- 06 Dec 2011 at 6:45 PM
S&P Downgrade Warning Gives European Politicians A Chance To Remind You That Eurozone Crisis Is All S&P’s FaultBy Matt Levine
Maybe this is just an effect of distance or translation, but one thing I really like about reading the fulminations of European politico-financey types is that they are savvier than their American counterparts about who to pick on. I never see a European politician or central banker quoted in the FT attacking poor children. They’ve got better scapegoats. Any time anyone says anything bad about European financial governance, they can go back to the well of “really this is all the fault of eeeevil financial speculators and ratings agencies.” And nobody likes those guys, because they’re eeeevil and dipshits, respectively.
So lots of European politico-financy types are very publicly very not amused by S&P’s threats to downgrade all of Europe, though I suspect that deep down a lot of them are excited to be able to spend today making fun of S&P rather than fielding serious questions about whether rising Italian yields are going to lead to trench warfare. So Christian Noyer of the Banque de France:
“The rating agencies were one of the motors of the crisis in 2008,” Mr Noyer said. “One can ask if they are not playing that role again today.”
Jan Kees de Jager, Dutch finance minister, said the rating agencies were caught out by the Greek debt crisis and dismissed the latest move.
“They [the rating agencies] were a bit asleep on the Greek debt crisis,” Mr de Jager told Dutch media. “Perhaps you should be guided more by the judgment of the IMF than by a rating agency.”
Right, sure, whatever. S&P got Greece wrong. Got it. Also you could have mentioned MBS. It’s been pretty conclusively demonstrated that no one should ever listen to a ratings agency ever again. But then there’s this:
The Basel Committee on Banking Supervision, which coordinates regulations for 27 countries, may let banks use equities and more corporate debt, in addition to cash and sovereign bonds, to satisfy new short-term liquidity standards, said two people with direct knowledge of the plans who requested anonymity because the talks are private. The move could reduce demand for European government securities, making it harder for nations on the brink of insolvency to fund themselves. …
“There aren’t enough assets in the world that are genuinely liquid and of high enough quality to allow all the banks to meet this ratio,” said Barbara Ridpath, chief executive officer of the International Centre for Financial Regulation, a London research group funded by banks and the U.K. government. “And that’s only likely to get worse because of the changing credit quality of some of the sovereigns.”
Well that was … maybe a bit more delicately put than the slagging on S&P. But the substantive thing is kind of the same. Yes, S&P kind of sucked at the whole calling things AAA that maybe weren’t so much. And lo, people created a lot of things that were called AAA, and everyone bought them and thought they were safe, and then they weren’t, and the world ended. And yes, it turns out that a zero risk weighting for European sovereign bonds created a lot of things that were called risk-free, and everyone bought them and thought they were safe, and then they weren’t, and that movie is still playing but, y’know, trench warfare.
But here we are, with both S&P and the Basel Committee slowly and tentatively lurching toward atoning for past mistakes by toughening up. And all they get for it is grief.
It’s easy to make fun of S&P, and lord knows we do, but all of these things are necessarily backwards-looking. Your model for rating RMBS looks like it works because there are no defaults; then there are and you look like a schmuck. Treating the bonds of your own sovereign as risk-free makes a lot of sense if you’re a bank in a first world country with its own currency; maybe it makes less sense now (especially when “your own sovereign” squishily becomes “any European sovereign” because, hey, you’re one financial system now) but there are good or at least understandable reasons why no one thought that until recently. The model that correctly rates and risk-weights everything, correctly taking into account what will happen in the future, has yet to be found.
Short of that model, there are only so many things you can really do. And so ideas get revived that look suspiciously familiar. The Bloomberg article on the Basel changes goes on to explain how equities might be included in the Basel liquidity buffer:
Broadening the definition of the liquidity buffer to include more liquid assets such as equities would make sense, said Kinner Lakhani, a banking analyst at Citigroup Inc. in London. The securities should be subject to “significant haircuts” to reflect price volatility, he said.
“The cash sovereign bond market has been less liquid than many would have imagined,” Lakhani said. “At least equities remain a liquid asset class.”
So here’s a tendentious characterization of that:
(1) our risk-free asset du jour, European sovereign debt, is kaput;
(2) actually available actually risk-free assets, say USTs (or gold, whatever), are in short supply; so
(3) let’s make a new risk-free asset out of a concededly risky asset. We’ll just overcollateralize it.
Because if a stock is worth $100 and its three-standard-deviation one-month move is $30, then surely it’s at least $70 of risk-free liquidity – just like if a pool of mortgages is worth $100 and its three-standard-deviation historical amount of defaults is $30, then surely you can carve out a $70 AAA tranche from that pool. Right?
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