While I agree with the author's conclusion that there is a barrier to the financial markets being taken off of central bank life support, I disagree that the barrier is the debt on the central bank balance sheets.
The reason that the financial markets are still on life support was the decision at the beginning of the bank solvency led financial crisis to adopt the Japanese model for handling the crisis.
Under the Japanese model, banks hid on and off their balance sheets the true extent of their losses and only recognize losses to the extent that they generate earnings in excess of banker bonuses, shareholder dividends and de minimum increases in book capital.
All banks know that every other bank is hiding losses. This is why the interbank loan market froze at the outset of the financial crisis and why it refroze as the Eurozone sovereign debt crisis gained momentum.
The response by the central banks has been to step in and provide the liquidity that the interbank lending market would provide. In doing so, the central banks have taken collateral for their loans.
The central bank programs are reversible if, and only if, policymakers and financial regulators adopt the Swedish model for handling the crisis and require banks to provide ultra transparency.
It is only when every bank is able to access the current asset, liability and off balance sheet exposures of every other bank on an on-going basis that each bank can independently assess the risk of each of its competitors and determine the amount and price of any loan to these competitors.
The result is that the private banks have already pledged anything good they had. They will not therefore lend to each other because they know none of them has any assets left which are worth anything. Thus they are forced to go back to the ECB and Fed for more money and those institutions are forced to take even more ropey assets in return for issuing even more loans. Each time round, each new QE and new lot of money, sucks in more bad assets and makes any possiblity of private funding even more remote.
The Central banks have swallowed the market. All debt and debtors are being drawn into ever tighter orbit. None will escape.While the author has clearly described a reinforcing spiral where the banks become ever more dependent on the central banks, the description ignores the simple fact that when making a loan, the first question to ask is will the borrower pay it back.
In the absence of ultra transparency, banks do not know which of their competitors can or cannot repay a loan. The interbank lending market is frozen because banks don't know which banks can repay a loan.
Provide ultra transparency and the dependency on the central bank is ended.
The author makes a very important point that the losses still exist.
However, pledging an asset that contains the loss to a central bank does not transfer the loss to the central bank. The borrowing bank is still on the hook for the loss. It is expected that the borrowing bank will repay the loan in full and get the asset containing the loss back.
This is because even though the banks have used that QE money to speculate on commodities and currencies to try to make a fast and out-sized profit – still chasing high risk and return – they still have huge liabilities (money they owe) not being paid for from income which is not coming in from yet more bad assets which are nevertheless still being held at imaginary values so as to make the assets side of the balance sheet look like it might balance out those liabilities....One of the reasons that ultra transparency is needed is so the market can exert discipline on the bankers and stop them from gambling on redemption. The experience of the US Savings & Loans was that in the absence of ultra transparency, bankers gambled on redemption, lost and dramatically increased the cost to the taxpayers.
My main point is that the banks, despite 4 years of never-quite-materializing recovery, still need loans from the central banks and still need to pledge assets to get them. How many more assets do they have? Probably many hundreds of billions. But they are increasingly awful....The question is why do the banks need to pledge increasing amounts of assets to the central bank?
Because market participants are becoming increasingly unwilling to fund the banks!
This takes several forms. First, there is the frozen interbank lending market. Second, there is the unsecured bank debt market which also froze due to a lack of ultra transparency and an inability to determine which banks can repay their debt. As loans from both of these frozen markets mature, they must be repaid... hence a need for central bank funding.
The third form of market participant unwillingness to fund the banks is the on-going bank run in Ireland, Greece, Spain, Portugal and Italy. As deposits flow out, banks turn to the central banks for funding.
Please note, all three ways that market participants show their unwillingness to fund the banks are addressable and reversible if the banks were required to provide ultra transparency.