspot.com/
Saturday, October 3, 2009
In the land of the brave?
The difference in bank capital requirement between an unrated client and an AAA is 6.4 percent, which at a capital cost of 15 percent, results in 1 percent a year. This represents a 1 percent tax on perceived default risk! Do the regulatory wimps really believe that creating jobs and moving the world forward is a risk free affair?
Read more at the Financial Times Economist Forum
Sunday, September 27, 2009
The financial regulator’s exam
Do you believe that the capacity of a client to repay his debt to a bank is so important to the health of the financial system and the economy so that you should not have any other concern than measuring the risk of default?
Do you believe that risk of default could be defined and measured in such a consistent way so as to be used for establishing different capital requirements for banks?
Do you believe there are credit rating organizations capable to resist being captured by those rated even if their ratings are used for establishing the capital requirements of banks?
If you decide to use different capital requirements for banks dependent on credit ratings will this be sufficiently transparent for the markets and not distort their risk allocation mechanism?
As a financial regulator do you see it your duty to stop any bank from defaulting?
Our financial regulators answered yes to all questions above and that is why we are in a mess. What is most incredible is that we allowed our financial regulators to elaborate and correct their exam themselves. From their answers anyone should have been able to see they were not ready to be financial regulators.
Do you believe that risk of default could be defined and measured in such a consistent way so as to be used for establishing different capital requirements for banks?
Do you believe there are credit rating organizations capable to resist being captured by those rated even if their ratings are used for establishing the capital requirements of banks?
If you decide to use different capital requirements for banks dependent on credit ratings will this be sufficiently transparent for the markets and not distort their risk allocation mechanism?
As a financial regulator do you see it your duty to stop any bank from defaulting?
Our financial regulators answered yes to all questions above and that is why we are in a mess. What is most incredible is that we allowed our financial regulators to elaborate and correct their exam themselves. From their answers anyone should have been able to see they were not ready to be financial regulators.
Wednesday, September 16, 2009
The current bank regulatory system is fundamentally flawed, at its core.
Even if the credit ratings are absolutely right, using them as they are used, as a basis for calculating capital requirements of banks, is wrong, because the regulators have no business introducing an arbitrary regulatory bias against risk-taking. The world moves forward taking risk, the world lies down and dies avoiding risk.
“The First Pillar” of our current bank regulations (Basel) establishes the “Minimum Capital Requirements” for the banks (MCRs).
The MCRs depend on a risk assessment of a quite vaguely defined risk of default. The risk assessment is to be carried out primarily by the Credit Rating Agencies but, in the case of larger banks, also by using their internal risk models. In this respect, as an example, the MCRs rule that if a bank lends to an ordinary not rated client, it is required to hold 8 percent in equity, which is equivalent to an authorized leverage of 12.5 to 1, but, if lending to a client that is rated AAA, then it only needs to hold 1.6 percent in equity, which is equivalent to an authorized leverage of 62.5 to 1.
The above represents two risks, both clearly evidenced in the current crisis.
The first is that the credit rating agencies, by being captured by other interests or plainly because of human fallibility, could be wrong in their assessments, with the consequences that too much capital will follow the wrong ratings in the wrong direction. The current crisis did not result from investment in anything that could be considered as risky but almost exclusively from investments in instruments carrying an AAA rating and which were considered to be absolutely free of risk.
The second risk with the structure of the MDCs is that they effectively imply a subsidy to anything perceived as having a low risk and, comparatively, a tax on whatever seems to carry a higher risk. The subsidies, or costs, of these regulatory risk-weights, are layered on whatever risk differentials the market already prices in their interest rate spreads. This creates confusion in the risk allocation mechanism of the market as the signals are obscured and no one knows for sure whether the low spreads are the result of low risks or the result of low capital requirements. But, so much worse, these risk-subsidies or risk-taxes help to channel and push capital flows into “risk-free” territories that could already be swamped or serve no real societal purpose, or stop capitals from flowing into dried areas much in need of capitals and which represent important societal purposes.
All human endeavors to move forward are risky by nature, and there is absolutely nothing that in economic terms justifies a regulatory bias in favor of what is perceived as having a low risk. In the current crisis immense amounts of capital were lost sustaining a useless and artificial housing boom in a developed country, and not lost in projects that for instance tried to combat climate change or create sustainable jobs.
The Gini Coefficient, in economics, measures the inequalities in the distribution of wealth and income, from cero, no inequalities, to 1, absolute inequality. The current bank regulatory system, by design, with the MDCs pushes up the world’s Gini Coefficient. Do we really want that?
Please help us mend the faulty core of our bank regulations. Without this, all our other important and needed efforts to reform our financial sector are meaningless.
Per Kurowski
perkurowski@gmail.com
http://financefordevelopment.blogspot.com/
The MCRs depend on a risk assessment of a quite vaguely defined risk of default. The risk assessment is to be carried out primarily by the Credit Rating Agencies but, in the case of larger banks, also by using their internal risk models. In this respect, as an example, the MCRs rule that if a bank lends to an ordinary not rated client, it is required to hold 8 percent in equity, which is equivalent to an authorized leverage of 12.5 to 1, but, if lending to a client that is rated AAA, then it only needs to hold 1.6 percent in equity, which is equivalent to an authorized leverage of 62.5 to 1.
The above represents two risks, both clearly evidenced in the current crisis.
The first is that the credit rating agencies, by being captured by other interests or plainly because of human fallibility, could be wrong in their assessments, with the consequences that too much capital will follow the wrong ratings in the wrong direction. The current crisis did not result from investment in anything that could be considered as risky but almost exclusively from investments in instruments carrying an AAA rating and which were considered to be absolutely free of risk.
The second risk with the structure of the MDCs is that they effectively imply a subsidy to anything perceived as having a low risk and, comparatively, a tax on whatever seems to carry a higher risk. The subsidies, or costs, of these regulatory risk-weights, are layered on whatever risk differentials the market already prices in their interest rate spreads. This creates confusion in the risk allocation mechanism of the market as the signals are obscured and no one knows for sure whether the low spreads are the result of low risks or the result of low capital requirements. But, so much worse, these risk-subsidies or risk-taxes help to channel and push capital flows into “risk-free” territories that could already be swamped or serve no real societal purpose, or stop capitals from flowing into dried areas much in need of capitals and which represent important societal purposes.
All human endeavors to move forward are risky by nature, and there is absolutely nothing that in economic terms justifies a regulatory bias in favor of what is perceived as having a low risk. In the current crisis immense amounts of capital were lost sustaining a useless and artificial housing boom in a developed country, and not lost in projects that for instance tried to combat climate change or create sustainable jobs.
The Gini Coefficient, in economics, measures the inequalities in the distribution of wealth and income, from cero, no inequalities, to 1, absolute inequality. The current bank regulatory system, by design, with the MDCs pushes up the world’s Gini Coefficient. Do we really want that?
Please help us mend the faulty core of our bank regulations. Without this, all our other important and needed efforts to reform our financial sector are meaningless.
Per Kurowski
perkurowski@gmail.com
http://financefordevelopment.blogspot.com/
Wednesday, September 9, 2009
The Basel Committee castrated our banks.
One of the most serious threats to development, both in developing and developed countries, is the castration of our banks by the Basel Committee by means of the minimum capital requirements for banks based on assessments of default-risk.
The real stability of a financial system does not depend so much on avoiding the risk of defaults but on making sure that the underlying growth of the economy in which the banks function is healthy and sustainable as a whole. In this respect, imposing “risk-weights”, could quite plausibly elevate the risks of getting the wrong sort of growth in which not only the banks would fail but also the rest of the economy.
The default-risk based capital requirements for banks have effectively imposed a tax on all lending to what is perceived by credit rating agencies as more risky, notwithstanding that these loans could be the most productive for the society; and effectively introduced a subsidy to anything that can dress up as having a low risk, notwithstanding that these loans could be the most unproductive for the society.
The default-risk based capital requirements for banks are effectively increasing the world’s Gini coefficient.
Therefore, if the wimps of the Basel Committee absolutely insist on discriminating between borrowers with their “default-risk weights”, then the society should at least have the right to request the introduction of some “loan-purpose weights” as counterweight to the risk-adverse maniacs.
Over the last years (2004-2007) trillions of dollars of funds, more than the World Bank and the IMF have lent altogether since they were created over sixty ago, were diverted, by the false AAA signs set up by the credit rating agencies, to finance an artificial housing boom. Had it not been for those signs much of those funds could have gone for instance to solve bottleneck problems in the infrastructure in developed and developing countries; to create decent jobs in developed and developing countries alike; or to help fight climate change.
The real stability of a financial system does not depend so much on avoiding the risk of defaults but on making sure that the underlying growth of the economy in which the banks function is healthy and sustainable as a whole. In this respect, imposing “risk-weights”, could quite plausibly elevate the risks of getting the wrong sort of growth in which not only the banks would fail but also the rest of the economy.
The default-risk based capital requirements for banks have effectively imposed a tax on all lending to what is perceived by credit rating agencies as more risky, notwithstanding that these loans could be the most productive for the society; and effectively introduced a subsidy to anything that can dress up as having a low risk, notwithstanding that these loans could be the most unproductive for the society.
The default-risk based capital requirements for banks are effectively increasing the world’s Gini coefficient.
Therefore, if the wimps of the Basel Committee absolutely insist on discriminating between borrowers with their “default-risk weights”, then the society should at least have the right to request the introduction of some “loan-purpose weights” as counterweight to the risk-adverse maniacs.
Over the last years (2004-2007) trillions of dollars of funds, more than the World Bank and the IMF have lent altogether since they were created over sixty ago, were diverted, by the false AAA signs set up by the credit rating agencies, to finance an artificial housing boom. Had it not been for those signs much of those funds could have gone for instance to solve bottleneck problems in the infrastructure in developed and developing countries; to create decent jobs in developed and developing countries alike; or to help fight climate change.
Think of it, don’t you see that if the AAA ratings of the subprime mortgages had been absolutely correct then we could be on our way to something even more disastrous, as the world concentrated more and more all its scarce financial resources in the building and the revaluing of houses in the USA.
Friend, please act now and help us recover our banks.
And also, please stop calling what detonated because of investments in the supposedly safest assets, mortgages and houses, in the supposedly safest country, the USA, and in the supposedly safest instruments, those rated AAA, a financial crisis resulting from excessive risk-taking. It is a financial crisis caused by an excessive and completely misguided risk-aversion.
Tuesday, September 8, 2009
Comments on the “Principles for Reforming the U.S. and International Regulatory Capital Framework for Banking Firms”
If the regulatory principles involved had been right then the proposal would represent a quite reasonable to good tweaking of the current regulatory system. Unfortunately since the underlying regulatory principle is wrong the tweaking will not achieve the results that are needed.
The real stability of a financial sector does not depend so much on avoiding the risk of individual banks failing, but on making sure that the underlying growth of the economy in which the banks function, is healthy and sustainable as a whole.
In this respect introducing regulatory biases in favor of risk-aversion could quite plausibly elevate the risks of getting the wrong sort of growth in which not only the banks would fail but also the rest of the economy.
Therefore if the regulators absolutely insist on discriminating between borrowers with their “risk of default weights” then the society should at least have the right to request the introduction of some “purpose weights” as counterweight to the regulator’s extreme risk adverse bias.
Most of the problem we encounter with the reform derives from the fact that most still believe that this crisis resulted from some excessive risk-taking, even when staring at the evidence that most of the losses resulted from trying to earn a couple of more basis points investing in AAA rated securities. The day regulators are able to see it as it is, the result of a misguided risk-aversion, much of it induced by the regulators, that day we stand a better chance for a better reform of our financial sector.
The real stability of a financial sector does not depend so much on avoiding the risk of individual banks failing, but on making sure that the underlying growth of the economy in which the banks function, is healthy and sustainable as a whole.
In this respect introducing regulatory biases in favor of risk-aversion could quite plausibly elevate the risks of getting the wrong sort of growth in which not only the banks would fail but also the rest of the economy.
Therefore if the regulators absolutely insist on discriminating between borrowers with their “risk of default weights” then the society should at least have the right to request the introduction of some “purpose weights” as counterweight to the regulator’s extreme risk adverse bias.
Most of the problem we encounter with the reform derives from the fact that most still believe that this crisis resulted from some excessive risk-taking, even when staring at the evidence that most of the losses resulted from trying to earn a couple of more basis points investing in AAA rated securities. The day regulators are able to see it as it is, the result of a misguided risk-aversion, much of it induced by the regulators, that day we stand a better chance for a better reform of our financial sector.
Saturday, September 5, 2009
As to the financial crisis Paul Krugman does not know what he is talking about.
Paul Krugman in "How Did Economists Get It So Wrong?", September 6 writes “There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year”
Absolutely not! Paul Krugman, in relation to the financial crisis, has no idea of what he is talking about. The collapse was doomed to happen, courtesy of the financial regulations in place.
In January 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.” http://bit.ly/5i1Bu
Also, in February 2000 in the Daily Journal of Caracas in an article titled “Kafka and global banking” I wrote the following:
A diminished diversification of risk. No matter what bank regulators can invent to guarantee the diversification of risks in each individual bank, there is no doubt in my mind that less institutions means less baskets in which to put one’s eggs. One often reads that during the first four years of the 1930’s decade in the U.S.A., a total of 9,000 banks went under. One can easily ask what would have happened to the U.S.A. if there had been only one big bank at that time.
The risk of regulation. In the past there were many countries and many forms of regulation. Today, norms and regulation are haughtily put into place that transcend borders and are applicable worldwide without considering that the after effects of any mistake could be explosive.
Excessive similitude. By trying to insure that all banks adopt the same rules and norms as established in Basle, we are also pushing them into coming ever closer and closer to each other in their way of conducting business. Unfortunately, however, nor are all countries the same, nor are all economies alike. This means that some countries and economies necessarily will end up with banking systems that do not adapt to their individual needs. http://bit.ly/HIi3x
Truth is only some PhD regulators who have never ever stepped outside their offices to walk the real streets of finance could have been as naïve and gullible to believe they could empower the credit rating agencies so much to determine the financial flows without setting them up to be captured.
The sooner the world stops the financial regulations from falling excessively in the hands of the PhDs the better and this, of course, does not mean that I do not recognize the importance of the PhDs.
And, by the way, I am an economist… only that I have walked the streets as a professional for over 30 years.
Absolutely not! Paul Krugman, in relation to the financial crisis, has no idea of what he is talking about. The collapse was doomed to happen, courtesy of the financial regulations in place.
In January 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.” http://bit.ly/5i1Bu
Also, in February 2000 in the Daily Journal of Caracas in an article titled “Kafka and global banking” I wrote the following:
A diminished diversification of risk. No matter what bank regulators can invent to guarantee the diversification of risks in each individual bank, there is no doubt in my mind that less institutions means less baskets in which to put one’s eggs. One often reads that during the first four years of the 1930’s decade in the U.S.A., a total of 9,000 banks went under. One can easily ask what would have happened to the U.S.A. if there had been only one big bank at that time.
The risk of regulation. In the past there were many countries and many forms of regulation. Today, norms and regulation are haughtily put into place that transcend borders and are applicable worldwide without considering that the after effects of any mistake could be explosive.
Excessive similitude. By trying to insure that all banks adopt the same rules and norms as established in Basle, we are also pushing them into coming ever closer and closer to each other in their way of conducting business. Unfortunately, however, nor are all countries the same, nor are all economies alike. This means that some countries and economies necessarily will end up with banking systems that do not adapt to their individual needs. http://bit.ly/HIi3x
Truth is only some PhD regulators who have never ever stepped outside their offices to walk the real streets of finance could have been as naïve and gullible to believe they could empower the credit rating agencies so much to determine the financial flows without setting them up to be captured.
The sooner the world stops the financial regulations from falling excessively in the hands of the PhDs the better and this, of course, does not mean that I do not recognize the importance of the PhDs.
And, by the way, I am an economist… only that I have walked the streets as a professional for over 30 years.
Wednesday, September 2, 2009
I am so disappointed with conservative, progressive and of course middle of the road think-tanks.
The minimum capital requirements for the banks drafted by the Basel Committee and that apply or inspire most bank regulations in the world establishes that if a bank gives a loan to a normal entrepreneur who does not have a credit rating then it needs 8 percent in capital; if the loan is to a client with an AAA rating then 1.6 percent in capital will do and if it is a loan to its government then there is no capital requirement at all,
Dear conservatives.
Eight percent in capital when lending to a citizen and zero when lending to the government…does this not upset you?
Is not risk taking what keeps a society moving forward? Is not taxing risks and subsidizing risk adverseness something like having your country lie down and die?
Do you not find it crazy that some few credit rating agencies, even if private, shall have so much to say in orientating the capital markets messing with the risk allocation systems?
Dear progressives.
Eight percent in capital when lending to an ordinary citizen and 1.6 percent when lending to a company rated AAA… do you agree with such discrimination? Does not the AAA rated company have enough advantages?
Don´t you know that AAA ratings in just a couple of years led more capitals to the US housing market than all the loans given by the World Bank and the IMF ever since they were founded? How come you can applaud silly initiatives like Banco del Sur when obviously a Credit Rating Agency del Sur seems to carry so much punch nowadays?
Low capital requirements just because someone has got an AAA rating and is supposedly risk free… and what about the purpose of the loans should not that count too?
Dear middle of the roaders.
All of the above plus:
Think about it, even if the credit rating agencies had been perfectly right in their assessments what would the country have gained… more mortgages to ever bigger houses?… more financing from abroad in order to keep on buying even more imports?
The way you kids growing up with GPS might never know what north, south, east and west means… do you want your bankers just to follow credit rating agencies opinions and never learn themselves about analyzing a client, looking him in the eyes and shaking his hand?
Do you really want to have your financial sector watched over by regulators so naive and gullible that they did not know that sooner or later the credit rating agencies that they empowered so much would be captured?
No, all of you think tanks… what´s wrong with you…. too lazy to even read the Basel Epistles that governs most of your current financial regulatory system? As a fact, from all of the books articles comments and other ways of expression we see from those selling themselves as experts on the crisis, there is clear evidence that 99 percent of them have not even read an abridged version of what is contained in Basel II.
Or are you all just a bunch of baby-boomers who follow whoever promises most to avoid risks, while you are around, doing your reverse mortgage of the world and shouting “Après nous le deluge”? If so, shame on you all!
Dear conservatives.
Eight percent in capital when lending to a citizen and zero when lending to the government…does this not upset you?
Is not risk taking what keeps a society moving forward? Is not taxing risks and subsidizing risk adverseness something like having your country lie down and die?
Do you not find it crazy that some few credit rating agencies, even if private, shall have so much to say in orientating the capital markets messing with the risk allocation systems?
Dear progressives.
Eight percent in capital when lending to an ordinary citizen and 1.6 percent when lending to a company rated AAA… do you agree with such discrimination? Does not the AAA rated company have enough advantages?
Don´t you know that AAA ratings in just a couple of years led more capitals to the US housing market than all the loans given by the World Bank and the IMF ever since they were founded? How come you can applaud silly initiatives like Banco del Sur when obviously a Credit Rating Agency del Sur seems to carry so much punch nowadays?
Low capital requirements just because someone has got an AAA rating and is supposedly risk free… and what about the purpose of the loans should not that count too?
Dear middle of the roaders.
All of the above plus:
Think about it, even if the credit rating agencies had been perfectly right in their assessments what would the country have gained… more mortgages to ever bigger houses?… more financing from abroad in order to keep on buying even more imports?
The way you kids growing up with GPS might never know what north, south, east and west means… do you want your bankers just to follow credit rating agencies opinions and never learn themselves about analyzing a client, looking him in the eyes and shaking his hand?
Do you really want to have your financial sector watched over by regulators so naive and gullible that they did not know that sooner or later the credit rating agencies that they empowered so much would be captured?
No, all of you think tanks… what´s wrong with you…. too lazy to even read the Basel Epistles that governs most of your current financial regulatory system? As a fact, from all of the books articles comments and other ways of expression we see from those selling themselves as experts on the crisis, there is clear evidence that 99 percent of them have not even read an abridged version of what is contained in Basel II.
Or are you all just a bunch of baby-boomers who follow whoever promises most to avoid risks, while you are around, doing your reverse mortgage of the world and shouting “Après nous le deluge”? If so, shame on you all!
Saturday, August 22, 2009
Do you?
Societies, do you want your bankers to know about credit risks or do you give them credit rating agencies? (Like in: Parents, do you want your children to know about north, south, east and west or do you give them a GPS?)
http://perkurowski.blogspot.com/2009/08/gps-and-aaas.html
http://perkurowski.blogspot.com/2009/08/gps-and-aaas.html
Thursday, August 20, 2009
And, what about some minimum capital requirements to cover for the credit rating agencies’ exposure in credit risk opinions?
If the banks invest in AAA rated securities then these are risk-weighted by the regulator to only signify an exposure of 20 percent and so if the banks invest $1 trillion of 1.000 billion dollars in these securities they have to put up only $16 billion in equity, the result of multiplying the now risk-weighted exposure of $200 billion times the basic capital requirement of 8 percent.
And so $16 to cover $1.000! The question that hangs in the air is why then do not the rating agencies need some capital requirements to back up the accurateness of their ratings.
I mean after taking away the $16 billion of equity of the banks their opinions are sort of backing the remaining $ 984 billion. Is it prudent to trust the word of the credit rating agency so much? You tell me!
We live in a crazy world, our financial regulators in Basel were so naïve and gullible they did not even know they were setting the credit rating agencies to be captured.
And so $16 to cover $1.000! The question that hangs in the air is why then do not the rating agencies need some capital requirements to back up the accurateness of their ratings.
I mean after taking away the $16 billion of equity of the banks their opinions are sort of backing the remaining $ 984 billion. Is it prudent to trust the word of the credit rating agency so much? You tell me!
We live in a crazy world, our financial regulators in Basel were so naïve and gullible they did not even know they were setting the credit rating agencies to be captured.
Friday, July 31, 2009
Capital requirements for banks could use a "credit risk - credit purpose" matrix
On July 29 2009, in Venezuela, the financial regulator, Sudeban, issued a norms 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 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.
The way it is done Venezuela 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.
Friday, July 24, 2009
Mark to market the government’s bail-out efforts
In order to bring some transparency to what the government is doing in bailouts it should sell in the market, at 100% of nominal value, a portion of the instruments they have received in return for their bailout funds; and compensate any differences in the market value of these instruments with a tax-credit. How would it work?
Let us say the government has received $100 in shares of GM. If these shares are worth that amount the government would get their money back immediately but, if not, buyers would ask to receive a tax credit. If the market only asks for a 10% tax credit, meaning $10 in tax credit to purchase the GM shares for $100 then the government is not doing so bad but, if the market asks for 90% in tax credits, then clearly the government is pouring money down the drain.
That would certainly pressure the government into doing better. Problem though is that most probably government would never dare to have their own actions marked to market that way.
Let us say the government has received $100 in shares of GM. If these shares are worth that amount the government would get their money back immediately but, if not, buyers would ask to receive a tax credit. If the market only asks for a 10% tax credit, meaning $10 in tax credit to purchase the GM shares for $100 then the government is not doing so bad but, if the market asks for 90% in tax credits, then clearly the government is pouring money down the drain.
That would certainly pressure the government into doing better. Problem though is that most probably government would never dare to have their own actions marked to market that way.
Thursday, July 23, 2009
The risk in not running the risk of the risky
The current crisis detonated because of investments in assets of the safest type, houses and mortgages; in the safest country, the US; and in the safest type of zero-risk instruments, triple-A rated, that turned out bad. Even so the immense majority of financial experts, even Nobel Prize winners, explain the crisis as the result of “excessive risk-taking”. They are wrong; the crisis is clearly the result of an extremely misguided excessive risk-aversion.
Looking to help the large international banks to compete better with the smaller local banks, and wanting also to avert a new bank crisis, the regulators from some developed countries got together behind closed doors in Basel and came up with what they thought was the brilliant idea of determining the capital requirements for the banks, based on how the credit rating agencies rated a loosely defined default risk of borrowers and securities.
We are not talking about something insignificant. According to the regulations known as Basel II and that apply or at least inspire most banking regulations in the world, in order to lend funds to a corporation that does not have a credit rating a bank is required to hold 8 percent in capital, but, if lending to someone rated AAA it is only required to have 1.6 percent. As you understand, these regulations, approved in June 2004, started a wild chase after the AAAs… and here we find ourselves where the global losses in what was supposed to be risk-free exceed many times what has been lost in what was considered to be more risky… among others because what is perceived as risky by itself always inspires more care.
This regulatory system is still applicable, causing immense hardships in the world economy. In tandem with how the ratings of borrowers worsen the banks need to obtain more capital and since bank equity is scarce, they try to obtain it freeing themselves from clients for whom because these have even worse credit ratings, they are required to hold even more capital. With that all bank clientele that is perceived as more risky, but that is just as or even more important to the economy, is exposed to additional pressures, just when they least need it.
Companies that are presenting difficulties and have to restructure their liabilities are among those most affected by these puritan and intrusive regulatory inventions. Clearly if the difficulties of a borrower seem to be unsurpassable the best things to do, for all, is to speedily cut it off from credit, but, if after having analyzed it, the decision is taken to help it out, it does not make any sense making it even more difficult for it, like by imposing higher capital requirements on its creditor banks. It should be just the opposite, not only because these companies need to be treated with delicacy, but also since normally, they have been more scrutinized than the majority of firms that show themselves off as representing zero risk.
It is natural that creditors would charge more or less for a loan in accordance with how they perceive the risk but… on account of what does a regulator arbitrarily intrude in the decision? Is by any chance a job in a company rated B- less important than a job in a company rated AAA?
Risk is the oxygen of all development and in this respect regulations oriented to conserve what has been developed because it is more likely to be perceived as less risky, are unacceptable. Less risky for whom? For the world? How naïve! There is nothing so risky for the world than to refuse to run the risk of the risky.
The triple-A ratings have, in only about four years, without leaving much development in its wake, taken over the precipice more capital than all that lent by the World Bank and the International Monetary Fund since their creation sixty years ago. I have for years debated and fought these regulations from Basel, in the World Bank, in the United Nations and on the web… while others lose their time and our oil revenues in such absolute irrelevancies as a Banco del Sur.
Translated from El Universal, July 23, 2009
Looking to help the large international banks to compete better with the smaller local banks, and wanting also to avert a new bank crisis, the regulators from some developed countries got together behind closed doors in Basel and came up with what they thought was the brilliant idea of determining the capital requirements for the banks, based on how the credit rating agencies rated a loosely defined default risk of borrowers and securities.
We are not talking about something insignificant. According to the regulations known as Basel II and that apply or at least inspire most banking regulations in the world, in order to lend funds to a corporation that does not have a credit rating a bank is required to hold 8 percent in capital, but, if lending to someone rated AAA it is only required to have 1.6 percent. As you understand, these regulations, approved in June 2004, started a wild chase after the AAAs… and here we find ourselves where the global losses in what was supposed to be risk-free exceed many times what has been lost in what was considered to be more risky… among others because what is perceived as risky by itself always inspires more care.
This regulatory system is still applicable, causing immense hardships in the world economy. In tandem with how the ratings of borrowers worsen the banks need to obtain more capital and since bank equity is scarce, they try to obtain it freeing themselves from clients for whom because these have even worse credit ratings, they are required to hold even more capital. With that all bank clientele that is perceived as more risky, but that is just as or even more important to the economy, is exposed to additional pressures, just when they least need it.
Companies that are presenting difficulties and have to restructure their liabilities are among those most affected by these puritan and intrusive regulatory inventions. Clearly if the difficulties of a borrower seem to be unsurpassable the best things to do, for all, is to speedily cut it off from credit, but, if after having analyzed it, the decision is taken to help it out, it does not make any sense making it even more difficult for it, like by imposing higher capital requirements on its creditor banks. It should be just the opposite, not only because these companies need to be treated with delicacy, but also since normally, they have been more scrutinized than the majority of firms that show themselves off as representing zero risk.
It is natural that creditors would charge more or less for a loan in accordance with how they perceive the risk but… on account of what does a regulator arbitrarily intrude in the decision? Is by any chance a job in a company rated B- less important than a job in a company rated AAA?
Risk is the oxygen of all development and in this respect regulations oriented to conserve what has been developed because it is more likely to be perceived as less risky, are unacceptable. Less risky for whom? For the world? How naïve! There is nothing so risky for the world than to refuse to run the risk of the risky.
The triple-A ratings have, in only about four years, without leaving much development in its wake, taken over the precipice more capital than all that lent by the World Bank and the International Monetary Fund since their creation sixty years ago. I have for years debated and fought these regulations from Basel, in the World Bank, in the United Nations and on the web… while others lose their time and our oil revenues in such absolute irrelevancies as a Banco del Sur.
Translated from El Universal, July 23, 2009
Tuesday, July 21, 2009
Something´s terribly wrong
When parents seem to give more importance to their children´s credit score than their school grades, like setting them up to the fact that they will have to work their whole life in just to pay interests, something´s terribly wrong
Tuesday, July 14, 2009
Sunday, July 12, 2009
Thursday, July 9, 2009
Let´s give Darwin a hand and tax those prone to sickness and subsidize those who rate healthy!
If the regulators of the insurance companies would decide to follow the regulatory paradigm concocted by the Basel Committee, then they would pick three health inspection agencies to rate the health of the insured and require the insurance companies putting up more capital when insuring someone with a low health rating and letting it of the almost off the hook if the insured is deemed to be in tip top form.
Since equity costs a lot, especially in times of crisis, the above is equivalent to placing a de-facto tax on those prone to sickness or giving a de-facto subsidy to those who rate healthy, both these on top of what the market already charges for any differences in health
With their minimum capital requirements based on a vaguely defined and extremely narrow concept of risk and as measured by their three amigos the credit rating agencies, the Basel Committee subsidizes anything that finds it easier to dress up in AAA clothing and castigates what is perceived as higher risk.
With these regulations they drove in a wedge that further increases the differences between the unsustainable status-quo and the sustainable future we all must try to reach, which of course requires a lot of risk-taking.
The misguided risk-aversion these regulations was the major force behind channeling in just a couple of years more than two trillion dollars into the supposedly safest asset, houses, into the supposedly safest country, the USA and into the supposedly safest instruments, AAAs…for no particular good reason at all.
All in all these Basel financial regulations add up to a crime against humanity and against common-sense.
Since equity costs a lot, especially in times of crisis, the above is equivalent to placing a de-facto tax on those prone to sickness or giving a de-facto subsidy to those who rate healthy, both these on top of what the market already charges for any differences in health
With their minimum capital requirements based on a vaguely defined and extremely narrow concept of risk and as measured by their three amigos the credit rating agencies, the Basel Committee subsidizes anything that finds it easier to dress up in AAA clothing and castigates what is perceived as higher risk.
With these regulations they drove in a wedge that further increases the differences between the unsustainable status-quo and the sustainable future we all must try to reach, which of course requires a lot of risk-taking.
The misguided risk-aversion these regulations was the major force behind channeling in just a couple of years more than two trillion dollars into the supposedly safest asset, houses, into the supposedly safest country, the USA and into the supposedly safest instruments, AAAs…for no particular good reason at all.
All in all these Basel financial regulations add up to a crime against humanity and against common-sense.
Wednesday, July 8, 2009
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