Wednesday, December 21, 2011

Have we reached the end for the ability of regulators and central banks to hide the losses in the financial system?

As regular readers know, since the beginning of the solvency crisis in 2007, I have been saying that the global economy is in a downward spiral with no logical stopping point until such time as transparency is brought to all the opaque corners of the financial system (for starters, this includes banks and structured finance securities).

This prediction was based on two simple observations.

  • First, everyone knows that as a result of the credit bubble bursting the banks have hidden losses on their balance sheets (no we were not fooled by the end of mark to market accounting or adoption of extend and pretend under regulatory forbearance).  

  • Second, Japan has shown with its 2+ lost decades what happens to an economy when policymakers and regulators develop a pathological obsession with helping the banks hide their losses.

For almost 4 years, I have watched policymakers and financial regulators in the US, UK and Europe chose policies that reflect this same pathological obsession with the same or even worse results.

During that time period, I have continued to say that requiring ultra transparency is the simple solution that saves the global economy.  It worked for FDR and his administration and there is no reason to think it would not work now!!!

As I look at the Eurozone banks signing up for funds from the ECB, it has become clear that we have reached the end for the ability of regulators and central bankers to hide the losses in the global financial system.

The reality is that we have a global solvency crisis that central bankers are attacking with the only weapon they have:  massive liquidity.

The Eurozone banks loaded up on central bank funds because investors recognize the banks are insolvent and won't give banks any new funds.  In countries where there is doubt about the solvency of the government, we have been seeing runs on the banks (please note that as long as depositors think they can always get their money back under a government guarantee, depositors don't care about the solvency of the bank).

The crisis of confidence is escalating as the pace of investor/depositor flight is increasing; particularly with the regulator inspired credit crunch and its related economic slowdown and further increase in bad debt impacting the Eurozone.

The question is will the ongoing loss of confidence and related plunge in the economy finally overwhelm the policymakers and regulators pathological obsession with helping the banks to hide their losses?

A quick question: When is a bank no longer a bank?  Is this point reached when a bank receives more of its funding from the central bank than it does from depositors and investors?

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