Regular readers will be familiar with the reasons he said these bailouts will not work as they were first presented on this blog.
Indeed, it now appears that the bailout could make things in Spain worse, not better.
And market indicators for the next domino in line for a bailout, Italy, point in the wrong direction.
This was bound to happen. That’s because bailing out the banks in each European country individually is a fool’s errand.Bailing out banks in a modern financial system is a fool's errand. Deposit guarantees and access to central bank funding eliminate the need to bailout the banks.
Experts often note — wrongly — that TARP, the Troubled Asset Relief Program that pumped $700 billion into the banking system in the United States, arrested the financial crisis in 2008. TARP, to some degree, has become the model for Europe.You are not much of an expert on our current financial crisis if you think that TARP did anything other than guarantee the payment of banker bonuses.
But we forget history: TARP was only one component of the bailout. Perhaps more important — consider it the unsung hero of ending the crisis — was the government’s unilateral move to raise the amount of money the Federal Deposit Insurance Corporation could insure, increasing the account limit to $250,000 from $100,000 and fully backstopping the entire money-market industry.
Investors and bank customers who were considering taking their deposits and running in 2008 no longer had reason to do so once deposits and money-market funds had been guaranteed. Keeping your money at Citigroup or Bank of America was relatively indistinguishable from a safety standpoint.The history of sovereign's providing deposit guarantees and breaking the back of a financial crisis dates back to the Great Depression. FDR and his administration implicitly guaranteed all bank deposits in a fireside chat at the end of the national bank holiday. Subsequently, they enacted legislation to formally guarantee bank deposits.
Since the introduction of deposit insurance, depositors no longer care about whether a bank is solvent or not. They also do not care if a bank has a positive or negative book capital level.
Your humble blogger has documented this by looking at the Less Developed Country loan crisis, the US Savings and Loan crisis, and the current crisis in Europe. Furthermore, I have confirmed this with simple experiences from everyday life (a parent telling a child the government guarantees they will get their money back from a bank; none of the economists championing higher bank capital requirements knowing what the book capital level is at the bank holding their checking account).
That is not the case in Europe. Customers of Spanish banks still have reason to worry about the solvency of their banks — and their country — making it reasonable for them to take their money from Spanish banks and send it to banks in safer countries like Germany.This is the result of the EU policymakers' threat to kick Greece out of the EU and force it to reintroduce the drachma. It is the threat of forced conversion to a less valuable currency that is triggering a bank run from countries like Greece, Spain and Italy. Depositors don't want to lose their money from the forced conversion.
Indeed, the bailout makes it less likely Spain can pay back its debts because the new loan of up to $125 billion was just added to its huge debt pile. Worse, Spanish banks had been the biggest buyers of Spanish debt (a farce of a way to prop up the economy) and that most likely won’t continue.
As a result, it could be argued that it would be irresponsible for an individual or company, which has a fiduciary duty to its shareholders, not to move its money out of Spanish banks.
Of course, money leaving the banks can become a self-fulfilling vicious cycle that virtually no amount of bank bailouts can plug. (By the way, countries like Spain have their own version of F.D.I.C., but it is all but worthless if you believe the country could collapse under its own debt.)
Ultimately, the only real way to begin to ensure the safety of the banks in Spain — and all of Europe — is to create a euro zone deposit guarantee system so that there would be no reason for a depositor to withdraw money.I recommended this in my blueprint to save the financial system. Specifically, I recommended that the European Financial Stability Fund and the European Stability Mechanism be used to backstop the sovereign deposit guarantees.
This addresses the issue of bank solvency prompted bank runs.
European leaders are expected to address the idea, along with regional banking regulation and a way to recapitalize ailing euro zone institutions, at a summit meeting at the end of the month.
Oddly enough, such a deposit guarantee would probably be pretty cheap. The psychological effect of such a guarantee would most likely ensure the solvency of more banks than the guarantee would ever have to pay out. That was the experience in the United States.Please re-read the highlighted text as Andrew Ross Sorkin confirms that the psychological effect of deposit guarantees is so strong that banks can continue to operate even when they are insolvent or have negative book capital levels.
Of course, there’s a catch. A euro zone deposit guarantee would require agreement from all the countries that use the euro, which is something that the leaders there seem incapable of reaching because ultimately it would mean tighter integration and, yes, a loss of sovereignty.
And here’s another problem with a euro zone deposit guarantee: Unless you believe the euro is going to remain the standard — that countries like Greece or Spain won’t be forced out or secede from the currency — even the guarantee might not be enough, unless the guarantee holds for all currencies.
For example, if a Spanish bank customer is worried that his euros might one day turn into pesetas — even with a deposit guarantee in place — he may well move his money.This is a problem created by EU politicians that is easily solved by EU politicians. They simply have to stop threatening to force a loss on depositors by converting their savings into a less valuable currency.
In the meantime, this piecemeal approach is bound to fail. Kicking the can down the road, to use again an overused phrase, at some point will fail — and that’s what may have just happened.At which point, the only solution to a bank solvency led financial crisis that has been shown to work should be adopted. This solution is the Swedish model with ultra transparency.