Tuesday, July 9, 2013

Simon Johnson discovers that he and everyone else is "fumbling through the fog surrounding Too Big to Fail"

In a very telling Bloomberg column titled Fumbling through the fog surrounding Too Big to Fail, MIT Professor Simon Johnson admits that there is imperfect information about TBTF banks.

This imperfect information leads to very predictable outcomes.
As Tom Hoenig, the current FDIC vice chairman, put it at the hearing: “Short-term depositors and creditors continue to look to governments to assure repayment rather than to the strength of the firms’ balance sheets and capital.”
Regular readers know that the reason no-one looks at the strength of the TBTF banks' balance sheets and capital is that these banks are "black boxes".

The information disclosed by the TBTF banks is inadequate for even these banks to determine which of the other TBTF banks is solvent and which is insolvent (the finding of the Financial Crisis Inquiry Commission).

As your humble blogger has been saying since the very beginning of the financial crisis, the only way any bank can be assessed by the market is if it discloses its current global asset, liability and off-balance sheet exposure details.

Without this information, there is no way to assess the risk of a bank.

By the way, it is not just your humble blogger who believes this, but also bank regulators.  It is the reason that bank regulators have access to what is happening at every bank 24/7/365.

If there is no way for the market to assess the risk of a bank, then it is only natural that short-term depositors and creditors should rely on governments, who have access to the necessary information, to assure repayment.

Let me repeat this very important point: so long as financial regulators have a monopoly on the information needed to assess each bank's risk, market participants are dependent on them and will rely on the government to guarantee the market participant will be repaid.

The starting point for ending market participants' reliance on the government guarantee is to require the banks to provide ultra transparency and disclose their current exposures.

Requiring this disclosure can be done under the 1930s Securities Acts.

Until banks are required to provide ultra transparency, all the talk about ending the threat to the financial system from the Too Big to Fail is just that: talk.

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