Thursday, December 1, 2011

Bank of England's Mervyn King on solvency crisis

This post contains excerpts from Sir Mervyn King's discussion of the current state of the global financial markets.

From a Guardian live blog of the discussion,

Even by his usual standards, Sir Mervyn King is in gloomy mood. On the issue of yesterday's liquidity push by the Bank and five other central banks, the governor explained that it would only bring temporary relief. 
King addresses the key issue about this crisis: "It is not a liquidity crisis, it is a solvency crisis."...
 "Funding follows the absence of concerns about solvency".
This is a point that your humble blogger has been focused on since the beginning of the solvency crisis on August 9, 2007.

There is only one way to end a solvency crisis:  require every bank to provide ultra transparency on an on-going basis.  Ultra transparency involves each bank disclosing its current asset, liability and off-balance sheet exposure details.

It is only with this data that market participants, including competitors, can independently assess the solvency of each bank.  It is only with this independent assessment that market participants can adjust both the amount and price of their exposure to reflect the risk of each bank.

Until this independent assessment can be done, the solvency crisis will persist throughout the global financial system as no market participant can be sure they have properly adjusted their exposure to any bank.

For those regulators who disagree with Sir Mervyn King and your humble blogger and see this as a liquidity crisis and not a solvency crisis, the market has spoken as shown by the fact that banks are refusing to lend in the interbank market due to solvency concerns.

From a Guardian article,
Sir Mervyn King, governor of the Bank of England, insisted that UK banks were well-capitalised but - with the storm in the eurozone escalating - it was "sensible" to improve their resilience.
As Dexia showed, high capital ratios are not synonymous with solvency.
King warned that "an erosion of confidence" was damaging economic activity, creating "a spiral characteristic of a systemic crisis."
The solvency crisis has always been systemic.  The opacity in the financial system has steadily eroded confidence.

After all, why would regulators not require ultra transparency?  Do they have something to hide?

This blog has noted repeatedly that insolvent banks can operate for years so long as their depositors believe that the guarantee on their deposits will hold and central banks will continue to lend against good collateral.  Given these facts, the regulators' failure to require ultra transparency is a clear indication of something to hide and a driver in the loss of confidence.

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