Ben Bernanke tells EU to clean up its banks

In a classic case of do what I say and not what I do, Fed Chairman Ben Bernanke says that the EU should clean up its banks.

Given that the US has also adopted the Japanese model for handling a bank solvency led financial crisis, perhaps the Fed should take its own advice and clean up the US banks.

For anyone who believes that the US banks are not insolvent, ask yourself "if the banks have nothing to hide, how come they insist on providing disclosure that makes them resemble black boxes and allows them to hide everything?"

As reported by the Telegraph,

“More needs to be done. Full resolution of the crisis will require a further strengthening of the European banking system,” he told Congress, calling for a “significant expansion of financial backstops, or ‘firewalls’, to guard against contagion in sovereign debt markets.” 

Regular readers know that no more bailing out of the banking system is needed.

Banks are fully capable of absorbing all of the losses hidden on and off their balance sheets and continuing to provide the credit needed by the real economy.

Yes, banks will be operating with negative book capital as a result of recognizing the losses.  But, banks can operate for decades likes this so long as depositors believe the deposit guarantee is good, central banks provide liquidity against good collateral and there is ultra transparency so market participants can see that the banks are not gambling on redemption as they rebuild book capital.

Strains in global financial markets “continue to pose significant downside risks”, he said but stopped short of criticising EU bank stress tests for banks. However, his comments reflect strong doubts in Washington over Europe’s strategy.

Washington doubts Europe's strategy because the same strategy is not working in the US.

The US stress tests are widely viewed as more rigorous, modelling the shock effects of a 5pc fall in GDP, a 52pc drop in equities, and a further fall of 21pc in house prices.

US stress tests are widely viewed as a renewal of the government's pledge to bailout the banks and prevent depositors, bond holders and equity holders from loss.

By contrast, the EU tests have already been overtaken by events, with both economic contraction and unemployment in Spain certain to exceed the worst case scenario for 2012.... 

US banks have little exposure to the Club Med bloc, but face “more material” risks in the eurozone core. European holdings amount to 35pc of US money fund assets of prime US money market funds, and these funds remain “structurally vulnerable”, he said....

What exactly are these "more material" risks to the eurozone core?

While Washington forced US banks to raise capital during the crisis, the EU has given its banks the choice of slashing loans books instead to meet core Tier 1 capital ratios of 9pc. The result has been to aggravate a credit crunch in southern Europe. 

Cheap three-year loans from the European Central Bank have prevented a collapse of weaker banks, but the cost has been to distort the EMU financial system, storing up trouble for the future.

The Fed has engaged in similar activity propping up the Too Big to Fail.