Wednesday, December 19, 2012

Geithner Doctrine undermines Draghi's claim that ECB oversight of banks will restore confidence

In a Reuters article, the head of the ECB, Mario Draghi, asserts that having the ECB at the head of a single eurozone bank supervisory mechanism will help to restore confidence.

In the US, the Fed is responsible for supervision of large, global banks.  Since at least the start of the current financial crisis, the Fed has operated under the Geithner Doctrine.  Yves Smith at NakedCapitalism stated the doctrine as follows:
Nothing must be done that will hurt the profits or reputation of any bank that is pretty big and/or well connected.
The manipulation of Libor provides an example of how the Geithner Doctrine is applied.

When told in May 2008 that banks were manipulating Libor interest rates for profit, in addition to trying to make their financial health look better than it was, Mr. Geithner sends to the UK a proposal to reform Libor that would not have ended the banks' ability to manipulate Libor.

For those who believe that the Geithner Doctrine is only being followed in the US, the ECB has already shown that it subscribes to the Geithner Doctrine.

For example, the ECB has been actively pushing for the creation of the European Data Warehouse so that banks can sell the equivalent of subprime mortgage-backed securities (think bank profits).  I say banks can sell the equivalent because transparency has two equally important elements, "what" is disclosed and "when" it is disclosed, and opaque subprime mortgage-backed securities meet the definition of transparency used by the data warehouse and endorsed by the ECB.
New European Central Bank powers to oversee euro zone banks will help restore confidence in the sector and revive interbank lending, its president, Mario Draghi, said on Monday. 
European ministers clinched a deal last week to give the ECB powers to supervise the currency bloc's banks from March 2014, taking the first step in a new phase of integration to help underpin the euro. 
"The single supervisory mechanism will contribute to restoring confidence in the banking sector across the euro area. It will help revive interbank lending and cross-border credit flows, with tangible effects for the real economy," Mario Draghi told the European Parliament's Economic and Monetary Affairs Committee. 
Bank-to-bank lending has yet to recover from the onset of the global financial crisis in 2007, and many banks rely on the ECB for their liquidity needs while others hoard their cash rather than lend it on....
Regular readers know that the interbank lending market is frozen because of a lack of transparency.  Banks with deposits to lend cannot assess the risk of the banks looking to borrow.

The solution for unfreezing and keeping the interbank lending market unfrozen is to require the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this information, banks with deposits to lend can independently assess the risk of the banks looking to borrow.
Draghi said: "The national supervisors' role gets bigger as the banks get smaller, but all national supervisors will be subject to the single rulebook as regulated from the centre. The ECB will retain power to call in any bank under its domain." 
Once ECB supervision is in place, the euro zone's rescue fund - the European Stability Mechanism - will be allowed in principle to recapitalise banks directly. 
For now, euro zone governments have had to shore up their banks, adding further to public debt and creating a vicious circle between weak banks and states. 
"Combined with possible direct recapitalisation of banks by the European Stability Mechanism and an envisaged single resolution mechanism, the single supervisory mechanism will go a long way towards breaking the vicious feedback loops between sovereigns and banks," Draghi said.
Regular readers also know that there is no legitimate reason (protecting banker bonuses not being a legitimate reason) that euro zone governments needed to shore up their banks and add further to public debt.

Modern banks are designed to be able to continue operating even when they have low or negative book capital levels.  They can do this because of the combination of deposit insurance and access to central bank funding.

With deposit insurance, taxpayers become the banks' silent equity partners when the banks have low or negative book capital levels.  Since taxpayers are already the silent equity partners, there is no need to use the government's ability to borrow in the capital markets to recapitalize the banks.

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