Saturday, March 16, 2013

A Run On The Banks And The Euro

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 adding activities.

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


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