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U.S. Bank Regulators Set Up Greek Tragedy

The regulators justified their reliance on the OECD Country Risk Classifications -- rather than on Standard & Poor's, Moody's, or Fitch, which together are known as the Nationally Recognized Statistical Rating Organizations (NRSROs) -- by saying that the OECD "is not subject to the sorts of conflicts of interest that affected NRSROs because the OECD is not a commercial entity that produces credit assessments for fee-paying clients, nor does it provide the sort of evaluative and analytical services as credit rating agencies." The regulators added that they were "considering additional measures that could supplement the CRCs to determine risk-weighting factors for sovereign debt positions."

It's a good thing they're considering "additional measures," since, according to a report from Oct. 28, available on the OECD website, the United States and Germany both had Country Risk Classifications of zero, but so did Greece.

FBR Capital Markets analyst Paul Miller pointed out that while federal regulators have been "talking tough on tangible common equity," and have excluded various types of equity, including most trust preferred stock, from regulatory capital calculations, "on the flip side, nobody can really calculate risk-weighted assets," which is why many investors "still look at financials as a black box."

It's been great fun bashing the ratings agencies over the past several years, especially because of their outrageous conflicts of interest when they were assigned AAA ratings to some questionable mortgage paper, for fees.

But applying a zero percent risk-weighting to investments in the sovereign debt of troubled countries is a complete farce.

S&P downgraded its sovereign rating for Greece to a below-investment grade BB-plus, in April of 2010. In June of this year, Greece's S&P rating was downgraded to CCC, with default of some debt appearing "increasingly likely." S&P would appear to be ahead of the curve, or at least ahead of the OECD and federal bank regulators, on this one.

According to Bloomberg, the current composite sovereign debt rating for Greece is CC+, and two-year Greek notes closed Thursday at 26 cents on the dollar. In comparison, two-year notes issued by Spain closed at 98 cents on the dollar.

So, by the new capital rules, sovereign paper trading at a 74% discount, would still have a zero percent risk-weighting.
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