With what is now happening in Cyprus eyes are again focused on the banks in Europe. A bank is liquid when it has funds available to meet withdrawals, and this has no relation to the state of the banks balance sheet. A bank with loads of bad debts but highly liquid will survive a bank crisis. A bank with a pristine debt book but low liquidity may not. A banking regulatory authority needs far less money to maintain liquidity in a bank than shore up its balance sheet. A financial system can be maintained at very low cost, even in the midst of a financial crisis, if the regulatory authority concentrated on providing banks with a drip feed of liquidity and guarantees deposits, no big amounts of money are needed to survive.
If the bank had a large number of bad debts it would not prosper, but
that is the shareholders' problem. It does not affect the bank
depositors, the bank users, or the economy as a whole. But the bank,
given government liquidity support, and nothing else, could continue to
operate. Big sums of money are not
necessary, if the bank runs low in cash, draw that minimal amount
from the central bank. Guarantee the bank's continued existence and no
more is necessary. The US action of massive loans to the banks or taking over
their bad debts was totally in denial of basic economic theory. These actions are distorting economies and creating bubbles everywhere. I have yet to hear anyone mention how money flowing into the safer German economy is creating a bubble there, but it is.
Recent UK bank runs were different, people were not fleeing UK! They were
simply withdrawing money from bankrupt banks, they were not transferring
money to another country. In the
EU, the recent use of the banks to purchase Eurobonds was misguided, and
a misuse of the ECB's activities. Place the above concept front and center in your mind, a bank crisis can be averted with relatively small
amounts of money. If the regulatory authority does not do the wrong
thing and give the banks massive and unnecessary amounts of money. It need only supply a drip feed of liquidity and guarantees the deposits, no
panic is necessary if the regulatory authorities know what to do. Given their current record however, that maybe is somewhat doubtful. The problem in Europe is that the Euro is structured to loosely, and based on economies unbound by "common" market forces.
During the height of the Euro crisis shares in Bankia plummeted on reports, later
denied, that customers were pulling deposits out of the Spanish lender.
Fears of a full-scale bank run in Greece were talked about. The possibility of a deposit run in Europe's peripheral states is still
very much alive. It is also the thing that policymakers are
least prepared for. As with most aspects to the euro crisis, the
usual answers are not much help. Old hands of emerging market bank runs piled cash up in full view of panicking customers so that they could see
how well stocked the banks were with money. The equivalent now is to let
the central bank provide enough liquidity that the ATMs always spit out
cash. Problem is that the idea may be to get your hands on euros today in case of a surprise currency redenomination tomorrow, if that happens you will want Euros under your mattress.
In this case a logical solution would be to set up a joint deposit-guarantee scheme, in which
euro-zone states pool resources to provide credible reassurance that
depositors across the zone will get their money back, up to a threshold of €100,000 ($125,000). The guarantee would have to be a promise to repay the original
value of the deposit in euros. The problem is that even if the political will to realize this end
existed (which is highly questionable), it would take a long time to
negotiate an agreement. There are all sorts of details for
Eurocrats to get their teeth into. Such as the cost and should the scheme be prefunded?
Should depositors be preferred creditors, or behind the ECB in the
queue? What supervisory arrangements are needed to ensure that creditor
nations have sufficient oversight of the deposit-taking institutions
they now insure in peripheral countries? And that is before you get into
the rigmarole of ratifying agreements.
The trouble with this is
that there is a horrible, mismatch between the timescales to
which Europe’s policymakers work and the timescale of a bank run. A run
is usually occurs quickly, and if a run starts, Europe’s
governments will have to reassure within a matter of hours. You might
just about get a communiqué from Brussels in that time-frame, but could
it really reassure when so many questions are unanswered? If it
does not, then the run will continue until such time as the banks close
their doors to further withdrawals or the central banks have satisfied
depositors’ demand for cash. The former means trapping depositors inside
a system they do not trust. The latter means providing liquidity to a
banking system that has been abandoned by its own citizens. It would be
hard to come back from either position.
Some people think that a propaganda war has been launched against the euro
to remove our attention from the disaster in the US and UK economies. Except for Germany most of Europe appears to be in denial as to what the real problem is, the banking crisis is just the tip of the iceberg. It is appearing first
because the crisis manifested in financial and sovereign solvency
crisis is being transmitted through the global financial markets.
But deep down it is the post war nanny state entitlement culture of most
of EU countries, supported by past dividends and borrowing. During that
period they not only expanded their lifestyle and entitlements on
borrowed money, those countries also lost their competitiveness on a
wholesale basis through massively moving away from economic value
Austerity and economic contraction remains inevitable and the only
feasible way to get the countries' books back to balance, and to get to
the restarting point. Mr. Hollande and others like him are deluding
themselves and their population through their socialist style spend and
grow talks. They seem not to have realized that the old debt fueled
consumption led growth model is dead, countries have borrowed money from the banks that they can never repay. This is what makes the Euro crisis a bank crisis, very specifically a City of London crisis. UK, German, and French banks lent massively to Greece. The banks secured their loans with CDS's written over London. Greece defaulted last year but the banks declared it hadn't
defaulted, so they didn't need to pay up on the CDS's. Now if Greece formally defaults the City of London has a big problem as they cannot pay
out on the insurance they sold.
What would happen if Greece or another country defaults it a way that can no-longer be denied thus causing banks to default? Some people think the Chinese and the Germans (etc) would most likely move into buy the assets of the bust industries at huge discounts and value. Needless to say, the troubled banks prefer large amounts of capital supplied free of charge, they like it even better if the government takes their bad debts off the
balance sheet a la TARP, but this is not necessary. Despite what you
have been told, banks can continue to operate
perfectly well, even with massive losses on their books. The
government need only guarantee their day to day liquidity, and
supplies a bit if necessary. This amount is vastly smaller than any
repayment of losses or capital support, and what we know as a bailout..
These are "money games" with governments loaning to banks and in response banks supporting those governments by buying government bonds. It is a massive transfer of money, to the bankers from the tax payers. Governments do NOT need to "improve balance sheets". Banks can
continue to operate with major losses on their books for years until
they pay them off. Bad for shareholders, but not bad for
depositors, bank users, or even the economy. It only means lean times for the bankers who would have to forgo huge salaries and bonuses as they worked their way out of the hole they put their institutions into. The response to runs and efforts to calm
worries about the solvency of specific institutions by beefing up deposit guarantees in the first phase of the crisis, is what governments did.
But that makes the problem worse, not better, if government solvency is
at the root of the problem, and this time government solvency is indeed the problem.
As A Footnote; Recently I posted about how currency trading has entered the "red zone" and in dangerous territory. Please take a peek if you have time, it is not a long post