Nicholas Knouf on Wed, 19 Sep 2012 03:19:06 +0200 (CEST)

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Re: <nettime> WSJ editor: it's the politicians and their mignons, stupid!

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It's interesting---but perhaps not surprising---that the WSJ doesn't
mention another speech by Andrew Haldane entitled "The Race to Zero"
where he specifically discusses the complexity of high-frequency
trading as problematic:

"The Flash Crash was a near miss. It taught us something important, if
uncomfortable, about our state of knowledge of modern financial
markets. Not just that it was imperfect, but that these imperfections
may magnify, sending systemic shockwaves. Technology allows us to
thin-slice time. But thinner technological slices may make for fatter
market tails. Flash Crashes, like car crashes, may be more severe the
greater the velocity.

Physical catastrophes alert us to the costs of ignoring these events,
of normalising deviance. There is nothing normal about recent
deviations in financial markets. The race to zero may have contributed
to those abnormalities, adding liquidity during a monsoon and
absorbing it during a drought. This fattens tail risk. Understanding
and correcting those tail events is a systemic issue. It may call for
new rules of the road for trading. Grit in the wheels, like grit on
the roads, could help forestall the next crash."

I have not read closely the recent speech by Haldane, but my reading
of this earlier speech and other texts by him suggest that he has a
more nuanced understanding of things than the WSJ is giving him credit


nick knouf

On 09/18/2012 01:44 AM, Patrice Riemens wrote:
> In case u didn't now already: the market, and especially the
> financial system can regulate itself perfectly, if it could only be
> left alone! (Take that, Dmytri! ;-)
> ............
> original to: 
>  Speech of the Year A regulator, of all people, shows how complex
> regulations contributed to the financial crisis
> While Americans were listening to the bloviators in Tampa and 
> Charlotte, the speech of the year was delivered at the Federal 
> Reserve's annual policy conference in Jackson Hole, Wyoming on
> August 31. And not by Fed Chairman Ben Bernanke. The orator of note
> was a regulator from the Bank of England, and his subject was "The
> dog and the frisbee."
> In a presentation that deserves more attention, BoE Director of 
> Financial Stability Andrew Haldane and colleague Vasileios
> Madouros point the way toward the real financial reform that
> Washington has never enacted. The authors marshal compelling
> evidence that as regulation has become more complex, it has also
> become less effective. They point out that much of the reason large
> banks are so difficult for regulators to comprehend is because
> regulators themselves have created complicated metrics that can't
> provide accurate measurements of a bank's health.
> The paper's title refers to the fact that border collies can often 
> catch frisbees better than people, because the dogs by necessity
> have to keep it simple. But the impulse of regulators, if asked to
> catch a frisbee, would be to encourage the construction of long
> equations related to wind speed and frisbee rotation that they
> likely wouldn't even understand.
> Readers will recall how ineffective the Basel II international
> banking standards were at ensuring the health of investment banks
> like Bear Stearns. The inspector general of the Securities and
> Exchange Commission, which adopted the Basel standards in 2004,
> would report in 2008 that Bear remained compliant with these rules
> even as it was about to be rescued.
> Messrs. Haldane and Madouros looked broadly at the pre-crisis 
> financial industry, and specifically at a sample of 100 large
> global banks at the end of 2006. What they found was that a firm's
> leverage ratio-the amount of equity capital it held relative to its
> assets-was a fairly good predictor of which banks ended up sailing
> into the rocks in 2008. Banks with more capital tended to be
> sturdier.
> But the definition of what constitutes capital was also critical,
> and here simpler is also better. Basel's "Tier 1" regulatory
> capital ratio was thought to be more precise because it assigned
> "risk weights" to each category of assets and required banks to
> perform millions of complex calculations. Yet it was hardly of any
> use in predicting disasters at too-big-to-fail banks.
> We've argued that Basel II relied far too much on the judgments of 
> government-anointed credit-rating agencies, plus a catastrophic 
> bias in favor of mortgages as "safe." Instead of learning from
> that mistake, the gnomes have written into the new Basel III rules
> a dangerous bias in favor of sovereign debt. The growing complexity
> of the rules leaves more room for banks to pursue regulatory
> arbitrage, identifying assets that can be classified as safe, at
> least for compliance purposes.
> Messrs. Haldane and Madouros also describe the larger problem: a
> belief among regulators that models can capture all necessary 
> information and then accurately predict future risk. This belief is
> new, and not helpful. As the authors note, "Many of the dominant
> figures in 20th century economics-from Keynes to Hayek, from Simon
> to Friedman-placed imperfections in information and knowledge
> centre-stage. Uncertainty was for them the normal state of 
> decision-making affairs."
> A deadly flaw in financial regulation is the assumption that a few 
> years or even a few decades of market data can allow models to 
> accurately predict worst-case scenarios. The authors suggest that 
> hundreds or even a thousand years of data might be needed before
> we could trust the Basel machinery.
> Despite its failures, that machinery becomes larger and larger. As
> Messrs. Haldane and Madouros note, "Einstein wrote that: 'The 
> problems that exist in the world today cannot be solved by the
> level of thinking that created them.' Yet the regulatory response
> to the crisis has largely been based on the level of thinking that
> created it. The Tower of Basel, like its near-namesake the Tower of
> Babel, continues to rise."
> Exploding the myth that regulatory agencies are underfunded, they 
> note that in both the U.K. and U.S. the number of regulators has
> for decades risen faster than the number of people employed in
> finance.
> Complexity grows still faster. The authors report that in the 12 
> months after the passage of Dodd-Frank, rule-making that represents
> a mere 10% of the expected total will impose more than 2.2 million
> hours of annual compliance work on private business. Recent history
> suggests that if anything this will make another crisis more
> likely.
> Here's a better idea: Raise genuine capital standards at banks and 
> slash regulatory budgets in Washington. Abandon the Basel rules on 
> "risk-weighting" and other fantasies of regulatory omniscience. In 
> financial regulation, as in so many other areas of life, simpler
> is better.
> .........
> (courtesy of the 'audi et alteram partem' deptt - we just like
> border collies and don't really understand how they landed in this
> mess....)
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