Gas Week

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Credit agencies grade investment risk wrongly; bank balance sheets must reflect drawn-down guarantees

Posted by gasweek on 20 September, 2007

Had the world’s central banks not lubricated the financial system, it could have seized up, Bill Harcourt wrote in The Canberra Times (5/9/2007, p. F6).

Agencies make disastrous risk ratings errors: “Recently the world’s cen­tral banks injected $US500 billion-plus into the world financial sys­tem… What caused all this? In the past 20 years, financial engineers have replaced your bank manager with a securities market that has created huge wealth,” wrote Harcourt. “The banks cut up their mortgages into little pieces and, using off balance-sheet entities, on-sold these pieces to hedge funds and others with bank guarantees. As well they even separated the mortgage repay­ments from the risks of defaulting and sold these risks as separate securities. So the financial institutions held bundles of bank guaranteed debt default securities. They relied on the credit agencies to measure the risks involved. The credit agencies, using mathematical formulas and computers, made disastrous errors giving these packaged bundles of risk investment grade ratings.”

Bank balance sheets burdened with billions in guarantees: “At present many hedge funds have been unable to roll over the finance borrowed to pay for the risk securities and have called in their bank guarantees,” Harcourt wrrote. “Thus the banks now have to include these drawn-down guarantees on their balance sheets. In Australia the NAB has $10 billion of these guarantees now on its balance sheet, while the ANZ, Westpac and the DBA have $5.5 billion. Also last week Australian hedge fund, Basis Capital placed its $320 million Basis Yield Fund in provisional liquidation. This is small cheese for our big four banks but worldwide it is the tip of the iceberg.”

The Canberra Times, 5/9/2007, p. F6

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