Sunday, June 16, 2013

Thomas Hoenig calls attention to well known fact: banks operating without much capital

Thomas Hoenig created a ruckus by pointing out that Deutsche Bank is "horribly undercapitalized".  Naturally, Deutsche Bank responded that in the make believe world of Basel capital requirements Mr. Hoenig was wrong.

To settle the matter, Zero Hedge weighed in and noted that EU banks, including Deutsche Bank, needed upwards of 500 billion euros of capital.  Citing the work on EU banks by Benink and Huizinga, Zero Hedge noted
Banks are already saddled with ample unrecognised losses on their assets, estimated by many observers to be at least several hundreds of billions of euros and mirrored by low share price valuations...
This whole debate highlights two important facts about our current financial crisis.

  1. Everyone knows that the banks are hiding losses and the extent of their hidden losses exceeds their current book capital levels.
  2. Banks are holding policymakers and central bankers hostage by threatening that disclosure of these losses and the related lack of capital will result in financial instability.
Please note that if everyone already knows the banks have low or negative capital, then revealing the exact amount should not result in financial instability.  Revealing the exact amount simply confirms what market participants already know and lets market participants know how close their estimates of the losses were to reality.

Your humble blogger is confident in his statement that revelation of the losses won't result in financial instability for several reasons including: market participants might have overestimated the extent of the losses and we have 6 years of experience that show that banks can continue to operate with what in reality is low or even negative book capital levels because of the combination of deposit insurance and access to central bank funding.

If revelation of the exact amount of losses is not going to result in financial instability, then policymakers and central bankers don't have to remain hostages of the banks.  And if policymakers and central bankers don't have to remain hostages, then there is no reason to continue to pursued the failed Japanese Model and preserve bank book capital levels and banker bonuses at all costs.

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