Monday, June 18, 2012

You couldn't make up policies that result from EU's choice for how to handle bank solvency led financial crisis

In his Telegraph column, Ambrose Evans-Pritchard describes just how absurd are the policies the EU is following in order to protect bank book capital levels.

Under the Japanese model for handling a bank solvency led financial crisis, policymakers and regulators do everything they can to protect bank book capital levels and the related banker bonuses.

In doing everything they can to protect capital levels and bonuses, they end up pursuing absurd policies.

This is what Professor Vanis Varoufakis from Athens University has to say about the Troika policies (via Naked Capitalism): 
"Consider what they are telling the Greek people: They are saying that Greece, to remain in the Eurozone, must, 
(a) carry on borrowing from the EFSF at 4% (and thus adding to Greece’s public debt) in order to pay the ECB (which will be making a 20% profit from these payments, courtesy of the fact that it had previously bought Greece’s bonds at a 20% to 30% discount) 
(b) reduce public spending by 12 billion euros in order to be ‘allowed’ to borrow for the benefit of bolstering the ECB’s profits from these transactions involving bankrupt Greece. 
If the Devil wanted to guarantee that Greece is pushed out of the Eurozone, he and his evil handmaidens could not make up the above, satanic, scenario. 
Meanwhile, the same happens in Spain, where the government is forced to borrow money (at nearly 7%) it can hardly raise in order to shore up banks that are borrowing from the ECB (at 1%) to lend to the Spanish government (at 7%) so that the latter can… bail them out. Not even the sickest of minds could make this up!" 
Indeed, you couldn’t make it up.
Regular readers know that there is an alternative to handling the bank solvency led financial crisis that does not result in absurd policies or enforcing austerity on countries.  This alternative is the adoption of the Swedish model with ultra transparency.

Under the Swedish model, banks absorb the losses on the excess in the financial system today.  Subsequently, they rebuild their book capital levels by retaining 100% of pre-banker bonus earnings.

This alternative is viable because of how the modern banking system is designed.  It has deposit guarantees, so depositors don't care about the level of capital at the bank holding their deposits, and access to central bank funding for unlimited liquidity, so depositors know that funds will be there should they want to make a withdrawal.

As a result of its design, bank capital is reduced to an accounting construct that is there to absorb the losses on the excesses in the financial system and to protect the real economy from the damage that would occur if it were required to carry the excess debt.

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