The Guardian says it is time to recognize we have a 'banking crisis'

In a very important column, the Guardian says its it time to recognize what we have is a banking crisis.  The Guardian also says that a banking crisis requires adopting policies that focus on the banks and not remodeling the social contract.

Regular readers know that the Japanese model for handling a bank solvency crisis that has been adopted by the EU, UK and US policy-makers puts preserving meaningless bank book capital levels ahead of the citizens of each area.

The implication of putting the meaningless bank book capital levels ahead of the citizens is that policies are adopted which transfer the losses on the excesses in the financial system onto the real economy and the citizens.  An example of these policies is calling for austerity and reducing the social safety net.

Regular readers also know that the Swedish model for handling a bank solvency crisis uses the banks to protect the citizens.  Wall Street protects Main Street because the banks absorb all of the losses on the excesses in the financial system today.

The Guardian column frames the choice between the Japanese and Swedish model as an issue of morality and how this applies to bankers.

According to Moody's, borrowing costs above 5.7% "significantly raise the chance of default" for Mariano Rajoy's government. If that's right, then Europe's fifth-largest economy – and the rest of the eurozone – is teetering on the brink of disaster. 

That's the trouble with this crisis: even the comparatively good news turns out to be deeply worrying. And the anxiety is hardly quelled by the responses from policy-makers. 

On the upside, this week's IMF meeting has seen nations slowly but surely giving cash to boost the eurozone rescue fund. On the downside, very few serious investors have much confidence that the rescue fund will be especially effective in the event of Madrid needing a bailout. 

European officials point to Mr Rajoy's resolve to make painful budget cuts; but all the evidence is that the spending squeeze is ruining the outlook for Spain's economy and its unemployed (especially the 50% of under-25s out of work) – without convincing financiers that the country is a decent credit risk. 

This is the problem with the Japanese model.  It locks each country adopting it into a long term downward economic trajectory.  Just look at what has happened in Japan where GNP was less in 2010 than 1995.

The reason for this is that the real economy is carrying the cost of the excess debt in the financial system.

Rather than income being channeled to consumption or investment in productive assets, it is funneled to debt service on the excess debt.  The more income that goes to this debt service and away from consumption and investment, the bigger the headwind to economic growth.

Speaking during this week's London Book Fair, the Toulouse-based economist Paul Seabright deftly summed up why such huge, painful efforts simply aren't paying off. Politicians, he said, remain hellbent on painting the euro crisis as a morality tale – a saga of profligate southern Europeans and virtuous northern Europeans – when it is anything but. 

Until the eve of the banking crisis, Spain had sounder public finances than Germany. Similarly, the idea that Athens was covering up the level of its debt only gets you so far. 

Anyone who cared to inspect the figures could see that by 2008 Greece had become the fifth-largest importer of arms in the world – behind China, India, the United Arab Emirates and South Korea, despite having a far smaller economy than any of those countries. 

As Mr Seabright put it, such information, denoting just how wildly Greece was spending on the wrong things, was "in plain view" of any supposedly cautious German banker who cared to look on the internet – the implication being that they couldn't be bothered. 

Arms dealers obviously do well out of such a relaxed approach to lending – but so do banks, at least during the good times. 

Which brings us to one of the most important yet under-remarked aspects of the euro meltdown. What has been painted as a battle between the virtuous, hardworking north and the lazy, feckless south should instead be depicted as a banking crisis. 

This is the crucial point made in a new paper published by Manchester's centre for research on socio-cultural change. Called Deep Stall, it compares the eurozone collapse with a plane crash and finds one big difference: whereas everyone in the aviation industry – from passengers to planemakers to airlines – has a vested interest in keeping planes up in the air, the banks have no such commitment to keeping the rest of the financial system afloat as long as they get paid out. 

The implication is clear: rather than devote efforts to ruining the lives of southern Europeans, a far more effective way to deal with the continent's crisis would be to restructure the banks, then rein them in for good. 

Please re-read this implication as this is what your humble blogger has been proposing with his Swedish model-based blueprint for saving the financial system.

Forcing the banks to recognize the losses hidden on and off their balance sheets, results in restructuring the banks.

Requiring the banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details reins them in for good.  It is the necessary condition for market participants to exert discipline on the banks so the banks do not take on too much risk.

The alternative is to trust in austerity for the public and generously allow the banks to "deleverage" and shrink their balance sheets at their own pace. This is exactly the policy that has turned a Greek tragedy into an existential threat to the entire euro.