Wednesday, June 20, 2012

Bank of England's Robert Jenkins: Prepare for Lehmans re-run

According to a Telegraph article, the Bank of England Financial Policy Committee member Robert Jenkins told the Global Alternative Investment Management conference in Monaco
Banks and traders must prepare for a devastating market seizure as governments grapple with the escalating economic crisis in Europe... 
Cheap and ready access to the liquid assets that oil the financial markets are under threat from both state-imposed capital controls and flagging confidence in the euro... 
Without easy access to liquidity, markets could seize in a re-run of the credit crunch after the collapse of Lehman Brothers.... 
“Those of you who traded asset backed securities in 2008 can testify to the speed with which liquidity can disappear,” .... “Yet despite these examples, many continue to assume that ... ‘liquidity’ is free and will be freely available.
Thanks Mr. Jenkins for confirming what your humble blogger has been talking about since the beginning of the financial crisis.  Specifically, that for all the sound and fury coming from the policymakers and the financial regulators, none of it actually addressed the fundamental issue of restoring investor confidence.

At the beginning of the financial crisis, the policymakers and financial regulators chose the Japanese model for handling a bank solvency led financial crisis.  This model is based on maintaining the deception that banks have positive book capital levels.

To support this deception, governments adopt a host of policies like bailouts, regulatory forbearance and stress tests.

The result of all this deception has been a dangled web of policies that further undermine investor confidence.

Investor confidence is not something that governments can provide directly.  Rather, it is the result of providing investors with all the useful, relevant information in an appropriate, timely manner so that investors can independently assess this information.

Confidence flows because investors trust their own analysis.

This point is critically important.

For example, investors don't trust the repeated statements by financial regulators that the banks passed a stringent stress test.  In the absence of ultra transparency where the banks disclose their current asset, liability and off-balance sheet exposure details and investors can independently confirm this fact, why should they?

In fact, the lack of ultra transparency is a sign to investors that both financial regulators and the banks have something to hide.  This fact has been confirmed with the nationalization of several banks subsequent to their passing a stress test.

Since implementation of the Japanese model does not promote confidence, Mr. Jenkins correctly observes that liquidity will not always be available.  Confirmation of this is easy to see in the ongoing freeze in the interbank lending and the unsecured bank debt markets.

I am already on record for saying the financial markets are prone to freezing because of the lack of ultra transparency.  When investors cannot assess the risk of an investment, most of the time, they don't make the investment.

The question is when will policymakers and financial regulators stop engaging in deception and instead  bring transparency to all the opaque corners of the financial system and end the financial crisis?

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