The idea of recapitalizing Greece's banks is nuts

The Wall Street Journal ran an article on the plans for recapitalizing Greece's banking system.  Simply put, the whole idea is nuts.

Why do I say that?

Is there anyone in Greece who does not know that the banks incurred sizable losses in the recent restructuring of the Greek sovereign debt?

Is there anyone in Greece who does not know that the banks face significant additional losses as a result of the contraction in the Greek economy?

Given that these two facts are well known, is there anyone in Greece besides the policymakers who believes that maintaining a positive level of book capital is important?

If Greeks were concerned about the potential for a negative level of book capital, the size of the bank run would be dramatically higher than it has been.

Furthermore, as Ireland has shown, injecting capital into the banks based on estimates created by BlackRock Solutions does nothing to restore confidence in the banking system or stop the ongoing bank run.

To stop the bank run, Greece and the European Stability Mechanism should guarantee the deposits.  At the same time, the ECB should reaffirm its willingness to lend to Greek banks against good collateral.  Between the two, depositors can believe that their money is safe.

As a result, there is no need to inject capital into the banks today.  Instead, the banks should be required to retain future earnings until such time as they have managed to restore a positive book capital level.

To assure that the banks do not take an inappropriate level of risk and that they realize all their bad debt, the banks should be required to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

I said that the idea of recapitalizing the banks is nuts for a second reason.  That reason is the same funds could instead be used to support the Greek economy.

As I see it, the choice is between injecting funds into banks to maintain a meaningless book capital level or using the funds to support economic growth.

Greece will announce by April 20 plans to recapitalize its cash-strapped banks, the country's prime minister said, a plan that will determine how much control of the sector the government may take. 

Prime Minister Lucas Papademos, who is in Cyprus for a two-day visit, told reporters late Thursday that Greece's cabinet will immediately make decisions on how to boost the capital position of lenders and that the plan will be implemented by the start of September.... 

the debt write-down has also left huge holes in the balance sheets of Greek banks, which now need an estimated €32 billion or more to recapitalize and must seek state support to do so.

Actually, they do not need the capital today.  They can operate for years with negative book capital levels.

A separate, independent audit of Greece's banking system completed late last year, but not yet made public, showed that banks also face huge write-downs for rising nonperforming loans and will have to set aside further provisions—or ask for more official help—to cover those losses, too. 

Again, while the losses should be recognized, the banks do not need capital today.  They have the ability to retain future earnings and restore their book capital levels.

 Once the details of the recapitalization plan are completed, lenders will present the details to shareholders and explain to them current capital needs and how they can be covered, a bank official said Friday. 

"The larger the assistance from the government, the larger its role will be in the banks' management. As to whether shareholders will want to put money into the banks will depend on the terms of the state aid and how and when the government can be paid back," said the official.... 

The Greek government should stay out of the business of managing the Greek banks.

By requiring ultra transparency, the government will be able to use market discipline as its ally in keeping Greek banks from taking on too much risk while the banks rebuilding their book capital levels.