Like the first leg of the financial crisis, the impact of the second downward leg can be moderated.
What it takes is for global policymakers and financial regulators to realize that the actions they have taken since August 9, 2007 have not worked. Clearly, there would not be second downward leg to the financial crisis if they had.
It is only by acknowledging this fact that the search for a different response is possible.
Regular readers know that the blueprint for rescuing the financial system presented on this blog is a reasonable alternative to the failed strategies.
Under the blueprint, banks are required to perform their function as a safety valve between the financial excesses in the financial system and the real economy. Banks will absorb the losses on the bad debt in the system. This seems reasonable because banks benefited initially from creating the financial excesses.
As a result of recognizing the losses on their bad assets, banks will have significant negative book equity. This is okay.
Banks can continue to function without the payment system collapsing or access to credit for qualified borrowers being diminished.
This blog has explained how depositors will not race to withdraw their deposits from banks with negative book capital so long as the depositors believe that they are covered by deposit insurance. In the case of some Eurozone sovereigns, their deposit guarantee needs to be supplemented with a guarantee by the European Financial Stability Fund.
This blog has also explained how central banks will have to lend against good collateral (and once the losses are recognized, it is all good collateral) so that banks have access to the funding they need.
Finally, this blog has explained that banks must be required to disclose their current asset, liability and off-balance sheet exposure detail. It is this data that allows market participants, including competitors and regulators, to assess the risk of the banks and to use market discipline to keep the banks from increasing their risk profile in the future.
"There is definitely going to be another financial crisis around the corner," says hedge fund legend Mark Mobius, "because we haven't solved any of the things that caused the previous crisis."...
Speaking in Tokyo, he pointed to derivatives, the financial hairball of futures, options, and swaps in which nearly all the world's major banks are tangled up.
Estimates on the amount of derivatives out there worldwide vary. An oft-heard estimate is $600 trillion. That squares with Mobius' guess of 10 times the world's annual GDP. "Are the derivatives regulated?" asks Mobius. "No. Are you still getting growth in derivatives? Yes."
In other words, something along the lines of securitized mortgages is lurking out there, ready to trigger another crisis as in 2007-08....
The Greek crisis is first and foremost about the German and French banks that were foolish enough to lend money to Greece in the first place.
What sort of derivative contracts tied to Greek debt are they sitting on? What worldwide mayhem would ensue if Greece didn't pay back 100 centimes on the euro?
That's a rhetorical question, since the balance sheets of European banks are even more opaque than American ones....
Greece will likely get another bailout — 30 billion euros on top of the 110 billion euro bailout it got a year ago.
It will accomplish nothing. Going deeper into hock is never a good way to get out of debt. And at some point, this exercise in kicking the can has to stop. When it does, you get your next financial crisis.
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