Simon Johnson and the great Basel Betrayal

In his NY Times Economix column, MIT Professor Simon Johnson examined the Basel Committee on Bank Supervision's new bank liquidity requirements.

Needless to say, he was not happy with what he found.

On the other hand, he was quite pleased with the Atlantic article by Frank Portnoy and Jesse Eisinger titled "What's inside America's banks".  [An article that regular readers know was based without attribution on the original content on this blog.]

When "investors think that the banks are hiding trouble in the published balance sheets", Professor Johnson asserts that confidence is not restored by relaxing bank regulation.

When "investors think that that banks are hiding trouble in the published balance sheets", your humble blogger would add that talking about bank capital levels also does not restore confidence as capital is meaningless if the banks are hiding their troubles.

What restores confidence is requiring the banks to disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.  With this information, market participants can independently assess the solvency and risk of each bank.

Market participants trust and have a high degree of confidence in the results of their own assessment of this information or the results of the assessment of this information by third party experts they hire.  It is this trust and confidence in the results of the assessment that restores trust and confidence.

The only positive role for regulation in restoring trust and confidence is regulation that requires the banks to provide ultra transparency.

This week the Basel Committee on Banking Supervision, as it is known, let us down – once again. Faced with renewed pressure from the international banking lobby, these officials caved in, as they did so many times in the period leading to the crisis of 2007-8. 

As a result, our financial system took a major step toward becoming more dangerous....

Why did this happen? Must Basel always let us down? And is there any alternative?

Yes, there is an alternative.  An alternative that I have brought to Professor Johnson's attention.

The alternative to the combination of complex rules and regulatory oversight, the specialty of the Basel Committee, is the combination of transparency and market discipline.

You will no doubt have noticed that very large banks with a global span have an unusual degree of political influence. 

Please note that one of the reasons complex rules and regulatory oversight fail is they are susceptible to political influence.

One of the reasons that transparency and market discipline works is that the market is not susceptible to influence by the banks.  After all, investors care about getting properly compensated for the risk they take on as they know in the parts of the financial system where there is transparency they will not be bailed out of their losses.

In particular, they have the ability to threaten the economic recovery. Their line is: if you don’t give us what we want, credit will not flow and jobs will not come back.

Policy makers in Washington are often impressed by this line, although less frequently than they used to be. 

Excuse me, but virtually every policy being pursued in Washington reflects the Japanese Model for handling a bank solvency led financial crisis and the fear that if bank book capital levels or banker bonuses are not protected the economic recovery will not occur.

More and more, managers have begun to understand that the people who run large banks have distorted incentives. 

Because they receive downside protection from the public sector – the too-big-to-fail phenomenon – bank executives want to take a great deal of risk. When things go well, they get the upside; when things go badly, that is largely someone else’s problem.

Regular readers know that I hold Professor Johnson in high regard for the work that he has done highlighting this issue of privatizing the gains and socializing the losses.

How does that desire for risk manifest itself? The banks lobby for the ability to fund themselves with more debt and less equity, and they also want to be less safe on other dimensions, including holding fewer liquid assets. 

The Basel Committee this week agreed to water down its liquidity requirements....

A prime example of how the combination of complex rules and regulatory oversight fail as a result of political influence.

If the banks were required to provide ultra transparency, then they would be subject to market discipline as to how much they hold in the way of liquid assets and capital.  Market discipline that would reward banks with a lower cost of funds/higher share price that had more liquidity and capital as these banks would be less risky.

The idea that the Basel process is all about expertise – or smart people working out the right answers – is exploded by Sheila Bair’s book, “Bull by the Horns.” ....

What we saw before 2007 and what we see now is not officials applying some sort of optimization procedure or sensible independent thinking. Rather, this is about an industry that wants to take more risk because that is how it gets larger subsidies. And this industry is expert at playing the regulators off against each other, including across borders. The Europeans are again the patsy.

Unfortunately, some United States officials are so captured or captivated by the ideology of modern banking that they want to play along....

This argument by Professor Johnson makes adopting the combination of transparency and market discipline compelling as it does not have fatal flaws including those that exist in the combination of complex rules and regulatory oversight.

We need a financial sector that works for the real economy – not a continuation of the dangerous, nontransparent government subsidy schemes that have brought the Europeans to their knees.

Professor Johnson nicely summarizes your humble bloggers argument for why banks must be required to provide ultra transparency.

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.

High-speed trading lobby and its conflicted paid for research

The Wall Street Journal carried an article describing how the high-speed trading lobby is trying to fend off regulation using research it pays for.

This practice is routine for lobbyists as they use it to shape policy makers perceptions of the issues.  The banking industry has engaged in similar activities.

The chief executive of Knight Capital Group Inc. KCG told Congress in June that rapid-fire trading, the backbone of its business, is a boon to the overall stock market. He cited a study that cautioned regulators against unintended consequences of curbing the practice known as high-frequency trading. 

It was a 2010 study Knight itself had commissioned. Its lead author that year joined the board of a stock-exchange company that caters to high-speed traders and is partly owned by Knight. 

Less than two months after the Knight executive's testimony, Knight nearly imploded when computerized trades went haywire, costing it $461 million in losses. Last week, the hobbled firm agreed to a takeover. 

High-frequency trading firms are fighting to fend off regulation as scrutiny of their practice of unleashing blizzards of orders coincides with repeated technical glitches in the markets. 

As the firms work to convince policy makers their practices are benign or even beneficial, one of their primary tools has been research seeded by the industry itself, promoted by lobbying that has increased in recent years. 

Yet research conclusions presented as firm endorsements of high-frequency trading don't always square with reservations harbored by some researchers themselves, who question how far existing studies can go to pin down the effect rapid trading has on the overall market.

The studies have value but also shortcomings, says the researcher hired and quoted by Knight, James Angel, a finance professor at Georgetown University. "Not even the exchanges have all the data," Mr. Angel said in an email. "We see a big jumble and it is impossible to pick out the good from the bad."

Mr. Angel said Knight's payment didn't influence his conclusions. Knight's sponsorship was noted by the firm's CEO, Thomas Joyce, in his appearance before Congress in June, though not in written testimony ahead of the hearing that also quoted the Angel paper. A spokeswoman for Knight said the Jersey City, N.J., firm "supports research that helps foster a better understanding of market structure."

Other research that rapid-fire-trading firms have cited includes additional papers paid for by such firms and a study whose author was hoping to sell software to computerized traders.

Please re-read the highlighted text as it raises a number of interesting points.

First, it raises the issue of the need for transparency so that market participants, including academic researchers and regulators, have all the data and can pick out the good from the bad.

Second, it raises the issue of using the school's reputation to hide the fact that the research was paid for by the industry.  The researcher's credibility is directly linked to the reputation of the school the researcher works for.  However, the school is clearly not endorsing the outcome of the research.

Third, it raises the issue of using the school's reputation to hide the researcher's motivation.

In high-frequency trading, computers place thousands of buy and sell orders and instantly cancel many of them, having placed them just to test demand. Such trading has come to dominate U.S. stock markets, making up more than half of daily volume, and increasingly influences how currencies, commodities and other assets trade. 

It is at the center of a debate about the future of financial markets. 

Defenders say high-frequency trading keeps markets lubricated with a constant supply of buy and sell orders that enables all participants to trade more efficiently and get better pricing..... 

Critics, for their part, worry that the traders' order torrent makes markets more opaque, less stable and ultimately less fair.

The absence of data cited by the industry's own researcher strongly suggests the critics are right that high speed trading makes the markets more opaque, less stable and ultimately less fair.

Large European banks continue to hoard cash at central banks

The Wall Street Journal reports that large European banks continue to hoard cash at central banks.  The reason for doing so is it is:

a move that reflects their lingering fears about the financial system despite signs of improvement.

Here we are five years after the beginning of the bank solvency led financial crisis and banks still cannot answer the questions highlighted by the Financial Crisis Inquiry Commission:

• Which banks are solvent; and
• Which banks are insolvent.

As your humble blogger has discussed at length, if banks with deposits to lend cannot tell if the banks looking to borrow are solvent, they simply will not lend.  This is easily shown by the fact that the unsecured interbank loan market has been effectively frozen since the beginning of the financial crisis.

What does it take to unfreeze the unsecured interbank lending market?

Requiring the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.  

With this information, banks with deposits to lend can independently assess the solvency of the banks looking to borrow and the probability that they will or won't be repaid.  Based on this assessment, banks with deposits to lend can adjust both the amount they are willing to lend and the price at which they are willing to lend to the risk of the borrowing bank.

Even the rich don't trust banks

A Telegraph article discusses a survey of wealthy UK investors that says these investors don't trust the banks.

YouGov figures show that over two thirds of well-heeled bank customers have less faith in the banking industry than they did a year ago. 

The survey looked at those with more than £250,000 in investable assets and found that the biggest reason for their lack of faith was the bonus culture, along with banks putting short-term profitability ahead of customer welfare. The Libor-fixing rate fixing was also a significant contributor. 

More than eight in 10 believed banking practices to be equally or more dishonest than those in journalism, despite the Leveson inquiry finding that many rich people had been the victims of hacking by newspapers. 

Nearly one in 10 of people surveyed had had their bank accounts hacked into, over a sixth of whom said their bank had not recognised the change in spending. 

You know it is bad when people see their victimization at the hands of the banks as worse than having their personal privacy stolen.

Regular readers know that the first step in restoring trust and changing the culture of banking is to recognize that sunlight is the best disinfectant.

Any bank that wants to demonstrate that it can be trusted will voluntarily provide ultra transparency and disclose its current global asset, liability and off-balance sheet exposure details.

Only this level of disclosure by banks allows sunlight to act as the best disinfectant.  For example, it would have been prevented manipulation of Libor.

Bank of England's Financial Policy Committee embraces transparency

As reported by the Telegraph, the Bank of England's Financial Policy Committee is recommending that

To give investors the confidence to put their money in the banks, lenders need to be more honest about the scale of bad debts they are carrying, the FPC said. 

“The task of attracting fresh external capital [could be] facilitated if steps were taken to reduce uncertainty about valuations of on-balance sheet assets,”

Please re-read the highlighted text as the FPC has effectively called for banks to provide ultra transparency as your humble blogger has been advocating and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

It is only with this level of granular information that uncertainty about valuations is reduced and investor confidence is restored.

Uncertainty is reduced because market participants can independently confirm the valuations.

With deposits running out the door, Spanish bad loans climb to almost 10%

According to a Guardian article,

Spanish bad bank loans climbed to a fresh high in July, with almost 10pc of households and companies now behind on their payments. 

Bad debts climbed to 9.86pc of total lending, the according to Bank of Spain data, the highest since records began in 1962. 

The data showed that €169.3bn of loans were more than three months past their repayment deadlines. June's bad loan rate was also revised up, to 9.65pc.

This increase in bad loans is no surprise to regular readers as your humble blogger has been saying for months that the level of bad loans was inconsistent with a 25% unemployment rate and a shrinking economy.

The real question is "what is the true state of the Spanish bank balance sheets".

Without ultra transparency under which the banks disclose all of their current global asset, liability and off-balance sheet exposure details, how are market participants suppose to know the true extent of the banks' exposure to losses?

The answer is that they cannot.

Bringing in a consultant does not provide confidence in the bad loan level.

Without ultra transparency, there is no reason to 'trust' the consultant's statement on the level of bad loans as the statement cannot be independently confirmed.

Without the ability to independently confirm, market participants have to ask themselves 'why is the government hiding the exposure level data'?

Barclays is 'working to become more transparent'

In reporting Barclays' half-year results, its Board Chairman, Marcus Agius turns to transparency to restore both integrity and market participants' trust in Barclays.

Our Citizenship agenda is now more important than ever; we have ambitious commitments that we must deliver and continue to evolve to address the issues that matter most to those we serve. 

We must focus on getting the fundamentals right – serving our customers and clients with integrity and maintaining the highest standards of service – while reviewing our business values and working to become more transparent.  

The question is:  will Barclays actually deliver transparency and begin disclosing on an ongoing basis its current global asset, liability and off-balance sheet exposure details?

This is the level of disclosure that is consistent with a bank that says "I can stand on my own two feet and I have nothing to hide".

If Barclays doesn't deliver this level of disclosure, the question is: why would anyone trust Barclays given that it has confessed to lying for the benefit of its bankers and itself and is clearly hiding something?

Barclays admits that Libor scandal 'decimated' trust in banks

As reported by the Telegraph, Barclays

has admitted the public’s trust in banks has “been decimated and needs to be rebuilt” as it set out measures aimed at rebuilding its reputation in the wake of Libor rigging.

Regular readers know that there is only one action that Barclays has to take if it ever wants to rebuild its reputation:  provide ultra transparency.

It is only by disclosing on an on-going basis its current global asset, liability and off-balance sheet exposure details that Barclays is providing market participants with the information they need to independently assess Barclays.  With the ability to independently assess Barclays comes the ability to Trust, but Verify.

Any action other than providing ultra transparency is simply putting lipstick on a pig.

Britain’s second-largest lender on Tuesday said the scandal that saw chief executive Bob Diamond and chairman Marcus Agius resign showed “banks need to revisit fundamentally the basis on which they operate, and how they add value to society”. 

Describing the “daunting” task ahead of it, Barclays said it needed a culture change that would see it “affirming key values” with “reinforcing mechanisms” to ensure staff behaved appropriately. Alluding to management and pay, it added “visible leadership” and rewards would have to be aligned to these values....

Hence the reason for adopting ultra transparency.  Sunlight is the best disinfectant and insures that staff behave appropriately.

“Barclays has a real opportunity to use the events of the past weeks to drive a change in its values and practices. I look forward to hearing views on the changes that should be made,” Mr Salz said. “I hope that this review will significantly assist Barclays in rebuilding trust and reaffirming its position as one of our leading institutions.”...

Consider this post your humble blogger's view on the change that should be made.


And by the way, consider it also former Citigroup head Sandy Weill's view as he called for banks to be "completely transparent". 

Libor, Central Banks and the "Mother of All Financial Databases"

On May 22, 2008 the Bank of England circulated an internal document that suggests the it had some idea that Libor was being manipulated.

There is a long standing perception that Libor by virtue of the manner in which it is set is open to distortions:  panel banks have no obligations to trade or to have traded at the rates that they submit, so it is at least plausible that these are influenced by commercial incentives.

According to a Telegraph article (ZeroHedge has a must read piece on this article), a former RBS trader claims hedge funds routinely asked for Libor to be manipulated.  Here was the commercial incentive as the hedge funds were a major source of revenue to the traders.

He claims in his lawsuit that asking for changes in Libor was "common practice" among RBS traders and that the bank "took requests from clients" to alter the rate.

As the Libor scandal continues to grow, what is important to focus on is that we are talking about the integrity of the global financial system.

The question that must be answered is how to restore the integrity of the global financial system in a way that everyone would believe.

Your humble blogger realizes he has been talking about the need to bring transparency into all of the opaque corners of the financial system since the beginning of the financial crisis.  However, if this is not done, nobody will believe the system is not rigged and easily manipulated by the banks.

The Dodd-Frank Act was based on the idea that regulators had learned their lesson from the financial crisis and by giving them a second chance they would prove their worth.  Well, the Libor scandal shows this isn't true.

Why?

If the regulators had learned their lesson, they would have known that if you want to stop manipulation of a benchmark interest rate, you have to tell someone and stop using it yourself!

The Fed did neither.  What exactly was their excuse for not telling the Bank of England in 2010 that Barclays had understated its Libor submissions or telling the US public before the debate on Dodd-Frank?  Actually, nobody wants to hear their excuse.

We want the focus to be on how we can restore integrity and trust to the global financial system.


The only way that has been proven that can do this is by bringing transparency to all the opaque corners of the financial system.  This was successfully done in the 1930s.

In the 21st century, this means we should create the "Mother of all financial databases".  This database will be a repository accessible to all market participants (not like the Office of Financial Research which is only available to regulators and is the poster child for where transparency and trust in the financial system go to die).

At a minimum the database should have,

• all the banks' exposure details on a borrower privacy protected basis.  The banks should be required to disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details; and

• all the current performance information on the collateral supporting structured finance securities.  This information should be reported on an observable event basis as activities like payments or default occur with the underlying collateral are reported before the beginning of the next business day.

This database should be overseen by an independent third party that is free of all conflicts of interest including who owns it, who is on its board, and who manages it.  We have seen in the structured finance market what happens when conflicted parties are involved in ownership and oversight of the data warehouse operating the database.

This independent third party's only business should be coordinating the database to maximize transparency in the global financial system now and into the future.

I fully expect that at their September 9th meeting, the leading central banks will endorse building the "Mother of all financial databases".  They know that restoring integrity and trust to the global financial system cannot wait.  

They also know that failing to endorse the building of the "Mother of all financial databases" is sending a signal that they are not unhappy with the current opaque, rigged financial system.

From the firm that sold the Abacus deal, Libor scandal undermines trust

As reported by Bloomberg,

Allegations of interest-rate rigging by global banks are hurting the financial system by undermining trust, said Lloyd C. Blankfein, chairman and chief executive officer of Goldman Sachs Group Inc. (GS) 

“The biggest impact is once more undermining the integrity of the system that has already been undermined so substantially,” Blankfein, 57, said .... “There was this huge hole to dig out of in terms of getting trust back and now it’s just that much deeper.”...

Mr. Blankfein is certainly in a position to know just how badly trust has been undermined and how big the hole is in terms of getting trust back given his firm's contribution through deals like the Abacus CDO transaction.

Blankfein, whose firm reaped 58 percent of first-half revenue from trading, said financial markets are damaged by a lack of trust. 

“Uncertainty is something that puts a burden on things -- it makes spreads wider, harder to transact,” Blankfein said. “But also a lack of trust is certainly at least a cousin of that.”

There is a relationship between uncertainty and trust.  Both cause spreads to widen and make it harder to transact.

Where they differ is in order of magnitude.  With uncertainty, deals can still be done.  With a lack of trust, the market freezes.

For anyone who doubts, look at the freezing of the interbank lending market because no bank could trust that any other bank could repay a loan.

Regular readers know that the only way to restore trust in the financial markets is by bringing transparency to all the opaque corners of the financial markets.

Trust returns because market participants can use the information provided by transparency to independently assess the risk of any investment and market participants trust their own assessment.

At a minimum, to bring transparency to the financial markets will require:

• banks to disclose on an ongoing basis all of their current global asset, liability and off-balance sheet exposure details; and
• structured finance securities to report on an observable event basis every activity like a payment or default that occurs with the underlying collateral before the beginning of the next business day.

What does it take to restore trust in financial system given financial regulators permitted Libor manipulation to continue?

Sometime this week, your humble blogger expects to hear the financial regulators trot out their defense for knowing about, but taking no action to stop manipulation of the Libor interest rate in 2008/2009.

The defense is quite simple.  They were willing to overlook criminal conduct out of concern that exposing this conduct would make the financial crisis worst.

Of course, this defense does not address the question of why the financial regulators did not bring up the manipulation of Libor interest rates prior to the debate over the Dodd-Frank Act or to the UK's Independent Commission on Banking.

It is this cover-up that has and is destroying trust in the financial system.

Who do you trust?

You cannot trust the banks.  Barclays has already admitted to lying both for profit and to present itself as financially healthier than it was.  Deutsche Bank has negotiated a deal to get off lightly in return for turning over evidence.

You cannot trust the financial regulators.  The failure to bring up the manipulation as the policy response to the financial crisis was being discussed is explicitly condoning banks manipulating Libor.

The problem that we know face is how do we restore trust in the financial system.

As your humble blogger has been saying since the beginning of the financial crisis, the solution is transparency.

• For banks, this means they must be required to disclose on an ongoing basis their current asset, liability and off-balance sheet exposure details.

• For structured finance securities, this mean they must be required to report on an observable event basis any activity, like a payment or default, occurring with the underlying collateral before the beginning of the next business day.

A quarter of Wall Street professionals see wrongdoing as key to success

As reported by Reuters, many Wall Street professionals see wrongdoing as necessary.

 If the ancient Greek philosopher Diogenes were to go out with his lantern in search of an honest man today, a survey of Wall Street executives on workplace conduct suggests he might have to look elsewhere. 

A quarter of Wall Street executives see wrongdoing as a key to success, according to a survey by whistleblower law firm Labaton Sucharow released on Tuesday. 

In a survey of 500 senior executives in the United States and the UK, 26 percent of respondents said they had observed or had firsthand knowledge of wrongdoing in the workplace, while 24 percent said they believed financial services professionals may need to engage in unethical or illegal conduct to be successful. 

Sixteen percent of respondents said they would commit insider trading if they could get away with it, according to Labaton Sucharow. And 30 percent said their compensation plans created pressure to compromise ethical standards or violate the law. 

"When misconduct is common and accepted by financial services professionals, the integrity of our entire financial system is at risk," Jordan Thomas, partner and chair of Labaton Sucharow's whistleblower representation practice, said in a statement.

The results of this survey are not surprising as they simply reflect that mentality captured by Yves Smith in her observation that nobody on Wall Street is compensated for creating transparent, low margin products.

With the Libor scandal, we have found out that even the Wall Street types working with low margin products game the financial system to enhance their personal income.

A review of the Bank of England's Financial Policy Committee performance after one year

Regular readers know that your humble blogger was not optimistic about the contribution that the Bank of England's Financial Policy Committee would make to promoting financial stability and, as a result, set the bar for success at "do no damage".

The reason for this low standard is the composition of the membership of the FPC.  It is long individuals with a PhD in Economics.

In addition, there is no one on the FPC who publicly predicted our current financial crisis.  I felt this might be a problem because in the absence of anyone who understood why the financial crisis occurred it was highly unlikely the FPC had the expertise to do anything to moderate the current crisis or prevent the next crisis.

Recall that the Queen also predicted that this was a problem when she asked the economic profession why it hadn't seen the current crisis coming.  The very question suggests that perhaps by training economists are very poorly suited for understanding the financial system and what might cause a crisis.

At its one year anniversary, I am sadden to report that the FPC could not get over the 'do no harm' standard.

Here is the performance of the FPC as described by external board member Robert Jenkins in a Telegraph column.

The financial policy committee of the Bank of England is now one year old. Its purpose is to identify and, where possible, mitigate threats to the British financial system. Financial stability is the goal.

Over the past 12 months, systemic fragility and troubles in the eurozone have been the key threats. 

Restoring confidence in the British banking system has been the priority.

Given this priority, has the FPC done the only thing that restores confidence in a financial system and called for banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details?  No.

Regular readers know that transparency restores confidence as it allows market participants to independently assess each bank.  Confidence is restored because market participants trust their own analysis (whether they do it themselves or they hire a third party to do it for them).

That banks should build balance sheet strength has been the primary recommendation and today the country's banking system is among the better capitalised and funded.

However, as everyone except the economists and other members of the FPC knows, bank capital is meaningless.  This is not just your humble blogger's opinion, but an opinion expressed by the OECD.

The reasons why bank capital is meaningless are extremely well known.

First, we have suspended mark-to-market accounting.  As a result, all those opaque, toxic securities and government bonds that still reside on and off the bank balance sheets have not been properly marked-to-market.  This results in an overstatement of bank book capital levels.

Second, bank regulators have engaged in regulatory forbearance that has allowed the banks to keep zombie borrowers alive using 'extend and pretend'.  Again, the banks have not taken losses and this too results in an overstatement of bank book capital levels.

So the primary recommendation for restoring confidence was to focus on a meaningless number as oppose to requiring the banks to provide ultra transparency and actually restore confidence.

Unfortunately, the primary recommendation to boost bank book capital also carried with it a well known and fully predictable  toxic side effect for the real economy:  a financial regulator induced credit crunch.

Since no investor is dumb enough to buy newly issued capital in a bank with large, undisclosed losses, to reach the higher capital ratios the FPC endorsed, banks had to shrink their balance sheets.  The number one place to shrink a bank balance sheet and get the most bang for the activity is by reducing loans.

The toxic side effect of the FPC's primary recommendation was to support a financial regulator induced credit crunch.  The FPC managed to take a situation where it was difficult for credit worthy borrowers to access bank credit and make it virtually impossible.  As a result, the real economy has been starved for credit to support it.  A clear violation of the "do no harm" standard.

Financial stability requires a healthy economy and a healthy economy requires financial stability.....

Is this true?

Couldn't we have financial stability in a recession (I would think a recession qualifies as a 'sick' economy)?

committee members have questioned whether there might be a trade-off between the strengthening of bank balance sheets on the one hand, and ensuring sufficient credit availability on the other.

In other words, was there a choice to be made between safer banks and a stronger economy? 

The discussion continues. To date, the following facts have informed the committee's recommendations: 

• Confidence must be maintained in our banks without which the banking system will cease to function. Loss of confidence in the banking system is the single biggest threat to lending. The strengthening of bank capital and liquidity has been critical to restoring confidence. 

Every part of the highlighted text is not a fact, but is rather something that only economists believe! (Of course. they are encouraged in this belief by bankers who tell them it is true as the bankers are looking to be paid their bonuses.)


It is a belief that results in the incredibly destructive policies adopted under the Japanese model for handling a bank solvency led financial crisis.


Regular readers know that under the Japanese model, bank book capital levels are protected at all costs.  This involves deception by the regulators and the adoption of policies like suspension of mark-to-market accounting and regulatory forbearance.


The result of these policies is that an accounting construct is held constant and the damage from excess debt in the financial system is forced onto the real economy.  This burden is more than the real economy can support and results in contraction of the real economy.


As your humble blogger has said many, many, many times, the combination of deposit insurance and access to central bank funding forever ended depositors' concerns about the book capital level or liquidity of a bank.  


(Let me give you two leading indicators of this simple fact.  First, to date, no economist I have asked what is the capital or liquidity level of the bank they have their checking account at as of the end of last quarter has known the answer to the question. Second, every economist I have asked that has helped a child open a banking account has answer the child's question of how do they know they will get their money back from the bank by saying the government guarantees the child will get their money back.)


Deposit insurance shifts the concern to the issue of can the government make good on its deposit guarantee.  If you live in Japan, the UK or the US, by definition the answer is yes because the government can always 'sell' bonds to the banks who can use these bonds as 'collateral' at their central banks to access funds that can be given to the depositor.


In the EU, until the politicians threatened to kick countries out and force them onto a new currency, depositors continued to believe that their governments would make good on their deposit guarantees.  By introducing re-denomination risk, the EU politicians have lowered the value of the deposit guarantee (you still get your 'money', it is just paid back in a currency worth significantly less than the euro).


What everyone, except the economics profession, learned during the Savings and Loan Crisis in the late 1980s is that bankers will continue to lend even when there is little confidence in the solvency of their institution.  Based on the commercial real estate boom that resulted from this lending, the link between 'solvency' and lending has been shown not to exist in the real world.


Our current crisis shows that bankers will also continue to gamble in the securities casino even when there is little confidence in the solvency of their institution.  In short, since bankers are compensated for gambling and lending they will continue these activities regardless of the solvency of their institution unless the financial regulators intervene with policies like higher capital ratios.

• The balance sheets of Britain's major banks total some £6 trillion. The aggregate of British lending to small and medium sized enterprises is below £200bn. The committee is concerned about that portion of SME lending which seeks and merits credit. It is also concerned about the loss-absorbing buffers needed to support the other £5.8 trillion. 

Leading up the financial crisis, the structured finance market was a significant source of funds for the SMEs.  The structured finance market is a fraction of its former size. This is a direct result of current disclosure practices that do not provide investors with the timely performance information on the underlying collateral that they need to know what they own.

Investors prefer not to blindly bet and instead are investing in asset classes that provide transparency.

To attract investors back to structured finance and reinvigorate SME lending will require that each security provide observable event based reporting.  Under observable event based reporting, every activity, like a payment or default, that occurs with the underlying collateral is reported to all market participants before the beginning of the next business day.

With current information, investors can know what they own and prospective buyers can independently assess the value of the security.

• There is a difference between capital levels and capital ratios. Higher capital levels absorb loss, inspire confidence and support lending. By contrast capital ratios can be "improved" by reducing lending without increasing capital. 

There is a difference between bank capital that is used to protect the real economy from the excesses in the financial system and bank book capital levels that are meaningless.

Bank book capital levels that are used to protect the real economy vary over time.  In times when there are excesses in the financial system, bank book capital levels decline dramatically as the losses on the excesses are absorb today.  If the losses are large enough, bank book capital levels can become negative.

Bank book capital levels that are meaningless tend to increase during a financial crisis.  This increase is a sure sign that the losses on the excesses in the financial system are being shifted onto the real economy and that there is a financial regulator induced credit crunch.

• Capital is not something locked away in the vault. An incremental pound of capital can fund an incremental pound of loans. And given current bank leverage, each £1 of additional capital can support £20 of additional small business lending – provided, of course, that the liquidity funding is available. Alternatively, some portion of incremental equity could support new lending with the remainder used to build buffers and reduce leverage. 

Of course, once again this focus on capital is irrelevant as it implies a link between lending and capital that does not exist.

What is well known to everyone except perhaps the FPC is that banks make loans when the opportunity arises and then look for how to fund the loans.

While many people think that structured finance was the original originate to distribute banking model, it wasn't.

For decades before structured finance became significant in size, banks would sell participations in their loans or the whole loans themselves to other banks, insurance companies and pension funds.  This was a classic way for smaller banks to diversify their loan portfolio by geography and industry.  It also resulted in matching loans to deposit funding already in the system.

• Allowing capital ratios to fall might lead to new real economy lending – but it might not. It might merely fuel intra-financial risk-taking with little positive impact on small business requests. 

• And even if lower ratios did lead to new business lending, to which businesses would the loans go: to a manufacturer in Manchester or a shoe factory in Shenzen?....

Of all the financial regulators, the FPC should know that it is not the job of regulators to approve or disapprove of individual positions taken by banks.  Doing so explicitly substitutes the regulators for the market in the allocation of capital.

Recently the Chancellor announced that the committee would add an economic growth objective to that of stability. 

How disappointing as it would have been far better for the UK and global financial stability if the Chancellor had put the FPC out of existence so that it could do no further harm to the real economy.

Barclays looking for new board chairman with my background

In a Telegraph column, Alistair Osborne looks at what Barclays needs in a new Chairman for its Board of Directors and discovers your humble blogger.

Barclays is seeking Agius’s successor. But for his fee of £751,000 a year, who would want the job?

If the rest of the compensation package including stock options was satisfactory, I would be willing to accept the job for that fee.

Clearing up after the Libor scandal is a near full-time post, not least once the lawsuits fly and regulators tighten the rules on banks.

One of the attractions of the post is the opportunity to clean up Barclays and make it the global standard for a financial institution that market participants trust and want to do business with.  The other is that it is a near full-time post so I could continue blogging!

And that’s before dealing with Mr Diamond.

Based on his speech a year ago about the importance of corporate culture in setting boundaries on behavior when nobody is watching, I am sure the Mr. Diamond will embrace maximizing transparency and minimizing reliance on corporate culture where there is opacity.

“It’s proving more difficult to find appropriate chairmen and chief executives for larger financial companies,” says Cannacord analyst Gareth Hunt. “They’re high profile roles that can be dangerous.”

These roles are only dangerous if the financial institution is opaque.

History has shown that sunlight is the best disinfectant to the types of dangers that arise at these firms.  By making all of Barclays' operation transparent, the risk in this role can be greatly diminished.

Indeed, Barclays is clearly preparing for no external candidates....

Excuse me, but I am an external candidate who fits the bill.  I have experience at a regulator (the Federal Reserve), experience in a bank (including asset/liability and capital management), experience in the capital markets and finally, experience with information technology in financial services.

In addition, I was one of the handful to publicly predict the financial crisis.  Since then, I have shown that I understand what it will take to be successful for a financial institution by making a number of predictions about the lack of success of various policies that have also come true.

In fact, my appointment is likely to result in a significant increase in Barclays stock price as investors associate me with transparency.  Investors know that Barclays' appointing me is a signal that Barclays has nothing to hide.

One complexity for outside candidates is the Financial Services Authority’s new vetting system.... 

The new criteria demand greater “financial services experience” for top banking jobs. But, as Sarah Wilson, managing director of corporate governance agency Manifest, points out, that is part of the problem. “If you only fish from the gene pool the FSA vets, you’ll get the same fish,” she says. “How will you get anyone from outside with a different perspective?” 

Indeed, as the Libor scandal extends to other banks, finding an untarnished experienced banker looks a stretch.

My background looks better all the time!

That’s why some analysts propose Mr Sants himself, though that forgets his regulatory failures during the banking crisis.

I can understand why Barclays would want to reward Mr. Sants for his regulatory failure before another financial institution gets there first.  His regulatory failure has been very profitable for Barclays' bankers.

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.

Morgan Stanley confirms no connection between high capital ratios and investor confidence

One of the ways that bank regulators and economists continue to embarrass themselves is with their obsessive focus on financial institution capital ratios.

Honestly, they need to get over it.  Especially since the OECD said that with regulators practicing regulatory forbearance both bank capital and bank capital ratios are meaningless.

Capital ratios are meaningless because everyone knows the banks are hiding losses.  For example, earlier this week I ran a post on how UK banks are sitting on billions of undeclared losses (by the way, the banks now claim that the estimate is high ... my response to the banks is prove it and provide ultra transparency so everyone can see what the undeclared losses on and off your balance sheet really are ... they won't provide ultra transparency because they have something to hide ... are the undeclared losses an order of magnitude greater than is currently being discussed).

Everyone knows that policymakers and financial regulators chose continuing payment of banker bonuses by adopting the Japanese model over protecting society and the real economy by adopting the Swedish model for handling a bank solvency led financial crisis.

At the heart of the Japanese model is the focus on protecting bank book capital levels at all cost.  One of the ways of doing this is through regulatory forbearance under which banks do not have to recognize the losses on all their bad debt.  Market participants know this and hence they know that capital ratios are meaningless.

In case market participants forget how meaningless capital ratios are, EU financial regulators have run stress tests the last couple of years.  After each stress test, banks the regulators claimed were adequately capitalized and passed the stress test had to be nationalized.  Can regulators and economists say capital ratios are meaningless?

Regular readers know that the source of confidence in the financial system is transparency.  Specifically, providing market participants with access to all the useful, relevant information in an appropriate, timely manner so that investors can make fully informed investment decisions.  A fully informed investment decision means the investor had a chance to use the disclosed information to independently assess the risk of the investment.

The reason transparency brings confidence to the market is that investors trust their own assessment of the risk.

Please note that capital is an accounting construct.  It is subject to manipulation.  By requiring banks to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details, investors have access to information that cannot be manipulated.  Hence the reason that investors trust their assessment of this information.

Bloomberg ran an article confirming that high capital ratios do not restore investor confidence.

Regulators and [economists] have touted higher capital ratios as the path for banks to restore confidence. Morgan Stanley (MS), the best-capitalized Wall Street firm, is proving that’s not enough. 

Morgan Stanley has the highest Tier 1 common ratio among the five largest U.S. investment banks, topping JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), Citigroup Inc. (C) and Goldman Sachs Group Inc. (GS) Still, it faces the largest potential downgrade from Moody’s Investors Service, has the highest-priced credit-default swaps and trades at the biggest discount to liquidation value. 

The firm’s underperformance highlights Chief Executive Officer James Gorman’s difficulty convincing investors that his is a different company than the one that borrowed more than $100 billion from the Federal Reserve to survive in 2008. Morgan Stanley also faces doubts after JPMorgan, the only U.S. bank with more credit-default swaps on its balance sheet, announced a $2 billion loss from derivatives trading. 

“With the recent surprise with what happened at JPMorgan, we are all very skeptical of what’s on those balance sheets that we as outsiders can’t figure out,” said Charles Peabody, an analyst with Portales Partners LLC in New York, who has a neutral rating on the stock. “Morgan Stanley has not proven in recent history to be good risk managers.”...

Please re-read the highlight text as it summarizes why only disclosure restores investor confidence.

“Capital doesn’t seem to be solving all the problems,” said Shannon Stemm, an analyst at Edward Jones & Co. in St. Louis. “Compared with the European banks, a lot of the U.S. banks look really well-capitalized, yet that’s still not helping them. They’re still trading at half of book value, just like the European banks.”...

That is because everyone knows that with the Japanese model and regulatory forbearance capital is significantly overstated.

Without ultra transparency, banks are 'black boxes' and investing in them is blindly betting.

Morgan Stanley and its competitors have faced declining trading volumes and low merger activity as investors and companies remain wary about the European debt crisis and the U.S. economy.  

David Trone, an analyst at JMP Securities LLC in New York, downgraded all five banks to market underperform on May 21, declaring them “un-investible” because of macroeconomic threats....

The lack of transparency into the current exposure details means that there is no way to evaluate the impact of these macroeconomic threats.

This analysts appears convinced that the threats are likely to overwhelm the meaningless reported capital.

Bankia writedowns cast doubt on Spain's bank estimates

A Bloomberg article confirmed your humble blogger's prediction that the Spanish government would undermine its credibility by making misleading statements about the true extent of the troubled assets in the Spanish banking system.

Spain’s two-week effort to overhaul its lenders and estimate for what it will cost taxpayers may already look out of date. 

Economy Minister Luis de Guindos said May 11 that a law tightening provisioning rules, his second in three months, would require public funds of less than 15 billion euros ($19 billion).  

BFA-Bankia, the bank nationalized the same week, said on May 25 it was taking 8.5 billion euros of provisions on top of those demanded by the two decrees, as it sought a 19 billion- euro state bailout.... 

“They’ve done two reforms already and there will probably be more; I don’t know how many more,” Javier Diaz-Gimenez, a professor at the IESE business school in Madrid, said in a telephone interview. “They have zero credibility.”...

Please re-read the highlighted text because it summarizes why Spain and every other country must require their banks to provide ultra transparency.

It is only when the banks disclose on an on-going basis their current asset, liability and off-balance sheet exposure details that market participants have the information they need to independently assess the banks.  It is only when market participants can conduct an independent assessment that they trust they know the condition of a bank.

“They are trying to do the minimum all the time and kick the can down the road,” Juan Rubio-Ramirez, an economics professor at Duke University and visiting scholar at the Federal Reserve Bank of Atlanta, said by phone yesterday. 

This is a direct reflection of policymakers and financial regulators having adopted the Japanese model for handling a bank solvency led financial crisis.  The policies adopted under this model are all about kicking the can down the road and praying for a miracle to solve the problem.

Efforts so far have focused on assets linked to the real estate industry, while the government and executives including Banco Santander SA Chief Executive Alfredo Saenz have said that household mortgages don’t pose a risk. Spain’s unemployment rate exceeds 24 percent and the economy is suffering its second recession since 2009. 

“Mortgages get paid in good times and in bad,” Saenz said on April 27. “Anyone raising this problem as one of the issues for the Spanish financial system is saying something stupid.”

Bankia may have cast doubt on that position by setting aside another 2.2 billion euros in provisions for individual loans, most of which are residential mortgages.....

Unemployed people don't pay their mortgages after they have exhausted their savings.

As part of de Guindos’s latest overhaul, Spain has commissioned Oliver Wyman Ltd. and Roland Berger AG to carry out a stress test on all Spanish banks’ entire loan book. That will be followed by a detailed audit carried out by three companies. 

“There should be a higher level of non-real estate provisions, whether that’s done through legislation or informally on the back of this external review,” Nomura’s Quinn said in a telephone interview. “There will be pressure for every domestic Spanish bank, except Santander and BBVA, to raise capital if you assume the kind of provisioning we’ve seen in Bankia.”

In the absence of requiring the banks to provide ultra transparency, neither the stress tests nor the detailed audit will restore the banks' or the government's credibility. 

Will Itallian banks provide ultra transparency to avoid a banking crisis

The Telegraph's Ambrose Evans-Pritchard looked at how the turmoil in Greece has increased the chances for an Italian banking crisis.

Hans Redeker from Morgan Stanley said the EU's mishandling of Greece has put Italy in grave danger. "The irrevocability of the eurozone is a valuable asset, and they are throwing it away. Global investors are preparing for the day Greece leaves," he said. 

The IMF said Italian bank exposure to the state is 32pc of GDP, including all forms of lending. "We are looking at this number very closely," said Mr Redeker. 

Almost half of this is owed to foreigners. Italy's central bank owes a further €278bn in 'Target2' claims to peers in Germany, Holland, Finland and Luxembourg, reflecting capital flight.

This reflects the on-going run on the Italian banks previously discussed on this blog.

Italy's former premier Romano Prodi said the EU risks instant contagion to Spain, Italy, and France if Greece leaves. "The whole house of cards will come down", he said 

Angelo Drusiani from Banca Albertini said the only way to avert catstrophe is to convert the European Central Bank into a lender of last resort. Otherwise Italy faces "massive devaluation, three to five years of hyperinflation, and unbearable unemployment." 

The ECB's emergency lending may have made matters worse, encouraging banks to buy their own states' debt. It has led to an incestous inter-linkange of fragile banking systems and fragile sovereign states, each propping the other up. Many of the banks used ECB money to buy state bonds until they need to roll over their own debt. They are now nursing stiff losses. 

Moody's downgraded 26 Italian lenders on Monday night saying the slump itself is the killer, joining a chorus of voices warning that too much austerity may be self-defeating. "Banks are vulnerable to the renewed recession in Italy, given their already elevated levels of problem loans and weakened profitability," it said. Moody's expects the economy to contract 1.9pc this year. 

The Italian Banking Association ABI accused Moody's of an "irresponsible, incomprehensible, and unjustifiable" smear. "Moody's decision is an attack on Italy, its companies, its families and its citizens," it said, calling on the EU authorities to clamp down "severely" on rating agencies. 

The agency said the "problem loans" of Italian banks have reached 9.3pc. The figure may be higher, given "concerns about the accuracy of reported non-performing loan measures." 

They depend on capital markets for 36pc of their funds. This source of finance has largely dried up.

If the Italian banks want to stop the deposit run and reopen the capital markets, they will have to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

With this information, concerns about the accuracy of reported non-performing loan measures disappears and market participants can independently assess the risk of each bank.

Telegraph's Harry Wilson asks 'Does it matter if a bank makes a profit or a loss?'

As bank earnings reporting season descends on us again, the Telegraph's Harry Wilson asked 'does it matter if a bank makes a profit or a loss?'

No.

So long as banks do not provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details, it is impossible for market participants to know if net income has any relationship to the actual performance of the bank.

In an environment where regulators are blessing hiding losses through regulatory forbearance and suspension of mark to market accounting, a bank can make up any net income number it wants.  This is one of the reason that the OECD said that bank capital is meaningless.

Your humber blogger has been advocating since the beginning of the financial crisis that banks adopt ultra transparency and come clean about what is on and off their balance sheet.  It is only by doing this that market participants will be able to trust bank financial reporting again.

Recent results from major banks have brought home this question as lenders have reported a confusion confection of core operating profits, adjusted pre-tax profits, and statutory pre-tax losses. 

Last week, Barclays reported an adjusted pre-tax profit of £2.45bn, but a statutory pre- tax loss of £475m. On Tuesday Lloyds announced a statutory profit before tax of £288, however on a pre-tax, combined business basis, this more than doubled to £628m. 

Today Royal Bank of Scotland added its results into the mix, saying it had made an operating profit of £1.2bn, but a pre-tax loss of £1.4bn. 

Asked this morning whether the bank was in the red or the black for the first quarter, RBS chief executive, Stephen Hester, said he did not really care and that you could take the bank's results "anyway you want". 

Please re-read the highlighted text as it is an acknowledgement of just how meaningless the financial numbers are.

While Mr Hester's candour is commendable, can it really be right that investors in Britain's largest banks have been left with such a confusing range of measures to work out the most basic of financial figures. 

The blame for the current situation lies largely with the damage wrought to banks finances by the financial crisis. 

With vast amounts of multi-billion pound one-off items running through their accounts over several years combined with the complexity injected by the use of "good bank" "bad bank" models, simple reporting of basic figures has been lost....

Please re-read the highlighted text as it describes why banks must be required to provide ultra transparency so that market participants can assess what is truly going on.

not all banks have gone down this path. 

Whatever your views of Swiss bank UBS, its financial results published on Wednesday were commendably straight forward. Just like, Barclays and RBS, UBS had to report a large fall in profits due to the bizarre debt valuation adjustment rules that force banks to account for the rises and falls in the value of their own debt. 

Unlike its British peers, UBS did not attempt to guide its investors towards an "adjusted" profit number or any other figure that stripped out the impact of this charge. 

This may seem like financial pedantism, but it has very real implications. 

While Barclays and RBS gathered a blizzard of positive headlines hailing their improved performances and better than expected results, UBS's results produced a media reaction of disappointment and missed forecasts. 

Yet, if UBS had used a similar adjusted number rather than using the admirably straightforward "net profit attributable to UBS shareholders" the bank would have reported profits of nearly Sfr2bn rather than the Sfr827 it actually made. 

With perception so important in the banking industry, it is surely not desirable that such financial spin is being routinely perpetrated by leading financial institutions, trust, after all, is the thing that senior bankers continually tell us is the most important thing for the industry to regain. Tricky numbers are not the way to achieve that goal.

Well said.