On broken donor promises

Promises by donor countries should be rated by credit rating agencies, to shame those who promise lightly; and the poor countries should be able to hedge these promises in the IMF.

This way, a broken promise will not fall on the shoulders of the poor countries least able to afford it, but on the shoulders of the IMF and this way, presumably, the possibilities of the promises being broken will also be reduced.

At the UN 192 countries got it wrong

192 countries got together for the United Nations Conference on the World Financial and Economic Crisis and its Impact on Development and, in their final communiqué, among the causes of the crisis they say “major failures in financial regulation, supervision, and monitoring of the financial sector, and inadequate surveillance and early warning… compounded by over-reliance on market self-regulation, overall lack of transparency, financial integrity and irresponsible behavior, have led to excessive risk-taking, unsustainably high asset prices, irresponsible leveraging, and high levels of consumption fuelled by easy credit and inflated asset prices.”

How can 192 countries get it so wrong? Yes it is true that assets reached unsustainably high prices and yes it is true there were high levels of consumption fuelled by easy credit and inflated asset prices but it is absolutely false that there was excessive risk-taking or autonomously created irresponsible leverage.

The markets, over just a couple of years channeled two trillions of dollars (perhaps more than what has been lent by the Word Bank and the IMF ever since their creation) to finance houses in the US through securities rated AAA and this would much better classify more as misguided excessive risk-aversion.

And the high real leverage of the banks was foremost a direct the consequences of the regulatory innovation of the minimum capital requirements for the banks based on risks that emanated from the Basel Committee. For instance the regulations authorized an outrageous 62.5 to 1 leverage for when banks lent to corporations rated AAA to AA-.

Nor did the conference say a word about how these minimum capital requirements by which the regulators arbitrarily intervened in the market mechanism of allocating risks, created a de-facto subsidy for what can dress itself up as low risk and a de-facto tax on whatever contains more risk, such as the risks normally present in development.

Is it real or bluff stuff?

The G-20 Statement of November 15, 2008 says “Regulators must ensure that their actions support market discipline, avoid potentially adverse impacts on other countries, including regulatory arbitrage…”

What more discipline could they want than having imposed on the markets as a Governess Fraulein Credit Rating Agencies and that later turned out to be so crazy as to send them of to the subprime swamplands? Do they really believe that finding a better qualified Mary Poppins, or a Maria will do it? Scary! Why don’t they leave the banks alone so that they learn to depend on themselves instead of following as a herd any agency that no matter how good it gets, is bound to take them, and us, sooner or later, over a cliff?

“Adverse impacts on other countries”? Like when the supposed global good of a credit rating agency turned into a global bad and caused a German bank that had never awarded a mortgage in Germany to be the first casualty of this subprime mortgage having followed the AAA signs looking for high risk-weighted returns in California?

“including regulatory arbitrage? Are we now finally get rid of the current “minimum capital requirements for banks” that has created such a damaging and useless regulatory arbitrage on risk…whatever that is?

The G-20, do they mean what they say, do they know what they say, or are they just bluffing?

Let us rescue Caveat Emptor!

The implied warranty of fitness given to us by the credit rating agencies has not served us well, especially when the issuers of the warranties now inform us that they give us their opinions under the protection of the First Amendment, and that they cannot therefore be held responsible for their opinions.

It is obviously high time to rescue the Caveat Emptor principles in financial regulations, though in fact it seems that the market has been doing so on its own lately.

Let us never forget that the current crisis did not result from the market investing in badly awarded mortgage loans to what is known as the subprime sector but from investing securities collateralized with such mortgages and that received a prime rating.

A letter in the Washington Post: "An Aspect of the Bubble"

An Aspect of the Bubble

The June 17 installment in the front-page series "The Bubble," though comprehensive, missed one vital piece of the subprime mortgage puzzle. The accompanying glossary defined a "credit rater" as "a company that Wall Street and investors rely upon" to provide analysis but did not tell us that a credit rater's credibility is foremost based on the rater's having been appointed by bank regulators. This arrangement sent the market the loud, clear and false message that risks could be precisely measured and that these entities were capable of carrying out this mission.

Nothing whetted the appetite for securities collateralized with plainly lousy mortgages as much as the combination of high returns and prime credit ratings. Using a regulatory system for banks that is based on following the credit rating agencies will, given that it is human to err, lead us into even greater danger.

If knowledge suffices then wisdom is superfluos

The least I seek here is to try to transmit wisdom, since I am too well aware of how correct Hermann Hesse was when in Siddhartha he wrote 'Wisdom is not communicable. The wisdom which a wise man tries to communicate always sounds foolish...Knowledge can be conveyed, but not wisdom."

And much less do I seek to transmit something as a wise man, since I recognize well the impossibility of being one; something clearly summarized by Socrates arguing that the only possible human wisdom is to know oneself not wise, or only possessing wisdom absolutely devoid of value.

But both you and I, perhaps not in our minds, but definitely in our hearts, nonetheless know, or intuit, or want to believe, there is someone who is wiser than other. Where? We do not know, surely not among the besserwisser. Where then? Assuming it has to do with God is a good start.

I say this because in a world with so much information and so much knowledge, time after time we face the dilemma of if knowledge is enough, then wisdom is superfluous and worthless; and I fear that those words contain the danger that we will get bogged down forever in a knowledge dictatorship.

With no doubt our society is being increasingly cornered by producers and worshipers of information and knowledge, who do not leave space enough for questioners to put their information and knowledge in a more correct perspective.

The above occurs in all fields. For example, in the financial area that is the only possible explanation for why our financial regulators so ingenuously assigned so much power of decision over the financial flows to some few and humanly fallible credit rating agencies.

What a pity that nobody read to regulators from the Apology of Plato, where speaking as Socrates says. "Artisans have real knowledge of their arts, but take that to mean that they are most wise with respect to the most important matters”. As I see it this hubris filled petulance spoils all their knowledge. 

And how do we rid ourselves of that knowledge dictatorship without having, like some of our primitives, resort to that remedy worse than the disease that is the cult of dis-information and ignorance? 

That’s not easy, but at least I think we have a better chance of doing so if we can prevent the configuration of incestuous technocratic majorities in our decision-making bodies. Multidisciplinary teams, with great variety of experience and lots of humility, are the ones that should configure our boards and ministries.

I introduce the factor of humility, because one of the main reasons the world is going through current financial turbulence, is because many expert professionals simply did not know, or did not dare to recognize, as Socrates did, that they did not understand anything of what they were approving.

Friends, let us remember that not understanding what happens, not necessarily make us less aware of what is happening.

Translated from “Si el conocimiento basta la sabiduría sobra” published in El Universal

Excessive weight given to credit rating agencies guarantees systemic risks

As an Executive Director I got invited to make some comments at a "Risk Management Workshop for Regulators: Assessing, Managing and Supervising Financial Risk" arranged by the World Bank in Washington during the week 27 April – 2 May 2003. This is what I told them about the credit rating agencies.

“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.”

I never got invited to speak to them again.

You could read more on this subject in my blogs:

http://www.subprimeregulations.blogspot.com/ and

http://teawithft.blogspot.com/ looking up under the labels of credit rating agencies and subprime banking regulations.

The riskiness of country risk

How horrible it must be to work as an air-traffic controller! Any slight error can provoke an unimaginable human tragedy. No wonder these professionals burn out so rapidly. I “suppose” the same must happen with the country-risk assessors, those people who carefully pass judgment as to what the country risk is for any given nation.

The all-important mission of these risk evaluators is twofold. The first that for which they are actually paid consists of analyzing whether or not the debtor nation will ultimately be able to honor its obligations. This determines whether or not pension funds, banks, and insurance companies will be willing, or even allowed, to invest in that country’s sovereign debt instruments. The second, even more important than the first, is to send subtle signals to the governments of these nations in order to help them improve their performance.

What a difficult job this is! If they overdo it and underestimate the risk of a given country, the latter will most assuredly be inundated with fresh loans and will be leveraged to the hilt. The result will be a serious wave of adjustments sometime down the line. If on the contrary, they exaggerate the country’s risk level, it can only result in a reduction in the market value of the national debt, increasing interest expense and making access to international financial markets difficult. The initial mistake will unfortunately turn out to be true, a self-fulfilling prophecy. Any which way, either extreme will cause hunger and human misery.

What a nightmare it must be to be risk evaluator! Imagine trying to get some shuteye while lying awake in bed thinking that any moment one of those judges, those with the global reach that have a say in anything and everything, determinates that a country has become essentially bankrupt due to your mistake, and then drags you kicking and screaming before an International Court, accused of violating human rights. If I were to be in the position of evaluating country risk, I would insure that the process is totally transparent, even though this takes away some of the shine of the profession and obligates me to sacrifice some of my personal market value.

How lucky we are that we are neither air-traffic controllers nor sovereign-risk evaluators! However, since we can easily become victims of their missteps, it behooves us, if only because of our survival instinct, to make sure that both do their jobs correctly.

We have seen in recent Country Reports how, after having introduced a myriad of information into the black box of methodology, as if by magic, a credit qualification is produced. Many of these reports seem to me like the pronouncements of film critics. It would seem that, more often than not, the individual evaluator is determining more how much he likes the ways or forms the Directors of a nation try to honor its obligations than on producing an honest and profound financial analysis of the country’s capacity for servicing its debt correctly.

In his book The Future of Ideas: The Fate of the Commons in a Connected World (New York: Random House, 2001), Lawrence Lessig maintains that an era is identified not so much by what is debated, but by what is actually accepted as true and so is not debated at all. In this sense, given the risk that the perceived country risk actually becomes the real country risk, it is best not to assign an AAA rating blithely to the risk qualifiers—perhaps not even a two-thumbs-up.

El Universal, Caracas, September 26, 2002

Daily Journal, Caracas, September 27, 2002

Included in "Voice and Noise" May 2006.'