Showing posts with label Germany. Show all posts
Showing posts with label Germany. Show all posts

Saturday, March 30, 2013

If deposits safe in EU, Schaeuble should have banks provide transparency to prove it

Reuters reports that German Finance Minister Wolfgang Schaeuble says that deposits are safe in the eurozone and won't be used to bailout insolvent banks.

If this statement is to be believable after uninsured depositors were effectively wiped out in Cyprus, Mr. Schaeuble should have the banks provide transparency and prove that they are not insolvent.

Naturally, the first banks to provide ultra transparency and disclose their current global asset, liability and off-balance sheet exposure details should be in Germany.

It is only with this information that market participants can assess the solvency of each bank and assess the risk that they might be called on to bailout an insolvent bank.

The failure of Mr. Schaeuble to back up his claim that deposits are safe by insisting that eurozone banks provide transparency is the equivalent of waving a big red flag and saying of course the banks have something to hide and we need depositors to keep their money in the banks so that we can seize it.

German Finance Minister Wolfgang Schaeuble has said savings accounts in the euro zone are safe, adding that Cyprus is a "special case" and not a template for future rescues....

"Cyprus is and will remain a special one-off case," Schaeuble said. 
"The savings accounts in Europe are safe."
Prove it! 

Require the banks to provide ultra transparency so that market participants can confirm this statement.
Schaeuble said the problem in Cyprus was that two large banks in Cyprus were in effect no longer solvent and the Cyprus government did not have enough money to guarantee savings. 
"That's why the other euro zone countries had to help," he said. "Together in the Eurogroup we decided to have the owners and creditors take part in the costs of the rescue - in other words those who helped cause the crisis."... 
"Yes, you could see that during the Cyprus crisis," he said. "The entire turbulence did not have any impact on the other countries in Southern Europe."...
Except for the fact that uninsured depositors are now quickly figuring out how to reduce their exposure so that all their deposits are insured.

Wednesday, March 27, 2013

Germany belief in its reliance on Deutsche Bank outweighs scandals

Reuters ran an interesting article in which it looked at how Germany's belief in its reliance on Deutsche Bank gave the bankers at Deutsche Bank immunity from scandals.

Germany has become so dependent on Deutsche Bank to grease the wheels of its export driven economy that it looks willing to gloss over scandals involving its largest bank.
Germany is not alone as similar observations could be made in the rest of the EU, Japan, the UK and the US when it comes to giving bankers immunity from scandals.
Deutsche is one of several European banks under investigation by regulators in Europe and the United States for its suspected role in rigging benchmark interest rates. It is cooperating with German authorities in a separate inquiry into alleged tax fraud. Deutsche has denied allegations it misvalued derivatives and mis-sold mortgage-backed securities. 
Such an array of inquiries could be expected to damage any bank's reputation.
Such an array of inquiries would be unnecessary if Deutsche Bank and the other banks were required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

It is well known that sunlight is the best disinfectant and this level of ongoing disclosure would encourage a culture where every action the bank takes is an action the bank would be willing to see on the front page of Der Spiegel.
But back-up from business leaders and key members of the bank's supervisory board appear to be helping Deutsche's new co-chief executives Anshu Jain and Juergen Fitschen put the scandals behind them. The two men, with more than 40 years experience at Deutsche between them, took over as co-CEOs on June 1. 
This bedrock of support is crucial for Deutsche, especially in a German election year when banks' perceived excesses and misdemeanours could become a campaign issue.
The bank's behavior risks becoming a campaign issue because there is no distinction being made between the bank as an institution and the individuals who worked for the bank who engaged in or oversaw the areas that engaged in misbehavior.

This distinction is important as it highlights the simple fact that individuals from the top of Deutsche Bank down can be punished without destroying the franchise or hurting its ability to support the German economy.
The newest revelations for Deutsche will come in the next few days when the German regulator issues a report on the bank's alleged involvement in the manipulation of Libor, a global interest rate benchmark.
If the bank was engaged in manipulating Libor, anything less than dismissal of everyone who engaged in or oversaw the areas, and oversight of the areas goes all the way to the bank's supervisory board, that engaged in manipulating Libor is an insufficient response.

After all, does Germany and Deutsche Bank really want to have individuals who were responsible for overseeing an area and failed to prevent it from engaging in manipulating a global benchmark interest rate around?
The report will test Germany's commitment to keeping Deutsche strong for the sake of its export led economy. That commitment is a common theme to surface in interviews Reuters has conducted with current and former Deutsche staff, business leaders, sources at the regulator and bank directors. 
Several sources familiar with the regulator's report have said it will focus on "organisational flaws" rather than placing blame on Jain or Fitschen, making it less likely the Berlin political establishment will call for them to go....
Regulatory capture at its finest.  But then again, the regulators didn't catch Deutsche manipulating Libor either and this suggests that a number of regulators should also lose their jobs.
Crucially for Jain and Fitschen, Deutsche's supervisory board chairman, Paul Achleitner, supports their strategy. 
A former Goldman Sachs executive who helped Deutsche make one of its biggest expansions into investment banking in 1998, when he advised it on a deal to buy Bankers Trust, Achleitner is a firm believer in a strong German investment bank. 
"What we need as a society is to come to an agreement over what we want. Do we want Germany to be home to a major bank of global importance? There aren't that many companies left in the financial sector capable of competing with U.S. firms," Achleitner said in a written statement in response to questions....
There is no reason that Germany cannot be home to a major bank of global importance.

After all, who would global clients rather deal with:  a bank that provides ultra transparency and prides itself on a culture of honesty or a bank that hides behind the veil of opacity provided by current disclosure rules and has a culture that actively supports manipulating benchmark interest rates for profit?

When the question is asked this way, ultra transparency is seen as a competitive advantage over US firms.
To ensure they retain the support of corporate Germany, Jain and Fitschen need to prove that 'Project Pharos,' a plan to become a more client focused lender really means a change in style. 
The restructuring efforts, set to be completed by 2015, has already seen about 1,400 jobs axed out of the investment bank, which had 9,094 staff at the end of 2012. 
The proprietary trading division, which used the bank's own money to make bets with a notional value of up to $128 billion on mortgage-backed securities, has been shut. 
Deutsche has pared back risk taking, reducing the value at risk at its main trading units to 57.1 at the end December, from 95.6 at the end of 2010. A lower number for value-at-risk indicates a reduced likelihood of potential losses....
Voluntarily adopting ultra transparency is a logical extension of Project Pharos.  After all, management wants to show that Deutsche has been cleaned up and to change its culture.
The bank has beefed up a 'risk and reputation' committee, which now includes four members of the Group Executive Committee, the bank's 18-member senior management panel. Potentially controversial business is discussed by the head of compliance, the chief risk officer and legal counsel.... 
Deutsche's problem is that the changes, underway since 2009, take time to filter through to the outside world, insiders say. 
"There is a lag between perception and practice," a senior Deutsche Bank executive said....
There is nothing that says you have changed as a bank like the adoption of ultra transparency.  It dramatically cuts down on the lag between perception and practice.

In the absence of ultra transparency, like Barclays recent announcements, Project Pharos can be seen as simply happy talk with no real substance behind it.
Senior Deutsche Bank staff say the reform process is credible. 
"Anybody who was involved in anything illegal is no longer with the bank, so it's unfair to keep drawing parallels between now and then," a second senior bank executive said. 
But critics says the investment bank's DNA still bears the legacy of Edson Mitchell, the American banker who helped lay the foundations of its global investment banking franchise by introducing a more Anglo-Saxon management style and Wall Street sized paychecks. 
"The vast majority at the bank doesn't need a cultural change. It's just the traders," said a Deutsche investment banker specialising in merger and acquisitions. "They have shown over and over again that they care more about themselves than about the bank's reputation."... 
Ultra transparency would provide an instant culture change to the trading floor.  Gone would be proprietary trading.  Only market making would survive.

Tuesday, March 26, 2013

Cyprus fallout: over half of Germans doubt deposit guarantee

Reuters reports that according to a survey by Stern magazine over half of Germans doubt that their government will honor its deposit guarantee.

At a minimum, this suggests how big the blow was to trust and confidence in the EU financial system caused by the decision to bail-in depositors to pay for the losses hidden on bank balance sheets.

Regular readers know that ultimately there is only one way to restore trust and confidence in the financial system: bring transparency to all the opaque corners of the financial system.

For banks, this means that they will have to disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.  It is only with this disclosure that market participants can see the true condition of these banks.

As predicted at the beginning of the financial crisis by your humble blogger, until transparency is brought to all the opaque corners of the financial system, the global economy will continue in a downward spiral (even with central banks and governments pursuing stimulative policies).

According to a recent survey commissioned by the magazine "Stern" 54 percent of Germans believe the promise of the Chancellor no longer that savings are safe in Germany.  
Conversely, only 41 percent trust their warranty.  
67 percent of Germans are great or at least a little worried about their savings. 
Because of the initially planned compulsory levy on Cypriot bank deposits under € 100,000 Merkel reaffirmed their guarantee for German savers last week over government spokesman Steffen Seibert. "It is the mark of a guarantee that it is," he said. Cyprus is a special case.  

Wednesday, March 20, 2013

Germany's policy: banking sector must contribute to recapitalizing banks

As the search for a solution on how to recapitalize Cyprus' banks continues, one thing has become clear.  Germany has adopted a new policy under which it will no longer contribute substantial funds to bailout another EU country's banking sector.

The new German policy can be summarized as:  the banking sector must contribute to recapitalizing the banks.

Regular readers know that this is what your humble blogger has been saying since the beginning of the financial crisis.

There is no legitimate reason why a government should issue debt to bailout the banks and Germany has correctly recognized this.

The question is how to get the banks to contribute 100% of the bailout funds.

What distinguishes my answer to this question from the approach initially proposed by Germany to Cyprus is how I handle the issue of how quickly the banks need to be recapitalized.

My approach recognizes that a modern banking system is designed so that banks do not have to be recapitalized immediately.  This is a very important point as it is the reason that banks can provide 100% of the bailout funds through retention of future earnings.

Banks are designed so that they can continue operating and supporting the real economy even when they have low or negative book capital levels.  Banks can do this because of the combination of deposit insurance and access to central bank funding.

Deposit insurance effectively makes the taxpayers the banks' silent equity partner when the banks have low or negative book capital levels.  This permits the banks to continue to make loans and handle payments.

Germany's approach of requiring the depositors to take a haircut is driven by their assuming that banks have to be recapitalized immediately.  Something that is not true, but has been obscured by Japan, the UK and the US pursuing policies of protecting bank book capital levels and banker bonuses at all costs.

Monday, March 18, 2013

Thanks to Cyprus, issue of who pays for bank losses re-emerges

By proposing to violate the sanctity of deposit guarantees to help fund its bailout of its banks, Cyprus has put the issue of who pays for bank losses back onto the agenda.

Thank you Cyprus and by extension Germany, Finland and the IMF.

Regular readers know that a modern banking system is designed so that the banks can pay for their losses, but that since the beginning of the current financial crisis, politicians have prevented this from occurring and instead have made savers and/or taxpayers pay for the banks' losses.

Let me unpack the bolded statement.

A modern banking system is designed so that banks can absorb the losses on the excess debt in the financial system and continue to operate and support the real economy even if the banks have low or negative book capital levels.

Why?

Because of the combination of deposit insurance and access to central bank funding.

Deposit insurance effectively makes the taxpayers the banks' silent equity partner when they have low or negative book capital levels.  With this "silent equity partner", banks can continue to extend the credit that the real economy needs for growth.

The idea that banks can continue to operate with low or negative book capital levels doesn't appear in any textbook or article in a scholarly journal.  What proof is there that the modern banking system is designed to act this way?

Let me provide you three examples that confirm the banking system is designed to act this way.

First, in the mid-1980s, the write-down of loans to Less Developed Countries meant that Security Pacific effectively had negative book capital.  This fact was well known to market participants as they knew the size of Security Pacific's exposures, the size of write-downs other banks were taking on similar exposures and how much book capital Security Pacific had before the LDC write-downs began.

Not only was Security Pacific not closed, but it was allowed to engage in a large acquisition (Rainier) to help it rebuild its book capital levels (pooling accounting).

Second, in the late-1980s, the US Savings and Loans saw their book capital disappear as a result of losses incurred in a rising interest rate environment by the mismatch in pricing between their assets and their liabilities.

The savings and loans didn't go away.  Rather they continued in operation, some would say gambling on redemption by making loans to real estate developers, until closed by the financial regulators several years later.

Third, in 2008, Citigroup's book capital level dropped to what can only be described as a low level.  Citigroup was not closed.

In each of these examples, despite low or negative book capital levels, the financial institutions continued to operate and provide credit to support the real economy.

In each of these examples, the ultimate authority that made the decision to close or not close the financial institutions was the financial regulator responsible for protecting the deposit insurance fund and the taxpayers and not the debt or equity markets.

What ultimately caused the savings and loans to be shutdown is that their franchise was unable to generate earnings that could be retained to rebuild their book capital levels and reduce the risk of loss to the deposit insurance fund and taxpayers.

Please note, that while the examples were drawn from the US, just from the latest financial crisis there are numerous international examples too.

The fact that a modern banking system is designed to absorb the losses on the excess debt in the financial system is inconvenient for policymakers and bankers.  

It is inconvenient because it provides an alternative to savers and/or taxpayers as the answer to the question of who pays for bank losses.  The alternative being the banks and bankers themselves by applying as much of their future earnings as is needed to absorb the losses.

Since the beginning of our current financial crisis, global policymakers have been pursuing a strategy of protecting bank book capital levels and, with it, banker bonuses at all costs.

They have done so under what I have called the Japanese Model (named after the failed policy response that Japan has been pursuing for the last 2+ decades to its financial crisis).  The Japanese Model always fails as a policy response because it is fundamentally flawed.

In protecting bank book capital levels, the Japanese Model allows the banks to kick the can down the road on recognizing losses.  This is not a costless exercise.  In fact, the cost of carrying those losses is very high.

The cost of carrying the losses includes zero interest rate and quantitative easing policies (which hit savers), fiscal stimulus (which hits taxpayers through the additional debt governments take on) and austerity (which hits the poor through a reduction in social programs).

What Cyprus did by "taxing" bank depositors was to simply speed up the process by which financial repression under the Japanese Model takes money from the savers and gives it to the banks (notice that no bankers in Cyprus were going to lose their jobs despite losing billions).

This confiscation of saver funds put the issue of who pays for bank losses back on the agenda.

Why?

Because the savers and taxpayers now know that their governments could also confiscate their deposits without warning to absorb the bank losses.  The lack of warning highlights the simple fact that savers and taxpayers were never consulted about who should pay for the bank losses at any time since the beginning of the financial crisis.

Having been fooled once into paying for the banks' losses, savers and taxpayers are now unlikely to be fooled again.

Germany provides confirmation of this as the current German government is facing defeat because the German citizens are tired of paying for bank losses that could and should be paid for by the banks themselves (even if this means that bankers' cash bonuses will be reduced).

Thursday, January 24, 2013

Defending the indefensible, Merkel insists on more austerity

In her remarks at Davos, Angela Merkel insisted that austerity must continue to be imposed despite the simple fact that more than 50% of the youth in Greece and Spain are long-term unemployed.

Why does she push austerity?

To defend German bank book capital levels and German banker bonuses.

As regular readers know since August 9, 2007, policymakers have faced a choice everyday as to how to respond to a bank solvency led financial crisis.  They can adopt the Japanese Model and protect bank book capital levels and banker bonuses at all costs or they can adopt the Swedish Model and require the banks to recognize upfront the losses on the excess public and private debt in the financial system.

If policymakers adopt the Japanese Model, they place the burden of servicing the excess debt on the real economy.  At best, this diverts capital that is needed for growth and reinvestment to debt service and produces a stagnate economy (think the 2+ decade Japan-style economic slump).  At worst, this diversion of capital produces a depression (think current economic conditions in Greece and Spain).

If policymakers adopt the Swedish Model, they protect the real economy and the social contract as capital continues to be available for growth and reinvestment in the real economy.

So who loses based on the choice policymakers must make everyday?

If policymakers choose the Japanese Model, the losers are their country's citizens.

If policymakers choose the Swedish Model, the losers are the bankers.

So who wins based on the choice policymakers must make everyday?

If policymakers choose the Japanese Model, the winners are the bankers and no one else.

If policymakers choose the Swedish Model, the winners are their country's citizens.

Clearly Angela Merkel and the German policymakers have chosen the Japanese Model, is there any reason this choice is indefensible besides the incredibly negative impact on society for the benefit of the bankers?

Yes, modern banking systems are designed to support the Swedish Model.  Because of the combination of deposit insurance and access to central bank funding, banks can operate with low or negative book capital levels.

When banks have low or negative book capital levels, deposit insurance effectively makes the taxpayers the silent equity partner of the banks.  As a result, banks can continue to operate and there is absolutely no reason for countries to bailout the banks by injecting funds or protect the banks' book capital levels by engaging in regulatory forbearance or suspending mark-to-market accounting.

Is there any proof that pursuing the Japanese Model results in ending a bank solvency led financial crisis?

No.  Japan is still struggling to end its financial crisis 2+ decades after it started.  In the US, the Japanese Model was pursued at the time of the savings and loan crisis.  It failed and ultimately the vast majority of savings and loans were closed.  However, by pursuing the Japanese Model to handle the crisis, the US financial regulators did succeed in dramatically increasing the cost of dealing with the insolvent savings and loans.

The Swedish Model sounds too good to be true, is there any proof that it works?

Yes.  The first example of the Swedish Model being used was by the FDR Administration during the Great Depression.  According to the NY Fed, adopting the Swedish Model (it wasn't called that in the 1930s, it was called a bank holiday where only the "solvent" banks were allowed to reopen) broke the back of the Great Depression.

There have been other examples including Sweden and most recently Iceland.  Despite some mistakes in implementation, each of these examples showed just how effective making the banks recognize the losses upfront on the excess debt in the financial system is at ending the financial crisis.

Why do policymakers have to make this choice everyday?

Because adopting the Swedish Model is always an option.

Angela Merkel has insisted there can be no let-up in the painful economic reforms being driven across Europe, despite union leaders warning that the risk of social unrest in southern European countries is increasing. 
In a keynote speech at the World Economic Forum's annual meeting, Merkel insisted it was vital to keep driving down labour costs to make Europe more competitive. 
"Were we to meet halfway, we would have accepted that Europe will not be competitive globally," said Merkel, adding that this would cause unacceptable damage to Germany's exporters.
Perhaps I missed something, but it appears that Germany's economy is slowing down as its exports are declining as the austerity it imposes on the rest of the EU closes one of its major markets.

As mentioned above, choosing the Japanese Model is bad for the citizens of the country whose politicians make the choice.
She argued that growth and fiscal consolidation are "two sides of the same coin", disappointing Davos attendees who hoped for a thawing on Europe's austerity drive....
I must really be missing something, but the countries that are pursuing austerity all seem to be in either a recession or depression.  Support for this observation comes from the IMF which after admitting that it underestimated how devastating austerity is to countries in a recession is now urging the UK to end its austerity obsession.
But labour officials in Davos are deeply concerned that political leaders are still failing to address the issue of unemployment
The easing of the financial crisis has lulled many into a false sense of security, warned Guy Ryder, director general of the International Labour Organisation. "I am often asked whether the levels of unemployment in southern Europe threaten social stability. Yes, it does. But you don't have to wait for a revolution to do something about it," said Ryder. 
He was speaking as new data showed that 60% of young Spaniards are now out of work.
Your humble blogger admits to really missing something as zero interest rate policies, unlimited quantitative easing, promises to buy unlimited amounts of bonds for eurozone countries that agreed to be in a permanently depressed state and 60% youth unemployment do not suggest that the financial crisis is easing in the slightest bit.

What the claim the financial crisis is easing suggests is that bankers are once again lined up at the trough to take outsized bonuses that they would not be entitled to if Angela Merkel and the German policymakers were not protecting bank book capital levels.
Merkel insisted current unemployment levels were a price Europe had to pay to become more competitive, and pointed out that Germany had been on the same path, with unemployment hitting 5 million before the public accepted structural reforms.
What her story misses is that the global economy was expanding briskly at that time.  The situation is dramatically different today.
Sharan Burrow, general secretary of the International Trade Union Confederation, said there was "a real lack of political will" to address the unemployment crisis. "Leaders feel the pressure, but there is only a commitment to a jobs plan in a very few countries," said Burrow. 
"They are waking up and worrying about stock markets and rating agencies, rather than things people really care about – such as education, growth and jobs."
The concern with stock markets and rating agencies over the things people really care about is one of the surreal aspects of the ongoing pursuit of the Japanese Model.

The policymakers are so trapped in manipulating the financial system that they lose sight of the fact that their primary concern should be the well-being of their citizens and not the banks and bankers.
Merkel ended her Davos appearance with a plea to global international companies to employ more young people in Europe, to bring them "jobs, peace and hope". She added: "I welcome anyone who will give a helping hand to young people."
She should start the process of giving a helping hand to young people by adopting the Swedish Model and requiring the German banks to recognize upfront the losses on their on and off-balance sheet exposures to the excess public and private debt.

This would be a major step to restoring growth to the eurozone economies and the hiring of young people.

Wednesday, January 9, 2013

Germany responds to Cyprus President saying austerity making EU financial crisis worse

Germany has responded to the Cyprus President saying that austerity is making the EU financial crisis worse.  According to the Guardian, German Chancellor Angela Merkel said that Cyprus must drop its opposition to privatization of state assets or it would not get a bailout.

Cyprus President observed
"It must be admitted that policies implemented on a pan-European level have not succeeded in providing a solution to the economic problems created by the crisis," ...
"On the contrary, they have recycled and worsened economic and social injustice," he added....
"The future of a United Europe cannot be poverty, deprivation, unemployment and homelessness."
Christofias said the EU's "one-sided" approach has failed to achieve growth in those recession-hit countries it has tried to help.
"A different approach is needed which will emphasise development, social cohesion and true solidarity within the Union. It is with sadness that we observe the absence of such policies."
Please re-read the highlighted text and Chancellor Merkel's response.

Angela Merkel has just given a clear signal that Cyprus will not get its bailout until it drops its opposition to wide-ranging economic reforms. 
During a press conference in Berlin, the German chancellor insisted the aid deal would not be completed without Nicosia agreeing to a programme including privatising some state-controlled companies. 
Merkel said (via Reuters): 
We agree it is important that the troika should talk with Cyprus and that there can be no special conditions for Cyprus because we have common rules in Europe....
As a correspondent to the Guardian said,

There is no love lost between Christofias and the EU but the German chancellor Angela Merkel's dark insinuations that there will be no money until the communist president leaves will end the leader's term in power on an even more sour note. 
Regular readers will recall that Christofias chose to end Cyprus’ stint at the helm of the rotating EU presidency with a rousing speech on why the bloc wasn't working. 
More than ever, he said, the European Union was in urgent need of re-embracing its founding principle of "solidarity." 
Ironically, it now seems that solidarity is the last thing EU partners are willing to show the leader who has repeatedly denounced the onerous terms and conditions attached to rescue funds from the EU, ECB and IMF.
For regular readers of this blog, none of this is surprising.

Germany adopted the Japanese Model for handling a bank solvency led financial crisis in order to protect its banks' book capital levels.  Nobody made its banks make loans to Cyprus or the Cypus banks that exceeded the ability of Cyprus or the Cyprus banks to repay.  Yet, Germany is trying to protect its banks from the results of these bad decisions.

In doing so, Germany is creating for Cyprus and other EU debtor countries, a future of poverty, deprivation, unemployment and homelessness.

Regular readers know that there is an alternative to the Japanese Model that achieves the positive outcome that the Cyprus President advocated.  The alternative is the Swedish Model which requires the banks to absorb the losses on the excess debt in the financial system.

The result is that that real economy in countries like Cyprus is protected and the debt in the financial system is reduced to a level that the borrowers can afford to service.

One of the benefits to Germany from adopting the Swedish Model is that it also protects the real economy in Germany.

You see, Germany has an export oriented economy.  As the EU economy collapses around it, it limits what Germany can export.  As Germany's exports collapse, so to does its economy.  This can be seen in its current economic slowdown.

Wednesday, January 2, 2013

Portugal president warns Europe's leaders to back off austerity demands

Picking up the baton from the leaders of Greece and Cypress, Portugal's president has come out and said that Europe's leaders need to back off their austerity demands as there are limits to what is economically and socially sustainable.

Austerity is a policy promoted by Germany that results from the choice of protecting bank book capital levels and banker bonuses under the Japanese Model for handling a bank solvency led financial crisis.

This choice puts the burden of the excess debt in the financial system on the real economy.  At best, this results in a never ending Japan-style economic slump.  At worst, this results in a depression and a rewriting of the social contract as the real economy is unable to generate enough capital to cover both the debt service burden and existing needs for reinvestment and social programs.

Regular readers know that there is an alternative to the Japanese Model that protects the real economy and does not require austerity or re-writing the social contract.  That choice is the Swedish Model under which the banks do what they are designed to do and recognize upfront the losses on the excess debt in the financial system.

Banks are able to do this because they can operate with low or negative book capital levels.  Their ongoing operations are supported by the combination of deposit insurance and access to central bank funding.  With deposit insurance, taxpayers become the silent equity partners while banks are rebuilding their book capital levels.

As reported by the Telegraph,
President Anibal Cavaco Silva called for urgent action to halt the “recessionary spiral”, warning Europe’s leaders that the current course had become “socially unsustainable”. 
In a speech to the nation, he said Portugal would “honour its international obligations”, but in the same breath called for a tough line with the European Union-International Monetary Fund Troika over the pace of fiscal tightening under Portugal’s €78bn (£63bn) loan package. “We have arguments, and we should use them firmly,” he said. 
“Fiscal austerity is leading to declining output and lower tax revenue. We must stop this vicious circle,” he said, cautioning the Troika that there would be no way out of the crisis until policy was set in the interests of the “Portuguese people” as well as foreign creditors.... 
Please re-read the highlighted text as Mr. Silva summarizes the argument that your humble blogger has been making.

Pursuing the Japanese Model, including fiscal austerity, does not work.

The Swedish Model balances the interests of the Portuguese people and foreign creditors.  Creditors take the losses they should take for extending too much credit.  The result of this write-down is the Portuguese people are left with debt that they can afford to repay.
Portugal’s jobless rate has risen from 13.7pc to 16.3pc over the past year, reaching 39pc for youth, even before the full impact of austerity hits....
Clearly, Portugal is in a severe recession that austerity would only make worse.  This in turn would decrease the ability of the Portuguese people to service any debt and increase the losses for the creditors.

The strategy with the best outcome for both the Portuguese people and the creditors is to forget about implementing austerity and rather write-down the debt.
“There are well-founded doubts over whether the distribution of sacrifice is just,” he said.... 
Popular anger is building over the over the Troika’s fiscal shock therapy, which will push up average income tax rates by 3.4 percentage points and bring in a plethora of surcharges and fees. It aims to cut the budget deficit to 4.5pc this year, largely through tax rises. 
Markets have so far brushed off worries that the country risks a Grecian vortex as austerity bites in earnest. ... 
“Investors are willing to give Portugal the benefit of the doubt right now, but the country still hangs in the balance,” said David Owen from Jefferies Fixed Income. 
“Our concern is that the fundamental economic situation is still getting worse. The European Central Bank’s policy is still too tight. They need to do quantitative easing and cut overnight rates below zero,” he said....
Adding austerity to a situation with deteriorating fundamentals in not a prescription for improvement.
Portugal has taken its medicine with stoicism until now, winning praise from the EU leaders for sticking to its bail-out terms. But Troika officials fear that “social cohesion” is fraying as the slump deepens. The country saw the biggest street protest this autumn since the end of the Salazar dictatorship.
As Ireland has shown, there is no benefit to stoicism as frankly Germany's leadership cares more about the book capital levels of its banks than the people of any debtor country.

Merkel rival threatens to upend Japanese Model media narrative

Since the beginning of the financial crisis, one of the most interesting developments has been the main stream media's unwillingness to critically assess the Japanese Model for handling a bank solvency led financial crisis.

Under the Japanese Model, bank book capital levels and banker bonuses are protected at all costs.  This implies adoption of a series of policies like austerity, bank bailouts and zero interest rates/quantitative easing that squarely place the burden of the excess debt in the financial system on the real economy.

There are predictable harmful consequences from adopting the Japanese Model.  These include the endless Japan-style economic slump that countries that adopt the Japanese Model experience.  In addition, there is the re-writing of the social contract by changing social programs under austerity.

Regular readers know that your humble blogger has been making the economic, political and social case for abandoning the Japanese Model and adopting the Swedish Model for handling a bank solvency led financial crisis.

Under the Swedish Model, banks are required to recognize upfront the losses on the excess debt in the financial system.  This protects the real economy and the social contract with its related programs as capital is not diverted to servicing the excess debt.

The Swedish Model also happens to be the policy choice that is supported by the design of our modern banking system.  Banks can continue to operate with low or negative book capital levels because of the combination of deposit insurance and access to central bank funding.

With deposit insurance, taxpayers become the banks' silent equity partner when the banks have low or negative book capital levels.

According to a column in the Guardian, Mrs. Merkel's challenger for the position of German Chancellor is threatening to upend the Japanese Model media narrative by pointing out all the harmful consequences of the policy choices.

This effectively puts Mrs. Merkel in the position of defending the indefensible (the Japanese Model has harmful consequences and has never been shown to be successful while the Swedish Model has no bad consequences, unless you consider a drop in banker bonuses bad, and has been successful where ever it has been implemented).

This also puts the mainstream media in the position of having to critically assess ongoing choice to pursue the Japanese Model when the Swedish Model could be adopted.

2013 is now upon us and when it comes to German politics it is already clear what the climax of this year will be: the federal elections in September. As 2012 drew to a close, the election campaign was already well under way. 
But rather than focusing on the policies needed to overcome the many issues Europe faces, the focus has been on Peer Steinbrück, Angela Merkel's social democratic challenger. And given the general lack of scrutiny of Merkel's politics one cannot help but feel that large parts of the German media landscape have a much too cosy relationship with the incumbent chancellor.... 
Whether you agree with all of Steinbrück's positions or not, he has two important qualities that are in short supply in the current climate: he is competent and honest. 
A former finance minister whose political stewardship during the financial crisis was widely praised even beyond the borders of Germany, he has for instance published a significant paper on reforming the financial sector.... He has recently also urged that eurozone crisis countries should be allowed more time to get their economies back on track and has also made comments against excessive austerity: a bold move in the current German political climate. 
Steinbrück is also right to accuse Merkel the of not having communicated the real nature of the European crisis: she continues to talk about a sovereign debt crisis even though, apart from Greece, the real macro-economic instability originated in the private sector. 
And she looks set to continue down this path. In her new year address she warned German citizens about difficult economic times in 2013, conveniently without mentioning her own role in bringing these economic risks about.... 
With exceptions such as Wolfgang Münchau of the Financial Times and Spiegel Online, the German media have failed to scrutinise these major mistakes in Merkel's politics, even though we are now entering the fourth crisis year and the situation has only calmed down because of bold action by the ECB.... 
Instead of doing the job of educating the public, most German media outlets seemingly prefer to engage in ad hominem attacks against her social democratic challenger. This, to my mind, is also why the majority of Germans still believe that Angela Merkel is doing a good job in European politics. 
Neither the government nor the German media have properly explained the real issues we face. Often, when I explain the alternative crisis view to one of my compatriots I get asked why this is not discussed more prominently in Germany. This is a good question for which I have no answer. 
But this is also a shortcoming that can be rectified this year. Election years are years of debate and political alternatives. Peer Steinbrück is the right man to challenge Merkel's crisis narrative and take this debate in a more constructive direction. 
And if the German media start to join in and scrutinise the real issues at hand, we are in for a very interesting election year.

Sunday, December 30, 2012

Merkel says eurozone sovereign debt crisis far from over

Reuters reports that in her New Year's address, German Chancellor Angela Merkel will say that the eurozone sovereign debt crisis is far from over.

Regular readers know this is true and that the sovereign debt crisis will remain far from over so long as the Germans continue to pursue and insist that the rest of the eurozone pursues the Japanese Model for handling a bank solvency led financial crisis.

Until such time as the banks do what they are designed to do and recognize all the losses on the excess debt in the financial system, the eurozone sovereign debt crisis will not end.

Modern banks, like those in the eurozone, are designed to continue operating with low or negative book capital levels because of the combination of deposit insurance and access to central bank funding. With deposit insurance, the taxpayers become the silent equity partner when the bank has low or negative book capital levels.

The euro zone sovereign debt crisis is far from over even though reform measures designed to address the roots of the problem are beginning to bear fruit, German Chancellor Angela Merkel has said in her New Year's address. 
Actually, the eurozone has yet to adopt a reform measure that addresses the roots of the problem.  The roots of the problem are opacity in the financial system and the related inability of market participants to figure out what is going on.
In a taped interview to be broadcast on Monday evening, Merkel urged Germans to be more patient even though the euro zone crisis has already dragged on for three years.
The Japanese have been patient for 2+ decades and have yet to see a positive result from pursuing the Japanese Model and protecting bank book capital levels and banker bonuses at all costs.

Perhaps it is not patience that is required, but rather a new approach.

Fortunately, there is another approach that has been successful at dealing with bank solvency led financial crises:  the Swedish Model.

Under the Swedish Model, banks are required to recognize upfront the losses on the excess debt in the financial system.  By not placing the burden of servicing this excess debt on the real economy, the Swedish Model protects the real economy and the social contract.
She drew a line linking German prosperity to a prosperous European Union.
"For our prosperity and our solidarity we need to strike the right balance," Merkel said. "The European sovereign debt crisis shows how important this balance is.
"The reforms that we've introduced are beginning to have an impact," she said. 
Yes, they have plunged Greece and Spain into a depression.  All the other eurozone countries that are adopting austerity are also seeing their recessions worsen.
"Nevertheless we need to have further continued patience. The crisis is far from over."
Merkel indirectly contradicted Finance Minister Wolfgang Schaeuble with those comments. In an interview on Friday in Bild newspaper Schaeuble said the worst of the crisis was over....
Mr. Schaeuble's comments were made after it was disclose by Der Spiegel that his ministry is looking at how to impose austerity on Germany as its tax revenue drops as a result of the deepening recession in the rest of the eurozone brought on by Germany's insistence on imposing the Japanese Model.

Rival to German Chancellor says austerity measures too severe

Reuters reports that a rival to Angela Merkel has said that the austerity measures being required of the eurozone peripheral countries are too severe.

Regular readers know that the austerity measures are the result of adopting the Japanese Model for handling a bank solvency led financial crisis and protecting bank book capital levels and banker bonuses at all costs.

By attacking austerity that has turned a recession into a depression in the eurozone peripheral countries, the rival has put the Chancellor in the position of having to defend the indefensible.

I call defending the Japanese Model and any of the policies that result from it indefensible because there is an alternative that has been shown to work everyplace it has been tried:  the Swedish Model.

Under the Swedish Model, banks are required to recognize upfront the losses on the excess debt in the financial system.  By recognizing the losses, the debt service associated with this excess debt is not placed on the real economy where it diverts capital from reinvestment and social programs.  This preserves the real economy and the social contract.

Former German Finance Minister Peer Steinbrueck, who is running against Chancellor Angela Merkel in next year's election, said austerity measures being imposed on struggling euro zone countries were too severe. 
In an interview with the Frankfurter Allgemeine Sonntagszeitung (FAS), Steinbrueck said austerity measures were pushing some countries to do too much too soon. He said there would be massive protests in Germany if such a heavy dose of austerity were to be imposed so quickly. 
"The savings measures are too severe, they're leading to depression," said Steinbrueck, 65, a Social Democrat (SPD) who was finance minister from 2005 to 2009 in Merkel's right-centre grand coalition government. 
"Some societies are being forced to their knees. Budget consolidation is in some ways like medicine. The right amount can save lives while too much can be lethal." 
Steinbrueck noted that some countries were being forced to make spending cuts that amounted to five percent of their gross domestic product (GDP). 
"In Germany that would amount to 150 billion euros (of spending to be cut)," Steinbrueck said. "You can imagine what the protests would be like on German streets with that." 

Wednesday, December 26, 2012

Germany: the next victim of the Japanese Model as plans for austerity made

As reported by Der Spiegel, the German government is making plans to adopt austerity as it is about to fall victim of the Japanese Model for handling a bank solvency led financial crisis.

Under the Japanese Model, bank book capital levels and banker bonuses are protected at all costs.

What this means in practical terms is that rather than banks recognizing the losses on the excess debt in the financial system, the burden of the excess debt is placed on the real economy.  This diverts capital that is needed for growth and reinvestment to debt service and shrinks the real economy.

The German government has aggressively pursued implementation of the Japanese Model throughout the eurozone following the beginning of the financial crisis in 2007.  It has done so to protect the German banks who hold a significant amount of this excess debt.

Unfortunately, this policy has now caught up to Germany.

Germany has an export oriented economy.  With the rest of the eurozone mired in a Japan-style economic slump from the forced adoption of the Japanese Model, there is less demand for German goods.  The result is a decline in the German economy.

A decline that the German government is planning on making worse by adopting austerity.  By design, austerity reduces government funded demand in the economy.  This should hasten the pace at which German slides into a recession.

Of course, all of this is easily avoidable by adopting the Swedish Model and requiring the banks to recognize upfront their losses on all the excess debt in the financial system.

The question that Germany's government faces is whether it should protect its citizens or continue to protect banker bonuses.
The German government and opposition are pledging higher benefits for pensioners, families and the long-term unemployed ahead of elections next year, but Finance Minister Wolfgang Schäuble is secretly planning cutbacks to prepare for a weakening economy and possible fallout from the euro crisis. 
German Finance Minister Wolfgang Schäuble has an inimitable way of misleading his listeners with a torrent of obfuscating words. 
This torrent of obfuscating words is a useful skill to have in politics as it allows the speaker to say something that implies support of one idea when it fact the speaker is in complete opposition to the idea.
When asked if the Greek bailout would cost more money, he responded: "Not necessarily," adding that there was merely "a greater financial requirement on the timeline."
Of course, Greece is going to require more funds. Its debt has not yet be written down to a level that it can afford.
It could soon be a similar story with yet another gem from Schäuble's repertoire of quotations. "Germany is clearly a gainer from the euro," as the minister likes to say. But if what his team has been writing over the past few weeks is true, Germans will soon find that their presumed winnings have transformed into losses. 
The government in Berlin is living in a dual reality. Strategists in the center-right coaliton parties are planning to enhance benefits for families, pensioners and the long-term unemployed in a bid to woo voters in the upcoming elections. 
By contrast, due to the economic slowdown, experts in Schäuble's ministry are anticipating an entirely different scenario: The next government -- no matter who will be chancellor and which parties will be in power -- won't be able to boost spending. Instead, it will have to impose rigorous spending restraint.
Austerity comes to Germany.
According to the recommendations made by Schäuble's team, in order to brace itself for the consequences of the euro crisis, Germany will have to drastically increase taxes and make painful cuts in social services over the coming years.
Why?  To protect the banks and banker bonuses.
These ideas don't fit with the current political climate in Germany, which has been characterized for months by a passionate debate about how additional money could be used to combat poverty among the elderly and improve life for low-wage earners. 
Schäuble nevertheless feels that his experts' forecasts are realistic. He has expressly approved their proposals and ordered them to continue to work on the cost-cutting program....
A cost cutting program that will undermine the social contract in Germany in the same way that the social contract is being undermined across the eurozone and US.
The Germans face a bitter déjà vu. It was only 10 years ago that then-Chancellor Gerhard Schröder of the center-left Social Democrats (SPD) and his conservative challenger Edmund Stoiber fought an election campaign that was primarily focused on social justice. After Schröder's victory, it became clear that Germany was strapped for cash. 
Subsequently, the chancellor introduced his radical -- and widely unpopular -- "Agenda 2010" reforms of the labor market and welfare system. This time, Schäuble's team has calculated that even deeper cuts may be needed.
No matter how deep the cuts are they will be insufficient.  The real economy is unable to support all of the excess debt and continue to grow.
What the Finance Ministry officials have listed under the seemingly innocuous title "Medium-Term Budget Goals of the Federal Government" is nothing less than the most comprehensive austerity program in postwar German history. In order to avoid forcing the government to incur additional debt, the officials are scrutinizing subsidies, entitlements and welfare benefits worth tens of billions of euros.
There are also plans to raise taxes. ... 
Schäuble's team wants to slash €10 billion from the federal government's contributions to the German health fund, which currently helps to stabilize premiums in the statutory health insurance system. ... 
The plan also calls for state pension funds to do their part. ...
It still won't be enough and look at how massively the social contract is being rewritten rather than have the banks absorb the losses and protect the real economy as they are designed to do.

This is an important point.  All of the rewriting of the social contract is being caused by government policy makers refusing to have banks perform as designed.

Banks are designed to continue operating and supporting the real economy even when they have low or negative book capital levels.  Banks are able to do this because of the combination of deposit insurance and access to central bank funding.

When banks have low or negative book capital levels, through deposit insurance the taxpayers effectively become the banks' silent equity partners.  It is the existence of the silent equity partners that allow the banks to continue operating.

Of course, if the banks recognize the losses on the excess debt, this means that banker cash bonuses will be reduced until such time as the banks have managed to rebuild their book capital levels.
Widows and widowers would also have to tighten their belts. Currently, the surviving spouse receives 55 percent of the deceased spouse's pension. The idea is to significantly reduce this level in the future. This initiative would annually save billions of euros for the state pension fund.
And someone in the German government thinks this is better than requiring the banks to recognize their losses.  Unbelievable!
Finance Ministry officials see additional cutbacks in social services as unavoidable if the state is to spend more money in other areas, for example, on repairing roads and improving the education system. These investments would "entail stronger limitations on consumptive expenditure," as it says in the draft paper. 
Of course, there would be plenty of money for both social services and repairing roads and improving the education system if needed capital were not be diverting from the real economy to support excess debt that the banks should absorb the losses on.
The proposals from Schäuble's ministry serve to tighten a regulation that has only been enshrined in the German constitution for the past few years: the so-called debt brake, which calls for the German federal government to "maintain a nearly balanced budget" starting in 2016. 
The government will still be able to take out loans to some extent. In 2016, for instance, it will be allowed to borrow some €10 billion. However, Schäuble and his staff say that Germany should not completely exhaust this scope for borrowing. They want a safety buffer. 
"It is absolutely necessary to maintain sufficient distance to the constitutional limit during budget planning to prepare for unexpected structural expenditure and revenue developments," it says in the paper.
The debt brake is a paid idea on par with pursuing the Japanese Model despite overwhelming evidence that it doesn't work (see Japan and its lost 2+ decades).

Since the Great Depression, government programs under the social contract have been designed to expand, think unemployment insurance payments, when economies have downturns.  By definition, governments will not be able to run a nearly balanced budget during a recession as at the time the government social programs are expanding the tax revenue will drop.
The experts also note that they intend to safeguard the national budget against a series of risks. 
One of the examples that they cite is "a sharp economic downturn." If the economy collapses, as it did in the wake of the financial crisis in 2009, experience has shown that public coffers come under considerable pressure. Tax revenues decline while expenditures, such as for the unemployed, massively increase. 
This can have a devastating impact on state finances. Following the most recent recession, government debt soared from 65 to nearly 83 percent of gross domestic product (GDP). 
Schäuble's experts say that the country cannot withstand another similar increase in public debt and conclude that it's time to take appropriate countermeasures. 
To make matters worse, Finance Ministry officials say that it's also possible that Berlin will have to absorb the costs of its bank bailouts. 
At the height of the financial crisis, the German government supported ailing financial institutions such as Hypo Real Estate, Commerzbank and WestLB with capital injections and guarantees amounting to nearly €180 billion. Large quantities of toxic assets were transferred to so-called "bad banks." 
But it's questionable whether these banks will ever be able to completely pay back this money. If that is the case, the federal government will have to waive its claims and permanently absorb the debt.
Again, the solution lies in having the banks absorb the losses on all the bad debt.
Schäuble's team foresees the possibility of a similar development with the euro rescue. 
Indeed, "irrevocable ESM payment defaults" is one of the reasons they list for their contingency plans. Behind the bureaucratic jargon lies the concern that Germany -- despite the government's solemn statements to the contrary -- will have to pay for the euro rescue. 
Germany is currently supporting the European Stability Mechanism (ESM) to the tune of at least €190 billion. A portion of these guarantees and loans could actually be lost if Greece's government creditors forgive some of the country's debt. The losses to German public coffers could then easily amount to tens of billions of euros.
Again, push the losses back on to the banks that are designed to absorb it without putting the burden for paying for these losses on the taxpayers.
Consequently, Finance Ministry officials contend that the government will have to make cutbacks elsewhere in the future. Now, in a scenario that euroskeptics have long been warning about, German Chancellor Angela Merkel's government has finally admitted, for the first time, that to balance out the impact of the monetary crisis it will have to reduce expenditure for pensioners and people taking early retirement.
So pursuit of the Japanese Model and protecting bank book capital levels and banker bonuses has finally come back to haunt the German taxpayer.
The paper by the Finance Ministry officials contains a further admission. The next finance minister will have to make up for what Schäuble has failed to accomplish. 
Merkel's most important minister forced half of Europe to submit to austerity measures while the Germans were spending money hand over fist at home....
Correct, Germany pursued the Japanese Model when it should have been pursuing the Swedish Model and requiring the banks to absorb their losses.

Had the German government done so, the real economy would have been protected and with it all of the social programs.
And, in keeping with his style, he is carefully preparing the Germans for hard times with his signature inscrutable Schäuble-speak: "We cannot allow ourselves to believe that the current positive situation is automatically secured for the future," he says. 
He goes on to say that sound public finances are "not a notion created by stubborn finance ministers, but rather the prerequisite for prosperity and social security." In plain language: Germany is going to start subjecting itself to some iron fiscal discipline.
In short, rather than admit the mistake of pursuing the Japanese Model and adopting the Swedish Model, the German government would rather rewrite the social contract to the detriment of Germany's citizens.

Thursday, December 20, 2012

Deutsche Bank becoming poster child for scandals

In a must read article, Der Spiegel looks at how Deutsche Bank's reputation lies in ruin as it slowly slides into a swamp of scandal.
Deutsche Bank was once Germany's proudest financial institution. Now, though, the giant is facing myriad investigations, legal troubles, scandals and accusations of malfeasance. Its current leadership has pledged a new beginning, but several executives are tainted as well.
This summary understates what is happening at the bank.

On one hand, the raid was a show of strength. But on the other, it exposed the public prosecutor's weakness in the face of Deutsche Bank, one of the world's largest financial institutions. 
The bank has long been an absolute symbol of the German economy, one that shaped much of the economic activity in the country and whose advice was in demand by those at the highest levels of government. Yet it was being treated like a criminal gang. 
The bank stands accused of tax evasion in conjunction with the trading of emissions certificates, but also of failure to report money laundering and of obstruction of justice -- hardly trifling matters, in other words. Nevertheless, the severity of the authorities' approach comes as a surprise, suggesting that the judiciary might be losing patience with Deutsche Bank. 
Yet the case is also notable for the persons involved: In addition to co-CEO Fitschen, Chief Financial Officer Stefan Krause and two executive board members are likewise among the accused....

It's a bitter irony that Fitschen, of all people, is now under investigation. A native of northern Germany, he ran the bank's corporate banking division for many years, and he is viewed as a respectable, classic German banker, one who represents Deutsche Bank's traditional virtues. 
This reputation is precisely why the supervisory board made him co-CEO with Jain, who had led the bank's investment banking operations. The board was unwilling to entrust management of a bank with more than 100,000 employees in over 70 countries, and with more than 20 million customers, entirely to Jain. 
Together, the duo was to regain what Deutsche Bank had gambled away in the years since the financial crisis: the trust of customers and of the public. 
Years ago, the bank used the slogan "Everything starts with trust" in its advertising. If this is true, then it can also be argued that lost trust is the beginning of the end. And the recent slew of scandalous headlines emanating from Deutsche Bank suggests that ground is being lost.
In the financial markets, trusts begins with disclosure.  Specifically, disclosure of all useful, relevant information in an appropriate, timely manner so that market participants can assess this information and make a fully informed investment decision.

Why is disclosure the foundation for trust?

Market participants trust their own independent assessment of the information.

It is well known that banks, including Deutsche Bank, are in the words of the Bank of England's Andrew Haldane 'black boxes'.  They fail to disclose all the useful, relevant information in an appropriate, timely manner.

Not surprisingly, once market participants realized at the beginning of the financial crisis that they could not independently assess the banks, trust in banks evaporated.
Indeed, since Jain and Fitschen took office in June, hardly a month has gone by -- at times, hardly a week -- without new accusations against the scandal-plagued bank becoming public. 
And armies of attorneys are now dealing with the many trials and investigations currently pending -- legal proceedings which present a financial risk to the bank which almost certainly amounts to several billion euros....
In addition, the company has been accused of involvement in the LIBOR affair, which saw several international banks collude to manipulate the key global interest rate. And Deutsche Bank is under investigation for having manipulated its books to hide liabilities so as to avoid having to be bailed out by the German government during the height of the financial crisis. It is also involved in myriad lawsuits relating to its treatment of investors during the crisis.
All of these scandals relate to actions taken by bankers behind the veil of opacity provided by the lack of disclosure.
Dealing with all the scandals costs the bank money, effort and credibility, at a time when Deutsche Bank is in worse shape than it's been in a long time. Profits are coming under pressure, and lawmakers are threatening to impose stricter regulation on banks. ... 
In their effort to stop this decline, Jain and Fitschen prescribed a drastic change in the bank's corporate culture when they took office last summer. For months, they have been proclaiming the new Deutsche Bank's message everywhere, a message that promises nothing short of a renewal. From now on, Deutsche Bank will never lose sight of its customers and will no longer pursue any deal that can make it money.
"We have opened a new chapter in the development of our bank," Supervisory Board Chairman Paul Achleitner wrote in a letter to employees in late June. He called for the cultural change needed to "reestablish the bank's reputation as the cornerstone of a modern society." 
The letter, unfortunately, coincided with allegations that employees of Deutsche Bank and other large multi-national financial institutions had manipulated the LIBOR key interest rate. 
Bank representatives stress that the LIBOR scandal and other such transgressions are all legacies from a different era. But each new scandal raises the question as to whether Fitschen and Jain are not in fact part of that past era -- and whether it isn't time for Deutsche Bank to embark on yet another new beginning....
Until they are willing to step out from behind the veil of opacity, there is no reason to believe anything has changed.
In its investigative report on the causes of the financial crisis, the United States Senate singles out only two banks whose dealings with toxic securities it believes played a "key role in the financial crisis": Goldman Sachs and Deutsche Bank. 
These questionable transactions are increasingly coming home to roost. The Frankfurt bank faces multiple lawsuits in the United States, brought by a Dutch pension fund, insurances companies and other banks. Some want their invested money back, while others are suing for damages. Here too the bank could be looking at billions in liabilities. 
The charges are always the same, and the word "fraud" appears almost everywhere: The bank stands accused of lying, swindling and cheating in conjunction with billions in real estate loan transactions. It is said to have cheated its customers while lining its own pockets. And it stands accused of having gambled more recklessly and exhibited less moral responsibility than many other financial institutions....
Opacity was not limited to the banks themselves, but extended to the products that they sold.

For example, these suits involve Deutsche Bank's involvement with opaque, toxic sub-prime mortgage backed securities.

Securities that would not have been opaque if they had provided the investors with observable event based reporting rather than out of date data once per month.
This summer, a company headquartered in Ireland filed a lawsuit against Deutsche Bank in a court in New York. The company, Sealink Funding, accuses the bank of fraud. 
The case is especially interesting, because the eastern German state of Saxony is ultimately behind the lawsuit. German taxpayer money is at stake, as is one of the biggest German scandals in the financial crisis: the near bankruptcy of Sachsen LB, the savings bank partly owned by Saxony. According to the complaint, Deutsche Bank bears a considerable share of the blame for the disaster. 
In the years before the financial crisis, Sachsen LB, hoping to become a big player in the market for mortgage-backed securities, established a subsidiary in Ireland. The consequences were catastrophic, and in the end the bank lost billions, bank executives were sued and politicians were driven out of office. In late 2007, Sachsen LB had to be rescued through an emergency sale to another state-owned bank, Landesbank Baden-Württemberg. 
But the toxic securities that had triggered the drama in the first place were excluded from the deal and spun off into a company for which the government is now liable: Sealink. 
The state of Saxony is still liable for up to €2.75 billion. So far more than €400 million in guarantee payments have come due. In the first nine months of 2012 alone, the state had to reimburse Sealink for €150 million in losses. 
Sealink's complaint now discloses the source of a substantial portion of the securities that brought down Sachsen LB: Deutsche Bank. The Frankfurt bank sold Sachsen LB's special-purpose vehicles about €960 million in residential mortgage-backed securities in 2006 and 2007 alone. 
The decision to invest in the securities was "made to a substantial degree because of the role of Deutsche Bank," according to the bank. In other words, the investors were confident that the securities were sound, because Germany's largest bank was involved.  
In reality, the securities were "of poor quality, and Deutsche Bank knew it." Even worse, it intentionally "created a false impression." The bank's behavior was "blatant fraud."...
The suit comes down to we trusted Deutsche Bank because all the useful, relevant information was not available in an appropriate, timely manner.
There is no doubt that the estrangement between politicians and Deutsche Bank grows with each new scandal. Commenting on the ruthless approach prosecutors took last week, Social Democratic Party Chairman Sigmar Gabriel says that it was "a really good sign that the prosecutors are conducting their investigation without regard for the reputation or rank of individuals." According to Gabriel, it's important to show banks that "they are mistaken if they believe that they are above the law." 
Green Party Chairman Jürgen Trittin, who could become finance minister should the SPD and Green Party be able to oust Chancellor Merkel in next year's elections, also had harsh words for top management. "Deutsche Bank has always prided itself on not having accepted any government aid. Now the public prosecutor's office is helping it disclose possible criminal practices." 
According to Trittin, Fitschen and Jain have failed so far in their effort to initiate change. "A fish rots from the head down. The same thing applies to the executive floor at Deutsche Bank." 
The bank is deeply resentful over the attacks from Berlin. Executives say that the same politicians who normally ask the investment bankers for help at every opportunity are now turning around and attacking them publicly. When politicians need advice on the euro crisis or debt repurchase programs for Greece, say bank officials, Deutsche Bank is indispensable....
Actually, Deutsche Bank is dispensable.

The advice that it provided politicians was most likely in its own best interest as the advice was to adopt the Japanese Model and protect bank book capital levels and banker bonuses at all costs.  This included adopting policies like bailing out the banks.

The alternative was well known.  It was to adopt the Swedish Model and require the banks to absorb upfront the losses on all the excesses in the financial system.  This would have protected the real economy and dramatically reduced banker bonuses.

Friday, December 14, 2012

EU seeks plan to handle failing banks without costing taxpayers money

Bloomberg reports that lead by German Chancellor Angela Merkel, the EU is looking for how to handle failing banks without costing the taxpayers any money.

Regular readers know that a modern banking system is designed to handle failing banks without costing taxpayers any money.

A bank "fails" when it becomes insolvent and the market value of its assets is less than the book value of its liabilities.

However, just because a bank is insolvent doesn't mean that the bank has to stop operating and supporting the real economy.  Modern banks are designed to operate and support the real economy even when they are insolvent.

How can banks that fail stay in business?

The combination of deposit insurance and access to central bank funding let banks stay in business even when they have failed and are insolvent.  When banks are insolvent or have either low or negative book capital levels, deposit insurance effectively makes the taxpayers the banks' silent equity partner.

As a result, the only market participant who can close a failed bank is its regulator.

Under what condition should a failed bank be allowed to continue to operate and support the real economy?

So long as the bank can continue to generate earnings, it should be allowed to continue to operate.  100% of these earnings before banker bonuses are retained and used to rebuild the bank book capital level and reduce the taxpayers' exposure to the bank.

To prevent the bank's managers from gambling on redemption, the bank must provide ultra transparency and disclose on an ongoing basis its current global asset, liability and off-balance sheet exposure details.  With this information, market participants and regulators can exert discipline to restrain the banks risk taking.

Under what condition should a failed bank be resolved?

When it cannot generate earnings for its core banking franchise.

But doesn't this mean that the taxpayer is on the hook for the losses when this bank is resolved?

No, the industry is on the hook for the losses.  The industry pays for deposit insurance.  The cost of deposit insurance increases to cover these losses.

So the answer to the question of who pays for all the losses on the legacy assets is first, the bank that holds these assets if they have a franchise that lets them generate earnings and second, the banking industry through higher assessments on their deposit insurance.

European Union chiefs pledged to seek a joint strategy for handling failing banks as German Chancellor Angela Merkel demanded taxpayers be spared the costs. 
Leaders agreed to start work next year on a single resolution mechanism for euro-area banks to complement the European Central Bank oversight role approved yesterday by European finance chiefs. Lenders should underwrite financial stability by repaying governments as needed, EU leaders said. 
Resolution “may not be at the cost of the taxpayers, but has to be structured so that those responsible for the failures of the banks carry the burden,” Merkel told reporters at 2:15 a.m. after nine hours of talks in Brussels. 
Bolstering confidence in banks is a key component of policy makers’ effort to defeat the debt crisis that has rattled markets since late 2009. They must decide how to handle existing bank weakness as well as future failures that emerge after the ECB takes on its oversight duties. In the first half of 2013, they will seek a deal on the terms of allowing the EU’s 500 billion-euro ($656 billion) rescue fund to provide direct aid to banks. 
“We made progress” on a resolution mechanism, said ECB President Mario Draghi. He pressed government leaders to confront how they will handle banking woes that spread across borders and exacerbate financial crises.....