Happy 3rd Anniversary Bank Bailouts

According to a Guardian article, it was three years ago this week that the UK engaged in the first bank bailout.  Shortly thereafter the US and Eurozone also bailed out their banks.

With these actions, a terrible precedent was set.  This precedent was even worse than the precedent set by crediting regulatory capital to insolvent US savings and loans in the 1980s.  The clear lesson from crediting regulatory capital was that it resulted in increasing the cost to taxpayers of unwinding the insolvent savings and loans.

What made the actual cash bailouts worse is that now, not only did it increase the cost to taxpayers, but global financial regulators and policymakers felt compelled to lie about the solvency of the banks.

For all its faults, the Office of Thrift Supervision never claimed the savings and loans that received regulatory capital were actually solvent, but rather with the addition of regulatory capital they did not have to be closed.

With the actual cash bailouts, global financial regulators and policymakers undertook a very public campaign to say that the banks were solvent.  Global financial regulators and policymakers have repeatedly made this claim and taken actions as if it were true.

However, given the available evidence, this claim was never believable in the first place nor required (as the savings and loans have shown, insolvent financial institutions can remain open for business for years until they are closed by the financial regulators).

• In the US, analysts are debating whether Bank of America needs to raise upwards of $200 billion in equity - well over $100 billion more than US financial regulators have ever said was necessary if BofA was to remain solvent;  

• In Europe, after each year's stress tests, within weeks banks that easily passed the test had to be nationalized - think Irish banks and Dexia.

By itself, this evidence suggests the claim of solvency is highly suspect.

Unfortunately, there is much more evidence.

• The Eurozone policymakers are meeting to discuss how much more capital to inject into the Eurozone banks - if the banks are solvent, then why do they need capital?

• Market participants are throwing out suggested capital shortfalls - Christine Lagarde and the IMF are suggesting 200 to 300 billion euros; BlackRock's Larry Fink is suggesting 2 trillion euros - if he is right then the interconnectedness of the global financial system is going to require that US and UK banks are bailed out too if Europe does not go for the full 2 trillion.

Why don't financial regulators and policymakers acknowledge that the banks are insolvent?  Without requiring banks to disclose their current asset and liability-level data, market participants already assume that there is something to hide.

More importantly, market participants know that what is hiding on the bank balance sheets or in the structured finance market will eventually emerge.  First, it was the sub-prime debt (which is still there and marked to make believe).  Now it is the sovereign debt.

Does anyone wonder why confidence is ebbing and market participants are aggressively reducing their risk?  They know that there is too much debt and that borrowers do not have the resources to repay it.  As a result, it is highly likely another problem area will emerge.

They are justifiably worried about the ongoing cycle of debt problems emerging that financial regulators and policymakers apparently did not see coming and the need for on-going bailouts.  Bailouts that the countries putting up the cash cannot afford and that are undermining their social fabric.

Since before the credit crisis began, your humble blogger has been suggesting an alternative policy for global financial regulators and policymakers that would have ended this cycle before it began and moderated the damage from the credit bubble.  This policy is based on bringing disclosure to all the opaque areas of the financial marketplace including structured finance securities and bank balance sheets.

Not just disclosure, but disclosure of all the useful, relevant information in an appropriate, timely manner so that market participants can use this information to assess the risk of and value a security or bank.

With this disclosure, market participants and regulators would already know which banks are solvent and which are insolvent and how the insolvent banks are going to be returned to solvency or closed, debt would have been written down to levels that are affordable to the borrowers and the focus would be on the next great investment.