BoE's Mervyn King: 'there are major credit losses to be realized'

The Bank of England and its Governor, Mervyn King, summarized exactly where the global financial system is today.

Officials said today that despite the changes in the near-term outlook, “the fundamental policy challenges” after the financial crisis and recession have stayed the same. 

Exactly the outcome to be expected given the choice of the Japanese model for handling a  bank solvency led financial crisis.

“There are major problems ahead,” King said. “There are major credit losses to be realized. Whatever happens there will be difficulties ahead that will undoubtedly affect us” and “it is not sensible to think solely in terms of ‘euro stays together -- excellent. Euro comes apart -- disaster,’” he said. 

“I don’t think anyone is under any illusion that we’re not all going to be affected by this,” King said. “Our banking system is exposed to the euro area. We certainly are going to be affected.”

In the Inflation Report, the central bank said concerns about the “possibility of a disorderly resolution” in the euro area have “adversely influenced asset prices, bank funding costs and confidence. Even if a disorderly outcome is avoided, the possibility of such ‘‘extreme outcomes crystallizing will continue to weigh on U.K. activity.’’

Those major credit losses include the losses that were on and off the banks' balance sheet at the beginning of the financial crisis.  Those major credit losses include the losses on sovereign debt issued to hide the losses on the banks' balance sheets.

Regular readers know that there is an alternative to continuing to pursue the Japanese model.  The alternative is the Swedish model.  Under the Swedish model, the major credit losses are realized and the excesses in the financial system are dealt with.

Regular readers also know that the modern banking system is designed to absorb these losses and continue to support the real economy.  Banks can do this because of deposit guarantees and access to central bank funding.

Update
As reported by the Guardian, Sir Mervyn King said

"What is so depressing about it is that this is a rerun of the debates in 2007/08 – these are not liquidity problems, they are solvency problems," King said. "Imbalances between countries in the euro area have created creditors and debtors and at some point the credit losses will need to be recognised and absorbed and shared around," he said. 

"Until that is done, there will not be a resolution. That is why just kicking the can down the road is not an answer. The European Central Bank has performed heroically in trying to buy time but that time hasn't been used to put in place fundamental underlying solutions."

Please re-read the highlighted text as your humble blogger has been making this point since the beginning of the financial crisis.