The fundamental problem of adopting the Japanese model is that policymakers and financial regulators lie about the true condition of the banks.
This deception commits them to taking actions that put the real economy into a downward spiral. Examples of these actions include bailouts, regulatory forbearance that allows the banks to practice 'extend and pretend' with zombie borrowers, austerity and zero interest rates.
Ultimately, of course, the underlying economic condition of too much debt in the financial system expresses itself.
The latest casualty is Spain.
As Ambrose Evans-Pritchard said in his Telegraph column,
Spain’s woes are mounting relentlessly. Suki Mann from Societe Generale said the collapse of confidence has at last begun to infect blue-chip companies, with groups such as Iberdrola, Red Electrica, and Gas Natural facing a jump in borrowing costs of 30 to 50 basis points since Friday.
“Any resilience has been washed away. There are no buyers,” he said. Companies deemed rock-solid weeks ago risk a downgrade to junk status, with grim implications for the real economy....Without ultra transparency, nobody knows what is the true condition of any bank in Spain. Since confidence in the financial system is a function of the ability to independently assess the facts, it is not surprising that confidence has disappeared.
Spain’s central bank said that the ratio of bad debts had jumped to 8.7pc in April, a figure certain to rise if house price fall another 25pc as expected. El Confidencial reported that an outside bank audit had uncovered a shortfall of up €150bn, though not all of that sum has to be covered by fresh capital.Actually, none of it should be covered by fresh capital. It should be covered by retention of 100% of future pre-banker bonus earnings.
Regular readers know that it is the deception that banks have positive book capital levels that links sovereign debt to bank book capital levels and introduces the idea that banks need fresh capital.
In the real world where there are deposit guarantees and access to central bank funding, nobody other than economists and bankers, where it effects receipt of their bonus, cares about bank book capital levels. As a result, banks can recapitalize themselves over several years.
Back to Germany.
The fact is that Germany continues to pursue the deception that its banks have positive book capital levels. As a result, it continues to insist on and implement for itself the Japanese model even though the impact of these policies has resulted in the effective collapse of the peripheral EU countries and increasing downward pressure on the German economy.
There is a simple way for Germany to avoid the fate of Spain. Adopt the Swedish model with ultra transparency.
Require all EU banks to step up and recognize the losses hidden on and off their balance sheets. This step should seem reasonable as nobody forced the banks to take on these exposures in the first place.
Then, require the banks to retain 10% of pre-banker bonus earnings until the banks have rebuilt their book capital levels.
Ultra transparency will allow market participants to a) confirm that all the losses have been recognized and b) exert discipline to restrain risk taking while the banks are rebuilding their book capital.