Regular readers will be familiar with his argument.
At last weekend's Jackson Hole summit, though, the new [IMF] Fund boss made a statement that sounded courageous and long overdue. [Christine] Lagarde said the big problem facing the developed world is an excessive overhang of debts that were used to finance spectacularly bad investments – not least those ghastly collateralised debt obligations.
Oh yes, the CDOs are still out there, levered-up 10-fold or more, those weapons of "financial mass destruction", lurking off-balance-sheet and largely undeclared in the "shadow banking system". They're the reason many Western banks are technically insolvent – and why the interbank market remains moribund, with banks reluctant to lend even to each other, given concerns over counter-party risk.Which banks are solvent and which banks are insolvent?
With wholesale credit channels blocked, lending to credit-worthy firms and households remains thin. That's why the wheels of finance are gummed up and the West's economic recovery has been so feeble. Bank claims about "a lack of demand for credit" are propaganda – an attempt to deflect attention from their own bombed-out balance sheets and the sector's singular failure to disclose their massive loses. Those arguing otherwise either doesn't understanding banking or, directly or indirectly, are in the pay of the banks.
Lagarde's actual words at Jackson Hole – "banks need urgent recapitalisation" – were a statement of the obvious. The so-called "stress tests", an attempt by regulators to secretly assess bank balance sheets, were a bad joke. The Irish banks, for instance, "passed" the first European tests, but were nationalised just a few weeks later. The second eurozone stress tests earlier this summer were also laughable, the results since deeply discredited.Under the FDR Framework, regulators are suppose to ensure disclosure of all the useful, relevant information in an appropriate, timely manner. They are specifically not suppose to weigh in on the merits of an investment.
Stress tests turn the FDR Framework inside out. They keep all the useful, relevant information secret. They have the government weighing in with its opinion of financial institutions as an investment.
There are many market participants who understand that their role is to Trust, but Verify. It is this role that has revealed the short-comings of the stress tests.
So when Lagarde pointed out that without mandatory recapitalisation "we could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis" she was only repeating what we already know.And what your humble blogger described as a downward spiral with no logical stopping point prior to the credit crisis.
After all, the trouble extends beyond the eurozone's periphery. Spanish banks, for instance, are majorly exposed to dodgy real-estate deals and other non-performing loans. Even Germany's ubiquitous Landesbanken are bankrupt.
So far, the insolvency of Europe's fragile banking system has generated sovereign debt risks, as eurozone governments have moved to "backstop" the banks. In recent weeks, though, an increasingly large number of European governments have been shown to be financially suspect which has, in turn, reflected investor angst back onto the banks.
Throughout August, even on slow summer-trading, equity markets were rocked by wild gyrations, wiping out all this year's gains. Such volatility was led by Europe's banks – which are now down 25pc during 2011.
In belated recognition of undeclared liabilities, many banks are now trading at a deep discount to the value of their assets. European credit default swaps, the cost of insuring against bank failure, have surged to levels beyond those seen even at the height of the subprime storm.
The danger now is that Europe's bank fragility becomes systemic, sparking another "Lehman-moment" and causing, in turn, a second economically-debilitating credit crunch. Within financial circles, recognition is growing that such an outcome could happen. Even if it doesn't, concerns it might will damage investment and jobs.Actually, it already is systemic as the lack of disclosure and resolution of the solvency crisis is destroying national balance sheets and investor confidence.
Lagarde's statement was welcome – and, as such, attracted praise. So lacklustre are our political leaders these days – and Lagarde, above all, is a politician – that even recognising an uncomfortable truth exists is enough to shine.
But what about actually doing something about it? What about emphasising that the only way to fix the Western world's banking system, so facilitating a decent economic recovery, is for powerful financial institutions to be forced to disclose their entire portfolio of losses.Please re-read as this is the point that I have been making since before the credit crisis began.
I've written this before. I will continue to write it, relentlessly, until it actually happens. Because happen it will. It's for our politicians and regulatory authorities to decide if this "reckoning" takes place in a relatively orderly way – with bad banks being broken-up and restructured, as solvent institutions absorb their depositors. Or maybe they'd prefer if the market just took its chaotic course?
Lagarde finally acknowledged the problem. But she stopped well short of acknowledging the implication. She said banks should be recapitalised from "funds in the markets first" and only then "seek public money if necessary". Lagarde must know this is nonsense. No commercial investor would invest in Europe's banks at this stage, given that they can't even know if such banks are solvent. Private-sector recapitalisation might have been possible a year ago, after the first round of stress tests, when global markets were awash with QE funny-money and investors had a warm glow. But not now.
Bank recapitalisation will, of course, have to be state-funded....I am more optimistic than Mr. Halligan on this point. I think that private-sector recapitalization is possible if investors know what they are investing in.
Also, there are many banks that might be insolvent (the market value of their assets exceeds the book value of their liabilities), but like Security Pacific, have a franchise that will allow them to generate and retain the earnings necessary to restore their solvency.
If there is to be more public-money spent on propping-up our banks, it absolutely must be used to facilitate restructuring, as loans are written off and investors are forced to take haircuts, rather than to finance the status quo. There really is no other way.A critical element of the Lagarde comments was the observation that governments have far fewer resources available to them to address the solvency issue.
What Mr. Halligan correctly identifies is the need to use these resources in such a way that solvency is actually restored and not to kick the problem into the future as was done in late 2008 and early 2009.
Far from addressing these realities, Lagarde, like almost every other Western regulator, continued to deny they exist.
None of this is to say that America's banking sector doesn't have problems. The US stress tests were also pathetic. Washington, too, has pandered to bank vested interest. But America's bank debt overhang is lower and a far higher share of liabilities have been "fessed-up".We really do not know who is solvent and who is insolvent in the US either. This question has been undermining Bank of America's stock price for the last several weeks.