LET’S suppose that the human, fallible credit rating agencies produce ratings that are absolutely perfect in terms of measuring the risk of default; and that banks use these ratings to choose who to lend to, at what rates and under what conditions.
But then let us add that bank regulators, such as those in the Basel Committee, believing they could act as risk-managers for the world, imposed on banks capital requirements based on perceived risks and specifically referring to the risks already reflected in the ratings.
The product is a hallucinogen, a bankers’ LSD. It increases the banker’s sensitivity to risk: he sees good credit ratings in much brighter lights; not-so-good ratings seem far scarier.
For anyone interested in finance and not engaged in regulatory group-think, the consequence of that hallucinogen must be excessive bank exposures to what is officially perceived as not risky – for instance, triple-A rated mortgage-backed securities or “infallible” sovereigns. The result is a dangerous overcrowding of the safe-havens and a growing bank underexposure to what is officially perceived as too risky: for instance, lending to small businesses and entrepreneurs. That is an equally dangerous outcome, because of the lost opportunities to create the next generation of jobs for our grandchildren.
All of these effects come about before we even enter into a discussion of the issue that the credit ratings are also sometimes wrong.
Regulators and experts have been able to spin this crisis as a result of excessive risk-taking when it is evidently the result of regulatory nannies suffering an excessive aversion to risk.
A couple of years into this crisis, now threatening to take the Western world down, the issue of how capital requirements drugged the banks is not even discussed, and, because of that, failed regulators are allowed to proceed with a Basel III, built upon precisely the same failed regulatory paradigm. Holy moly.
Who am I? In 1999, I wrote: “The possible big bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing gods, manage to introduce a systemic error in the financial system, which will cause its collapse.”
In 2003, I wrote again: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds.”
As an executive director of the World Bank, in October 2004, my formal written statement delivered at the board warned: “We believe that much of the world’s financial markets are currently being dangerously overstretched, through an exaggerated reliance on intrinsically weak financial models, based on very short series of statistical evidence and very doubtful volatility assumptions.”
I am someone who was much too right, much too early for his own good.
I am not someone who argues that bank regulators were an acceptable 8.17 degrees off target, but who argues they were 180 degrees wrong. In other words, one who wants to – Occupy Basel.
Per Kurowski is a Venezuelan citizen who served from 2002-04 as one of 24 executive directors at the World Bank. http://bit.ly/dFRiMs