Saturday, January 14, 2017

Reflections on Terracotta Warriors, credit ratings, and capital requirements for banks

I read in Latin American Herald Tribune of January 14, 2017: “A Chinese state-run newspaper reported that armed with clubs authorities destroyed a museum with 40 fake Terracotta Warriors that tricked numerous tourists and prompted some complaints”

Oh I can already hear it! “Tom, you see, I told you those terracotta soldier boys they took us to see seemed fake. Why did you not listen to me? Why did we have to show those photos to Nancy and George? Do you think we could now sue the Chinese tourism authorities for those terra-whatever being fakes, or at least for disclosing those as fakes after the fact?

My head started to spin too. Some years ago I bought some small Terracotta Warriors in China. Because of their size and pricing, I always thought these to be absolute fakes. No problema! But are these now exposed to being crushed by some Chinese regulator? Might someone over there have a copyright on these that has been infringed?

Come to think of it, do we not need some Chinese Terracotta Authenticity rating agencies? 

Perhaps, but, if those rating agency fall for the temptations to be most certainly offered to them by shady Terracotta Warrior suppliers, hey we’re talking China here, could we ask our government to sue these agencies? 

I mean like the US has done with Moody’s and S&P with respect to their worse than lousy rating processes that produced totally unworthy AAAs for some of the securities backed with mortgages to the subprime sector in the US.

But then again, if these terracotta rating agencies mislead us, would we see some of the money from the fines, or would that only go to those who, to begin with, excessively empowered the rating agencies? 

And should then regulators in China request the vendors of Terracota Warriors to hold more capital, against the risk of being sued, the faker the rating shows its product to be; somewhat like what is being done with banks and their risk weighted capital requirements?

I would not think so. I would have bought my Terracota Warriors even if rated very fake; since the price was right.

Of course, the real problem, like in the case of the AAA rated securities, would be an AAA rated Terracota Warrior, and for which partly because of that rating, billions had been paid for at an auction, if it then later proves to be fake.

Does this mean that the better a Terracota Warrior would be rated, the more capital should the suppliers hold? Yes! Precisely! That’s what fundamentally current bank regulators got wrong.

The safer an asset is ex ante perceived, decreed concocted or rated, the riskier it could be ex post. They completely ignored Voltaire’s “May God defend me from my friends, I can defend myself from my enemies