Italy's banks may be forced to seek capital from government

Reuters reports that Italy's banks may be forced to seek capital from the government if they recognize some (all?) of the losses currently hiding on and off their balance sheets.

Italy is following the same failed strategy as Ireland, Portugal, Greece, Cyprus and Spain.

Step 1:  Have the banks announce modest losses
Step 2:  Hope market participants will be dumb enough to belief the banks when they claim to have cleaned up their balance sheets.
Step 3:  Failing to find enough dumb investors, the government will stand ready to buy any equity that market participants don't want.

There is no reason for investors to buy equity in any Italian bank in the absence of transparency that discloses that bank's current global asset, liability and off-balance sheet exposure details.  It is only with this information that the investor can confirm that all losses have been realized and an assessment of the remaining risk made.

Under pressure from the Bank of Italy, banks are cleaning up their balance sheets before a health check-up on asset quality by the European Central Bank (ECB) expected in early 2014, before it takes over supervision of euro zone lenders mid-year. 

That may force them to turn to the market or the state for cash. 

"If done properly, the asset quality review should result in loan losses spiking in the second half, dividend cuts and potential capital increases," analysts at Berenberg said in a note to clients. 

Monte dei Paschi, the country's scandal-hit No. 3 lender, and a string of mid-sized banks look particularly vulnerable. 

"Italian mid-tier lenders are among the weakest in Europe," Royal Bank of Scotland chief credit strategist Alberto Gallo said. 

He estimates that Monte dei Paschi, which posted its fifth straight quarterly loss on Wednesday, may need up to 5 billion euros over the next three years, on top of a 4.1-billion-euro state bailout it received in February. 

The bank will find it difficult to lure private investors for such a sizeable amount - more than twice its market capitalisation, potentially requiring more support from Italy's cash-strapped government, Gallo said.

Swiss banking regulator adopts bail-ins, but in time of crisis will this work

Reuters reports that the Swiss banking regulators have adopted the following structure for absorbing bank losses before a taxpayer funded bailout: shareholders, contingent convertible holders, unsecured debt holders and then senior debt holders.

While this sounds like a good plan, there is one small detail that hasn't been addressed: implementation during a time of financial crisis.

One of the primary lessons learned from our current global financial crisis is that bank regulators will not require banks to recognize their losses if the result would be to reduce the level of bank book capital.

Why?

For fear of sending a message about the safety and soundness of the banking system.

The result is that bank regulators have an irresistible urge to use taxpayer funds instead.

Regular readers know that the way to end this irresistible urge is to require the banks to provide transparency into their current global asset, liability and off-balance sheet exposure details.

With this level of transparency, market participants can assess and know the current condition of each bank.

Should a bank need to be recapitalized through bail-in, market participants know this and the size of the bail-in.  As a result, actually implementing the bail-in doesn't send a message that threatens the safety and soundness of the banking system.

Switzerland shouldn't bail out its largest banks again before asking creditors and shareholders to stump up, the local financial regulator said on Wednesday. 

Authorities have been grappling since the collapse of U.S. investment bank Lehman Brothers five years ago with the question of how banks regarded as systemically important - or too big to fail (TBTF) - can be recapitalised without causing panic or needing taxpayer cash.... 

The regulator recommended spreading bank losses across a range of creditors, including shareholders, holders of contingent convertible (CoCo) instruments (which may convert into equity under certain conditions) and owners of debt including senior debt. 

"This recapitalisation must be sufficient to meet the needs of all group companies in Switzerland and abroad," FINMA said in its position paper. "This buys time with regard to restructuring the affected banks so that they can return to viable operation."

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.

The real mistake over Cyprus bailout would be to think it can't happen here

In his Telegraph column, Graeme Archer asks the question of whether depositors living in the UK could find themselves, like Cypriot depositors, suddenly losing their money to bailout the UK banks.

It no longer feels unimaginable that we could wake up one day, and find our interconnected banking system had hit another glitch, cutting us off from “our” money. 

As the European Commission announced on Thursday: “In certain circumstances, the stability of financial markets and the banking system in Cyprus constitutes a matter of overriding public interest and public policy justifying the imposition of temporary restrictions on capital movements.” 

In other words, a ban on cheques and a limit of 300 euros a day on withdrawals. 

Couldn’t happen here? 

In Britain, where incomes have stagnated, prices have risen, and the workings of the banks remain as opaque as the inner sanctum of that mysterious money-god’s temple? Where those who rely on other people’s money remain in utter denial about the new reality?...  

How can our politics work, when so many voters are affected by the restrictions on public expenditure, restrictions that are required to stave off those supra-national impositions on private expenditure, which would follow failure to get to grips with the problem?... 

would it be more likely, or less, that Britain’s future would resemble Cyprus’s present? [bold added]

As your humble blogger has repeatedly observed, if policymakers and financial regulators are going to use depositor bail-ins to recapitalize the banks, the policymakers and financial regulators must first require the banks to provide ultra transparency.

With each bank's current global asset, liability and off-balance sheet exposure details, depositors have access to the information needed to independently assess the risk and solvency of the banks.

Depositors can do this independent assessment themselves or hire a third party expert to do the assessment for them.  An examples of investors relying on third party experts are mutual fund portfolio managers.

Regardless of who assesses this information, based on this assessment, the depositor can determine how much exposure they want to a bank.

As your humble blogger has repeatedly observe, the global financial system is based off the FDR Framework which combines the philosophy of disclosure with the principle of caveat emptor (buyer beware).

 Simply put, it is only fair if an investor is responsible for all losses on the investment that the investor have access to the all the information needed to make a fully informed decision and can therefore limit their exposure to what they can afford to lose.

ECB's Knot backs banks providing transparency before depositor bail-ins

Reuters reports that the ECB's Klaus Knot supports the EU template that includes having uninsured depositors helping to bail-in undercapitalized banks.  However, he wants the banks to provide transparency before any uninsured depositor bail-ins.

A point that your humble blogger first presented!

Mr. Knot recognizes that the problem is not that uninsured depositors are a source of funds for recapitalizing the banks.  The problem is that in the absence of transparency there is both a perception and reality that the deposits are being "seized".

What further exacerbates this perception and reality of deposit seizure is the governments have made an investment representation about the banks through the announcement of the results of the stress tests.

By announcing that the banks passed a solvency-focused stress test or need a modest amount of additional capital, the government creates a moral obligation to protect depositors who could reasonably rely on these results when making a decision to keep funds at a bank.

Regular readers know that the government announcing the results of a stress test would not be a problem if the banks were required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

Under the FDR Framework, which is the basis for the global financial system, investors are responsible under the principle of caveat emptor (buyer beware) for all losses on their investment exposures.  This gives investors the incentive to not rely on the government's representation, but to independently assess the disclosed information and make an investment decision based on the results of their own assessment.

Your humble blogger supports Mr. Knot and would ask that the EU policymakers declare a moratorium on deposit bail-ins until a) the banks provide ultra transparency and b) depositors and other investors have had 6 months of access to this information to assess the risk and solvency of the banks.  After the 6 months has ended, all new uninsured deposits along with unsecured debt and equity is subject to being used to bail-in and recapitalize the banks.

European Central Bank Governing Council member Klaas Knot said on Friday there was "little wrong" with Eurogroup chair Jeroen Dijsselbloem's recipe for dealing with future euro zone banking crises, a newspaper reported. 

Dijsselbloem, the head of the euro zone's finance ministers and like Knot a Dutchman, said on Monday the rescue program agreed for Cyprus - the first to impose a levy on bank deposits - would serve as a model for future crises.....

But Knot, who sits on the bank's main decision-making body, said: "There is little wrong with Dijsselbloem's remarks. 

"The content of his remarks comes down to an approach which has been on the table for a longer time in Europe. This approach will be part of the European liquidation policy."...

"Firstly, there has to be transparency about losses in the banking sector. Secondly, banks have to wind down their loss-making operations," Knot said.

Savers will be raided to pay for hidden bank losses

As reported by the Telegraph, the EU has decided that the way to break the bank-sovereign link is to have savers pay for the losses still hidden on the EU bank balance sheets.

This is a very important change in policy because savers have no way to assess the risk of the banks and therefore how much of their money will be seized to pay for the hidden losses.  A point that the Bank of England's Andrew Haldane made abundantly clear when he referred to banks as 'black boxes'.

EU policy makers would like savers to trust some combination of high capital ratios and the stress tests run by financial regulators.  However, there is absolutely no reason for savers to trust either the book capital reported by the banks or the results of the stress tests.

The history of book capital is that it is easily manipulated by both the financial regulators and the bankers.  As the OECD pointed out, regulators manipulate it by suspending mark-to-market accounting.  They also manipulate it by engaging in regulatory forbearance which allows the bankers to engage in 'extend and pretend' with their non-performing loans and turn them into 'zombie' loans.

The history of the stress tests is that passing the test with high capital ratios is not a good predictor that the bank will not subsequently be nationalize/closed due to insolvency.  This was shown first with the Irish banks, subsequently with Dexia and most recently with the Cyprus banks (July 2011 Cyprus banks pass stress tests).

What made the US stress tests "successful" was former Treasury Secretary Tim Geithner pledging the full faith and credit of the US to provide all the capital necessary to support the insolvent banks.  Previously, the EU made the same representation about its stress tests.

Regular readers know since the beginning of the financial crisis your humble blogger has been saying that if the policy makers and financial regulators want the unsecured creditors of the banks to be responsible for absorbing losses, the banks must first provide ultra transparency.

It is only when the banks disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details that market participants have the information they need to assess the risk of the banks.

Under the FDR Framework, it is only when market participants have access to all the useful, relevant information in an appropriate, timely manner, which is what ultra transparency is, that market participants become bound by the principle of caveat emptor (buyer beware) and responsible for losses.

Without ultra transparency, savers, including large depositors and other unsecured creditors, are being asked by EU policy makers to blindly gamble on the contents of a black box.  Why should they?

I understand the reluctance of the EU policy makers and financial regulators to require the banks to provide ultra transparency before they seize the savers' money.  Ultra transparency will show just have negative the book capital level is for each bank.

Fortunately, it is not a problem if market participants know how negative the book capital level is for banks as banks are designed to operate with 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 they have low or negative book capital levels.  As a result, banks can continue to lend and support the real economy.

Your humble blogger has proposed on numerous occasions how to transition so that investors are responsible for losses:

1. Require banks provide ultra transparency.
2. Continue to protect large depositors and unsecured debt holders on all investment made at each bank until 6 months after the bank has begun providing ultra transparency.  This gives market participants a chance to assess the risk of the bank.
3. All new large deposits or unsecured debt purchased after the 6 month period has elapsed is subject to being bailed-in.

At the same time that investors become responsible for losses, the banks become subject to market discipline.

Transparency is missing ingredient for bank creditors to participate in bail-ins

As reported by Reuters, Germany has decided that the time has come in the ongoing financial crisis that bank creditors and equity holders rather than taxpayers contribute to bailing out the banks.

While your humble blogger agrees that this should in fact happen, there is one small step that needs to be taken first.  That small step is that the banks need to be required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details?

Why is transparency necessary?

The global financial system is based on the FDR Framework which combines the philosophy of disclosure with the principle of caveat emptor (buyer beware).

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 so they can independently assess this information and make a fully informed decision.

Under the principle of caveat emptor, investors are responsible for all losses on their exposures.  This gives the investor an incentive to use the information that banks would disclose under ultra transparency  to independently assess the risk of the banks.  Based on this risk assessment, the investor would then adjust their exposure to an amount they could afford to lose given the risk.

Currently, banks are not transparent.  They are in the words of the Bank of England's Andrew Haldane 'black boxes'.  As a result, it is impossible for investors to independently assess the risk of the banks and adjust their exposures to what they can afford to lose.

To make the situation worse, governments have created a moral obligation to protect the investors and spare them from participating in a bail-in.

Governments are doing this by making investment recommendations about the banks.  For example, the bank regulators run annual stress tests and announce that the banks are well capitalized.

It is reasonable for an investor to rely on this representation as to the solvency of the banks.  This is what gives rise to the moral obligation to protect the investor from a solvency related bail-in as it is simply unfair for the government to say a bank is solvent and then turn around and say fooled you and take the investor's money.

The way to end the moral obligation to protect the investors and expose the investors to bail-in risk is to provide ultra transparency.  With ultra transparency, investors have all the useful, relevant information they need so they are no longer reliant on the governments' investment recommendation.  This ends the moral obligation to protect the investor.

Please note that providing ultra transparency and weaning the investors off of the moral obligation cannot happen overnight.  We are looking at a period of 24-36 months to a) make the bank data available, b) let market participants assess this data and c) let market participants adjust their exposures based on their assessments.

To put this transition period into perspective, until there is ultra transparency, there is always going to be morally justifiable push-back to the notion of bank investor bail-ins.

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.

A much better alternative for Cyprus

In his Reuters blog, Felix Salmon eviscerates Andrew Ross Sorkin's argument for why the current Cyprus bailout proposal with its violation of deposit guarantees is ok and touts the benefits of a bailout proposal put forth by Lee Buchheit and Metu Galati.

At first blush, the Buchheit/Gelati proposal appears like an elegant solution.  It leaves untouched all deposits covered by the deposit guarantee and terms out all the other depositors.  To make being termed out acceptable, they propose securing these termed out deposits against future Cypriot gas revenue.

There is only one wee problem with this solution.  By securing the deposits against future Cypriot gas revenue, it protects the banks from any consequences of their actions.

The cost of the bailout falls on the Cypriot taxpayers.

They are the ones who, if there is gas revenue, pay off the termed out deposits as gas revenue that could be used to support social programs or lower taxes instead flows to the depositors.

They are the ones who, if there is no gas revenue, are left to pay off the termed out deposits.

Fortunately, the problem with this solution is easily fixed.  Rather than secure the termed out deposits with Cypriot gas revenue, let the banking system operate as it is designed.  Let the banks absorb the losses on all the excess public and private debt.

While the banks have low or negative book capital levels, they can continue to operate because of the existing deposit guarantee and access to central bank funding.  The deposit guarantee effectively makes the Cypriot taxpayers the silent equity partners of the banks.  Silent equity partners who happen to have the future gas revenues.

Over time, the banks can generate the earnings to pay off the termed out deposits and rebuild their book capital levels.  While this is going on, there won't be any banker bonuses paid in cash.

Everyone wins.  There is a haircut on uninsured depositors, including those who laundered money.  The bankers are held responsible for their actions.  The Cypriot taxpayers are not asked to explicitly bailout the banks.

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).

EU establishes principle of imposing losses on insured depositors

As reported by Bloomberg, EU policymakers are establishing the principle of imposing losses on insured bank deposits.

By doing so, in a single stroke, they have undermined the whole concept of deposit insurance and created massive instability in the financial system.  Deposit insurance is suppose to be an ironclad guarantee by the sovereign that up to a specified level, all money put into a bank is protected from the financial performance of the bank.

The EU policymakers have decided to unilaterally end this guarantee.

At a minimum, for countries like Greece, Spain, Portugal, Italy and France, this should accelerate the run on their banks.

Why should depositors take the risk of losing money when there is no way of knowing if the banks are solvent?

This is a global issue.  Just this past week, the Fed effectively said that JP Morgan was insolvent by calling into question its fortress balance sheet (I know JP Morgan passed a stress test, but banks around the world, see Dexia and banks in Ireland, have been nationalized shortly after passing a stress test).

In the absence of ultra transparency where banks disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details, there is no reason to believe that a bank is solvent and that depositing money in the bank is nothing more than a chance to have a high risk of loss for zero return.

With the EU policymakers ending trust in the sanctity of the deposit insurance guarantee, the only way to re-stabilize the financial system is by requiring the banks to provide ultra transparency.

With this information, market participants can independently determine which, if any, banks are solvent and therefore safe to put money into.

Euro-area finance ministers agreed to an unprecedented tax on Cypriot bank deposits as officials unveiled a 10 billion-euro ($13 billion) rescue plan for the country, the fifth since Europe’s debt crisis broke out in 2009. 

Cyprus will impose a levy of 6.75 percent on deposits of less than 100,000 euros -- the ceiling for European Union account insurance -- and 9.9 percent above that....

A tax is just another name for a loss.

Officials have struggled to find an agreement that would rescue Cyprus, which accounts for just half of a percent of the euro region’s economy, without unsettling investors in larger countries and sparking a new round of market contagion....

The European Central Bank will use its existing facilities to make funds available to Cypriot banks as needed to counter potential bank runs. Depositors will receive bank equity as compensation. 

Finance Minister Michael Sarris said the plan was the “least onerous” of the options Cyprus faced to stay afloat....

Actually, there was a far less onerous option that I have been talking about since the beginning of the financial crisis:  Let the banks recognize their losses and rebuild their book capital levels out of future earnings.

There was absolute zero reason to impose losses on depositors other than the EU policymakers are trying to bailout banks in countries like Germany that invested in the Cyprus banks.

The option chosen by the EU policymakers was the absolutely worse option available.

While the tax on deposits will hurt wealthy Russians with money in Cypriot banks, it will also sting ordinary citizens. 

Some ATMs in the country have run out of cash, Erotokritos Chlorakiotis, general manager of the Cooperative Central Bank, told state-run CYBC.

A run on the banks that will not be limited to Cyprus.

Funds to pay the levy were frozen in accounts immediately, ECB Executive Board Member Joerg Asmussen said. The levy will be assessed before Cypriot banks reopen on March 19 after a March 18 national holiday.... 

“As it is a contribution to the financial stability of Cyprus, it seems just to ask a contribution of all deposit holders,” Dijsselbloem said... 

Asmussen said tapping deposit holders was needed to expand Cyprus’s tax base. 

European Union Economic and Monetary Affairs Commissioner Olli Rehn called the assessment a strictly fiscal measure. Rehn had warned against so-called haircuts on depositors to avoid setting a destabilizing precedent. 

When asked if a deposit assessment could be ruled out for future rescues, Rehn said in an interview: “It can and there is no concrete case where it should be considered.”

Mr. Rehn's comment that losses will not be imposed on depositors in other countries is completely unbelievable.  As Mr. Asmussen said, it was necessary to impose losses on the depositors in order to be able to recapitalize the banks today.

“This kind of stability fee is clearly a much better choice from the point of view of financial stability and Cypriot citizens than a full-scale bail-in, which would have led to very chaotic consequences in the Cypriot economy,” he said.

This stability fee is a loss assessed on depositors.

From the standpoint of Cypriot taxpayers, it would have been far better to have the banks recognize their losses today and let the banks slowly recapitalize themselves through retained earnings.

This was possible to do as the banks have deposit insurance and access to central bank funding.  The deposit insurance effectively made the taxpayers the Cypriot banks' silent equity partners until the banks had rebuilt their capital.

The lesson of the stability fee will not be missed by bank depositors globally.

Barry Ritholtz: Bankistan vanquishes America (and the EU, Japan and UK too)

From Barry Ritholtz blog, the Big Picture comes a terrific summary of exactly where the global financial system is currently:

Is there a single doubt left in your mind? 

Are you still a believer in Rufus T. Firefly Jamie Dimon as the world’s smartest banker? 

Is there a scintilla of wonder left in your mind that the giant banks are legitimate? 

Have you come around to understanding — finally — what some of us have long understood about banks? 

Are you willing to accept the truth about these corporate behemoths — that they are a horrific combination of economically dangerous, criminally inept, led by pathologically lying CEOs? 

Do you harbor any doubts that the giant banks are anything less than ruthlessly efficient criminal enterprises? 

Can you — finally — admit that our bank-created financial crisis of 2008-09 has led us to where we are today? 

Do you understand the only options presented as a result of that — either corporate bankruptcy and nationalization or a completely artificial Fed driven recovery? (The third option was a Japan-like multi decade recession). 

Do you realize that the feeble recovery, the slow, deleveraging-driven process of gradual economic healing was the result of how our policy makers chose?

Our policy makers chose the Japan-like multi decade recession in which bank bonuses are protected at all costs and society, particularly through cuts in social programs like Medicare and Social Security, pays the cost.

Do you recognize that the world of banking is divided into two camps? 

On one side, there are those who understand that the giant banks must be broken up. They are dismayed at the large banks  under-capitalization, over-leverage and opacity.  

These folks have figured out that these banks are not only too big to fail, but are so large that they are too big to succeed, and that the best route is to let insolvent banks fail. They are unhappy that our finance sector is a trillion dollar black box. 

Insert call for banks to provide ultra transparency here.

They know that the majority of giant banks’ profits come from bailouts, and subsidies. This group is dismayed at the corruption of our political system by financiers.

Insert Jeff Connaughton and the Blob (aka, politicians, regulators, lobbyists and Wall Street) here.

They understands huge banks are anti-competitive, a blaspheme against capitalism.

Insert that we need to adopt the Swedish Model and require the banks to recognize the losses on the excess debt upfront here.

They are shocked about  corruption of even the most fundamental measures of interest rates such as LIBOR.

Insert bankers behaving badly behind a veil of opacity and the need for ultra transparency as sunlight is the best disinfectant and the source of confidence in the financial system.

They are stunned that bankers have overturned a bedrock, fundamental principle of our society — the rule of law rule — with the threat of disrupting the world’s economy if prosecuted for their crimes.

Insert need for requiring ultra transparency as it is only the market that can discipline the banks as they are too big for individual nations to control.

On the other side lay the bank apologists, corrupted politicians, and crony capitalists.  

They advocate the Big Lie of the financial crisis. They choose to ignore the facts and data that disprove their narrative. 

They continue to push the lies that the bailouts were a good investment. (They weren’t). 

They work against the Bipartisan consensus that the giant banks should be broken up.

Insert if banks provided ultra transparency, market discipline in the form of higher cost of funds would force them to reduce their risk and complexity (closing those thousands of subsidiaries that only exist to arbitrage regulations and taxes).

A likely outcome of reducing risk and complexity is that the banks would shrink significantly in size.

They ignore the many former bank CEOs who call for thebreak up of “Too Big to Fail” banks. 

They mandated that GSEs were banned from Lobbying, but they made sure that the big banks retained their influence peddling and hold on Washington DC. 

They no longer represent the voters of their districts, but instead are the elected representatives of Bankistan. 

And unless we do something — and soon — they will vanquish America.

This is also true of the EU and UK.

In the EU, we had the appointment of technocrats to carryout austerity in countries that should have had the banks take losses on their sovereign debt holdings. 

In the UK, we had the chancellor pleading with the EU not to limit bankers' bonuses.

Anat Admati: "The Bankers' New Clothes", right fairy tale, wrong conclusion

In an American Banker column, Professor Anat Admati makes a very important observation about the gutting of financial regulation.  It tends to be good for bankers and bad for society.

The column is an excerpt from a book she co-authored with Martin Hellwig, "The Bankers' New Clothes: What's Wrong With Banking and What to Do About It."

Regular readers know that your humble blogger differs with Professor Admati on both the diagnosis of what is wrong with banking and what to do about it.

I see the problem with banking being opacity.

Opacity that let's bankers engage in bad behavior knowing that they are Too Big to Jail.

Opacity that makes the financial system unstable because market participants are dependent on financial regulators both correctly assessing and communicating the risk of each bank (something the regulators cannot do because of concerns about the safety and soundness of the financial system).

Opacity that prevents the market from exerting discipline on the banks and restraining their risk taking.

Opacity that creates moral hazards like bailouts because investors relied on the Fed's stress tests when making an investment decision.

Opacity that makes the banks such "black boxes" that banks with deposits to lend cannot assess the risk and solvency of the banks looking to borrow.

Opacity that has been made even worse by the response of policymakers and financial regulators.  They have decide we need more of what failed to prevent the financial crisis in the first place.  Namely, the combination complex rules and regulatory oversight.

Professor Admati has championed the notion that banks were holding too little capital going into the financial crisis and by simply upping capital standards all will be well.

This is knowably untrue.

The OECD has written extensively how due to the suspension of mark-to-market accounting and creation of 'zombie' loans under regulatory forbearance bank financial reporting and bank book capital is meaningless.

Opacity hides the true condition of the banks.  Who knows just how distorted each bank's financial statement is from reflecting its true financial condition?  After all, Dexia reported very high capital levels shortly before it needed to be nationalized.

Until there is ultra transparency and banks have to disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details, bank financial reporting and book capital will remain meaningless.

Ultra transparency is the necessary condition for Professor Admati's capital standards to be relevant.

Do we have to resign ourselves to having a fragile and dangerous banking system, one that harms the economy and requires government support when the risks turn out badly?

No.

As we have seen, there is not much prospect of dealing with failures of large and interconnected banks, particularly those that are active internationally, without imposing large costs on the economy.

Actually, there is a simple solution for dealing with these banks without imposing large costs on the economy.  Require the banks to provide ultra transparency.

Like all market participants, banks know that when they have access to all the useful, relevant information in an appropriate, timely manner they become responsible for all losses on their exposures.

In practical terms what this means is that the banks will independently assess each of the other banks that they have dealings with and they will adjust their exposure to what they can afford to lose should the other bank fail.

With ultra transparency, the cost of failure of a bank is absorbed by investors (including other banks) and not the real economy or society.

Ultra transparency is very important as it also ends the mechanism of financial contagion.  Each bank manages its exposures so that it can survive the failure of the other banks.

The economy is also harmed when many banks are distressed at the same time and do not make sufficient loans because of their overhanging debts.

There is a common misconception that a distressed bank stops making loans.  This is untrue.  I must be too old, but I distinctly remember that in the US Savings & Loan crisis, the management of these institutions gambled on redemption by making large real estate development loans.

As a practical matter, bank lending and the funding of these loans has been separate for at least 40 years.  The reason that they are separate is that holding a loan on a bank balance sheet is not the only option for the bank.  It can sell the loan to a bank syndicate, a hedge fund, an insurance company or a pension fund for example.

It is therefore important to focus on preventing banks and other financial institutions from running into distress or insolvency....

Please re-read the highlight text as Professor Admati has nicely summarized a point that your humble blogger has been making since the beginning of the financial crisis.  We need to take actions that prevent a financial institution from running into distress or insolvency in the first place.

This is why banks must be required to provide ultra transparency.

Investors know that with access to the information they need to independently assess the risk of each bank comes the responsibility for absorbing the losses on their investment exposures.  As a result, investors have an incentive to exert discipline on management so that management does not let the bank become distressed or insolvent.

For this purpose, we need better regulation and supervision.

True, but better regulation does not necessarily mean more regulation and better supervision does not necessarily mean more regulatory oversight.

If the banks' own incentives with respect to the risks they take and the extent of their reliance on borrowing were aligned with those of society, banking regulation would be less important. 

As it turns out, however, the incentives of banks with respect to the risks they take and to their borrowing are perversely conflicted with those of society.

This is only true because of the opacity of the banks.

If banks were required to provide ultra transparency, there would be much more alignment with the incentives of society.  This alignment would occur because investors would no longer be in a position where gains are privatized and losses are socialized.

With ultra transparency, investors know they will get hit for losses should a bank fail.  As a result, investors have an incentive to restrain the risk taking of the banks.  Restraining the risk taking results in banks focusing on supplying the credit the real economy needs and not on taking proprietary bets.

In the last few years, many proposals have been made to address the risks that the banking system imposes on society. Very few, however, have been implemented. 

Most proposals have been rejected, diluted, or delayed, some of them endlessly it appears, because the banks have convinced policymakers, regulators, and sometimes the courts that the regulations might be too expensive.... 

Please re-read the highlight text again as Professor Admati makes a very important point.

Regular readers might recall that before the financial crisis the SEC ran a cost/benefit analysis on bringing observable event based reporting to structured finance securities and concluded that the cost of transparency could not be justified.

Today, a cost/benefit analysis easily justifies bringing observable event based reporting to structured finance securities and ensuring that they are transparent.

Better Markets would argue that our financial system is based on the philosophy of disclosure and therefore transparency should never be subjected to a cost/benefit analysis.

From the bankers' perspective, any regulation that constrains their activities or might reduce their profits is expensive. 

What is expensive for the banks, however, need not be expensive for the economy. 

The costs to the banks are important, but other costs must be considered as well, particularly the costs to everyone else resulting from financial crises or bank bailouts....

When bankers complain that banking regulation is expensive, they typically do not take into account the costs of their harming the rest of the financial system and the overall economy with the risks that they take. 

Public policy, however, must consider all the costs and not simply those to the bankers. 

The point of public intervention is precisely to induce banks, or dye producers, to take account of costs they impose on others. 

For society, such intervention can be very beneficial. 

Appropriate banking regulation is available that would reduce the potential for harm to the financial system without imposing any costs on banks other than the loss of subsidies from taxpayers....

Actually, ultra transparency would cost the banks much more than the loss of their subsidies from taxpayers.

It would end their ability to profit from engaging in illegal activities like manipulating benchmark interest rates like Libor.

It would significantly reduce the profitability of their proprietary trading as market participants could trade against them to minimize their gains while maximizing their downside.

It would reduce their ability to profit from the mismatch between what regulators lead investors to think is the risk profile of the bank and what is actually the true risk profile of the bank.

It would reduce their ability to profit from engaging in regulatory or tax arbitrage.

The fact that this is beneficial and not costly for society is all too often obscured by flawed and misleading claims, what we refer to as the bankers' new clothes.

The bankers' new clothes are simply opacity.

Like the fairy tale Emperor, banks should not be hiding anything.

Is the BoE's Mervyn King's plan to break-up RBS brilliant today?

In his Telegraph column, Philip Aldrick looks at Sir Mervyn King's plan to break-up RBS into a good bank and bad bank and concludes that four years ago it would have been brilliant, but it would be a disaster today.

Actually, the plan would not have been brilliant four years ago or a disaster today.

Quite simply, the whole plan is unnecessary.

What is necessary?

First, Sir Mervyn King gets it right that RBS be required to recognize upfront all the losses on the bad debt currently hidden on and off its balance sheet.  This takes the burden off of the real economy to divert capital needed for reinvestment and growth to support the debt service on the bad debt.

Second, RBS must be required to provide ultra transparency and disclose on an ongoing basis its current global asset, liability and off-balance sheet exposure details.  With ultra transparency, market participants can confirm that RBS has recognized all its losses and exercise restraint on management's future risk taking.

Third, the UK government should avoid bailing out RBS as it is unnecessary.  The combination of deposit insurance and access to central bank funding mean that RBS can continue to operate and support the real economy even when it has low or negative book capital levels.  As a result, RBS can be left to rebuild its book capital levels through retention of 100% of pre-banker bonus earnings.

Royal Bank of Scotland should be broken up, the Governor of the Bank of England reckons. And not just that. It should be seized control of, restructured, split into a good bank and a bad bank, made to declare losses that would blow out the public finances, and finally be sold – or at least the good part – a year later. 

As an idea, it’s brilliant. It’s what the Scandinavians did in the 1990s during their banking crisis. It would also release the “good” RBS to support economic growth through lending, unencumbered by its disastrous past decisions. In fact, it’s a model that the Treasury has already put to good effect with Northern Rock. There’s just one problem. It’s not going to happen.

In fact, the Swedish Model is still effective today.  The issue is how to implement it.

Sir Mervyn King is four years too late. He argued for a good bank, bad bank split at the time of the bail-out in 2008, when he also demanded more capital be injected that would have certainly pushed RBS into “temporary public ownership”, as Labour insisted on calling nationalisation....

Sir Mervyn King's implementation was and still is flawed.

This is not surprising given that there are very few, if any, economists who actually understand the FDR Framework on which the western economies' financial systems are based.

Why don't economists understand the FDR Framework?

It is not covered in either their undergraduate or graduate course work.

Could economists understand the FDR Framework?

Of course, but it would require that they actually were open to listening to what anyone without an economics PhD says.

Regular readers know that under the FDR Framework banks are designed because of the presence of deposit insurance and access to central bank funding to be able to operate even when they have low or negative book capital levels.  Simply put, taxpayers become the banks' silent equity partners and, as if by magic, the banks have abundant capital to use to support the real economy.

Why was this designed into the FDR Framework?

To create a mechanism to protect the real economy from those times when banks and the financial markets created too much debt.

So why did governments bailout the banks?

The bankers wanted the bailouts as it insured that their bonuses would be protected while the real economy bore the cost of the excess debt (recall the principle of privatizing the gain and socializing the losses puts bankers first).

Sir Mervyn’s argument is that a broken-up RBS would support economic growth more than RBS as it is. That would be one hell of a gamble.

Actually, this is not much of a gamble as the RBS good bank would continue to support economic growth at levels that are at least as high as the current RBS consolidated good and bad bank is.

Despite Sir Mervyn’s unfair claim that “nothing has been achieved” at RBS since Stephen Hester took over as chief executive in 2008, RBS is on the road to recovery. Last week, it accelerated its restructuring – pledging to shrink the investment bank faster and float the US retail bank with two years.

In the absence of ultra transparency so that market participants could see if anything has been achieved, I will side with the financial regulator who actually has information from the bank examiners at RBS over a newspaper columnist who like myself is guessing what is inside the contents of the black box that is RBS.

Take control of RBS and the investment bank will haemorrhage staff. With less skilful people in charge to wind down the business, it could prove to be a time bomb – racking up far greater losses than currently....

Isn't 4 and half years enough time to wind down the business?

It is not clear that the current approach is minimizing losses.  We don't have any data to prove or disprove that.

What is clear is that the current approach maximizes bonuses paid to the bankers.

Given that there is no chance the politicians will follow through with Sir Mervyn’s recommendations, there can only be one explanation for why he would be so brash. His legacy. The Governor leaves office at the end of June, and he clearly wants to ensure he will be remembered for championing the little man – and battling against the banks. 

His comments will certainly achieve that. But they also expose him as insecure and lacking in the diplomatic statesmanship you would expect of a Governor. 

One more thing. RBS shares barely twitched at the threat of such huge disruption, which can only mean the markets are no longer listening.

The markets have already seen that David Cameron is incapable of admitting that his policies are wrong.

Here is Mervyn King saying that a response to the financial crisis has proven itself to be demonstrably wrong and that it is not too late to go down a different, better path (adopt the Swedish Model and require banks to recognize upfront the losses on the excess debt in the financial system).  A path that has been proven to help restart the economy which is a goal of Mr. King.

What the market are saying is that David Cameron is not capable of changing a failed policy that he inherited.

Imagine that, a politician who has no idea how to blame the other party for the problems in the economy.

Are European policymakers about to trigger EU-wide bank run

Reuters reports that EU policymakers are looking at making bank depositors bear some of the cost of bailing out the banks in Cyprus.

Once established, this policy will apply to banks in Spain, Italy, France ... and the EU-wide run on the banks will be on as a) no one can tell if any EU bank is solvent and b) there is plenty of anecdotal evidence that none of the EU banks is solvent.

European policymakers are split over how to handle a bailout of Cyprus, with Germany and some other countries pushing for bank depositors to bear part of the cost and many other member states worried such a move will cause a bank run. 

Euro zone officials say momentum has built in recent days behind the idea of "bailing-in" Cypriot bank shareholders and depositors, although the specifics of how such an operation would be carried out have not been pinned down....

Germany, Finland and the Netherlands are among those who say taxpayers cannot be expected to go on financing euro zone bailouts, saying it is time for owners and depositors in risk-laden banks to accept losses on investments. 

The concern is that announcing such a move will provoke the immediate, large-scale withdrawal of deposits from all Cypriot banks, where a large number of international investors, including many Russian and British companies, hold accounts....

While Cyprus is the euro zone's third smallest economy with annual GDP of only around 18 billion euros, a bank run could have repercussions across the single currency bloc and re-ignite the debt crisis, officials warn. 

"We have to consider that risk," said one euro zone officials whose country is undecided about whether a bail-in of depositors is the right course of action. "It's a real option but some countries don't want it."

I happen to agree that unsecured bank debt and equity holders should bear losses.

However, the necessary condition for these investors to hold losses is that the banks provide ultra transparency and disclose their current global asset, liability and off-balance sheet exposure details.

With this information, investors can assess the risk and solvency of a bank and can adjust both the amount and price of their exposure to a bank to reflect this assessment.  As a result of having the information on which to make an informed investment decision, the investor is responsible for all losses on their exposure.

Unfortunately, this is not the case.  As the Bank of England's Andrew Haldane says, current bank disclosure leaves them resembling 'black boxes'.

If they were only black boxes, then losses could be imposed on the gamblers who buy the unsecured debt and equity of these black boxes.

Banks are not just black boxes.  Banks are black boxes where the bank regulators have been making public comments about the content of these black boxes.  Specifically, bank regulators have been saying that they are solvent.

Oops.  How can you impose a solvency related loss on an investor who relied on the bank regulators' statements that the bank was solvent?

The simple solution is to realize that banks are designed to operate with low or negative book capital levels and to not bail out the banks.

By requiring the banks to provide ultra transparence, the market can exert discipline so that the bankers do not gamble on redemption as they retain future earnings to rebuild their book capital levels.

"Complete Strip-tease" by Spanish banks shows no more need for capital

The Telegraph reports that Spanish Prime Minister Mariano Rajoy thinks that the 'complete strip-tease' by the Spanish banks shows that they need no more capital.

As everyone knows, there is a difference between a strip-tease and the fully monty.  The former leaves much of the subject still covered, while the latter reveals all.

If Mr. Rajoy thinks that the Spanish banks have bared all, then his administration should be more than willing to require all Spanish banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

If there is nothing to hide after the strip-tease, then there is no reason for the banks to object to letting market participants confirm this fact for themselves.

On the other hand, by not requiring the banks to provide ultra transparency, the Spanish government is waving a red cape saying that the banks still have something to hide.

Mariano Rajoy has said that he is "absolutely convinced" that Spain will not need any more funds to prop-up its ailing banking sector, as he urged Germany and other stronger eurozone nations to do more to boost growth in the region. 

Spain's prime minister dismissed doubts over the current health of Spanish lenders, and argued that the country's banks had already revealed the extent of their troubles in a “complete striptease” of the sector. “I am absolutely convinced that Spanish financial institutions will not require any more funds than were given already,” he told the Financial Times.

Spain was forced to seek a bank bail-out of up to €100bn from the EU last June. A later audit revealed that the country's lenders would need a combined capital injection of almost €60bn. 

BoE says that Lloyds and RBS need billions more in capital

The Telegraph reports that the Bank of England has said Lloyds and RBS need billions more in capital to shore up their balance sheets.

This "news" confirms that the Swedish Model and not the Japanese Model is the appropriate choice 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 eliminates the need for policies like austerity that undermine the social contract.

A modern financial system is designed so that banks can protect the real economy by absorbing the losses on the excess debt.  Banks can do this because of the combination of deposit insurance and access to central bank funding.

This combination allows the banks to continue operating and supporting the real economy while they have low or negative book capital levels because deposit insurance makes the taxpayers the silent equity partners of the banks.

The need for billions more in capital is an explicit confirmation that a modern financial system works as designed.  These banks have been operating with we now find out were low or negative book capital levels for the last several years after the losses hidden on their balance sheets have been taken into account.

Under the Japanese Model, bank book capital levels and banker bonuses are protected at all costs.  One of the policies adopted to achieve this goal was to bailout the banks.

The need for billions more in capital also confirms that the bailouts under the Japanese Model were unnecessary.  Again, the banks operated just fine with the taxpayers as silent equity partners.

Finally, the need for billions more in capital confirms that the only beneficiaries of the Japanese Model are the bankers.  Think of all the money paid as cash bonuses by these banks since the beginning of the financial crisis.

Cash bonuses that would not have been paid had the Swedish Model been pursued and banks required to retain 100% of their pre-banker bonus earnings until their book capital levels had been rebuilt.

UK regulators have given Royal Bank of Scotland and Lloyds Banking Group until March to begin dealing with a black hole that Brooks Newmark, a Tory member of the Treasury Select Committee, suggested could be as large as £30bn. 

Bank officials refused to quantify the capital shortfall in evidence to the TSC yesterday, but they confirmed it was substantial. Michael Cohrs, a member of the Bank’s Financial Policy Committee, said it was “a big number” while Andy Haldane, the Bank’s executive director for financial stability, agreed it was “material”. 

The warning came as regulators admitted that the government had overpaid when rescuing the banks in 2008 and that the taxpayer would never make as large a profit from the bail-outs as the US, if at all. 

Asked whether returns for the UK taxpayer might match the 15pc made in the US, Mr Cohrs said: “I don’t think the UK taxpayer will get those returns.” Pressed on whether the taxpayer would make a profit at all, he added: “I don’t know.” 

Sir Mervyn King, the Bank’s Governor, said: “The sad truth is, in 2008, the idea of focusing efforts on recapitalising the banking system was a UK idea. We got there first but, like many UK ideas, the Americans developed it faster and better.”...

Given that both the UK and US have modern financial systems, the bailouts were unnecessary in the first place.

Although RBS and Lloyds will have to take action to boost their capital, the taxpayer may not have to inject any more than the £65bn already invested, the regulators said. 

The two banks can sell assets or “reduce their investment bank balance sheets, for instance”, Andrew Bailey, head of prudential regulation at the Financial Services Authority, suggested....

Of course there is a third alternative, the banks can boost their capital by retaining 100% of pre-banker bonus earnings.

The UK’s other banks and building societies are under similar regulatory scrutiny, following the FPC’s warning in November that the industry had up to £60bn of hidden losses on its balance sheet – from understated bad debts to underestimated provisions to cover fines and compensation for Libor rigging and other scandals. 

Lloyds and RBS need billions more in capital despite a taxpayer funded bailout that supposedly took into account all the losses hidden on and off their balance sheets.

Given that the UK financial regulators appear to have under-estimated the true amount of capital Lloyds and RBS needed, there is no reason to believe that the FPC's estimate does not suffer from the same problem.

The only way market participants will ever know if the banks are solvent again is if the UK requires its banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

Ultra transparency will give UK banks a global competitive advantage.  Market participants will be able to assess the risk of the banks and adjust the amount and pricing of their exposure to the banks based on each bank's risk.

At the same time, market participants know that any bank not providing ultra transparency is undoubtedly hiding something and is far riskier than the UK banks.  As a result, market participants will require a higher return to provide capital to these banks.  This gives the UK banks a competitive advantage until the other banks also provide ultra transparency.

The FPC wants capital positions reinforced to support economic growth....

Regular readers know that it reinforcing bank capital positions is not necessary to support economic growth.  The solution so that credit is available to support economic growth is the originate to distribute model with transparency.

Under this model, structured finance securities ranging from covered bonds to securitizations provide observable event based reporting on all activities like payments or delinquencies on the underlying assets by the beginning of the next business day so that investors can know what they own.

It is the ability to know what you own or know what you are buying that will bring investors back to the structured finance securities and insure that there is sufficient capacity to support economic growth.

Sir Mervyn argued the best course of action was to deal with a lack of capital “straight away”. “Banks have two options – either they raise more capital or they restructure... Investors may not like it, but they will be better off over time,” he added.

Sir Mervyn is wrong.

The best course of action is to adopt the Swedish Model and the originate to distribute model with transparency.

Mr Bailey said: “If you want to sell the Government’s shareholding [in RBS and Lloyds], you have to have a balance sheet and business model that have a stable future.” The taxpayer owns 41pc of Lloyds and 82pc of RBS.

AIG, Financial Contagion and Transparency

As the public furor over the AIG shareholders suing about the terms of the US government's bailout subsides, it is important to remember that the bailout would have been unnecessary if there was transparency in the financial system.

The driver behind bailing out AIG and paying off 100% of the value of its derivative positions was the fear of financial contagion.  Under financial contagion, the collapse of one firm triggers a domino effect that causes other firms and the financial system to collapse.

Regular readers know that under the FDR Framework, the government is responsible for ensuring that market participants have access to all the useful, relevant information in an appropriate, timely manners so the market participants can independently assess this information and make a fully informed investment decision.

To provide an incentive for market participants to use this information, under the FDR Framework, market participants are made responsible for all gains and losses on their investments by the principle of caveat emptor (buyer beware).

Market participants know that they will not be bailed out of losing investments and as a result, they limit their investments to what they can afford to lose given the risk of the investments.  This effectively ends financial contagion.

How does this apply to AIG?

If market participants had information on the size of AIG's derivative portfolio, they would have ceased doing additional business with AIG far sooner because they would have known that there was a high risk that AIG could not perform if there were problems with sub-prime mortgage-backed securities.

Bottom line:  if there had been transparency, Wall Street would not have needed to be bailed out because the losses that Wall Street firms would have suffered from AIG's failure would have been within their capacity to absorb.

Matt Taibbi: US government lied about health of large US banks

In a Rolling Stones article, Matt Taibbi discusses how the US government adopted the policy of lying about the health of the large US banks.  In doing so, he makes the case for why the only way to restore trust in the banks and end the moral hazard of Too Big to Fail is if the banks provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

Regular readers are familiar with Yves Smith's Geithner Doctrine:

Nothing must be done that will hurt the profits or reputation of any bank that is pretty big or well-connected.

Mr. Taibbi sums up the result of implementing this doctrine:

It built a banking system that discriminates against community banks, makes Too Big to Fail banks even Too Bigger to Failier, increases risk, discourages sound business lending and punishes savings by making it even easier and more profitable to chase high-yield investments than to compete for small depositors. 

The bailout has also made lying on behalf of our biggest and most corrupt banks the official policy of the United States government. 

And if any one of those banks fails, it will cause another financial crisis, meaning we're essentially wedded to that policy for the rest of eternity – or at least until the markets call our bluff, which could happen any minute now.

In reaching this conclusion, Mr. Taibbi looks at how the US government handled the issue of reporting the true condition of the largest US banks since the beginning of the financial crisis.

In doing this, Mr. Taibbi shows why the financial regulators' information monopoly must be ended and banks must be required to provide ultra transparency.

The main reason banks didn't lend out bailout funds is actually pretty simple: Many of them needed the money just to survive.

Please recall that starting on August 9, 2007, the question asked globally was which banks are solvent and which banks are not.  This question could not be answered because the banks' current disclosure practices leave them, in the words of the Bank of England's Andrew Haldane, resembling 'black boxes'.

Which leads to another of the bailout's broken promises – that taxpayer money would only be handed out to "viable" banks.

Walter Bagehot, the father of modern central banking, said that the central bank's role as lender of last resort was to lend at high interest rates against good collateral to solvent banks.

What was obvious to all from the beginning of the financial crisis is that the global central banks were lending at low interest rates against even the most worthless collateral whether the banks were solvent or not for fear of financial contagion.

Regular readers know that the only way to end financial contagion is to require the banks to provide ultra transparency.  With this information, market participants can assess the risk of each bank and adjust their exposure to the banks to what they can afford to lose.  As a result, the collapse of one bank does not bring down the entire financial system.

Please re-read the preceding as this is the necessary condition for ending our current financial crisis.

Your humble blogger is not alone in calling for this.  See the article "What's inside America's Banks' based on this blog written by Frank Portnoy and Jesse Eisinger as well as Nassim Taleb's call for an anti-fragile system.

Soon after TARP passed, Paulson and other officials announced the guidelines for their unilaterally changed bailout plan. Congress had approved $700 billion to buy up toxic mortgages, but $250 billion of the money was now shifted to direct capital injections for banks.... 

This new let's-just-fork-over-cash portion of the bailout was called the Capital Purchase Program. Under the CPP, nine of America's largest banks – including Citi, Wells Fargo, Goldman, Morgan Stanley, Bank of America, State Street and Bank of New York Mellon – received $125 billion, or half of the funds being doled out. Since those nine firms accounted for 75 percent of all assets held in America's banks – $11 trillion – it made sense they would get the lion's share of the money. 

But in announcing the CPP, Paulson and Co. promised that they would only be stuffing cash into "healthy and viable" banks. This, at the core, was the entire justification for the bailout: That the huge infusion of taxpayer cash would not be used to rescue individual banks, but to kick-start the economy as a whole by helping healthy banks start lending again. 

This announcement marked the beginning of the legend that certain Wall Street banks only took the bailout money because they were forced to – they didn't need all those billions, you understand, they just did it for the good of the country. 

"We did not, at that point, need TARP," Chase chief Jamie Dimon later claimed, insisting that he only took the money "because we were asked to by the secretary of Treasury." Goldman chief Lloyd Blankfein similarly claimed that his bank never needed the money, and that he wouldn't have taken it if he'd known it was "this pregnant with potential for backlash." 

A joint statement by Paulson, Bernanke and FDIC chief Sheila Bair praised the nine leading banks as "healthy institutions" that were taking the cash only to "enhance the overall performance of the U.S. economy." 

But right after the bailouts began, soon-to-be Treasury Secretary Tim Geithner admitted to Barofsky, the inspector general, that he and his cohorts had picked the first nine bailout recipients because of their size, without bothering to assess their health and viability.

Paulson, meanwhile, later admitted that he had serious concerns about at least one of the nine firms he had publicly pronounced healthy. 

And in November 2009, Bernanke gave a closed-door interview to the Financial Crisis Inquiry Commission, the body charged with investigating the causes of the economic meltdown, in which he admitted that 12 of the 13 most prominent financial companies in America were on the brink of failure during the time of the initial bailouts.

On the inside, at least, almost everyone connected with the bailout knew that the top banks were in deep trouble. "It became obvious pretty much as soon as I took the job that these companies weren't really healthy and viable," says Barofsky, who stepped down as TARP inspector in 2011.

Please re-read the highlighted text as it confirms what your humble blogger has been saying since the beginning of the financial crisis that the financial regulators chose not to communicate to the market their true assessment of the solvency of the banks.

This is very important as the financial regulators have a monopoly on the information that market participants need to assess the solvency of each bank.  If the financial regulators misrepresent the banks' financial condition, there is no way for market participants to properly adjust both the price and amount of capital they provide to the banks.

More importantly, once the government started lying about the condition of the banks, everyone knew it.

How?

Please notice that the interbank lending market froze at the beginning of the financial crisis because banks with deposits to lend could not determine which banks were solvent and could repay the loans and which were not.

The interbank lending market is still frozen.

This is the banks' way of telling the market that they are still concerned with the solvency of other banks because they know that they too are hiding losses on and off their balance sheets.

This early episode would prove to be a crucial moment in the history of the bailout. It set the precedent of the government allowing unhealthy banks to not only call themselves healthy, but to get the government to endorse their claims. 

Projecting an image of soundness was, to the government, more important than disclosing the truth. Officials like Geithner and Paulson seemed to genuinely believe that the market's fears about corruption in the banking system was a bigger problem than the corruption itself. 

Time and again, they justified TARP as a move needed to "bolster confidence" in the system – and a key to that effort was keeping the banks' insolvency a secret. In doing so, they created a bizarre new two-tiered financial market, divided between those who knew the truth about how bad things were and those who did not....

Please re-read the highlighted text because not only are the banks fighting to maintain opacity so they can continue to gamble and engage in bad behavior like manipulating Libor, but the government has committed itself to maintaining opacity.

As you can imagine, this effectively undermines the US financial system as it is based on the FDR Framework and its combination of the philosophy of disclosure and the principle of caveat emptor (buyer beware).

The sweeping impact of these crucial decisions has never been fully appreciated. 

In the years preceding the bailouts, banks like Citi had been perpetuating a kind of fraud upon the public by pretending to be far healthier than they really were. In some cases, the fraud was outright, as in the case of Lehman Brothers, which was using an arcane accounting trick to book tens of billions of loans as revenues each quarter, making it look like it had more cash than it really did. 

In other cases, the fraud was more indirect, as in the case of Citi, which in 2007 paid out the third-highest dividend in America – $10.7 billion – despite the fact that it had lost $9.8 billion in the fourth quarter of that year alone. 

The whole financial sector, in fact, had taken on Ponzi-like characteristics, as many banks were hugely dependent on a continual influx of new money from things like sales of subprime mortgages to cover up massive future liabilities from toxic investments that, sooner or later, were going to come to the surface. 

Now, instead of using the bailouts as a clear-the-air moment, the government decided to double down on such fraud, awarding healthy ratings to these failing banks and even twisting its numerical audits and assessments to fit the cooked-up narrative. 

A major component of the original TARP bailout was a promise to ensure "full and accurate accounting" by conducting regular­ "stress tests" of the bailout recipients. 

When Geithner announced his stress-test plan in February 2009, a reporter instantly blasted him with an obvious and damning question: Doesn't the fact that you have to conduct these tests prove that bank regulators, who should already know plenty about banks' solvency, actually have no idea who is solvent and who isn't?

The government did wind up conducting regular stress tests of all the major bailout recipients, but the methodology proved to be such an obvious joke that it was even lampooned on Saturday Night Live. (In the skit, Geithner abandons a planned numerical score system because it would unfairly penalize bankers who were "not good at banking.")  

In 2009, just after the first round of tests was released, it came out that the Fed had allowed banks to literally rejigger the numbers to make their bottom lines look better. When the Fed found Bank of America had a $50 billion capital hole, for instance, the bank persuaded examiners to cut that number by more than $15 billion because of what it said were "errors made by examiners in the analysis." Citigroup got its number slashed from $35 billion to $5.5 billion when the bank pleaded with the Fed to give it credit for "pending transactions." 

Such meaningless parodies of oversight continue to this day. Earlier this year, Regions Financial Corp. – a company that had failed to pay back $3.5 billion in TARP loans – passed its stress test. A subsequent analysis by Bloomberg View found that Regions was effectively $525 million in the red. Nonetheless, the bank's CEO proclaimed that the stress test "demonstrates the strength of our company." Shortly after the test was concluded, the bank issued $900 million in stock and said it planned on using the cash to pay back some of the money it had borrowed under TARP. 

This episode underscores a key feature of the bailout: the government's decision to use lies as a form of monetary aid. State hands over taxpayer money to functionally insolvent bank; state gives regulatory thumbs up to said bank; bank uses that thumbs up to sell stock; bank pays cash back to state. What's critical here is not that investors actually buy the Fed's bullshit accounting – all they have to do is believe the government will backstop Regions either way, healthy or not. "Clearly, the Fed wanted it to attract new investors," observed Bloomberg, "and those who put fresh capital into Regions this week believe the government won't let it die." 

Through behavior like this, the government has turned the entire financial system into a kind of vast confidence game – a Ponzi-like scam in which the value of just about everything in the system is inflated because of the widespread belief that the government will step in to prevent losses.... 

They're building an economy based not on real accounting and real numbers, but on belief. 

The time has come to stop doubling down and build an economy based on real accounting and real numbers.