With passing grades on their stress tests assured, big banks look to make mockery of capital regulations with big payout

Bloomberg reports that the Too Big to Fail US banks are preparing to unleash a tsunami of dividends and stock buybacks with the announcement by the Fed that they have once again passed a meaningless stress test.

The Dodd-Frank Act mandates annual stress tests to reassure the market that the moral obligation to bailout the banks is still in place.

Each year, the Fed recognizes that the safety and soundness of the financial system requires that it say the banks are adequately capitalized.  Naturally, the Fed sticks to this script even if the reality of the losses hidden on and off the bank balance sheet suggests otherwise.

By sticking to the script, the Fed obligates the US Treasury to bailout the banks should they encounter any solvency problems.  This obligation occurs because it is hard to stick investors with solvency related losses after the Fed has effectively recommended the banks as an investment.

Regular readers know that FDR specifically pointed out that the role of government is to never make an investment recommendation as doing so creates a moral obligation to bailout the investor.  Rather, it is the role of government to ensure that all the useful, relevant information is made available in an appropriate, timely manner.  Investors have an incentive to use this information as they are responsible for all losses on their investments.

Naturally, under the Geithner Doctrine (nothing should be done that would hurt the profits or reputation of a big or politically connected bank), the US government adopted incurring the moral obligation.  With this obligation, the government improves the profitability and reputation of the banks.

This year, the banks are turning their guns on making a mockery of bank capital regulations.  Having gamed the system to show high levels of capital, the banks are set to engage in massive payouts to shareholders.

The six largest U.S. banks may return almost $41 billion to investors in the next 12 months, the most since 2007, as regulators conclude firms have amassed enough capital to withstand another economic shock.....

The highlighted text nicely summarizes one of the most important failures in the response to the financial crisis.

Regulators are offering their opinion on whether the banks have enough capital or not to withstand another economic shock.

Please recall that these are the same regulators who missed the financial crisis.

Were it not for the moral obligation, actually it is more than that since then Treasury Secretary Tim Geithner pledged the full faith and credit of the US to supply the banks with all the capital they need, there would be no reason to bet on what is inside the black box banks.

However, with the downside eliminated by the US government, no reason not to gamble....

“You’ve gone from a few years ago, when the industry as a whole didn’t have enough capital, to the point where in the not- too-distant future, it’s going to have too much,” Jason Goldberg, a New York-based banking analyst at Barclays Plc, said in a telephone interview. The Fed’s endorsement is “a Good Housekeeping seal of approval.”

A seal of approval that FDR would say should never under any circumstances be provided by the government as it creates the obligation for the government to absorb the investors' losses.

Most troubling aspect of Standard Chartered's Iran scandal is Peter Sands advised UK government to bailout banks

The Telegraph reported on the possibility of Standard Chartered having its $190 billion dollar clearing operation in New York closed as a result of what the New York State Department of Financial Services  said was its intentional violation of US money laundering laws.

Naturally, Standard Chartered is saying it didn't do what it is accused of doing and if it did the number of transactions involved was a fraction of what the NY authorities claimed.  Which is not much of an excuse given that zero transactions could have been easily achieved.

To me, the most troubling aspect of this scandal is not that it occurred.

Since the beginning of the financial crisis, we have discovered that every large global financial institution has had a culture that permitted, some might say, encouraged bad behavior.  This is just another unsavory example.

As former Barclays CEO Bob Diamond said, culture is how you behave when no one is watching.  The fact that banks are wrapped in opacity means no one is watching and bankers had and have the opportunity to behave badly.

To me, the most troubling aspect of this scandal is that the UK government turned to the head of Standard Chartered, Peter Sands, for advice and as a result implemented a bailout of the banks.

Regular readers know that in a modern banking system, banks do not have to be bailed out.  Deposit guarantees and access to central bank funding allow banks to operate with negative book capital levels. As a result of the deposit guarantees, taxpayers are banks' silent equity partner when the bank has negative book capital levels.

Banks are designed to absorb the losses on the excesses in the financial system and protect the real economy.

With Standard Chartered's Iran scandal have we finally run out of bankers the UK government will take advice from that recommend bailouts over requiring the banks to recognize their losses and provide ultra transparency to confirm the fact?

Standard Chartered could be expelled from Wall Street amid explosive allegations that for 10 years the bank “schemed” to bypass American anti-money laundering sanctions and process $250bn (£160bn) of transactions on behalf of Iranian clients. 

New York’s top financial regulator has claimed that “flagrantly deceptive actions” by the British bank left the US “vulnerable to terrorists, weapons dealers, drug kingpins and corrupt regimes”. 

In a devastating 27-page order Benjamin Lawsky, superintendent of the New York State Department of Financial Services, claims that Standard Chartered Bank (SCB) “operated as a rogue institution” – and that the bank’s group directors in London were complicit. 

In October 2006, the head of the bank’s American operations “sent a panicked message to the group executive director in London” saying that the bank’s handling of Iranian clients could cause “catastrophic reputational damage”. The unnamed director allegedly replied: “You f****** Americans. Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians.” 

The order ... claims: “Motivated by greed, SCB acted for at least 10 years without any regard for the legal, reputational, and national security consequences of its flagrantly deceptive actions. 

Lord Davies, the former Labour minister, was chief executive of Standard Chartered between 2001 and 2006. The current chief executive, Peter Sands, was promoted to the top job from finance director in November 2006. Mr Sands, one of Britain’s most respected bankers, was credited with masterminding the “Balti bail-out” that shored up the financial system at the apex of the crisis in 2008.

Update
The Wall Street Journal focused on the hit to both Standard Chartered's and Peter Sands' reputation and the simple fact that shutting down the dollar clearing operation would have very negative consequences for the bank.

In the U.K., Mr. Sands has long been heralded as a voice of reason in the country's turbulent banking sector. The former consultant, who was named Standard Chartered CEO in 2006, regularly espoused the importance of sound governance and sensible investment. 

While several of its British peers were being bailed out by taxpayers, Mr. Sands was guiding the Asia-focused bank to record profits boosted by growing trade between emerging nations. The executive stressed the fact that Standard Chartered doesn't have an investment bank and didn't need European Central Bank cheap loans to keep its business ticking over. 

As a result, Mr. Sands is one of the few top British bankers to see his stock rise in the past decade.... 

At this stage, few analysts expect the allegations to have any bearing on Mr. Sands's job. 

However, some wonder why Standard Chartered was taken so flat-footed by the report. "It's not going to be helpful that the management team was basking in the glory saying that they weren't hit by compliance scandals," said Gary Greenwood at Shore Capital. "It doesn't look good as they probably ought to have known this was going on." 

When asked by reporters about the U.S. investigation last week, Mr. Sands played down its importance. 

The New York State Department of Financial Services on Monday threatened to revoke the license of Standard Chartered Bank, a U.S. unit of the U.K. bank located in midtown Manhattan. 

Standard Chartered's U.S. dollar clearing business is the seventh largest in the world, according to Deutsche Bank. Standard Chartered has positioned itself as a facilitator of trade between Western and emerging nations, so being able to offer this service is critical, analysts say. 

However, the bank can easily afford the fine, said Mr. Greenwood.  The real cost, he said, is to the management's reputation.

Bob Diamond confesses: Barclays falsified Libor to protect bank during crisis

As reported by the Telegraph's Harry Wilson,

Barclays chief executive Bob Diamond has admitted for the first time that the bank made a conscious decision to falsify Libor rates in order to protect the bank at the height of the financial crisis. 

The revelation in a letter to the Treasury Select Committee will put increasing pressure on Mr Diamond to reveal whether the decision was taken at board level. 

“Even taking account of the abnormal market conditions at the height of the financial crisis, and that the motivation was to protect the bank, not to influence the ultimate rate, I accept that the decision to lower submissions was wrong,” he stated. 

In the most detailed account so far on how the Libor rates were manipulated, Mr Diamond said fixing of Libor rates was carried out by individual trades and, separately, by the bank itself. 

He said traders attempted to influence the rate in order to benefit their own desks’ trading positions. The bank made the decision in order to protect shareholders’ interests, he said..... 

In the letter Mr Diamond appeared to try and defend elements of the practice by pointing the finger at other banks. 

Addressing the market turbulence at the height of the financial crisis he wrote: “The unwarranted speculation regarding Barclays’ liquidity was as a result of its LIBOR submissions being high relative to those of other banks. At the time, Barclays opinion was that those other banks’ submissions were too low given market circumstances.” 

He also said individuals within the bank raised concerns about Libor rates with authorities including the FSA, Bank of England and US Federal Reserve.

The simple fact is that neither Barclays nor any other bank should ever be put in a position where they can and have an incentive to lie about their financial condition.  At the same time, no financial regulator should ever be put in a position where it might appear that they either encourage or condone a bank lying about its financial condition.

The only way to prevent either of these from occurring in the future is to require all banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

With ultra transparency, market participants have the facts and lying would be for no benefit.

Did Bankia's depositors buying bonds require Spain to bailout bank?

Bloomberg carried an interesting article in which it presents the argument that Spain was on the hook for bailing out Bankia because its depositors were significant investors in its bonds.

This argument reflect one true and one fase assumption:

• True:  Spain has a moral obligation to protect investors; and

• False:  Maintaining positive book capital levels is necessary to prevent bank runs.

Spain has a moral obligation to protect investors that results from its information monopoly.  

If banks were required to provide ultra transparency and disclose on an ongoing basis their current asset, liability and off balance sheet exposure details, market participants would not be dependent on the government's assessment of the bank's solvency.  There would be no moral obligation as investors could use this disclosure and independently assess the solvency of the bank's for themselves.

However, since investors, unlike regulators, do not have access to ultra transparency, they are dependent on the the regulators to accurately assess this information and to report their findings.  This dependency creates the moral obligation.

Bank book capital is an accounting construct.  In a modern financial system with deposit guarantees and access to central bank funding, it can be positive or negative without effecting the bank's ability to operate and provide loans to the real economy.

As a result, there is no reason for governments to bailout the banks today.  The banks can simply rebuild their book capital levels through retention of future earnings.

Spain’s hands are tied with the rescue of Bankia (BKIA) because alternatives to injecting cash or government debt, such as forcing bond investors to bear the cost, risk hurting ordinary depositors.

Actually, the alternative of requiring the bank to recognize all of the losses hidden on and off its balance sheet today and provide ultra transparency does not risk hurting ordinary depositors.

Ordinary depositors are protected by deposit guarantees.  These guarantees are strengthened by the government not investing.  These guarantees are strengthened by the losses being recognized as the losses do not become a burden that crushes the real economy.

Bankia is among Spanish lenders that sold 22.4 billion euros ($28.2 billion) of preferred stock to individual investors through retail branches, according to data compiled by CNMV, the financial markets supervisor. 

In a so-called bail in, these investors would be wiped out before holders of more senior bonds, which tend to be banks and institutions.... 

“The sale of preferred stock to depositors means that almost the only option for the government now is injecting capital,” said Arturo Bris, a professor of finance at IMD business school in Laussanne, Switzerland. “A writedown of preferred shares placed with depositors would cause a social problem. It’s not really a feasible alternative.”...

The option of letting the bank rebuild its book capital level through retention of future earnings is still feasible.  It would avoid the social problem.

A taxpayer-funded bailout of Bankia would foist losses on a wider portion of society than making individual bondholders, many of them depositors, lose money....

A taxpayer-funded bailout would place the burden of the excess debt squarely on the real economy.  Everywhere this has been tried the result has been a long term economic decline.  As a result, this is not a viable option.

Fernando Herrero, the secretary general of ADICAE, a Madrid-based association of clients of financial institutions, estimated that about 1 million Spanish households bought banks’ preferred shares, some of which have been converted to common equity or subordinated convertible bonds.

“The instruments were marketed as very liquid and as safe as a deposit,” said Herrero, who described issuing the risky securities to individual investors as an “original sin.”

The bank was able to get away with this marketing because of the government's information monopoly.

If the bank had to provide ultra transparency, investors could have assessed the riskiness of the bank for themselves.  Since investors could not assess the risk of the bank, they had to trust what the government said about the bank.

Following the lead of the US, UK and EU, Spain jeopardizes financial system and real economy by lying

In a must read Bloomberg article, the problems with pursuing the Japanese model for handling a bank solvency led financial crisis are laid bare.  At the top of the list is lying about the true condition of the banking system.

Spanish banks are masking their full exposure to soured property loans while they continue to prop up insolvent “zombie” developers, leading to credit-rating downgrades and plummeting share prices. 

Spain is trying to clean up its banks, requiring lenders to set aside more for possible losses on loans deemed performing to developers likeMetrovacesa SA (MVC), which hasn’t completed a project in more than a year and has none under way. 

While that represents about 30 billion euros ($38 billion) of increased provisions, it’s not enough because many of the loans said to be performing aren’t, said Mikel Echavarren, chairman of Irea, a Madrid-based finance company specializing in real estate. 

“Spain has engaged in a policy of delay and pray,” Echavarren said in an interview. “The problem hasn’t been quantified by anyone because there is huge pressure not to tell the truth.”

Please re-read the highlighted text as it confirms why banks must be required to provide ultra transparence and disclose their current asset, liability and off-balance sheet exposure details.

Without requiring ultra transparency, banks, their financial regulators and their host governments will lie about the condition of the banks by allowing them to engage in 'extend and pretend' practices....

There is a significant cost to the real economy from this practice.

Many Spanish banks are avoiding property sales so they don’t have to make “mark to market” valuations. Instead, they’re giving developers new loans to pay debt coming due to prevent defaults, said Ruben Manso, an economist at Mansolivar & IAX and a former Bank of Spain inspector. 

“The larger banks have been selling bits and pieces and can absorb the losses,” Manso said. “Smaller savings banks are acting in bad faith in their refusal to allow transactions and saying they can’t mark to market because there isn’t one.”...

In an environment of regulatory forbearance, banks have a number of ways of avoiding recognition of the losses on and off their balance sheets.

“The Irish property market had to collapse like the Spanish one because the economy was collapsing,” Kelly said. “Spain is looking like a re-run.” 

More than half of Spain’s 67,000 developers can be categorized as “zombies,” according R.R. de Acuna & Asociados, a real-estate consulting firm. They have combined debt of 180 billion euros that will lead to 104 billion euros of losses that hasn’t been fully provisioned for, Acuna estimates. 

“They aren’t officially bankrupt because they have been refinanced time and time again,” Fernando Rodriguez de Acuna Martinez, a partner at the company, said by telephone. “Their assets are worth much less than their liabilities, they struggle to repay loans and they haven’t revaluated them to reflect today’s prices.”

Confirming why all the strategies that failed in Ireland will also fail in Spain.

The Bank of Spain allows loans that are refinanced before turning delinquent and interest-only loans to be considered “normal” or “performing” on banks’ books, according to Manso. 

“You won’t find that data anywhere,” Manso said. “There has been a lot of cheating going on where banks have lent developers new money, classed as new lending, so they can pay off their original loans.” That’s masking delinquency, he said.

This is an example of what banks can do when there is regulatory forbearance and banks are not required to provide ultra transparency.

Refinancing the current and future zombie developers will cost 30 billion euros over the next two years, according to Acuna. The depreciation of those developer assets from 2012 onwards will generate a further 20 billion euros of losses in that time, he said. 

The Bank of Spain doesn’t publish data on the amount of restructured developer loans or interest-only paying loans that are classed as normal. The bank closely monitors refinancing to ensure that arrears aren’t being hidden, said a spokeswoman for the Bank of Spain who declined to be identified.

Please re-read the highlighted text as this is a partial estimate of the cost to the real economy from not forcing the banks to recognize their losses.

[Echavarren] forecasts that the larger Spanish banks with income from international operations will be able to pay for domestic real-estate losses within two years. The rest can’t take such a hit and will have to be nationalized, he said.

Confirming again that the government should not bailout the banks but should instead allow the banks to rebuild their book equity through retention of future earnings.

“We cannot continue to jeopardize the whole financial system by not telling the truth,” Echavarren said.

Shockingly, the latest round of stress tests to show banks almost fully recovered

As the annual exercise of the US government guaranteeing all bank depositors, debt holders and equity investors for another year draws to an end, speculation grows that the Fed is going to announce that the results of its latest stress test show the banks are almost fully recovered from the financial crisis.

Regular readers know that the stress tests morally and intellectually bind the policy makers and the regulators to insuring that no bank depositor, debt holder or equity investor suffers a loss as a result of the insolvency of a bank.

This is the direct result of and inescapable conclusion from the simple fact that the stated purpose of the stress test is to discover if the banks are adequately capitalized (ie, solvent) in the face of difficult economic conditions and increased losses on their loan portfolios.

After all, how can the policy makers and regulators not step in and prevent bank depositors, debt holders and equity investors from suffering a loss after using the regulators' information monopoly to determine that the banks are solvent?

As for the meaningless results of the latest stress tests, a NY Times article provides more details on the expected conclusion.

In another milestone in the banking industry’s recovery from the financial crisis, the Federal Reserve this week will release the results of its latest stress tests, which are expected to show broadly improved balance sheets at most institutions.... 

Hence the US government guarantee!

Still, while unpleasant surprises are possible, analysts are counting on the Fed to find banks largely healthy....

Due to the fact that current bank disclosure leaves them as 'black boxes', analysts don't have access to the data necessary to disprove the Fed's findings.

More importantly, if analysts had access to the necessary data, analysts could run their own stress tests and the Fed would not have to announce the result of its stress test.  By not announcing the result, the Fed would end the explicit and implicit government guarantee.

After all, if analysts working for market participants can independently assess the risk of the banks, then market participants become fully responsible for all gains and losses on their exposures.

And all it would take for analysts to have the necessary data is to require banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off balance sheet exposure details.

“Everybody wants to avoid headlines,” said Chris Kotowski, an analyst with Oppenheimer. 

“People are angry at the banks, and both the banks and the regulators just want to do something to show we’re working our way back towards normalcy. That’s what everyone is craving.”

Actually, what everyone is craving is the disclosure of the bank data so that the risk of each bank can actually be independently assessed.

It is only when market participants have the data needed for doing their homework that normalcy can return.

The examination is not merely an intellectual exercise....

True.  It is a reaffirmation of the US governments pledge to bailout the banks and make sure that depositors, debt holders and equity investors do not lose money.

Under the tests, Federal Reserve specialists are trying to predict how capital levels at the 19 largest banks would withstand an economic downturn even more severe than the one that followed the Lehman collapse....

Your humble blogger never ceases to be amazed at the hubris involved in the stress tests.  Apparently Federal Reserve specialists are better at assessing the risk of banks than the market which includes the banks themselves and all of their in-house experts.

Regulators are walking a fine line: if they permit the banks to return too much capital now, that might leave the industry vulnerable in the event of a downturn and lead others to think the industry was returning to its risky ways. On the other hand, a raft of negative results would alarm investors just as calm seems to be returning to the markets. 

“It’s going to end up being a compromise between regulatory constraints and what the banks desire,” said Kamal Mustafa, chairman and chief executive of Invictus, a consulting firm in New York that focuses on the financial sector....

No it doesn't.  As RBS's Stephen Hester's confession showed, regulators are already blessing banks hiding losses on and off their balance sheet.

The stress tests are limited to showing the level of losses that the banks can absorb without interrupting the flow of bonuses to bankers.

“The industry is on much firmer ground than it was three years ago,” said Jason Goldberg, an analyst for Barclays. “This will show how much progress the banks have made in cleaning up their balance sheets.” 

“It was painful to get here in some instances,” he said, referring to institutions like Bank of America and Citigroup that had to sell billions of dollars’ worth of new stock to raise capital, lowering the value of the stock held by shareholders and leaving their shares well below precrisis levels. “But we did get here.”...

Think of the pain of the bankers endured from having their bonuses cut back marginally from their 2007 peak.

Excuse me, but is it possible that if the regulators had not blessed hiding losses that banker bonus would have been zero for the last several years?

Federal Reserve officials, led by Daniel K. Tarullo, a Fed governor, have pushed to make more information public about underlying conditions, despite opposition from bank executives.

In this case, the Fed will release figures like the potential drop in revenues, expected losses, and capital levels in the event of a sharp downturn.... 

Wall Street's Opacity Protection Team applying de minimus pressure and the result is the Fed releases only numbers invented by the staff of these banks with the explicit intent of the invented numbers being to convey solvency.

Update
Institutional Risk Analytics, a firm that specializes in valuing banks, provides its own unique twist to the stress tests in its latest weekly letter:

[In] terms of the Fed stress tests this week, it is hard for us at IRA not to yawn. These stress tests are a complete fabrication, more a political process than a true risk management exercise. 

The Fed's mishandling of large bank supervision and these ersatz stress tests just proves why the central bank should be stripped of all legal responsibility for supervising large financial institutions. 

The fact that the Fed has allowed banks to pay dividends and, more important, reduce reserves over the past 18 months pretty much shoots the Fed's credibility on this issue in the head. If large bank charge-offs show signs of rising in 2012, then look for a bull stampede out of large cap financials when the high-beta finally crowd gets the joke. There are few real investors in these top-four names, so make sure to stand clear of the door when the first earnings reports roll out.

Simon Johnson rejects the 'ideology' for the ongoing gifts to bankers

In a must read column in the Guardian, Simon Johnson looks at the 'ideology' behind bailing out banks and concludes that this ideology harms the real economy as it justifies an ongoing stream of gifts to the bankers.

Regular readers know that your humble blogger has been very critical of this ideology.  Specifically, I have used historical evidence to show that the assumption underlying the ideology that banks must have a positive book value in order to make loans is simply false.

By showing that assumption is false, the rest of the ideology including the need to a) bailout the banks or b) hide the losses on the banks' balance sheets crumbles with it.

To be sure, the [Washington Mutual] executives lost their jobs and now must drop claims for additional compensation. But, according to the FDIC, the four still earned more than $95m from January 2005 through September 2008. So they are walking away with a great deal of cash. 

This is what happens when financial executives are compensated for "return on equity" unadjusted for risk. The executives get the upside when things go well; when the downside risks materialise, they lose nothing (or close to it). 

At the same time, their actions – and similar actions by other bankers – are directly responsible for both the run-up in housing prices and the damaging collapse that followed. 

That collapse has impacted non-bankers in many negative ways, including through the loss of more than 8 million jobs. 

It is also leading to austerity – taxes are increasing and government spending is falling at the local and state level around the country. A difficult fiscal conversation still lies ahead at the federal level, but cuts and contractions of various types seem likely.

Some people argue that Americans need to tighten their belts. That's an interesting discussion, particularly at a time with unemployment is still above 8% (with recent declines largely the result of many jobless workers' decision to stop looking and drop out of the labour force altogether). Precipitate austerity is hardly likely to help the economy find its way back to higher employment levels. 

But what about government support for the big banks? 

Is this contracting in the light of our current fiscal pressures? Unfortunately, it is not; much government support remains, implicitly through allowing banks to be "too big to fail," and explicitly through various kinds of backing provided by the Federal Reserve. 

The rationale – or perhaps we should call it ideology – behind supporting big banks is that they are needed for the economy to recover. But this position looks increasingly doubtful when the banks are sitting on piles of cash while creditworthy consumers and businesses are reluctant to borrow. 

The same situation exists in Europe today, where the reality is even starker. Banks are receiving ever-larger bailouts, while countries that borrowed are cutting social programmes and face rising social tensions and political instability as a result. Countries like Greece, Italy, and arguably Portugal over-borrowed, and now their citizens face severe consequences. But the bankers face no consequences whatsoever for over-lending. 

To be sure, some major European financial institutions may now face difficulties, and – who knows – perhaps some of their executives will end up being fired. But does anyone think that the people who ran European banks into the ground will leave their positions with anything less than considerable wealth? There is no real austerity – now or possibly in the future – for leading bank executives.... 

Big banks represent the ultimate in concentrated economic power in today's economies. They are able to resist all meaningful reform that could really change their compensation schemes. Their executives want to get all the upside while facing none of the true downside. 

But capitalism without the prospect of failure is not any kind of market economy. We are running a large-scale, nontransparent, and dangerous government subsidy scheme for the benefit primarily of a very few, extremely wealthy people.... 

concentrated financial power is a gift that keeps on giving – but not to you.

Ex-Freddie, Fannie Chiefs sued by SEC over disclosure; solution ultra transparency

A Bloomberg article reports that the SEC is suing the former chiefs of Freddie Mac and Fannie Mae for understating by billions of dollars their exposures to sub-prime mortgages.

The takeaway from this lawsuit is the need for all financial firms to provide ultra transparency.  By disclosing on an on-going basis their current asset, liability and off-balance sheet exposure details, financial firms eliminate the possibility of misleading the market about the firm's risk.

Daniel Mudd, the former chief executive officer of Fannie Mae, and Richard Syron, ex-CEO of Freddie Mac, were sued by the U.S. Securities and Exchange Commission for understating by hundreds of billions of dollars the subprime loans held by the firms. 

The lawsuits filed today in Manhattan federal court were followed by an SEC statement that it had entered into non- prosecution agreements with each company.... 

In the lawsuits, the SEC said Syron, Mudd and other executives understated exposure to subprime mortgage loans. 

From 2007 to 2008, Freddie Mac executives said the company’s exposure was between $2 billion and $6 billion when it was actually as high as $244 billion, according to one SEC complaint. 

From 2006 to 2008, Washington-based Fannie Mae executives said the firm’s exposure to subprime mortgage and reduced documentation loans was about $4.8 billion when it was almost 10 times greater, according to the regulator.

“Fannie Mae and Freddie Mac executives told the world that their subprime exposure was substantially smaller than it really was,” Robert Khuzami, direct of the SEC’s enforcement division, said today in a statement. “These material misstatements occurred during a time of acute investor interest in financial institutions’ exposure to subprime loans, and misled the market about the amount of risk on the company’s books.”...

Mudd, now CEO of Fortress Investment Group LLC (FIG), was ousted when Fannie Mae and Freddie Mac were seized by regulators in September 2008. In a statement today, he said the federal government and investors were aware of “every piece of material data about loans held by Fannie Mae.” 

“The government reviewed and approved the company’s disclosures during my tenure, and through the present,” Mudd said in the statement. “Now it appears that the government has negotiated a deal to hold the government, and government- appointed executives who have signed the same disclosures since my departure, blameless -- so that it can sue individuals it fired years ago.”

This blog has previously discussed the issue of 'regulatory approval' when it came to banks disclosing a) their loans from the Fed and b) regulatory forbearance.  In both cases, the regulator appears to be telling the bank that it is okay to mislead the market with their disclosures.

What good would regulatory forbearance be if banks actually had to reserve for what are obviously impaired assets?  The whole exercise is based on the idea of misrepresenting the true status of the bank balance sheet.

Regular readers know that this is one of the readers that your humble blogger advocates ultra transparency. It removes most, if not all, of the ways that banks and their regulators can mislead the market using disclosure.

Secret Fed bank loans make definitive case for requiring the financial system be based on ultra transparency

Bob Ivry wrote a must read article for Bloomberg on how secret Fed loans during 2008-2009 gave banks an undisclosed $13 billion boost to income.  As Mr. Ivry observes, 'a fresh narrative of the financial crisis emerges' when actions by the Fed, like the loans, are examined.

In fact, the narrative that emerges is my narrative on an opacity driven solvency crisis where the only way to fix the financial system is to require ultra transparency from all market participants, including banks and the Federal Reserve.

These loans illustrate everything that is wrong with the current financial system including:

• The opacity of banks.  This blog has frequently cited Bank of England's Andy Haldane referring to banks as 'black boxes'.
• As documented by the Financial Crisis Inquiry Committee, the crisis began with banks asking the question of which banks are solvent and which are not.  Clearly, there was inadequate disclosure.  The fact that the Fed could make secret loans confirms this inadequacy and the need for banks to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.
• The reason that banks were asking about solvency was the exposure of banks to opaque, toxic securities -- CDOs, sub-prime mortgage backed securities.  Clearly, ultra transparency needs to be applied to these securities too.

• The relationship between banks and their regulators.  
• In a NY Times article, Gretchen Morgenson and Louise Story covered how the Office of Thrift Supervision advised IndyMac to misrepresent its capital to market participants.  How is offering secret loans to the banks any different than advising the banks to misrepresent their capital to market participants?
• The Nyberg Report on the Irish Financial Crisis showed how even when a member of the regulatory body saw that something was wrong, the regulatory bureaucracy pushed to suppress this finding.  Contributing to this result was both political pressure on the regulator and lobbying from the banks.

• The dependence of market participants on the regulators because of the regulators' information monopoly.
• Unlike every other market participant, banks are not a black box to financial regulators as they have access to all the useful, relevant information.  This includes access to the bank's current asset, liability and off-balance sheet exposure details.  The result of this access is that market participants rely on the regulators to properly assess the risk of the bank and to communicate this risk to the market.
• The moral obligation to bailout investors after each round of stress tests where the banks are deemed to be solvent.

I could go on, but the more the facts behind what caused the financial crisis and how the crisis was handled come out, the stronger is the case for requiring ultra transparency.

The Federal Reserve and the big banks fought for more than two years to keep details of the largest bailout in U.S. history a secret. Now, the rest of the world can see what it was missing. 

The Fed didn’t tell anyone which banks were in trouble so deep they required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day. 

Bankers didn’t mention that they took tens of billions of dollars in emergency loans at the same time they were assuring investors their firms were healthy. 

And no one calculated until now that banks reaped an estimated $13 billion of income by taking advantage of the Fed’s below-market rates, Bloomberg Markets magazine reports in its January issue. 

Saved by the bailout, bankers lobbied against government regulations, a job made easier by the Fed, which never disclosed the details of the rescue to lawmakers even as Congress doled out more money and debated new rules aimed at preventing the next collapse. 

A fresh narrative of the financial crisis of 2007 to 2009 emerges from 29,000 pages of Fed documents obtained under the Freedom of Information Act and central bank records of more than 21,000 transactions 

While Fed officials say that almost all of the loans were repaid and there have been no losses, details suggest taxpayers paid a price beyond dollars as the secret funding helped preserve a broken status quo and enabled the biggest banks to grow even bigger....

The size of the bailout came to light after Bloomberg LP, the parent of Bloomberg News, won a court case against the Fed and a group of the biggest U.S. banks called Clearing House Association LLC to force lending details into the open. 

The Fed, headed by Chairman Ben S. Bernanke, argued that revealing borrower details would create a stigma -- investors and counterparties would shun firms that used the central bank as lender of last resort -- and that needy institutions would be reluctant to borrow in the next crisis....

Here we have the major bank regulator in the US arguing for opacity.  Chairman Bernanke takes the position that market participants should not know the true condition of the banks because if they did the market participants might properly assess the risk of the banks and adjust the amount and price of their exposure accordingly.

Think of how absurd a position that is for the Chairman of the Federal Reserve to be arguing.  Particularly one who is a scholar of the Great Depression and the introduction by FDR of a financial system based on transparency.

There is only one way to prevent any Fed Chairman from ever being in a position for making this argument again and that is requiring ultra transparency.

Had ultra transparency existed for the structured finance securities, CDOs like Abacus could never have been sold.

Had ultra transparency existed for banks, market discipline would have restricted casino banking activities to what a bank could have afforded to lose.  If the bank insisted on taking more risk than this, its cost of funds would have gone up and its access to funds down as investors adjusted their exposure to reflect the risk of the bank.

Had ultra transparency existed for the Fed, it would never have violated Walter Bagehot's advice to lend against good collateral at high rates of interest.  There would not have been a $13 billion gift from the Fed to the banks.

Bankers didn’t disclose the extent of their borrowing. 

On Nov. 26, 2008, then-Bank of America (BAC) Corp. Chief Executive Officer Kenneth D. Lewis wrote to shareholders that he headed “one of the strongest and most stable major banks in the world.” He didn’t say that his Charlotte, North Carolina-based firm owed the central bank $86 billion that day....

Is this a fundamental misrepresentation similar to the advice of the Office of Thrift Supervision to IndyMac on its capital?

With ultra transparency, regulators are permanently blocked from inadvertently supporting misrepresentations to the financial markets.  Market participants could have seen that BofA was borrowing from the Fed and that IndyMac did not have adequate capital.

The Fed has been lending money to banks through its so- called discount window since just after its founding in 1913. Starting in August 2007, when confidence in banks began to wane, it created a variety of ways to bolster the financial system with cash or easily traded securities. 

By the end of 2008, the central bank had established or expanded 11 lending facilities catering to banks, securities firms and corporations that couldn’t get short-term loans from their usual sources.

“Supporting financial-market stability in times of extreme market stress is a core function of central banks,” says William B. English, director of the Fed’s Division of Monetary Affairs. “Our lending programs served to prevent a collapse of the financial system and to keep credit flowing to American families and businesses.”...

As regular readers know, restoring and maintaining confidence in banks comes from providing market participants with access to ultra transparency so that the market participants can independently analyze each bank.

None of the lending programs engaged in by the Fed restored confidence.  This is supported by the fact that the Fed announced that its late 2011 round of stress tests is designed to restore confidence.

As previously discussed on this blog, all the Fed's latest stress tests will do is create a moral obligation for the Fed to bailout investors.  After all, investors cannot be expected to incur losses on a bank that is reported as solvent under the Fed's stress tests subsequently blows up ... look at the need to bailout the investors in Dexia after the latest round of European stress tests found it adequately capitalized.

While the emergency response prevented financial collapse, the Fed shouldn’t have allowed conditions to get to that point, says Joshua Rosner, a banking analyst with Graham Fisher & Co. in New York who predicted problems from lax mortgage underwriting as far back as 2001. 

The Fed, the primary supervisor for large financial companies, should have been more vigilant as the housing bubble formed, and the scale of its lending shows the “supervision of the banks prior to the crisis was far worse than we had imagined,” Rosner says.

Ultra transparency is needed so that the failure of bank supervision no longer puts the financial system at risk.

With ultra transparency, market participants are no longer reliant on the regulators to properly assess the risk of the banks.  Market participants can assess the risk for themselves.

“I believe that the Fed should have independence in conducting highly technical monetary policy, but when they are putting taxpayer resources at risk, we need transparency and accountability,” says Alabama Senator Richard Shelby, the top Republican on the Senate Banking Committee....

So Senator Shelby when can I expect a call from your staff to discuss legislation bringing ultra transparency to the financial markets before December 31, 2011?

“Some might claim that the Fed was picking winners and losers, but what the Fed was doing was exercising its professional regulatory discretion,” says John Dearie, a former speechwriter at the New York Fed who’s now executive vice president for policy at the Financial Services Forum, a Washington-based group consisting of the CEOs of 20 of the world’s biggest financial firms. “The Fed clearly felt it had what it needed within the requirements of the law to continue to lend to Bear and Wachovia.”

Ultra transparency ends regulatory discretion of picking winners and losers.  That is the job of the market.

On May 4, 2010, Geithner visited Kaufman in his Capitol Hill office .... At the meeting with Kaufman, Geithner argued that the issue of limiting bank size was too complex for Congress and that people who know the markets should handle these decisions, Kaufman says....

Provide ultra transparency and banks will come under enormous pressure from the market to reduce their risk and shrink their asset base.  It will also be harder for them to run their casino banking business because everyone can see their proprietary positions ... a trader's worse nightmare because of the potential to be front run when buying or selling.

Dean Baker, co-director of the Center for Economic and Policy Research in Washington, says banks “were either in bad shape or taking advantage of the Fed giving them a good deal. The former contradicts their public statements. The latter -- getting loans at below-market rates during a financial crisis -- is quite a gift.”...

Regardless of which one, requiring ultra transparency eliminates this from occurring again in the future.

Measuring financial contagion - Simon Johnson on banks disclosing their 'exact exposures'

In his NY Times Economix column, Simon Johnson discusses the need for banks to disclose their 'exact exposures' so that market participants can assess and exert market discipline on the banks.

Regular readers are very familiar with the argument Professor Johnson makes as it touches on many of the central themes addressed in detail on this blog.  In particular,

• Bank runs -- when market participants do not know which banks are solvent and which are not and there are questions about the strength of the sovereign's deposit guarantee;

• The cost of opacity -- in the form of bank bailouts and losses on opaque structured finance securities;

• How regulators create financial instability by preserving their monopoly on all the useful, relevant information on financial institutions -- market participants are dependent on the regulators to properly assess this information and convey it;

• Moral hazard in the form of an obligation to bailout investors from potential losses after regulators use their information monopoly to conduct stress tests and say the bank is solvent;

• The need to require banks to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details;

• If market participants are unable to understand a bank's disclosed data, this is a diagnostic tool that tells the regulators the bank must reduce its complexity until market participants can understand its disclosed data;

• How the risk of financial contagion is virtually eliminated as market participants will adjust their exposures based on the risk of each bank; and

• The return of market discipline -- it will put pressure on banks to reduce their risks as high risk banks will find they face high funding costs.

Gotta give the guy credit for recognizing a good idea!

People see one bank failure and fear the consequences – hence, panics and runs on the bank. 

Anyone who thinks that we solved this problem with forward-thinking central banks or fiscal interventions has not been paying close attention – either to the United States or to Europe – over the last three years. 

We really need transparency on the exact exposures of banks. To whom have they lent and on what basis? 

Just telling supervisors does not help us at all, because sharing information only behind closed doors is just another potential mechanism for regulatory capture. 

For large financial institutions – those with more than $100 billion in total assets – everything should be out in the open. 

If you want to operate in relative secrecy, stay small. 

The costs of today’s opaqueness are huge, creating the basis for the plea, “Save us or you’ll lose the world.” 

And if the published information is too complex for outsiders to understand, big banks must be forced to simplify their operations until they become sufficiently transparent. Potential contagion risks must be measurable and apparent to the marketplace, including to independent analysts who have access only to public information. 

Needless to say, if any institution poses major contagion risks, as measured on this basis, it should be forced to become safer. 

Richard W. Fisher, president of the Federal Reserve Bank of Dallas, spoke recently about what he called the “pernicious problem” of too-big-to-fail financial institutions, “in a culture held hostage by concerns for ‘contagion,’ ‘systemic risk’ and ‘unique solutions’”: 

“Invariably, these behemoth institutions use their size, scale and complexity to cow politicians and regulators into believing the world will be placed in peril should they attempt to discipline them. They argue that disciplining them will be a trip wire for financial contagion, market disruption and economic disorder. Yet failing to discipline them only delays the inevitable – a bursting of a bubble and a financial panic that places the economy in peril.” 

You can only discipline a big troubled bank if you understand and can measure the consequences of its failure.

Naomi Prins on banks and disclosure

In her post on ZeroHedge, Naomi Prins takes aim at the willingness of the media to believe anything that Wall Street's Opacity Protection Team says and the issue of banks and disclosure.

Please note, with ultra transparency it is game over for banks engaging in speculative behavior.

Most of the media goes along with the notion that US banks exposed to the ‘euro-contagion’ will hurt our (nonexistent) recovery. US Banks assure us, they don't have much exposure - it's all hedged. (Like it was all AAA.) 

The press doesn't tend to question the global harm caused by never having smacked US banks into place, cutting off their money supply, splitting them into commercial and speculative parts ala Glass-Steagall and letting the speculative parts that should have died, die, rather than enjoy public subsidization and the ability to go globe-hopping for more destructive opportunity, alongside some of the mega-global bank partners. 

Today, the stock prices of the largest US banks are about as low as they were in the early part of 2009, not because of euro-contagion or Super-committee super-incompetence (a useless distraction anyway) but because of the ongoing transparency void surrouding the biggest banks amidst their central-bank-covered risks, and the political hot potato of how many emergency loans are required to keep them afloat at any given moment.  

Because investors don’t know their true exposures, any more than in early 2009. 

Because US banks catalyzed the global crisis that is currently manifesting itself in Europe. Because there never was a separate US housing crisis and European debt crisis. Instead, there is a worldwide, systemic, unregulated, uncontained,  rapacious need for the most powerful banks and financial institutions to leverage whatever could be leveraged in whatever forms it could be leveraged in. 

So, now we’re just barely in the second quarter of the game of thrones, where the big banks are the kings, the ECB, IMF and the Fed are the money supply, and the populations are the powerless serfs.

Moral responsibility from next round of stress tests puts Fed on the hook for $5 trillion in off-balance sheet exposures

As Fed Governor Daniel Tarullo was discussing the next round of stress tests, US bank counter-parties were smiling.

Why?

Because when the Fed signs off on the next round of stress tests and says that firms like JP Morgan and Goldman are adequately capitalized and can pay a dividend, the Fed takes on the moral responsibility for making good on their derivative books.

Please re-read the preceding sentence.  While doing so remember that banks use credit default swaps to 'hedge' their positions and after Greece there is good reason to believe that credit default swaps will not act as a hedge and pay out.

As regular readers know, under the FDR Framework, governments are responsible for ensuring that market participants have access to all the useful, relevant information in an appropriate, timely manner.  The corollary to this is that governments are suppose to make sure that they never offer an opinion on an investment.

It is up to the other market participants, since they are responsible for all gains and losses on their investments, to decide for themselves how much, if any exposure they want to an investment.  They do this by using the disclosed information to assess the risk of the investment and then adjusting their exposure based on the result of this analysis.

Currently, banks are not required to disclose all their useful, relevant information in an appropriate, timely manner.  The Bank of England's Andy Haldane observed that they are a 'black box'.

Banks are a black box that only the regulators can look into.

As a result of their access to all the useful, relevant information, when the regulators conduct a stress test and say that banks are solvent and adequately capitalized, market participants rely on them.

It is this reliance on the regulators properly assessing the riskiness of the banks that creates moral responsibility.

Specifically, governments are morally responsible for bailing out the investors/derivative counter-parties in the event that the bank becomes insolvent because the investors/derivative counter-parties relied on the government's representation that the bank was solvent.

This is the problem of governments offering an investment opinion.

The only way to get the Fed off the hook for the $5 trillion in bank derivative exposure is to require that the bank's disclose on an on-going basis their current asset, liability and off-balance sheet exposure detail.  With this data, market participants can assess the risk and take on the responsibility for any gains and losses on their exposures to the banks.

EU prepares law to impose losses on bank bondholders

An Irish Times article reports that the European Commission is moving forward with a law that would see the bondholders of failing banks share in the losses.

Some would call this the return of capitalism.

The banks would call this the end of the world.  They fear that investors would not be interested in buying their debt.

Regular readers recall that the global financial regulators have created a moral hazard when it comes to requiring bank bondholders to take a loss.  After all, how can the global financial regulators impose a loss on a bondholder after they run a stress test and say that the bank is solvent?

Is the investor suppose to question the global financial regulators' ability to analyze the solvency of a bank?

If an investor is suppose to question the regulators' assessment, then why would anyone assume that any of the major banks are solvent today?  After all, each bank is loaded up with sovereign debt, toxic mortgage backed securities, commercial real estate loans, mortgages that cannot be repaid by individuals and exposure to other potentially insolvent banks.

The solution for the regulators is to require each bank to disclose on an on-going basis its current asset, liability and off-balance sheet exposure details.

With this information, investors could independently analyze the risk of the banks (there are no longer dependent on the regulators statement that the banks are solvent).  Based on this analysis, investors can decide how much, if any, exposure they want to the bonds of the banks.

With the ability to independently assess the risk of each bank, investors become responsible for all gains and losses on each bank's bonds.

The European Commission is set to propose a law within weeks that could let supervisors impose losses on the bondholders of a flagging bank, officials said, a move it has delayed until the end of the year for fear it will panic markets. 

The law is part of a European framework on winding up or salvaging troubled banks, seen as crucial to preventing another financial crisis, but which is sensitive because it has echoes of the Greek bailout package, in which holders of Greek government bonds share some of the losses. 

Banks are also worried that the new European law would break a finance industry taboo that bondholders are spared losses, making investors more reluctant to lend to banks and possibly compounding a credit freeze. 

From the banks perspective, it certainly is taboo.  If bondholders are not spared losses, then neither will the banks and the bankers.

If bondholders are not spared losses, the banks lose a significant amount of leverage in obtaining additional bailouts.

Banks have said that forcing bondholders, especially senior ones, to take a hit when a bank is in trouble should only be a last resort option. 

Earlier this year, the EU's executive began consulting with the industry about the change of rules. 

It said at the time: "This might include possible mechanisms to write down appropriate classes of the debt of a failing bank to ensure that its creditors bear losses. Any such proposals would not apply to existing bank debt." ....

One official, speaking on condition of anonymity, said the new rules would correct the imbalance between the treatment of bondholders and of shareholders, many of whom lost their investments in banks that failed during the crisis. 

"It is all very good saying that banks need more capital. But who will give it?" he said. The EU is prodding banks to raise extra capital to cope with a Greek default. "Why should bondholders be treated more favourably than equity investors?" ....

The new rules would allow a supervisor under the watch of the European Banking Authority to impose losses on bondholders of an endangered bank to keep it up and running.

Things can get better if leaders make the right policy choices

The Guardian ran an interesting column on the leadership vacuum that has accompanied the credit crisis.

When the credit crisis began in 2007, governments adopted the policy of protecting the banking system at all costs.  They interpreted this policy as meaning that they must protect the status quo.  Hence, the moral hazard of too big to fail.

Unfortunately, this policy carried with it an unintended consequence.  The act of protecting the status quo meant not coming to grips with the "toxic" assets on the banks balance sheets, but instead adopting Japanese policies that have resulted in lost decades.

The role of markets is to establish a clearing price.  But how are markets, like the residential or commercial real estate market, suppose to establish a true clearing price when they know that supply is being artificially reduced (banks are not forced to recognize the losses) and demand is being artificially boosted (due to government policies like low interest rates)?

The answer is that markets do not function under these conditions.

Market participants know that following the policies that Japan has implemented since its real estate bubble burst is a prescription for lost decades.  In their desire to protect the status quo, western governments have managed to reproduce the results of Japan's policies - we are looking at lost decades.

There is however a way out of the policies that contribute to lost decades.  It is to implement the same advice that the US freely gave to Japan at the start of its credit crisis.  That advice was to recognize losses.

Obviously, it was easier for the US to give the advice than act on it when faced with the same problem.

It is not too late for the US and western governments to take their own advice.  Doing so would lead to the brighter future that everyone wants.

The cry goes up: this crisis is a moment for leadership. And of course that is true .... But if leadership is needed then to where, and with whose consent? 

In the face of financial apocalypse ... They rub against the progressive expectation of democracy: that tomorrow can be better than today. Perhaps that isn't always true. 

Despite their differences, capitalists, socialists, liberals and conservatives are united by a common idea. It is the assumption of linear progress for human civilisation: the belief, seldom stated because rarely challenged, that things can only get better or – if they seem not to be – can get better if we choose the right policies. 

To this way of thinking, a turn for the worse is seen as a setback: a reason to condemn one set of politicians for choosing the wrong policies, and elect another instead who offer different ones. Normal service will be resumed shortly. We'll sort the problem out, maybe try a new tack – and continue on an upward path. 

For several centuries the west has been right – most of the time – to assume this rule applies.  

It may still be right to assume it now.... But behind the sloth of a European elite on holiday as so much goes wrong lies a miserable possibility. Perhaps no G7 summit, no telephone call, no brilliant speech by Barack Obama, no amount of breezy calm from Cameron, no hammering by Ed Balls, can break paralysis. 

The terror of the financial crisis is not that it requires a series of complex policy responses which, if followed, will set the world economy back on a path to growth. It is that no amount of fiddling may do anything other than delay the judgment: and the sentence is decline. 

What, once summoned back to their offices, do we expect ministers to do? Fix the financial meltdown, of course. But how? Through a tax rise, or a tax cut? More austerity, or a spending boom? By permitting a United States of Europe with one government and one debt, or by busting up Europe into many currencies? By appeasing the markets or defying them? 

No one can agree, of course, but it's worse than that: no proposed strategy carries complete conviction even with those who propose it. There is a thundering absence of bright ideas, of the "hey, here's how" variety. Hence the frightening silence. 

Actually, this blog has been discussing the very bright idea that the government leaders should be looking for.

The result of implementing the FDR Framework is not decline, but a very bright and stable future. 

Yesterday eurozone leaders talked; today they may buy some Italian bonds and perhaps tame the markets temporarily; but few think this will do anything other than carry us on to the next disaster. 

That is because it is a policy that addresses a symptom and not the underlying solvency problem.  Until solvency is comprehensively addressed, it will weigh on the global economy.

We want government and we need government, but perhaps we are wrong to hope that government will always be able to protect us.

Under the FDR Framework, government is not suppose to "protect us".  It is suppose to make sure that all the useful, relevant information is made available in an appropriate, timely manner so that we can protect ourselves.  For good measure, it allows governments to make use of the analytical capabilities of the market to step in when imbalances start to develop.

... Yet it runs against the grain of the politician's job to promise voters a poorer tomorrow. 

Democracy depends on there being competing sets of positive possibilities. 

Cameron appealed most in opposition when he attempted to associate his party with optimistic plans for the future. But he has found himself leading a government which has come closer than any other in recent times to believing itself to be powerless. 

The implicit message from the coalition is that the best Britain can do in this storm is avoid drowning, while others, worse off, sink.  It may be good policy but it is a peculiarly lowering way to behave. 

The prime minister has found himself on the pessimistic side of politics, as he never intended to be. He must explain to a nation which wants decent state provision of services, that this (in his view) is no longer possible, and to people looking for a plan for growth why all he has to offer is the removal of obstacles to business. Maybe, if the world grows, that will help us. But it is not much use now. 

In prior posts, this blog has discussed that austerity related policies carry with them their own economic headwind.  Their biggest flaw is that they do not address what is the problem with the economy.  The problem is the failure to address the "toxic" assets (broadly defined) that are clogging up the financial system and making it impossible for markets to operate without massive government intervention (as oppose to regulations).

When historians look back on this period what will stand out most is the absence of political heroes. No one – not even Obama, who is the closest thing the world has to a leader – seems able to turn present disaster into a sense of future possibility. We are left with politicians who have persuaded themselves that there is nothing significant they can do to rescue their citizens from crisis. 

"The markets caused the trouble. Now the markets must put things right," Angela Merkel's office said on Friday evening: and that from the one person in Europe with the cash to respond.

It was not the markets that caused the trouble.  It was the failure of regulators that caused the trouble.  Rather than ensure disclosure, regulators decided that markets should police themselves.

The lesson of the Great Depression is that Wall Street will sell opaque products that investors cannot properly analyze if regulators allow it.  Regulators allowed it and the result has been massive damage to the financial system.

... But the routes away from this disaster involve things that will be unpopular: higher taxes, lower spending, the controlled impoverishment of people conditioned to believe their lives would get better. It's no surprise politicians shy away. 

This is a list of the routes that Wall Street wants away from the crisis.  Notice how none of these ideas actually addresses the problem of solvency.

Disclosure does not require higher taxes, lower spending or the controlled impoverishment of people conditioned to believe their lives would get better.

Disclosure addresses the solvency problem and allows markets to operate without Wall Street extracting an opacity premium because of a non-market making informational advantage.

Wall Street naturally does not want anyone to address solvency because it will also show a bright light on how Wall Street behaved prior to and since the crisis.