The Telegraph reports that the IMF's Christine Lagarde sees big banks as "more dangerous than ever".
And why are they more dangerous than ever? Because
"many banks are still in an early stage of repair – not enough capital and too many bad loans on their books. Even outside the periphery, there is a need to shrink balance sheets, reduce reliance on wholesale funding, and improve business models,” she said.
Because the banks are broken, cheap credit is not getting through to the parts of the economy that need it.
“Because of insufficient financial repair, monetary policy is “spinning its wheels” – meaning that low interest rates are not translating into affordable credit for people who need it,” she said.
“So the priority must be to continue to clean up the banking system by recapitalising, restructuring, or – where necessary – shutting down banks.”
Please re-read Ms. Lagarde's comments as she has confirmed what you humble blogger has been saying since the beginning of the financial crisis about why the policy response doesn't work and what it takes to fix the global economy.
The necessary first step is to fix the global banking system by requiring it to recognize upfront all the losses on the excess public and private debt in the financial system.
Banks can absorb these losses because they are designed to continue operating and supporting the real economy even when they have low or negative book capital levels. Banks can do this because of deposit guarantees and access to central bank funding. Deposit guarantees effectively make the taxpayers the banks' silent equity partner when they have low or negative book capital levels.
After absorbing the losses, the banks whose interest income exceeds their interest expense and pre-banker bonus cost of operating can rebuild their book capital through retained earnings.
To ensure that these banks don't take on too much risk while rebuilding their book capital, they must be required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details. With this disclosure, market discipline will restrain banks gambling on redemption.
After absorbing the losses, the banks whose interest income is less than their interest expense and pre-banker bonus cost of operating should be resolved.
Please note that this solution, what I call the Swedish Model for handling a bank solvency led financial crisis, results in the bankers paying for the losses in the financial system that they created.