Wednesday, February 8, 2012

If banks absorb losses, does this let Greece, Portugal, Spain and Italy off hook for reform

Regular readers know that under the blueprint to save the financial system, banks are required to act as a safety valve between the excesses of the financial system and the real economy.

Banks do this by recognizing the losses on the existing excesses in the financial system today and rebuilding their book capital through future retained earnings and equity issuance.

But doesn't this let borrowers like Greece, Portugal, Spain and Italy off the hook for continuing with the necessary reforms?

No.

The borrowers are going to want to be able to raise money in the capital markets in the future.  To do so, they are going to have to be able to show an ability to repay the new debt.  This form of market discipline insures that progress is made on implementing the necessary reforms.

At the same time, this form of market discipline also insures that these countries undertake policies to increase their economic growth.

2 comments:

Fungus FitzJuggler III said...

"Increase growth"? Examine that phrase carefully!

Bubbles form where banks carry out their lending far too well and unwisely, egged on sometimes by the state itself.

The disruption after this, as all bubbles burst, can take a generation to correct!

You underestimate and underemphasise!

Richard said...

My focus is on countries adopting "growth" policies that address their high unemployment rate. I was thinking more along the lines of tax and spending policies.