Basel Admitting Mistake Making Sovereign Risk-Free

Even I think anyone should realize
politics is a dangerous profession
and they should not have given the
politicians a blank check as in the
Basel Framework. Of course that
would lead to a public debt
bubble sooner or later. 

Bank of International Settlements in Basel, the mother of the Basel Framework recently (October 2011) admitted the large mistake to zero risk sovereign debt. In this paper they describe the problem and that "the regulatory treatment of sovereign risk could be seen as supporting “financial repression” (ie policies that require private savings to be invested in government bonds and are likely to end up with a long-term misallocation of capital)". Then the paper goes on and on describing that it has definitely not been the case and it is only a misperception by some that the Basel Framework did promote sovereign risk at all. 

Anyway the paper concludes: "Moving from denial to recognition of sovereign risk in bank regulation is one key element that will help to restore confidence and to foster fiscal discipline" and a "Need to put an end to the fiction of a uniform zero risk weight for sovereigns" thus admitting its fatal mistake.

The key question is what did the notion came from that politics is risk free and how did it end up as a cornerstone in the financial regulation? Maybe because the Framework was created in Europe in the 80-ties, when we still had the Iron Curtain and we were overly confident of the benefit of large public sectors. That would fit with introducing the highest capital requirements for corporates, since they were not overly popular at the time.

The paper defines the way forward : "[We] Need to put an end to the fiction of a uniform zero risk weight for sovereigns." 

A Leader Faces the Future, Not the Past

I received a very interesting comment yesterday regarding leadership from De Kiewit Treasurer Search claiming not all treasurers are fit to be business leaders but the concept of "business leader" is better understood than previously. Thanks Pieter, for your much valuable input.

The past few years have been extremely turbulent and have excelled the role of treasury from an accounting to a strategic management role. I've discussed this with many CEO and board directors to be able to pinpoint more exactly the new requirements on the treasurer:

* You need to understand the business model and modelling. This is not in a conceptual way, it is in a detailed way and having the ability to view it as a three-dimensional model. Expect to answer questions like: "How does the new capital requirements and scarcity of cash affect our business model and how can we change it to increase our market shares and customer offerings?"

* You need to be able to understand and support your business areas by approaching the market and optimizing the supply and demand chain. Figure out how you can improve the financial supply chain to create more revenues and increased profitability.

* You need to understand your core markets and customer offerings. Visit the customer fronting units often. Show you understand and that you are interested, and learn from them. The best business development happens when interacting with the customers.

* Always act in a group perspective and be expert in your field. This might force you to break rules - do it!

* Never communicate detailed reports unless explicitly asked for. Communicate areas of importance and conclusions first and substantiating analysis only if requested. Do not lecture. Present only the parameters needing attention, be precise, do not expect your audience to draw the conclusions. Give recommendations for decisions and take responsibility for them.

* As a Leader you are hired to improve top and bottom line and when doing so you earn your right to grow and only then.

* Have your eyes on the future, not the past. Most treasurers and CFO focus on past quarters and dissect them in boring detail. Every CEO on this planet wants a treasurer and CFO who focuses on the future and performs reliable forecasting, with no surprises and excuses, and contributes with scenario analysis, and mitigation plans. It is usually very easy to predict what might happen. The real difficulty lies in predicting when and where, and by whom. This is the focus of the CEO, share it if you want to grow.

* Physical stamina. Your body and mind is the same system. To take the pressure of being a business leader and staying sharp at all time, physical stamina is key.

Credit Risk on Borrowings Too

I have had the good fortune of working in two banks that got bust. Honestly it was an incredibly valuable experience since I got the opportunity to see the extremes. In such situations everything comes into the light, even things you could not image. In hindsight it is actually very simple. When a bank goes bust it lacks capital and therefore always immediately the balance sheet has to be slimmed to comply to capital requirements. Therefore the account executives are ordered out to collect the loans. After a while the so called bad loans are taken out to a new entity called the bad bank that receives state funds as capital with the ambition to close all engagements as soon and as profitably as possible. Remember the state always makes the profits in the end.

So if you borrow from a bank that later becomes insolvent, the first step is to figure out if you end up in the bad bank. You may risk ending up there even though you are fulfilling all your obligations since engagements in sectors the good bank shall not have in its portfolio will end up in the bad bank. Even if you remain in the good bank you need to understand that banks ability and ambition to build new relations and expand on existing ones. Usually good banks do not receive a proper strategy and expansion plan for a very long time. Therefore remaining in the good bank may not be that good after all and the chance is that where ever you end up you want out.

So whatever way you turn you have a credit risk - also when you borrow.

P.S. I hear this morning that the EU leadership has agreed a 50% hair cut for Greece by the banks and on top of that they want the banks to increase capital requirements. We risk a serious crowding out effect of corporate lending. Hope it will not be like the one I've sketched in this post.

High Readership on "Where To Invest"

The man in the picture has no
connection to this blog, to ballooning
public debt, to an unhealthy regulation,
or to Basel.

There are many readers globally of the post "Where to Invest?" published 21st October 2011. Every day I speak to treasurers of their concerns for raising cash. We have a situation when the crisis again is slowing growth in the Western World. Thankfully the demand in the growing markets (mainly Asia) compensates for many peer companies.

Meanwhile the European banks are squeezed by the EUR crisis developing into a Latin America disaster from severe political failure. American banks are cautious bi-sitters. Meanwhile the investors search alternatives to sovereign risk and the corporates postpone capital investments and acquisitions. There is not much advise to give rather than prepare for the worst case scenarios as discussed in the previous peer group meeting in London end of September.

Fortunately the corporate sector is in a better shape than 2008 and will be more able to sustain a recession next time. However when the banking system is built to be a cash machine for the public sectors and crowding out the corporates - growth and welfare creation will severely suffer.  "The system isn't broke, it was built this way."

For the future we need a much more stable and sensible financial rule set. It's time to scrap the idea behind the Basel Framework and instead balance the financing needs of the public, private and corporate sectors equally. Implement same capital requirements for all sectors!

EU Commission Censoring Ratings

The figures have no connection to this blog post or to
the EU Commission, or to Esma

Esma, the European market regulator shall now approve all rating methods and approve all sovereign ratings. This was reported by the Financial Times yesterday (21st October).

The very best method to cure the fever is to cool the thermometer. We the European peoples must hail our leaders in the EU Commission for the wisdom and deep concern for our welfare they show to us. We are so happy they use their immense collective intelligence and sharp brains to come up with the conclusion that they are much better suited to device rating methods and individual sovereign’s ratings than the gangster credit rating agencies. Since Esma has no bias rating sovereigns the best solution is obviously they do it. Censorship is democracy at its best.

Considering that our EU leadership has created and is promoting the Basel framework stipulating that sovereign risk is no risk, they have surely proved they have an extremely good judgment for the rating profession.

The decision is as clever as it is simple. If everyone would be AAA rated we would not have any financial crisis. The crisis will be over in a whim and these bad times will go away and all demonstrators can go back to work.

Freud had the theory that in social groups the dumbest person determines the group’s intelligence level. The EU Commission has proven him right with yet another extraordinary accomplishment.

With this and other well-grounded and wise decisions and actions our leadership again clearly shows the world that Europe is the region with highest potential for growth, wealth creation and entrepreneurship. Dear leaders, we praise the paths you take and are prepared to pay even more taxes to prove our obedience to you. 

Where to Invest?

Neither the man in the picture nor
his hand has anything to do with
this post or this blog.

I had a great discussion with an investment banker yesterday. I met him on Eurostar from London to Paris and learnt a lot and he gave me many new perspectives. We got an additional two hours since the train collapsed in the tunnel. Anyway his main problem was to find papers to invest in. He was very cautious to increase his sovereign exposure since yield is low and the credit risk is increasing. We hear France risks a downgrade maybe forcing Germany to take on an even higher burden with possible implications on its rating and risk profile. Now he instead searched safer paper, such as high rated corporate bonds. Just look and feel at that strategy. It's 180 degrees from Basel! Corporate risk is regarded lower than sovereign risk, despite Basel requires full capital requirements for corporates and no capital at all for states even when they are throwing out debt right, left and center. As you might understand I have some philosophical issues with the Basel Framework ;). The regulators do not take the satellite perspective, they are on the gravel level. But since many of them are raised in the state bureaucracy what can you expect? If you look inside your hand, you only see a hand.

On the other side I currently hear from corporates that the banks cannot help them find investors with reasonable yield expectations. But I happened to bump into one such investor on a train....

Maybe the corporates should go directly to investors and circumvent the banks? That idea is not new and will probably become even more valid the higher versions of Basel we get.

Regulation is Like Penicillin

The following rules apply:

1. Use the correct Penicillin for the disease you intend to cure

2. Do not overdose. Remember you are killing necessary and good bacteria too

3. Be careful for bacteria becoming resistant. A bit farfetched, I admit ;) but I mean avoid creating systemic risks

4. Manage your body and mind so you become naturally resistant, for instance with proper governance in all sectors of the society

Corporate Governance vs Political Governance

The corporate governance debate forced for decades has created a rigorous system of transparency, control routines and reporting requirements. Understanding the corporate accounts and the risks in the company is no hassle and the information you need is easy available. Corporate crime including tax fraud leads to long term sentences and humiliation. Never, ever in modern time has corporate defaults led to a severe financial crisis. Despite that fact the Basel framework still regards corporate risk as something that shall be crowded out from the banks’ balance sheets into the second engine.

The Basel framework regards real estate collateral as a semi high risk. Since the mid 1980-ties and the first version of Basel we have had several real estate bubbles bursting creating huge financial meltdowns. In 1991-92 the Swedish real estate bubble almost made Sweden go bankrupt. It was avoided thanks to the country’s small size and international limited importance and clever politicians making fast and bold decisions. Generally speaking Sweden’s high tax rate still depend on the tax payers to mortgage their homes for larger investments (such as a new car or a kitchen). Saving money after tax is for most Swedes impossible. In fact the whole Swedish economic system is built on creating real estate bubbles, which is a clear systemic risk facilitated by Basel.

Globally we are now in the largest and most devastating financial crisis since the 1930-ties again created by a real estate bubble, which the Basel framework regards as a limited probability of happening! The first crisis 2007-09 disclosed inappropriate sovereign risks effectively leading to countries defaulting with Iceland being the first and who knows what PIIGS countries will follow? All of us will lose money in this crisis and on the countries defaulting in particular.  The “private investors” shall cut 50% of the holdings it’s told. We, the people, are the private investors through our retirement funds and savings.  No one is open about who the private investors actually are. The word private investors lead us to believe they are the rich and glorious bankers we all are taught to hate. But eventually we – the people – will have to pay the costs – again.

Political governance does not at all reach the same standards as corporate governance. Far from. Effectively any political administration can bankrupt any country and live happily ever after. There is no transparency where the tax payers’ money is spent. There is no percussion for financial crime in the political world. Genocide is the only thing an administration should avoid. That may lead to a conviction in The Hague. But impoverish a whole nation and putting the global financial system at risk is ok. The Basel framework encourages speculation in sovereign risk! We should acknowledge the largest financial crashes are caused by political failure. From where is the notion that politics is low risk?

We need to balance capital requirements in a way so they are as high for corporates as for real estate collateral as for sovereign debt. A director of the Swedish Central Bank recently said:  “The problem is that Greece has been able to borrow to the same low cost as Germany.  No one made a country analysis [my translation from Swedish]”. Of course this happened since it is what EMU is all about! Blame directly the systemic risk caused by the Basel framework making everyone regarding sovereign risk as low risk. Unfortunately the analysts put too much faith in the political system to enforce financial discipline in the EMU. There are lots of criticism against the financial institutions for the crisis and that’s ok. But I believe this financial crisis is created by the political system. The lack of governance has given us incompetent, shortsighted and populist politicians. We urgently need systems for strict political governance or they’ll draw another disaster on us immediately after we’ve endured and paid for this one.

What Direction Will We Take on Future Financial Rule Set?

The Wall Street demonstrations are a bad sign that populists might take over the discussions on the future financial rule set. We risk of ending up in an environment of Tobin taxes and weird legislation imposed on us by politicians seeking votes. I hope you agree that it is necessary to take a more strategic and holistic discussion with the woman and man in Main Street. How shall we regulate the financial sector and what purpose shall the sector and regulation have? The demonstrators do not have a clue how it works and the central bankers and commercial banks have internal discussions no one else understands. Envy to bank bonuses risks to be the driver for future regulation and that will surely not benefit growth and global value creation. 

I feel it is time the the corporates - large and small - start to voice their opinions and concerns. 

From the September Meeting in London

In end of September we had a great few days in a summer hot London. We welcomed several new members to the groups. We met with board directors, economists, supra nationals assisting us to perform even better in our positions and bring home very valuable insights for  managing this very volatile period. We are extremely proud of regularly receiving such good feedback and rating from the peers. It's a pleasure and honor to participate and learn from you. It's interesting to see that despite our distinguished guests it is always the round tables that receive the highest praise because of the competence and open atmosphere. 

There were multiple take-aways from the meetings e.g. yet another model how to avoid profit and loss volatility without hedge accounting, how to find the most comprehensive political insurance, how to communicate with the board, the economic scenarios currently, best practice in SWIFT connectivity just to mention a few. The program for the next meetings is being put together and revealed later.

Magnus moderating

Peers preparing to present conclusions

Susanna gathering ideas for next meeting

Playing With Fire

I fully agree with JPMorgan Chase's chief Jamie Dimon's criticism of the Basel Framework. The terribly confused discussion of Basel III, tax on transactions, regulation of OTC derivatives etc have brought us far away from a holistic and philosophical view on why we have banks in the first place and how to organize the future financial set of rules. I mean we should have a financial system supporting global wealth creation instead of one that primarily aims (and constantly fails) to prevent banks defaulting!

The design of the financial regulation is far too important to delegate to European social engineers! Unfortunately the present debate is hardly visible in the society and only restricted to banks and central banks. Politicians seem uninterested since it does not create any votes to spend time on it. Scary to say the least.

I blame the Basel framework for the real estate and sovereign bubbles we have had the past decades and even the present crisis. It is terrifying that the corporate treasuries hardly participate in the debate and instead plan for alternate funding alternatives outside of the banking system. This is true for large investment graded corporates as well as for small and medium sized companies having less and less interaction and businesses with banks. And image the world after Basel IV and V! Hasta la vista, Banks.