Tuesday, February 21, 2012

Eurozone Greek bailout repeats errors in handling banks [update]

Eurozone policy makers appear to have avoided the lessons from the experience of Sweden or Iceland when it comes to dealing with a solvency crisis.

According to a Telegraph article, once again BlackRock has been paid a significant amount of money for what is effectively Kentucky windage -- in this case, they concluded from their diagnostic exercise that recapitalization of Greek banks might require 50 billion euros rather than 40 billion euros.

Based on this analysis, bailout money is going to be injected into the Greek banks.

Compounding this mistake, the Greek banks are going to be required to hit a meaningless 9% Tier I capital ratio in September and a 10% Tier I capital ratio in June.

As has already been shown throughout the Eurozone with the 9% Tier I capital ratio target, the result of this requirement is that the banks a) delay recognition of their troubled assets for as long as possible, b) shed performing assets and c) minimize new lending to the real economy as they try to hit the meaningless Tier I capital ratio targets.

With regards to the Greek banks, the Eurozone bailout appears to be working against the goal of stabilizing Greece and putting it on a path towards economic recovery.

Rather, the Eurozone bailout appears to be once again be putting the interest of bankers ahead of society.

Regular readers know that there is a far better solution.
  • First, require the Greek banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.  With this information, the market and not BlackRock will determine the shortfall between the market value of the assets and the book value of the liabilities.
  • Second, require that Greek banks write-down the value of their assets to market value.
  • Third, require that Greek banks retain all future earnings until such time as they have restored their book capital to 10% Tier I capital ratio.  Bonuses can continue to be paid, but they have to be paid in stock.
  • Fourth, have the EFSF and the ESM backstop the Greek government and guarantee the deposits in the Greek banks.  This additional guarantee will alleviate any concerns with runs on the Greek banks.
  • Fifth, use the money that would have gone into recapitalizing the banks today for programs that will improve the prospects for economic growth in Greece.
According to a column in Der Spiegel, 
Greece is bankrupt and will need a 100 percent debt cut to get back on its feet. The bailout package about to be agreed by the euro finance ministers will help Greece's creditors more than the country itself. EU leaders should channel the aid into rebuilding the economy rather than rewarding financial speculators for their high-risk deals....

In truth, Greece has of course been bankrupt for a long time. The country doesn't need debt forgiveness of 70 percent, it needs a 100 percent debt cut if it is ever to recover.... 
Most of the countless officials dealing with the Greek problem in the euro zone are well aware of this simple truth. Some of them, including people in the German government, privately admit that the €130 billion won't solve the problem. It's only about buying time, they say. Time until the financial markets have stabilized to such an extent that they can weather a Greek default without a disastrous chain reaction. Without bank insolvencies, without domino effects through credit default swaps and without an explosion of bond yields in the euro zone's other ailing economies.

But when will that moment be reached if not now?
As previously discussed on this blog, the Japan model for handling a solvency crisis is to buy time.  Time which in theory the banks use to generate earnings so they can recognize the losses hidden on and off their balance sheet.

Unfortunately, buying time is expensive.

Since last autumn, the European Central Bank has been showering banks with liquidity. Spain and Italy, the two wobbling giants of the euro zone, have new government leaders who have made credible pledges to reduce debt. Most of the other EU states are similarly committed to budget discipline through the EU's fiscal compact. And the problem with the credit default swaps isn't as serious as the banking lobby keeps claiming. 
If the European politicians have a shred of faith in all the work they've done in the two years since the breakout of the euro crisis, they should now admit what everyone already knows: Greece is bankrupt and all the country's debts should be forgiven. 

This is the problem with the Japan model for handling a solvency crisis:  there is no easy way out as the same politicians and regulators who made the decision to buy time in the first place are now required to make a different decision.

Compounding the problem is the simple fact that the cost of buying time exponentially increases the cost of the initial insolvency.

Ultimately, the only way out is to adopt the Swedish model and force the banks to recognize the losses in the financial system.

Greece should nevertheless get the €130 billion. But the money should be paid in another form. Instead of rewarding financial speculators for their high-risk deals, the money should flow into the reconstruction of the Greek economy. A new Marshall Plan is needed, rather than a manic insistence on debt repayments.

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