As every good economist knows, there is only one way to restore confidence in a financial system: provide transparency so that market participants can independently assess the risk.
Since the source of concern are the banking systems across the EU, Mr. Summers is effectively calling for all these banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details. With this information, market participants can assess the risk of each bank and adjust the amount and price of their exposure accordingly.
Former U.S. Treasury Secretary Lawrence Summers said that the European Central Bank and the region’s governments must do more to restore confidence amid the euro-area sovereign debt crisis.
“The situation is very difficult,” Summers said in an interview on Bloomberg Television today. “They are discovering ways in which they did not expect that the single currency is brittle. The risks, it seems to me, are all on the side of lack of confidence and self-fulfilling fear.”There is a reason for fear as the global economy appears to be slowly spiraling downward. Under the Japanese model that Mr. Summers supported the US and other countries adopt at the start of the financial crisis, the losses banks are hiding on and off their balance sheets are placing such a drag on the real economy that it is overwhelming fiscal stimulus and expansionary monetary policies.
European Central Bank President Mario Draghi said officials are ready to add more stimulus to the euro region’s economy if necessary, while damping expectations that another round of three-year funding for banks is imminent. The ECB is under pressure to lower rates and introduce more liquidity support for banks as governments struggle to fix a crisis that’s engulfing Spain and could force Greece out of the euro.
“A central bank wants to bend over backwards to be reassuring, to reassure people that liquidity is there and that’s the perspective that needs to inform the central bank,” he said.
“The overwhelming imperative of the situation is to instill more confidence than there is today, and I certainly hope that’s going to inform the policy makers of Europe.”Starting with the Great Depression, history has shown that the only way to instill more confidence is to provide more transparency. Thanks Mr. Summers for calling for ultra transparency.