Here is the succinct but complete explanation of the subprime crisis. One, which apparently should not be told.

Here's a prologue, on the 10th anniversary of the Lehman Brothers collapse: In 2006 in a letter to the Financial Times I argued for the long-term benefits of a hard landing. The Fed and ECB decided to kick the can forward and upwards, which could have worked; better at least, had they removed the distortions that created the crisis. 

Just four factors explains it all, or at least 99.99%.

Securitization: The profits for those involved in securitization are a function of the betterment in risk perceptions and the duration of the underlying debts being securitized. The worse we put in the sausage – and the better it looks - the more money for us. Packaging a $300.000, 11%, 30 year mortgage, and selling it off for US$ 510.000 yielding 6% produces an immediate net profit of $210.000 for those involved in the process. (Those signing the mortgages do not participate in the profits)

Credit ratings: Too much power to measure risks was concentrated in the hands of some very few human fallible credit rating agencies.

Capital requirements for banks. Basel II, June 2004, brought down the risk weight for residential mortgages from 50% to 35%. Additionally, it set a risk weight of only 20% for whatever was rated AAA to AA. The latter, given a basic 8%, translated into an effective 1.6% capital requirement, which meant bank equity could be leveraged 62.5 times to 1.

Borrowers: As always there were many financially uneducated borrowers with needs and big dreams that were easy prey for strongly motivated salesmen, of the sort that can sell a lousy time-share to a very sophisticated banker. 

Clearly the temptations became too much to resist for all involved.

The European banks, thinking that if they could make a 1% net margin they could obtain returns on equity of over 60% per year, went nuts demanding more and more of these securities; and the mortgage producers and packagers were more than happy to oblige, signing up lousier and lousier mortgages and increasing the pressure on credit rating agencies. The US investment banks, like Lehman Brothers, also participated, courtesy of the SEC.

Of course it had to end bad... and it did!

Can you image what would have happened if the craze had gone on one or two years more?

I have explained all the above in many shapes or form, for much more than a decade. Unfortunately it is an explanation that is not allowed to move forward, because it would put some serious question marks about the sanity of some of the big bank regulators.

Might I need to go on a hunger strike to get some answers from the Basel Committee and the Financial Stability Board?

PS. Here is a somewhat more extensive aide memoire on the mistakes in the risk weighted capital requirements for banks.

PS. And here are some of my early opinions on these regulations, some of them while being an Executive Director at the World Bank, 2002-04

PS. Here’s my recent, 2019, comments sent to the Financial Stability Board

PS. Here’s my recent, 2019, letter sent to the IMF

PS. And here is a very humble home-made youtube comment on it all, from 2010

The Big Short is short on the whole truth. There’s too much vested interest in “Bank regulators can’t be that wrong!”

Paul Krugman, in the New York Times of December 18, 2015 wrote: “You want to know whether the movie [The Big Short] got the underlying economic, financial and political story right. And the answer is yes, in all the ways that matter”

No! I now saw “The Big Short”. It is a very good movie that describes accurately many elements of the crisis that resulted from excessive exposures to AAA and AA rated securities; those that were backed with badly awarded mortgages to the subprime sector.

But, unfortunately, just as I suspected, it remains totally mum on what really propelled the crisis, namely outlandishly bad bank regulations.

In the over two hours movie, we do not hear a single word about that banks in Europe, and investments banks in the USA, thanks to the Basel Committee and the SEC, were allowed to hold these securities against only 1.6 percent in capital… meaning they could leverage their equity, and the support they received from society, a mind-blowing 62.5 times to 1.

The risk-adjusted returns on equity banks expected to make on AAA to AA rated securities by leveraging them over 60 times, blinded everyone. When in the movie it is mentioned that even though the default rate of the subprime mortgages was increasing dramatically, and yet the price of those securities was rising, they ignored among others the runaway European demand for these. These securities, CDO, MBS, ABS or what you want to call them were in fact thought to be the new gold to be found in California, and way over a trillion Euros pursued that gold during less than two years. 

Want to read about it? Here is what happened to little Narvik of Norway in “And then the roof caved in”, page 114. 

Anything that could be traced back to an AAA rated security allowed banks to finance any operation with it against almost no capital. For instance if AAA rated AIG sold you a credit default swap, that was enough… and so everyone bought CDS’s from AIG, who could not resist selling CDS’s on AAA rated securities.

Paul Krugman and others like Joseph Stiglitz, even though bank regulations odiously discriminate against “The Risky” and in doing so increases inequality, cannot find it in themselves, or in their agendas, to accept that technocratic regulators, regulating on behalf of governments, could be so wrong.

The Big Short mentions though a prime driver of the disaster. One broker confesses he would make immensely higher commissions supplying truly lousy adjustable rate mortgages to the packagers of AAA security, than sending them reasonable fix rate prime mortgage. The way the incentives worked, the worse the mortgage, the higher was the added value of the to AAA-ratings conversion process.

PS. And not only The Big Short is guilty of omission. In its 848 pages the Dodd Frank Act, though the US is a signatory, does not even mention the Basel Accord and the Basel Committee

PS. I just looked at the index of Michael Lewis’ “The Big Short again”. It does not mention Basel regulations, risk weighted capital requirements for banks, nor the meeting on April 28, 2004 when SEC decided that the investment banks in the US, would be able to play by Basel rules… and thereby open the way for the minimum capital requirements against anything AAA rated for these banks.

The financial crisis explained to dummies in terms of capital requirements for banks: Lehman Brothers - AIG - Greece

The regulators, with Basel II, decided that against any private sector assets rated AAA banks, and against any sovereign rated as Greece was until November 2009, banks needed to hold only 1,6 percent in capital, meaning these could with those assets leverage their capital over 60 times to 1. (When holding “risky” assets like loans to entrepreneurs and SMEs they were only allowed to leverage 12 times to 1. 

On April 28, 2004 the SEC decided that was good for the Basel Committee was good enough for them and allowed Lehman to leverage over 60 times to 1 with AAA rated securities guaranteed with mortgages to the subprime sector… Since Europe were allowing their banks to do the same… the demand for these AAA securities became so huge that it overpowered all the quality controls in their manufacturing and packaging process… and Bang!

If AIG that was AAA rated guaranteed an asset, banks could dramatically reduce the capital they needed to hold against that assets, and this overwhelmed AIG’s capacity to resist selling “very profitable” loan default guarantees… and Bang!

Greece was of coursed offered loans in such amounts and in such generous terms, so their otherwise "so" disciplined and fiscally conservative governments could not resist the temptations… and Bang!

And as should have been expected not one single asset class that was perceived as risky played any role in causing the financial crisis… although of course these assets also suffered a lot when the “safe” came tumbling down.

One would think regulators would by now have discovered that banks already clear for the perceived risks with their risk premiums and the size of their exposure; and so to also force them to also clear in the capital for exactly the same risks, would cause banks to overdose on perceived risks. But no, they haven’t. So this little financial history lesson for dummies is of course primarily directed to them.

What is our major problem now? John Kenneth Galbraith explained it well: “If one is pretending to knowledge one does not have, one cannot ask for explanations to support possible objections.”

What did we in the Western world do, to deserve getting saddled with so dumb bank regulations/regulators?

The pillar of current bank regulations issued by the Basel Committee for Banking Supervision is “the risk weighted capital requirements for banks”.

For those interested, a more accurate name would be “the portfolio invariant credit-risk-weighted equity requirements for banks”

In essence it signifies that the more the ex ante the perceived credit risk is, the more equity banks need to hold.

That does not make any sense! It is never what the perceived credit risk is that constitutes any real risk for a bank and much less for a banking system. It is only how wrong banks could have perceived the risks to be, which represents the real risk.

If something is perceived as safe and turns out risky, everything is ok.

If something is perceived as risky but turns out to be less risky, then that is only good news.

If something perceived as risky turns out to be even more risky, then that is bad, but at least in that case one can suppose the balance sheet exposures to be lower, and that the bank has been receiving higher risk premiums that partly compensate.

But, if something perceived as safe turns out ex post to be risky, that is where the real dangers lie.

And so we can only conclude in that: the safer a bank asset may seem the more dangerous it becomes… and which is 180 degrees opposite of what current regulators think.

And that mistake also stops the banks from financing precisely those our society most need to be financed, in order to move forward, namely "the risky" small businesses and entrepreneurs.

What did we do to deserve that?

Scene 6 on the crazy reality lived while “Banking in times of the Basel Committee”

Jr. Credit Officer Martin: “But Sir, how can we put this 30 years, 11 percent, lousily awarded mortgage into a security that aspires an AAA rating?” 

Bank President Wally: “Easy, let me explain it to you Martin. To put a proper AAA quality mortgage, with a proper interest rate into that security, would be absolutely useless, as it would generate no profits for us. But, if we put that very bad mortgage you refer to in a security, and manage to get an AAA rating for it, then we can resell it as earning solely a six percent return… and that would mean an instant profit to be share among us all of $210.000. Irresistible eh?” 

Jr. Credit Officer Martin: “But Sir, would not the bankers find out how bad these AAA rated securities were?” 

Bank President Wally: “Dear Martin, when you are allowed, by your regulator, to leverage your equity more than 60 times, only because an AAA to AA rating is present, and which means that if you believe you can make a 1 percent margin means you expect a 60 percent return on your equity, you do not make a lot of questions. You see, if the ratings only go down to the range of A+ to A, then banks can only leverage those securities less than 25 times. Imagine from more than 60 to less than 25!...

In fact Martin, it is the European banks and our US investment banks who are demanding these AAA securities so much that frankly we have to cut corners… don’t forget that we are a service company… and we do what our clients wants us to do... hi-hi-hi!”

Scene 1

Scene 2

Scene 3

Scene 4

Scene 5

David A. Stockman’s “The Great Deformation” did not include what is perhaps the greatest deformation.

David A. Stockman’s The Great Deformation is a truly great book, except for the fact that sadly it misses out on what in my mind constitutes the greatest deformation… namely allowing for much much lower capital (equity) requirements for banks on exposures that are considered as “absolutely safe”, than what they are required to hold for exposures considered as “risky”.

That allows the banks to grow so as to end up as Too Big To Fail, and to earn much higher risk-adjusted returns when lending to “The Infallible”, than when lending to “The Risky”.

And that distorts completely the way credit is allocated within the real economy, so that too much at too low interest rates of it goes to the "The Infallible", like the sovereign and the AAAristocracy (or AAArisktocracy) and too little to at too high interest to "The Risky", like medium and small businesses, entrepreneurs and star-ups.

And that effectively increases the de-facto risk-adverseness of banks, in the home of the brave, and in all other countries were these truly lamentable regulations are applied. And if that is not a deformation, what is?

Stockman does not mention that because of Basel II, approved in June 2004, and what SEC approved for US investment banks, April 2004, the European banks and the US investment banks could hold AAA rated securities, or lend against these securities, holding only 1.6 percent in capital, meaning leveraging their equity a mind-boggling 62.5 times to 1. 

And a result, though Stockman, in Chapter 20, “How the Fed brought the gambling mania to America’s neighborhoods”, explains splendidly the tragedy of how extremely bad mortgages were awarded to the subprime and other sectors in the US, and then packaged into dubious AAA rated securities sold all over the world, he misses out completely on the main reason for why the world demanded these securities and all other “supper-safies” so much, that it completely lost its common sense.

Let me assure everyone that if the banks had needed to hold the 8 percent they have to hold when lending to their “risky” citizen, then the current US subprime, Greek sovereign, Spanish real estate, Cyprus' banks, and similar tragedies, would not have happened. It is as easy as that… which of course does not make it any easier to swallow.

I hope that in the next edition of “The Great Deformation” David Stockman at least rewrites his chapter 20 so as to include these considerations. It would be a shame not to do so in such a good book.

And I need to repeat it again: A nation were banks need to hold 8 percent in capital when lending to the citizens, but are allowed to lend to their government against zero capital, is a deformed nation.

PS. The risk weights of 0% for the Sovereign, 20% for the AAArisktocracy and 100% for We the People, is anathema to America.

God make us daring!

Democrats and Republicans… for the sake of America, agree at least on eliminating bank regulations which discriminate against "The Risky” and in favor of "The Infallible"

The access to bank credit has been rigged against those perceived as "risky", like small businesses and entrepreneurs, by means of requiring banks to hold much higher capital when lending to them compared with what the banks need to hold when lending to those perceived as “not risky”. 

This, in a country that became what it is, thanks to risk-taking, and which also likes to refer to itself proudly as “the land of the brave”, is a direct affront to the American courage and spirit of entrepreneurship.

This, is what most neutralizes the impact of fiscal and QEs stimulus, and which most stands in the way of job creation.

Why cannot Democrats and Republicans set aside their differences for one second, and agree on eliminating any bank regulations which discriminate against those perceived as “risky”? 

Would they do so, there would be no reason to concern themselves with a heightened risk in the financial sector, since never ever has a major bank crisis resulted from excessive exposure to those perceived as “risky” (consult your Mark Twain), these have always resulted from excessive exposures to what was ex ante erroneously considered as “absolutely-not-risky”.

Republicans could sell it to their side, correctly, as an elimination of regulatory distortions that impede the markets to efficiently allocate economic resources. 

Democrats could sell it to his side, also correctly, as an elimination of a discrimination against the “risky-not-haves” and in favor of the “not-risky-haves” which drives increased inequality.

Both parties need to understand that discriminating against "The Risky" and in favor of "The Infallible" is about as Un-American it gets... in fact it is outright immoral!

http://perkurowski.blogspot.com/2008/08/discrimination-based-on-financial.html

A Financial AAAristocracy… in the US?

Bank regulators, who knows based on what right, created a financial aristocracy. It is composed by “The Noble Infallible” borrowers, like “The Noble AAAs”, and “The Noble Systemic Important Financial Institutions”, technically known as “The Noble SIFI’s” or, in more vulgar terms, “The Noble Too-Big-To-Fail banks”, “The Noble TBTF”.

When compared to the commons, like any unrated borrower, “The Risky”, like small businesses and entrepreneurs, and to smaller banks, like community banks, also known as “systemic un-important financial institutions”, the Financial Aristocracy has been endowed with immense privileges.

Just as an example, according to the Basel II orders, a bank can lend to a “Noble AAA” holding only 1.6 percent in capital, while if lending to any lowly member of ‘The Risky”, it needs to hold 8 percent in capital, five times as much!

The previous signifies of course that every dollar paid in risk adjusted interest rates by a Noble AAA represents five times in return on bank equity that the same risk-adjusted dollar in interests paid by the unrated "risky" commoner.

Of course to keep their rulers happy, bank regulators also named these as “The Absolute Infallible” and which, again according to the rulings of Basel II, signified that banks needed to hold no capital at all when lending to the Supreme Sovereign.

I can understand perhaps how this appointments of a Financial Aristocracy, or more precise yet an AAArisktocracy might have slipped through in Europe, but, in America, where its Constitution establishes: “No Title of Nobility shall be granted by the United States”... how on earth did that happen?

And though the United States in June 2004 formally committed to implementing the Basel II bank regulations; and though the SEC in April 2004 delegated supervision decisions to the Basel Committee,  there is surrealistically enough not one single mention of these regulations, or of the Basel Committee for Banking Supervision, in the 848 pages of the Dodd-Frank Act. And this though that Act makes reference to foreign organizations like the Extractive Industry Transparency Review (EITI). It would seem like someone somewhere, has been playing some dirty tricks on someone.

And, by the way, discriminating against risk-taking, in a land which became what it is thanks to risk-taking, in “the land of the brave”… You’ve got to be kidding!

I accuse the bank regulators... they caused the crisis!

If risk models, credit ratings and market intuitions were perfect, then a bank would really not need any capital at all, since all risk considerations would have been correctly priced, in the interest rates, in the amounts and in the duration of the loans. But, since risk-models, credit ratings and market intuitions are often not perfect, the regulators needs to require the banks to hold some capital, to make sure that there is an adequate cushion provided by the shareholders who are profiting from the bank activity, before creditors and tax payers are called upon to help out. 

Unfortunately the current generation of bank regulators, stupidly, did not base their capital requirements for banks on the possibility of mistakes, but on precisely the same risk models, credit ratings and market intuitions… requiring for instance minimal equity when the perceived risk of default of a borrower seemed minimal.

And it is precisely there, where the perceived risks of default seem minimal, where the risks for a systemic bank crisis resides, as what is ex-ante perceived as “risky” does never grow into a dangerously sized exposure.

And so, instead of helping to cushion for the mistakes of the banks, the regulators, with their distortions, increased the probabilities of the mistakes being made, and their negative financial consequences. 

And that they did by allowing banks to hold only 1.6 percent in capital when investing in triple-A rated securities or lending to sovereigns like Greece, which implied an authorized leverage of 62.5 to 1, while at the same time requiring the banks to hold 8 percent in capital when lending to job creating small businesses and entrepreneurs, an authorized leverage of 12.5 to 1. And that they also did by allowing the banks to lend to the “infallible sovereigns” against no capital at all, where not even the sky was the limit on leverage. 

And that is why we got those monstrous large bank exposures to what was ex-ante officially perceived as not risky, and which have now, ex-post, exploded in the whole Western World. 

And that is why the “risky” small businesses and entrepreneurs find access to bank lending so curtailed and expensive.

The bank regulators need to be held fully accountable for what they did, because if we do not get to the bottom of this sad affair, neither won’t we get out of it.

Here´s a video that explains a fraction of the stupidity of our bank regulations, in an apolitical red and blue! http://bit.ly/mQIHoi

Dodd-Frank Act… legislative surrealism!

The Dodd-Frank Act signed today seems to me a surrealistic piece of legislation. 

Though the United States in June 2004 formally committed to implementing the Basel II bank regulations; and though the SEC in April 2004 delegated supervision decisions to the Basel Committee, surrealistically, there is not one single mention of these regulations, or of the Basel Committee for Banking Supervision, in all 848 pages of the Dodd-Frank Act. And this though the Act makes reference to foreign organizations like the Extractive Industry Transparency Review (EITI). It would seem like someone somewhere, has been playing some dirty tricks on someone.

PS. (Dated later) And it does not mention the fact that risk-weighted capital requirements for banks, in the home of the brave, does seem to be quite un-American. What do you mean regulators about discriminating against "the risky", those who are already being discriminated by the banks because they are perceived as risky?

The fact that the distortions in the allocation of bank credit caused by the risk-weighted capital requirements had not been understood, much less accepted, made it impossible for the Dodd-Frank Act to really serve its purpose... in many ways... by opening discussions on so many other fronts and thereby distracting the attention from what most urgently matters, only made it worse.

PS. Homeland Security. Bad regulations could be used as a lethal weapon of terrorism

PS. The complaint I presented to the Consumer Financial Protection Bureau

PS. In essence the Dodd-Frank Act did absolutely nothing to correct the most fundamental mistake in current bad regulations. It did not even recognize it!

PS. A letter published in Washington Post

Has the US Congress delegated to the Basel Committee the settings of capital requirements for banks?

Can anyone explain why the Basel Committee is not mentioned even once in the 1336 pages long reform bill presented to the US Senate or in the 1776 pages long H.R. 4173 financial regulatory Act approved by the House of Representatives?

Has the US Congress delegated into the Basel Committee the settings of capital requirements for banks? If so is the US citizen aware of it?

For instance is Congress unaware of that the SEC when it on April 28, 2004 allowed the US investment banks to substantially increase their leverage, it did so explicitly stating that “the consolidated computations of allowable capital and risk allowances [be] prepared in a form that is consistent with the Basel Standards”.

Don’t they know that if there is anything that has guided the evolution of the current financial regulations, those that I have for so long sustained doomed the world to exactly the type of crisis we now have, that is the Basel Committee. Basel’s AAA-bomb was ignited on June 26 2004, when the G10 countries, which includes the US endorsed the revised capital framework for banks known as the Basel II standards.

The lover’s spat between Goldman Sachs, Paulson and “sophisticated investors” is not the real problem!

The beauty of the action of the SEC against Goldman Sachs is that it allows us to understand with a real and public example a lot of what happened all over the market. Let us see it here from the perspective of IKB the German Bank who invested $150 million in ABACUS 2007-AC1.

In paragraph 58 we read that IKB bought $50 million of the A1 tranche paying Libor plus 85 basis points, and $100 million of the A-2 tranche paying Libor plus 110 basis points. The average return comes to about 102 basis points.

Since these $150 million were rated Aaa by Moody’s and AAA by S&P when purchased, that meant that IKB’s investment, for bank capital requirement purposes, would be weighted at only 20% signifying only $30 million for which 8% capital requirements had to be held. IKB would therefore need $2.4 million of their own capital to back the operation, a leverage of 62.5 to 1.

$150 million at 102 basis points and $ 2.4 million in capital signifies then an expected gross return of 63.75% on IKB’s capital.

In order for IKB to make a comparable return when lending to their traditional client base of small and medium sized businesses, most certainly unrated, and who therefore are risk weighted at 100%, IKB would have to lend them the funds at Libor plus 510 basis points.

And here we have it, the way the current capital requirements for banks are based on the risks perceived by the credit rating agencies, provide huge incentives for the banks to enter into the virtual world and invest in these “synthetic” operations, instead of lending to the real world... and, that problem is so much larger than a simple lover’s spat between Goldman Sachs, Paulson and “sophisticated investors”.

Do you understand why I beg of you to keep your eyes on the ball? Do you understand why I am upset nothing of this is even discussed in the current proposals for financial regulatory reform?

Goldman’s ABACUS 2007-AC1: The whole truth and nothing but the inconvenient truth!

But the whole truth and nothing but the truth would in the case of ABACUS 2007-AC1 have to include the following facts, no matter how politically or agenda inconvenient they might be:

IKB, a commercial bank headquartered in Germany did not use $150 million to lend to small and medium sized German companies, as they historically had done, but instead invested and lost “$50 million in Class A-1 notes at face value” and “$100 million in Class A-2 Notes at face value” in ABACUS 2007-AC1, exclusively because of the following two reasons:

First both tranches, the A1 paying Libor plus 85 basis points, and the A-2 paying Libor plus 110 basis, points were rated Aaa by Moody’s and AAA by S&P when purchased by IKB.

Second, in order to invest $150 million in these securities which because of their ratings were risk-weighted by Basel II at only 20%, IKB needed only to have $2.4 million of capital, 1.6%, compared to the $12 million it would be required to have if lending that amount to unrated small and medium sized German companies.

If IKB had known that Paulson had had his hand in the picking, and known fully about his motives, then they might have asked for a slightly higher interest rate, maybe 10 basis points more, and still have bought the securities.

If the securities did not have the splendid credit ratings assigned to them by the credit rating agencies then they would probably not have bought them even if Mother Teresa had done the picking.

If the regulators had placed the same type of capital requirements on all assets then IKB would have stayed home, lending to their traditional clients, instead of going to California to dig prime rated subprime gold.


And so while naturally we should lend all our support to efforts to eliminate wrong-doings like those described in the SEC action against Goldman that should not signify we take our eyes of the unfortunate truth of having been saddled with grossly inept regulations, creating grossly bad regulations.

Now all of this does of course not imply that the Goldman Sachs, the Tourres, the Paulsons or the ACAs of this world are angels… it is just about putting it all in the right perspective.

And now, is it time for some “Razzle dazzle 'em”?

SEC’s action against Goldman Sachs in paragraph 53 states:

“IKB… late 2006, was no longer comfortable investing in the liabilities of CDOs that did not utilize a collateral manager, meaning an independent third-party with knowledge of the U.S. housing market and expertise in analyzing RMBS”.

The above sounds a lot like a type of b.s. excuse, construed by someone trying to hide their own responsibility in the affair… that of having invested solely based on the juicy interest rate offered when considering solely the credit ratings issued by the credit rating agencies.

Did for instance IKB really believe what is said on ABACUS 2007-AC1 flip book, on page 34, about ACA Capitals ABS Credit Selection including an “On-site Visit”? What a laugh! Checking up on the individual mortgages?

And so do not take your eyes of the IKB executives either, they most probably perpetrated real silly stuff against their own investors and so they might now be doing a “Razzle dazzle 'em” routine to cover their own fingerprints.

Are not victims inclined to perform as victims… especially when sophisticated? Are we seeing an Oscar class crocodile tears performance here? ... for which the SEC has also fallen?


Give 'em the old Razzle Dazzle, Razzle Dazzle 'em,

Show 'em the first rate sorceror you are

Long as you keep 'em way off balance

How can they spot you've got no talent

Razzle Dazzle 'em, Bazzle 'em,

And they'll make you a star!

Widespread criminal negligence!

I quote from the fraud action by SEC against Goldman Sachs… “for making materially misleading statements and omissions in connection with a synthetic collateralized debt obligation … ABACUS 2007¬AC1…tied to the performance of subprime residential mortgage-backed securities… was structured and marketed by GS&Co in early 2007 when the United States housing market and related securities were beginning to show signs of distress.”

“when the United States housing market and related securities were beginning to show signs of distress”?

Absolutely, at the date when ABACUS 2007AC1 was issued, April 26, 2007, I had already made four posts related to the subprime mortgage crisis… http://bit.ly/cwbLT2

And so: Where had the minimum caveat emptor we should expect from regulators gone? Where were the regulators? This has all the sign of being more complicated than it is been made out to be… Was it not all criminal negligence all over the place?

Hush! Less we lose the chance to beat on a foe or a convenient scapegoat.

The ABACUS 2007-AC1 flip book states:

“Although at the time of purchase, such Collateral will be highly rated, there is no assurance that such rating will not be reduced or withdrawn in the future, nor is a rating a guarantee of future performance.”

The truth is that had it not been because the investors believed that the credit ratings were correct, they would not have invested, no matter how much Goldman Sachs could have argued with them based on other false statements.

But this is of course is something many do not want to be known, because this would take away all the fun of being able to go after such a juicy foe as Goldman Sachs or such a convenient scapegoat to be used by the inept regulators.

We need to get to the real bottom of this... because that is were the truth can be found.

We can’t shame enough the irresponsible silent experts and the plain lousy regulators

As an Executive Director of the World Bank and a member of its Audit Committee 2002-2004, time and again I repeated what I extract below from my book Voice and Noise, 2006.

“From what I have read and seen, I believe there is a clear possibility that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions”

I also frequently spoke out on the risk posed by empowering the credit rating agencies too much and, in May 2003, I even had a letter published in the Financial Times which ended with “I simply cannot understand how a world that preaches the value of the invisible hand of millions of market agents can then go out and delegate so much regulatory power to a limited number of human and very fallible credit-rating agencies. This sure must be setting us up for the mother of all systemic errors.”

Therefore if someone like me, a non-expert on financial markets, could have said the previous back in 2003-2004, I can only conclude that a crime of pure negligence, of sheer monumental proportions, was committed against humanity by an incredibly large number of professionals.

And so even though I agree of course that all those who pulled the triggers should go to prison, like those accused in Goldman Sachs, if proved guilty, in that prison, for true justice to be served, they should be accompanied by all those who kept mum because it was generally convenient for them to keep mum… and of course by the plain lousy regulators.

We must not let the intellectual mum-keepers go free! The world deserves more than some mea-culpa, the world deserves to find how to make the responsible speak up in time… if need be even by law.

The largest moral hazard is not having banks-bailed out… it is not shaming enough the irresponsible silent experts and the plain lousy regulators.

Some argue no one saw the crisis, “20.000 blind economists”, this is pure nonsense. Our biggest problem is how some few egos in a mutual admiration club dominate the debate and sell us what they believe sounds the best.

The day SEC delegated to the Basel Committee

On April 28, 2004 in an Open Meeting the SEC had the following as Item 3 on the Agenda:

"Alternative Net Capital Requirements for Broker-Dealers that are Part of Consolidated Supervised Facilities and Supervised Investment Bank Holding Companies"

The following was considered and approved:

"The Commission will consider whether to adopt rule amendments and new rules under the Securities Exchange Act of 1934 ("Exchange Act") that would establish two separate voluntary regulatory programs for the Commission to supervise broker-dealers and their affiliates on a consolidated basis.

One program would establish an alternative method to compute certain net capital charges for broker-dealers that are part of a holding company that manages risks on a group-wide basis and whose holding company consents to group-wide Commission supervision. The broker-dealer's holding company and its affiliates, if subject to Commission supervision, would be referred to as a "consolidated supervised entity" or "CSE." Under the alternative capital computation method, the broker-dealer would be allowed to compute certain market and credit risk capital charges using internal mathematical models. The CSE would be required to comply with rules regarding its group-wide internal risk management control system and would be required periodically to provide the Commission with consolidated computations of allowable capital and risk allowances (or other capital assessment) prepared in a form that is consistent with the Basel Standards. Commission supervision of the CSE would include recordkeeping, reporting, and examination requirements. The requirements would be modified for an entity with a principal regulator.

The other program would implement Section 17(i) of the Exchange Act, which created a new structure for consolidated supervision of holding companies of broker-dealers, or "investment bank holding companies" ("IBHCs") and their affiliates. Pursuant to the Exchange Act, an IBHC that meets certain, specified criteria may voluntarily register with the Commission as a supervised investment bank holding company ("SIBHC") and be subject to supervision on a group-wide basis. Registration as an SIBHC is limited to IBHCs that are not affiliated with certain types of banks and that have a substantial presence in the securities markets. The rules would provide an IBHC with an application process to become supervised by the Commission as an SIBHC, and would establish regulatory requirements for those SIBHCs. Commission supervision of an SIBHC would include recordkeeping, reporting and examination requirements. Further, the SIBHC also would be required to comply with rules regarding its group-wide internal risk management control system and would be required periodically to provide the Commission with consolidated computations of allowable capital and risk allowances (or other capital assessment) consistent with the Basel Standards."

In other words, that day the SEC, explicitly, delegated some of its functions to the Basel Committee.

That day Goldman Sachs, Morgan Stanley, Bear Stern, Lehman Brothers, Merrill Lynch were authorized to leverage themselves way more than was traditional. In fact 62.5 times to 1 when in the presence of a AAA rating. That day those firms were authorized to use their own financial models to govern themselves. “With that the five big investment firms were unleashed”.

That day a very serious warning by Mr. Leonard D Bole was blithely ignored.

You can hear the New York times commenting more about that highly unfortunate delegation here