Thursday, September 15, 2011

Larry Fink: Regulators Broke Europe; TYI: Regulators can fix Europe

A Wall Street Journal blog summarized BlackRock Chairman and CEO Larry Fink's speech on the European financial crisis succinctly as regulators broke Europe.

The finger of blame is pointing all over the globe when it comes to the European sovereign-debt crisis. BlackRock CEO Larry Fink knows exactly who is at fault. 
You could argue this was created by regulators,” Fink said of the Eurozone crisis at today’s “Delivering Alpha” conference. “This was not an accident. This was a very visible action by banks and regulators are aware of it. And now we’re sitting with some deep exposures to sovereign credits….
Mr. Fink has gone further than say that regulators are a source of financial instability.  He has specifically said that regulators are a cause of financial instability.

How exactly did the regulators cause Europe's current sovereign debt and banking crisis?  He attributes it to the regulators being aware of what the banks were doing and not taking action.

Why is this the regulators' fault and not a failure of market discipline given that buying sovereign credits "was a very visible action by banks"?  Because the regulators had a monopoly on all the useful, relevant information about bank sovereign debt exposures.

It was only with the latest stress tests that banks were required to disclose this information.

Since then, lead by BNP Paribas, the French banks have been moving towards 'utter transparency' and disclosure of the 'hard facts'.
To me it’s going to require similar actions to what we did in ’08 and ’09 to stabilize.” 
Memories are short, Fink said, and investors are uncertain of what the policy response could look like. “Until we have greater comfort that government is going to do the right thing, it’s pretty binary.”
These actions presumably include the European version of TARP and PPIP.

Regular readers know that taking "similar actions to what we did in '08 and '09" is the absolutely wrong strategy and would waste a considerable quantity of taxpayer money.  Rather than address the problem, these actions address the symptoms.

The issue the market is dealing with is trying to answer the question of which banks are solvent and which are not (including the impact of restructuring government debt).  The only way this issue can be addressed directly is with disclosure that provides 'utter transparency'.

It is only with this information that the market can determine which banks are solvent and which are not.  It is only with this information that the market can determine which of the insolvent banks is capable of earning its way back to solvency and which need to be recapitalized or closed.

It is only by going through the steps of disclosure, analysis and then action that the problem of solvency can be addressed.

When I proposed this solution to the US Treasury in 2008, they agreed with me that addressing the issue of solvency required going in order through these steps, but they felt they needed to "buy" time as disclosure and analysis was not going to happen over night.

The rest is history.  The Great Reprieve from the financial crisis that began in 2007 was bought at large cost to the taxpayers.  Unfortunately, the time of the Great Reprieve was not used to bring disclosure and address the global solvency issue.

Today, the global solvency issues have returned and Europe no longer has access to a charge card for buying time.  The German public has sent the clear message that taxpayer money has to be spent on addressing the underlying solvency problem and not on an unending stream of bailouts.

Fortunately, Europe has an alternative for buying time that will allow it to take the steps of disclosure, analysis and then action.

The alternative is a statement by the regulators.  This statement has two parts.

  • The first part includes a reminder that the regulators have access to all the useful, relevant information that other market participants do not have.  The statement then goes on to honestly lay out what the situation really is for the European banks on a bank by bank basis. 
    • This is not a statement of how each bank performed on the stress tests.  The results of the stress test are a combination of a bank's current position and assumptions made by regulators about the future.  
    • This is a statement of each bank's current condition.  It is the starting point off of which all other market participants should and will base their analysis of a bank's solvency.
  • The second part is to implement 'utter transparency' under which banks will disclose their current asset and liability-level data. 
    • The US Treasury is right that this will not happen over night.  A much more realistic time period is 36 - 48 months for implementing disclosure through a data warehouse. [by way of background, I have designed and patented information technology for collecting, standardizing, and disseminating loan-level information through a data warehouse.]
This statement sends a very powerful message.  It asks the market to trust the regulators.  Perhaps more importantly, it tells the market that it is going to receive the information necessary to verify that what the regulators said is the situation is in fact what is happening.

Trust but Verify.

This is a very powerful combination that will provide Europe with the time it needs to implement disclosure.

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