July 14, 2009
Obituary - Basel II: 1995-2009
Basel II: passed away at home after a long illness - not with a 'big bang' but a whimper.
On 8th July 2009, the UK Treasury announced the death of Basel II. Whenever they revealed new unilateral rules on 'macro prudential regulation' and 'counter-cyclical capital buffers', the UK government pulled the plug on the life-support system that was keeping Basel II alive. In doing so, they cruelly terminated a short but spectacular era in banking regulation.
Like many children of a very successful parent, Basel II had a life-long inferiority (Oedipus) complex. His father, Basle I was the quintessential central banker [it is rumored that Basel II changed the family name because it was 'too French' for American tastes].
As a regulator, Basle I was over-bearing and dictatorial forcing through tough capital charges over the wishes of most international bankers. Basle I was equally aloof and strict at home, reportedly always referring to his only child by the formal Basel Vous rather than the more affectionate, familiar Basel Tu. Unlike his father, Basel was a sensitive child, with a life long love of literature, ballet and opera; however, when he told his father that he wanted a career in the arts, Basle I demanded that he enter the family business - banking regulation.
Basel was conceived in the late 1990s, as bankers and politicians came to believe that the 'one size fits all' approach to regulation of Basle I was too restrictive (especially on management bonuses). Unlike his dictatorial parent however, Basel II was more amenable to the pleas of bankers and developed a novel approach, allowing banks to develop their 'own models' for calculating the capital that they needed. It is reported that Basle I suffered a seizure when hearing of this heresy and never communicated with his offspring again.
Basel II was a lone, tortured genius and after several rejections eventually published, in 2004, his master work "International Convergence of Capital Measurement and Capital Standards - A Revised Framework" also known the 'New Accord' or simply Basel II.
The New Accord was an instant critical success. Like the works of his hero - Marcel Proust - Basel's creation was vast, complex and impenetrable.
Bankers loved it because it freed them to do what they do best - i.e. destroy the life savings of widows and orphans. Regulators were ecstatic because it required them to do little but jet off to exotic locations for regulatory conferences. And consultants adored it because it generated lots of new fee income from totally bewildered banking clients. Academics lauded Basel as the first 'post modern' regulator: certainty was replaced by ambiguity and all history was subjective (especially useful when parceling up a load of rotten sub-prime loans for selling to unsuspecting insurance companies, like AIG).
Basel's popularity reached its peak in 2008 when he strode the regulatory landscape like a colossus and his ideas were adopted enthusiastically in many jurisdictions around the world [however, he never cracked Broadway!]
But then disaster struck in the form of the Global Credit Crisis. Overwhelmed by debt that only their over-blown models could defend, banks ignored Basel and went scuttling to governments for injections of capital. As the crisis unfolded, it became clear that the philosophical underpinnings of the New Accord, such as dependence on rating agencies for credit ratings, were seriously flawed.
Basel was distraught and, being extremely sensitive to criticism, took to his bed and slowly wilted away, existing only on chamomile tea and madeleines. His last days were spent in a darkened room, pleading with his butler to replay some of his earlier successes, such as developing capital charges for Operational Risk.
Basel's regulatory masterpiece is often compared to the flourishing of new art movements, such as Art Deco, after the Great War. However, after a brief explosion of creativity in the 1920s, the Great Depression cruelly curtailed such artistic experimentation. In the 1930s, the framework for strict banking regulation, which held sway until the advent of the New Accord, was put in place. It would be a cruel irony if the Credit Crisis were similarly to overturn Basel's inventive work on banking self-regulation.
Basel II is survived by two children: a boy, Basel III, (of whom little is known and less expected) and a girl, Solvency II, the illegitimate love child of a brief but intense romantic encounter with the insurance industry. It is rumored that some of his more fanatical followers have formed a semi-religious sect called the 'Basel Committee' to carry on his name, but it remains to be seen whether they will be forced to go underground for their faith as governments turn against them.
Details of Basel's funeral service will be announced in due course but the family has requested 'no flowers'. If an appreciation is considered appropriate then the family has requested that donations should be made to the Charity for Distressed Bankers (also known as the US government) or to the Sir Fred Goodwin pension fund.
Posted by pjmcconnell at 06:24 PM
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July 04, 2009
HELLO - Earth to Planet Basel
Somewhere in a galaxy far, far away.
In several episodes of Star Trek, the Starship Enterprise lands on a picturesque planet where: the streets and buildings are clean and shiny; beautiful young women wear 1960s miniskirts; handsome young men wear 1970s jumpsuits; and the planet is ruled by wise, old bearded men wearing togas. [Incidentally, why is that advanced civilizations always seem to have such bad taste in fashion?]
The planet is a lush paradise and the crew of the Enterprise take the opportunity for a little R&R, somewhat like the Playboy Mansion reality show without the porn. All, that is, except the Enterprise's Chief Rick Officer, Dr. Spock, who has a gut feeling that all is not right.
Not least because we have seen similar plot lines before, we know that there is likely to be a dark secret at the heart of this planet, and soon Spock and Kirk will find it. The secret usually involves an all-powerful 'computer brain' that is kept alive by regular sacrifices of young children. When this is pointed out to the inhabitants of the planet, all hell breaks out, since nobody wanted to know the answer to the question of why their kids were disappearing in the first place. The final scene of the plot usually shows the crew of the Enterprise fleeing from an angry mob, and as the spaceship blasts off, the planet behind disintegrates into exploding chaos.
The not so subliminal message is that 'Earth may not be paradise, but at least it is not based on a lie' [mmmmnh? - discuss]
This fantasy is not dissimilar to Planet Basel!
Now Planet Basel should not be confused Basel, which is a Swiss city, also clean and shiny with a few beautiful women, handsome men and wise elders, but with fashion that is more like 1980s East Berlin than Swinging London. The only really taxing question in that Basel is: Fondue - why?
Planet Basel on the other hand is a regulatory paradise, where all is perfect and thorny questions are never asked, let alone answered.
A recent example is a speech by Jose Maria Roldan, a wise elder of Planet Basel's ruling clique, ominously called 'the' Committee. In his pronouncements to British Bankers (the few that are left of course), Senor Roldan reportedly said that 'Basel II is the best way forward to build banks' capital requirements on'. While admitting some minor difficulties, he nonetheless opined that 'the idea is certainly not to replace Basel II, but rather to add another layer of safety.' 'You don't give up using the seatbelt just because you have an airbag', he added, failing to point out that neither the seatbelt nor the airbag worked in the recent crash.
Such optimism would be admirable, were it not for the fact that the world has just experienced a major banking crisis that not only was not foreseen by the Committee, but, during which, banks' capital requirements had to be augmented by huge taxpayer handouts.
Planet Basel's dirty secret is out: Basel II doesn't work and probably never would have worked. But the Committee is still feeding the monster and living the lie.
While the philosophical basis for banking capital requirements is best left to a more suitable forum, such as an episode of the Simpsons, one word points up the double-speak at the core of Basel II - 'counter-cyclical'.
'Counter-cyclicality' is a typical economist's term - full of suggestion, yet totally devoid of meaning. Since the advent of the Global Financial Crisis, regulators everywhere have been chanting this mantra to ward off the evil spirit of irrelevancy. In this context, counter-cyclical basically means 'make sure you keep enough gas in the tank to get to the next gas station'.
However, regulators just do not realize that one can have Basel II OR Counter-cyclicality but NOT both.
Basel II is about precision, calculating (and I use that term loosely) the minimum capital needed to cope with 'unexpected losses' over the next 12 months. On the other hand, taking a counter-cyclical approach means building up a capital buffer, well above the regulatory capital mandated by Basel II, to cope with potential problems in the medium and long term.
Basel II is like a driver who, after calculating distance, average fuel consumption, and taking into account traffic and weather conditions, buys exactly enough gas to get to the next station. On the other hand, counter cyclical drivers will fill up at the first gas station, then pull in at the next to top up and so on for the rest of the journey, always keeping plenty in the tank for emergencies. Of course, the advantage that the Basel II driver has is that, if (i.e. when) they make a mistake, there is always a taxpayer-funded gas truck coming along behind to give them a top-up of fuel when needed.
For counter-cyclical advocates, the tricky question is how much of a capital buffer is needed? We don't know. We don't even know what part of the economic cycle we are in, the beginning, middle or end, so how can we know how big the buffer should be. What is the point of calculating Basel II capital to a precise confidence interval of 99.9% if we are then going to wave a counter-cyclical finger in the air and multiply by 1.2, or 2.3 or 6.7 or whatever?
You cannot sensibly have both approaches! Unless, that is, you live on Planet Basel?
All of this, of course, would be a comedy, if were not for the tragedy that the Committee is plowing ahead with a raft of changes to Basel II, even before the rules have been rolled out to all existing jurisdictions, most notably the USA.
As bankers flee from the angry mob of Planet Basel regulators, they can look back on an empire that is close to disintegration. Maybe they can adapt the immortal words of Captain Kirk - 'boldly go, em, go boldly, em, just go!
Posted by pjmcconnell at 04:34 PM
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