Saturday, February 27, 2010

Absurd and naïve bank regulations stand in our way!

The European Commission initiated on February 26, 2010 additional public consultations on changes to the Capital Requirements Directive for banks (CRD). The following was my response.


The world swallowed the idea proposed by the bank regulators that if one creates incentives for banks to finance what is perceived as having less risk, and disincentives to avoid what is perceived as having more risk, then we would all be better off.

The regulators implemented it by placing lower capital requirements on those bank operations that are perceived by the credit rating agencies to have lower risk of default, the AAAs, than on those perceived as having higher risk, the BBBs of the world.

What an absurd and naïve thing to do!

• As if there was enough real AAAs to go around!

• As if economic growth and human development resided primarily in AAA land!

• As if you need to give more incentives to the AAAs already favored by the natural cowardice of capitals!

• As if you can measure risks without risking affecting those same risks.

• As if those operations perceived as less risky did not face the risk of more carelessness.

• As if those human fallible credit rating agencies would not be subject to very strong pressures to award the AAAs.

What happened? What was doomed to happen!

Increasing the value of the perceived safe-havens created incentives for selling some not so safe havens as safe, by influencing perceptions, which led to dangerously overcrowding a subprime haven; which caused the current financial crisis.

What needs to be done? Start from scratch!

There is no way to build something good on top of a foundation as faulty as the Basel Committee´s “The First Pillar – Minimum Capital Requirements”. Unfortunately this could prove to be an impossible task if keeping those regulators who so entirely succumbed to the current paradigms.

Europe, wake up! The current crisis did not result from excessive risk-taking. It was the result of misguided excessive risk-aversion. The losses occurred in AAA land not in BBB land.

Europe, wake up! Risk-taking is what takes one forward. Risk aversion can only guarantee being diminished. Europe, do not allow yourself to be diminished! Rest of the world that goes for you too!

Per Kurowski

Friday, February 26, 2010

Governor Daniel K. Tarullo on Financial Regulatory Reform

U.S. Monetary Policy Forum, New York on February 26, 2010

Tarullo said: “But financial stability alone is not the aim of financial regulation”

About time! About 20 years too late! In the 347 pages of the bank regulations known as Basel II there is not one word about any other purpose for our banks than being stable

Tarullo said “Supervisors counted on capital and risk management to be supple tools that could ensure stability”

Absolute nonsense! They created a very crude and simple set of capital requirements based on perceived risks; then outsourced simplistically the risk-watch function to the credit rating agencies; and then they simply went to sleep.

Conclusion: A lot of good thoughts but yet not a word on the true problems with their current regulatory paradigm, being that there are not enough low-risk AAAs to go around for everyone; and that real economic growth and development does not happen in any risk-free AAA land.

Wednesday, February 24, 2010

Should we not have higher capital requirements for banks on what is perceived as less risky?

This “Not your average airport!” courtesy of “Learning from dogs” is a great example of that when something is risky everyone is more careful...

And so what we might really need is higher capital requirements on what is perceived as not risky and which therefore can induce carelessness. Just exactly the opposite of what the financial regulators have been and are doing.

Be more wary of the “too big to govern”

“Laissez govern” is infinitely more dangerous than “laissez faire” so we must never allow the “too big to govern” to become the substitute of “the too big to fail”.

Friday, February 19, 2010

Dangerous global coordination was the real cause of the crisis

Capital is intrinsically coward and loves anything triple-A rated. Therefore, when on top of this natural love, the global regulators in the Basel Committee awarded the triple-A rated additional benefits in terms of these generating much smaller capital requirements for banks... the demand for triple-A rated instruments soared. As should have been expected the supply mechanism of the market started to fabricate triple-A rated instruments in enormous volumes... something that by definition should be anathema to low risk.

There were of course many other economic imbalances that aggravated the final result but this, the excessive belief in that risk should and could be avoided, is why the current financial crisis came to happen.

In February 2000 in an article titled “Kafka and global banking” published in the Daily Journal of Caracas I wrote: “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.”

In January 2003 the Financial Times published a letter in which I wrote: “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.”

But now when the above has unfortunately been proved to be too true, Dominique Strauss-Kahn of the IMF, in “Nations must think globally on finance reform” February 18, keeps on going as if nothing has happened writing that “the work of [the Basel Committee and the Financial Stability Board] must be accelerated to harmonise rules that limit excessive risk taking”.

IMF, before going forward, needs to reflect more on the dangers that the very real possibility of a bad global coordination might signify.