Since the beginning of the solvency crisis, we have tried both fiscal stimulus and austerity (see Greece and Ireland). Neither has restored confidence nor should they as they are tools for adjusting aggregate demand in the economy at one point in time and not for addressing solvency.
Since the beginning of the solvency crisis, we have tried policies including zero interest rate policies and quantitative easing. None of these policies has restored confidence nor should they as they are tools for adjusting aggregate demand and not for addressing solvency.
This failure to restore confidence is not surprising, because it is regulatory policy that is the source of confidence and the tool for addressing solvency.
It is the ongoing failure of regulatory policy that is causing the solvency crisis to continue. It is the ongoing failure of regulatory policy that undermines confidence and stymies expansionary fiscal and monetary policy.
Why has regulatory policy failed? It has failed because the key to ending a solvency crisis is answering the question of who is solvent and who is insolvent. This question is the starting point for determining how to address the insolvent banks and sovereigns.
In their defense, the global financial regulators would say that they have adopted policies to answer the question of who is solvent and who is insolvent. They have engaged in bank recapitalization and stress tests.
These policies were predestined to fail in the absence of the ability of market participants to Trust but Verify.
Why should market participants trust the regulators given their pre- and post- solvency crisis track record? Before the solvency crisis, the regulators failed to fulfill their number one responsibility of preventing the crisis from occurring in the first place. Since the beginning of the solvency crisis, regulators have run stress tests that have been discredited shortly after the results were announced.
As predicted under the FDR Framework, it is only by providing market participants with access to each bank's current asset and liability-level data and each structured finance security's current loan-level performance data that the question of who is solvent and who is insolvent can be answered.
- It is only when market participants have this data that they can value the structured finance securities.
- It is only when market participants can value the structured finance securities and all the assets on each bank's balance sheet that they can determine which banks are solvent and which are not.
- It is only after doing this analysis that market participants have assessed the risk of an investment in the banking system and are willing to be responsible for all gains or losses on any new investments they make in bank related securities.
- It is only when market participants have the confidence to invest in the banking system that they have confidence to invest in the economy.
If market participants cannot have confidence in their banking system, it is impossible for them to have confidence in their economies.