Wednesday, July 13, 2011

No One Could Have Predicted This

. Wednesday, July 13, 2011

Today we see that banks are worried about their exposures to sovereign debt from Europe, especially now that Italy is wavering.

Yesterday, we saw that banks owned so much sovereign debt because it was well-rewarded in the regulatory code. Of course that happened because governments write the regulatory rules, and governments want to stack the deck to make sure they have access to plenty of cheap funds with which to fund spending programs. They do that by privileging sovereign debt in the regulatory requirements, specifically the risk-weights given to debt assets in the capital adequacy standards.

This is no surprise, but it's worth taking a step back every now and then to consider what's going on.


Nick Gogerty said...
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nick gogerty said...

The BIS is now taking over the Ratings agencies roles with varied weightings assigned to Sovereign debt.

this is bad on two fronts.

1. The BIS has a few dogs in the fight considering it is effectively a collection of central banks and by extension sovereign issuers.

2. Homogenous ratings regimes where all most conform to self-similar asset holdings are short term efficient but long term fragile as all portfolio converge on either gaming approaches or holdings.

Homogenous systems are not robust, they are fragile. I would prefer a heterogeneous short term in-efficient system that is longer term stable.

From a systems perspective I will trade today's localized uncertainty for tomorrows systemic stability.

Kindred Winecoff said...

Well, the BIS/BCBS has always taken a variable approach to sov debt ratings, in that only OECD debt gets a 0% risk-weight.

In general I completely agree that the regulatory system we have is practically designed to correlate risk and reward arbitrage. Unfortunately there isn't a good way around that that doesn't rely on tons of discretion. This is why I am both less sanguine about the ability of regulators to "learn" from crises, and am skeptical of arguments that deregulation "caused" the recent crises. You could just as easily say that the specific regulatory structure that we built over decades caused it by rewarding securitization, the rise of the shadow banking system, and sov debt accumulation.

Sounds like your consulting group is on the right track with this stuff.

No One Could Have Predicted This




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