'Too Complicated to Succeed'

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I once had great faith that the world was run by people who were far smarter than I—and that their superior intelligence, work ethic, and virtue could be relied upon to steer us through when the glassy seas blew into high swells and maelstroms. While nothing has yet convinced me that my meager perspective is not routinely exceeded — both in quality and degree—I have lost my faith in my betters.

Here's a thumbnail sketch of why.

In the face of enormous challenges—for example, the Spanish banking & European debt crisis—a cadre of intellectual elites are often summoned into action to solve the problems at hand. Those elites devise clever and elegant solutions—in this case, analytic and regulatory models—commensurate to their great collective intelligence.

But then the challenge arises. Because of the enormous scale of the problem, huge numbers of people have been 'impacted'; therefore, a large number of individuals are required to work the solution set. By definition, there aren't enough elites to go around. And so lots of ordinary people must implement—and to a lesser extent, understand—the solution. Those people look a lot like you and me.

Such may be the case with the regulatory/oversight/restructuring regime for Spanish banks.

So forget about 'Too Big to Fail': Contemplate 'Too Complicated to Succeed'.

Perhaps TCTS is one of the issues at stake in the Spanish bank recapitalization nightmare.

Bloomberg reported yesterday:

"Spanish bond yields rose and bank stocks fell, indicating the blueprint Finance Minister Elena Salgado outlined to strengthen the financial system failed to calm investor concerns."

So it's fair to say that Salgado's scheme did not meet its intended goal. But why?

Tracy Alloway and Joseph Cotterill pick up the coverage in The Financial Times Alphaville blog :

"It seems—to start—there's been some confusion about the Basel-ness of the proposed core Tier 1 ratio. Matrix analyst Andrew Lim, for instance, reckons the 8 per cent target is really being calculated on a far less-onerous Basel II basis…"

Yes, indeed: Confusion.

Alloway and Cotterill go on to quote several analysts—and to nobly hash through the issues at stake as well as anyone could be expected to. (Their article is certainly well worth reading in its entirety.)

The core issue is—as everyone knows—the weakness of the Spanish banking sector.

The basic problems regulators are now facing is devising a way to recapitalize the banks; also, how to balance capital requirements with assets that have been stratified, weighted, and adjusted for risk.

But a series of conflicting, overlapping, and incomplete regulatory regimes are not making the solution any clearer.

Essentially, a series of highly complex banking and accounting regulations are being filtered through the prism of national, supranational, and theoretically universal financial regulation— with all the attendant politics inherent at every level.

Even the analysts seem to be struggling to understand and assess what's going on.

I provide the quote below as an example of the theme—not in an attempt to explicate, in any great detail, the discussion:

"Last night Mrs Salgado, finance minister, set a minimum core capital ratio of 8 percent for Spanish banks (we understand under Basel II, not yet applying Basel III methodology) and indicated that the additional capital needed would be of up to €20bn. It is our understanding that FROB is being considered as core capital, while we would regard it as lower quality compared to pure equity."

(The delightfully named 'FROB' is a Spanish acronym for 'El Fondo de Reestructuración Ordenada Bancaria—which seems to translate into English as 'The Fund for Orderly Bank Restructuring'. The purpose of the FROB, according to their website: 'The Fund for Orderly Bank Restructuring was created to manage the restructuring processes of credit institutions and assist in the enhancement of their equity, on the terms laid down by this Royal Decree-Law.')

I'm willing to allow that all of this—in its enormous and monolithic complexity—this makes perfect sense to someone.

Perhaps the 'best and brightest' fully understand the entire system—both as a whole and in all its mind numbing detail.

That's certainly a possibility.

(However, it is helpful to note that the very phrase 'best and brightest' was conceived by David Halberstam—dripping with caustic irony—to refer to the architects of our nightmare in Southeast Asia.)

You have to ask yourself: Is it possible for legions of bank employees and regulators to work with this stuff every day without drowning in overwhelming—and often conflicting—detail?

Can a banking system function with such absurd complexity at its core?


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