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Some level of the financial crisis can be laid into the Basel agreements that wrote ratings agencies into the process - i.e. AAA is safe for pension funds, etc.

This ECB rule is the same mistake writ large. I understand the urge to invoke an outside agency on country ratings - it helps pretend things are "not political" - but the reality is that the ratings agencies are dominated by an ideology that is in fact very political.

Alas, the Brussels-Frankfurt Consensus is just another genetic mutation of the Washington Consensus, so the ECB is quite comfortable with the political ideology of the ratings agencies...

by Metatone (metatone [a|t] gmail (dot) com) on Thu Mar 25th, 2010 at 06:53:45 AM EST
Some level of the financial crisis can be laid into the Basel agreements that wrote ratings agencies into the process - i.e. AAA is safe for pension funds, etc.

This is because the Basel accords are a product of the (evolving) financial conventional wisdom of the last 20 years. According to Neoclassical Economics, ratings agencies make a lot of sense!

This ECB rule is the same mistake writ large.

But this is an ECB internal rule, right? Not a consequence of the treaties. What A central bank will accept as collateral at the discount window is entirely up to that central bank, and in fact that choice is a key instrument of both banking regulation and monetary policy.

Of course, this assumes the ECB is not blindly following Monetarist dogma... Oh, wait!

The brainless should not be in banking -- Willem Buiter

by Migeru (migeru at eurotrib dot com) on Thu Mar 25th, 2010 at 07:02:52 AM EST
[ Parent ]
We need better bankers, both central and private. Without better bankers better banks are impossible. With better bankers better banks are not really necessary. Same with regulators. But all are probably impossible without better electorates.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Mar 25th, 2010 at 01:38:49 PM EST
[ Parent ]
I can tell you there's nothing but snickers around the table every time I attend a presentation about the Basel accords and the rating agencies come up.

For definiteness, here is the definition of a rating agency in the Basel accords: (source: Bank of International Settlements, Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework - Comprehensive Version Part 2: The First Pillar - Minimum Capital Requirements

B. External credit assessment

1. The recognition process

90. National supervisors are responsible for determining whether an external credit assessment institution (ECAI) meets the criteria listed in the paragraph below. The assessments of ECAIs may be recognised on a limited basis, e.g. by type of claims or by jurisdiction. The supervisory process for recognising ECAIs should be made public to avoid unnecessary barriers to entry.  

2. Eligibility criteria

91. An ECAI must satisfy each of the following six criteria.

  • Objectivity: The methodology for assigning credit assessments must be rigorous, systematic, and subject to some form of validation based on historical experience. Moreover, assessments must be subject to ongoing review and responsive to changes in financial condition. Before being recognised by supervisors, an assessment methodology for each market segment, including rigorous backtesting, must have been established for at least one year and preferably three years.
  • Independence: An ECAI should be independent and should not be subject to political or economic pressures that may influence the rating. The assessment process should be as free as possible from any constraints that could arise in situations where the composition of the board of directors or the shareholder structure of the assessment institution may be seen as creating a conflict of interest.
  • International access/Transparency: The individual assessments should be available to both domestic and foreign institutions with legitimate interests and at equivalent terms. In addition, the general methodology used by the ECAI should be publicly available.
  • Disclosure: An ECAI should disclose the following information: its assessment methodologies, including the definition of default, the time horizon, and the meaning of each rating; the actual default rates experienced in each assessment category; and the transitions of the assessments, e.g. the likelihood of AA ratings becoming A over time.  
  • Resources: An ECAI should have sufficient resources to carry out high quality credit assessments. These resources should allow for substantial ongoing contact with senior and operational levels within the entities assessed in order to add value to the credit assessments. Such assessments should be based on methodologies combining qualitative and quantitative approaches.
  • Credibility: To some extent, credibility is derived from the criteria above. In addition, the reliance on an ECAI's external credit assessments by independent parties (investors, insurers, trading partners) is evidence of the credibility of the assessments of an ECAI. The credibility of an ECAI is also underpinned by the existence of internal procedures to prevent the misuse of confidential information. In order to be eligible for recognition, an ECAI does not have to assess firms in more than one country.
The observation is usually that no agency satisfies these conditions. So, national supervisors (that is, central banks) would be well in their rights to decree that the institutions they supervise are not required to use agency credit ratings to risk-weight their assets for regulatory capital purposes.

The brainless should not be in banking -- Willem Buiter
by Migeru (migeru at eurotrib dot com) on Thu Mar 25th, 2010 at 03:54:10 PM EST
[ Parent ]
I can well imagine snickers but when you come to:
Objectivity: The methodology for assigning credit assessments must be rigorous, systematic, and subject to some form of validation based on historical experience.

...I would expect gales of laughter. How does "validation based on historical experience" survive Q3, '08? Or is treating all of '08 as an aberration what they mean by "some form"?

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Mar 26th, 2010 at 11:24:57 AM EST
[ Parent ]
Also, anyone with an ounce of statistical sense knows that an "implied probability of default" of 0.04% annually is ridiculous on its face even if allegedly estimated from historical data...

The brainless should not be in banking -- Willem Buiter
by Migeru (migeru at eurotrib dot com) on Sat Mar 27th, 2010 at 07:29:18 AM EST
[ Parent ]

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