Friday, June 25, 2010

What the G20 or the US Congress or the regulators do not understand they cannot fix.

Have you ever heard about a financial crisis that happened from lending or investing in anything considered risky? Of course not, these have all started with lending or investments to something that offered more returns than what its perceived very low risk merited. Even the infamous Dutch tulips, in their own bubble time, would probably have been rated AAA.

That is why the current paradigm of assigning lower capital requirements to what the credit rating agencies perceive as having lower risk, like if they possessed some extraterrestrial sensorial abilities others don’t, is plain ludicrous. That only increases the expected returns from what is perceived as having no risk… precisely what would be prescribed for a financial heart-attack.

And since the Congress and the G20 do not yet get that, do not hold your breath waiting for any major progress in financial regulatory reform.

Also, to allow financial regulators to focus so excessively on the risk that lies closest to their heart, namely the risk of default, is, in a world with so many other risks, like the AAA rated BP can attest to, plain scandalous.

The biggest risk for society is that our banks will not perform efficiently their role in allocating capitals and it is always better for them to fail when taking real and worthy risks than to survive or fail taking useless Potemkin risks!