Saturday, March 24, 2012

Jean-Claude Trichet: radical central bank action should not disguise crisis

In a Telegraph article, Jean-Claude Trichet, the former head of the ECB, expressed his opinion that while radical central bank action has been justified it should not disguise the fact that the global economy has yet to emerge from a multi-year crisis.

No one should think that "because of the forthcomingness (of central banks), there is no crisis," Jean Claude Trichet told a conference in Washington on Saturday. That should be a "collective, collegial message from the central banks." 
"No one would have expected that such a long time after Lehman we would still have the scale of expansion in our balance sheets."
Actually, your humble blogger did think that central bank actions would continue.  I even said so prior to Lehman.

The way I phrased it was that until we had disclosure (ultra transparency) and could value structured finance securities (and other opaque parts of the financial system including banks) we were in a downward spiral with no logical stopping point.
However, the French banker who stepped down after eight years at the helm of the ECB in October, said that the move by his Italian successor, Mario Draghi to offer European banks cheap, three-year loans was "fully justified." 
Mr Draghi began offering the loans in December amid fears that one of the Continent's financial institutions would collapse as their sources of private funding dried up.
And of course the reason for fear of a collapse in a financial institution's access to sources of private funding is opacity.  Just as your humble blogger predicted.

The reason that access to private sources of funding dries up is that the private sources of funding cannot evaluate the risk of an investment in the financial institution and the likelihood they will be repaid.

If financial institutions had to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details, market participants would be able to assess the risk of these firms.  Market participants would then adjust the price and amount of their exposure to these firms based on their on-going risk assessments.

As the risk of the financial institution increases, the price of the market participant's exposures would go up and the amount of their exposures would go down.

While bank management might not like the high price they have to pay to attract funds, so long as market participants can assess the risk of the bank, funding should be available.

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