New EU rule allows regulators to keep bailouts secret

According to an article on Global Financial Strategy, the EU's draft Market Abuse Regulation would allow regulators and financial institutions to conceal emergency rescues if public disclosure might hurt the broader financial system.

Excuse me, but doesn't every market participant want to know if a financial institution is rescued?  Without this knowledge, how could market participants properly assess the risk of the financial institution after the rescue?

Does this also mean that regulators could recapitalize all the Eurozone banks and not tell anyone?

Clearly, a regulation like this would not exist under the FDR Framework.  With its clear disclosure requirements, a financial institution "rescue" would be immediately well known.

Regulators, banks and insurers will be handed the power to hide the existence of emergency bailouts if it is argued public disclosure could have a "systemic" impact, under the EU's new Market Abuse Regulation. 

With the regulation, a draft of which has been seen by Global Financial Strategy, financial institutions and supervisors will be able to withhold inside information from investors if release could lead to large losses. 

In practice, it could mean that a bank with a serious hole in its accounts could resist informing shareholders, the stock market and the public if it successfully claimed disclosure might badly hit the share price of itself or others.

Collapse of bank stocks sends global policymakers and regulators unambiguous message: require disclosure now

At the beginning of the financial crisis, your humble blogger observed that we are in an economic downward spiral until such time as there is disclosure in all the currently opaque corners of the global financial system.

Over the last three months, the pace of this downward spiral has accelerated.

• In Europe, we have seen the gradual re-freezing of the inter-bank loan market and the wholesale funding market as well as bank public debt issuance cease.  This was on top of the run on the European bank deposits occurring in the peripheral countries.

• In both Europe and the US, we have seen bank stock prices collapsing.

All of this financial instability is the result of opacity in the financial system.

Fortunately, opacity can be cured with disclosure.  Disclosure ends the financial and confidence sapping costs of opacity on the economic system.

I would like to direct readers to an excellent post by Barry Ritholtz on The Big Picture blog.  In the post, he looks at the contribution of opacity to the collapsing bank stock prices.

Morgan Stanley in a free fall. Goldman Sachs at multi-year lows. Citigroup looking Ugly. Bank of America off 50% from recent highs. 

You may be wondering what is going on with the major firms in the financial sector. While each of these firms have different problems — vampire squids to Countrywide acquisitions — they all have something in common: Their balance sheets are opaque. 

This is no accident.... 

Banks loved ["Mark-to-Market" accounting] during a boom period. M2M made the more unusual balance sheet holdings  — derivatives, the mortgage-backed securities (MBS), exotic liabilities, and other assets — look fantastic. The fair value measurements of these items — essentially, yesterday’s closing price — allowed the accounts to show enormous profits. Those were the underlying basis for huge bonuses, stock option grants and of course, company share prices. 

The reality was quite a bit different. These were not equities or treasuries or corporate bonds — they were thinly traded items whose prices were ramping upwards on a sea of delusional optimism. As soon as the credit bubble ended and housing began to retreat, these assets would free fall like an Acme anvil in a Roadrunner cartoon — and the bankers were the Coyote. 

Uh-oh, this was gonna be a problem. So the bankers began to lobby FASB to change the rules governing Fair Value Accounting. Sure, it was hugely helpful on the way up, but now, reporting actual holdings — previously marked at all time highs — was becoming problematic. 

To their credit, the accounting board resisted. What Bankers were proposing — marking to their models — was patently absurd .... Some people began calling the proposed accounting changes  “Mark-to-Make-Believe.” 

In the midst of the 2008-09 collapse, however, Congress was in a panic. They mandated that FASB accept Mark-to-Make-Believe accounting in the Emergency Economic Stabilization Act of 2008. It gave the Securities and Exchange Commission the authority to “Suspend Mark-to-Market Accounting.” In March and April of 2009, that is precisely what occurred....

The bottom line is this: Investors do not really have a clear idea of how healthy any of these banks truly are. We do not know the state of their balance sheets. We do not know what their exposures are to mortgages, to Europe, to Greece, etc. They could all be technically insolvent, as far as any investor can tell. ... 

Investors have decided they cannot take the risk of a holding an opaque, possibly under-capitalized probably over-leveraged financial firm blindly. They are telling the banks no thanks, we are not interested, we are going to be prudent and we have to assume the worst. 

Hence, for the second half of 2011, they have been selling off their holdings in these opaque, potentially insolvent too big to succeed entities....

Investors fear worst for banks

The Financial Times ran an article highlighting how opacity is unhelpful at a time of intense investor skepticism about Eurozone banks.

As Barry Ritholtz observed on the Big Picture blog,

Investors have decided they cannot take the risk of a holding an opaque, possibly under-capitalized probably over-leveraged financial firm blindly. They are telling the banks no thanks, we are not interested, we are going to be prudent and we have to assume the worst. Hence, for the second half of 2011, they have been selling off their holdings in these opaque, potentially insolvent too big to succeed entities.

Regular readers know that the solution is to end opacity and for banks to disclose their current asset and liability-level data.

A global bank’s share price drops more than 10 per cent in a single day over concerns about its exposure to the eurozone’s spiralling sovereign debt crisis. Sounds familiar? ... However, when that bank is Morgan Stanley ... it raises broader questions about shareholders’ confidence in the fundamental integrity of some of the world’s largest financial institutions, and whether the worst of the bear market for banks is yet to come.... 

So it is somewhat surprising that French bank executives continue to insist that their priority is deleveraging, rather than recapitalisation. “In this kind of market, I wouldn’t even know how much capital I had to raise,” one top French banker said last week, while insisting that investors in the US, in particular, are peddling doomsday scenarios. 

It is true that the hit from a Greek default, while painful, would be manageable. BNP, which holds the largest amount of Greek debt among French lenders, is expected to take an additional €1.7bn hit in its third-quarter accounts. The impact of a writedown of its Greek exposure would shave just 15 basis points off BNP’s core tier one capital ratio, the key measure of financial strength, according to the bank’s estimates. 

Markets, however, are pricing in the impact not only of a Greek default, but of a substantial haircut on Italian and Spanish debt. Investors simply do not believe that French banks hold enough loss-absorbing capital to withstand contagion across Europe.

To address the fact that investors do not believe they are adequately capitalized, French banks, led by BNP Paribas and Societe Generale have started down the path towards 'utter transparency' by providing more disclosure about their exposures to sovereign debt.

The sooner they actually offer 'utter transparency' in the form of current asset and liability-level data, the sooner they will be able to address investors' worst fears.

Which brings us back to Morgan Stanley, where its sharp sell-offs have been traced in part to a widely circulated report that claimed the bank held $39bn worth of exposure to France. 

People familiar with the situation at Morgan Stanley say the figures reported were from the end of last year and were gross, rather than net, numbers. The bank’s net exposure to France, those people say, is actually near zero.... 

Turbulent markets and a drop-off in dealmaking in recent months are expected to take a heavy toll on Morgan Stanley’s earnings, but executives insist its fundamentals remain sound. 

Like the rest of the banks, Morgan Stanley has reached put up or shut up time.  Either disclose your current asset and liability-level data to show that investors should not be worried or understand that the lack of disclosure is confirmation of the problem.

Like their European rivals, however, they may be shouting into the wind.

Actually, investors who lack the ability to Trust, but Verify bank management's claims are acting prudently by reducing their exposure.

UK Chancellor looking to by-pass the banks to get credit to small businesses

According to a Telegraph article, George Osborne, the UK's Chancellor, has directed the UK's Treasury to look into how the government could directly lend money to small businesses and then package these loans so they could be sold in the capital markets.

The UK government would not need to do this if the securitization markets were functioning.  If they were, there would be private firms that would make the loans and sell them into the capital markets.

Regular readers know that the securitization market is not functioning because the buyers are on strike.  They went on strike at the beginning of the credit crisis and are not coming back until they have access to current performance information on the underlying assets.

The UK government could restart loans flowing to small business simply by requiring current performance disclosure on the underlying assets.

Of course, the UK government could also elect to retain the credit risk of the loans as an enticement to attract buyers.  But by doing so, it is no longer really "selling" the loans.  Instead, it is setting up the equivalent of Fannie Mae and Freddie Mac in the US - an agency where private investors do well and taxpayers are stuck with the losses.

George Osborne used his speech at the Conservative Party Conference to announce plans for "credit easing" - which is a form of quantitative easing for businesses. 

The Chancellor said: "I have set the Treasury to work on ways to inject money directly into parts of the economy that need it such as small business. It is known as credit easing. It is another form of monetary activism," he said. "It is similar to the national loan guarantee scheme we talked about in opposition." ...

However the Government could deploy public to buy corporate bonds either directly through the Treasury or via the Bank of England's asset purchase facility. This facility was set up in 2009 during the apex of the financial crisis but has hardly been used since. 

The Treasury wants to create packages of small business loans that could then be traded. 

In this way the Government support would not add to the national debt for accounting purposes because they would be a tradable asset. 

The plans also include setting up a Small Business Bank that could handle the new policy. At the Liberal Democrat Conference two weeks ago, Vince Cable used his speech to back plans for a new state-backed bank as a way of tackling the failure of banks to lend to small firms.... 

The chancellor also repeated that he would give the Bank of England the green light to engage in further quantitative easing if it decided to go for more asset purchases. 

John walker, National Chairman, Federation of Small Businesses, said: We also welcome steps to help inject money into small firms, but need to see more detail so look forward to working with the Government on this."

Economist Magazine asks: How much capital do European banks need?

The Economist Magazine ran an article in which it asked:  How much capital do European banks need?

Readers will notice that in answering the question, the Economist highlights many of the issues raised by this blog including:

• Before deciding if and how to recapitalize European banks, market participants need to be able to figure out which banks need to be recapitalized;

• In the absence of information to determine which banks are solvent and which are not, market participants are perfectly capable of assuming a need for more capital than banks currently hold or that their host countries might be able to provide.

From the article,

THE fire raging in Europe’s financial system is growing fiercer by the day. Banks across the region have been unable to sell any long-term unsecured bonds since early July. Short-term markets have also been closing to some banks.... An obvious step to douse the flames would be to recapitalise European banks. Yet by how much and with what capital?

This blog has repeatedly pointed out that without current asset and liability-level disclosure, market participants are left to guess the current condition of each bank.  How much capital a bank needs to raise is dependent on this guess.

Why are regulators making market participants guess what are knowable facts?  Do they think that investors are more likely to invest in the absence of facts?

The alternative is to use 21st century information technology and provide market participants with access to all the knowable facts.  With these facts, all market participants analysis begins at the same starting point.

Global regulations are already forcing banks to plump up their cushions significantly. Nomura reckons that simply getting banks to comply with the new Basel 3 rules, plus an additional surcharge on globally important banks, could leave European lenders, Britain’s included, needing to raise more than €100 billion ($136 billion). 

In theory banks have until 2019 to raise this amount, and much of it could come from profits over the next few years....

On top of this requirement is the extra capital that banks would need to absorb losses from a recession or the debt crisis. Such calculations depend on lots of assumptions, from the amount of capital that banks ought to hold to the precise nature of any euro-zone write-downs. 

Actually, with current asset and liability-level disclosure, many of the assumptions go away and are replaced with market values.  For example, why guess at what a write-down might be when you can use a price that the security recently sold for in the market.

The use of market values allows market participants to determine who is solvent and who is insolvent where solvency is determined by comparing the market value of the bank's assets to the book value of its liabilities.

A good estimate of the amount of additional equity a bank requires is the amount that the book value of its liabilities exceeds the market value of its assets.  It is only after the shortfall between the market value of the assets and the book value of the liabilities has been determined that attention should be turned to how and when to cover the shortfall.

As this blog has frequently noted, there are many alternatives for raising this capital and, equally importantly, so long as market participants think the bank has a viable franchise and the regulators do not close the bank, a window of time in which to raise the capital.

“The key issue is what scenario the banks would need to be recapped for,” says Huw van Steenis of Morgan Stanley. “A soft restructuring in just Greece? Or restructuring in multiple peripheral countries?” 

Start with a Greek write-down and the numbers look quite manageable. Even assuming a 50% reduction in the value of Greek government bonds, the total hit to the capital of non-Greek banks in Europe would probably not exceed €10 billion. Simply buffering the system against a Greek default may not be enough, however. 

Investors now fret about the solvency of bigger countries. If banks were to undergo a recession and mark to market their holdings of bonds issued by Greece, Ireland, Portugal, Spain and Italy, they would need more than €300 billion in capital. 

Banks have several options for boosting their capital ratios. One is to cut assets. The benign way to do so is by selling them. On September 28th Crédit Agricole became the third of the big French banks to say that it would sell some assets to bolster equity ratios. The harmful way is to stop lending. Some analysts forecast a fall in lending across peripheral countries of 10-15% by the end of 2012. 

Asset sales need buyers, however, and slimming balance-sheets takes time. Raising lots of money quickly may require more rights issues. The trouble is that institutional investors have little appetite for more shares in European banks, even at seemingly attractive prices. Indeed, low share prices make it harder for banks to raise meaningful amounts of money without wiping out existing shareholders. Volatility also makes a rights issue risky, even for relatively strong banks. 

Might sovereign-wealth funds from the Middle East or Asia ride to the rescue, much as they did after the 2008 meltdown? Many of these state-owned investors lost significant sums during the subprime crisis and are wary of investing too soon this time, say bankers who have been meeting with them. At best they are likely to buy stakes in only a handful of the region’s strongest banks. 

If push came to shove, other European banks would probably have to be recapitalised by governments. Among the bigger economies, Germany and France would be able to muster the cash but Italy and Spain might need help, perhaps from the euro zone’s bail-out fund. 

That raises yet another series of complications. The first is that national bank bail-outs would increase state borrowing relative to GDP, which could raise question-marks over some sovereign credit ratings. There is also the risk that European competition regulators could force recapitalised banks to restructure if they have received state aid worth more than 2% of risk-weighted assets....

“There is no amount of capital that banks could reasonably hold that would insulate them from a break-up of the euro zone,” says one banker.

Thank you NY Fed: Asking for daily liquidity reports confirms FDR Framework based bank disclosure can be done

According to a Bloomberg Businessweek article, the NY Fed is thinking of requiring detailed daily reports on liquidity from European banks.

Regular readers know that the only way to monitor a bank is to have current - daily - information on the bank's individual assets and liabilities.  By thinking about requiring it, the NY Fed has confirmed that this information is and can be made available to all market participants.

It is no surprise that the data is available on a daily basis.  After all, it is tracked by banks using 21st century information technology.

Since before the beginning of the financial crisis in 2007, I have been saying that there is the need for the "Mother of all financial databases".  At a minimum, this database would be global and have the current asset and liability-level data for the financial institutions in each country.  The data would be made available for free to all market participants.

The Mother of all financial databases is feasible given the current state of 21st century information technology.

If the database existed, the NY Fed would be easily able to access the information that it would like.

The Federal Reserve Bank of New York may ask foreign lenders for more detailed daily reports on liquidity as the U.S. steps up monitoring of risks from Europe’s sovereign debt crisis, according to two people with knowledge of the matter. 

Regulators held informal talks with some of the largest European lenders about producing a “fourth-generation daily liquidity” or 4G report, according to the people, who asked for anonymity because communications with central bankers are confidential. The reports may cover potential liabilities such as foreign-exchange swaps and credit-default swaps, said one person. The U.S. has already increased the number of examiners embedded in these banks, the person said....

“The Fed is trying to understand what the pressure points are in terms of liquidity and potential risks that are imposed by foreign banks to domestic institutions in our financial system,” said Kevin Petrasic, an attorney at the Washington- based law firm of Paul, Hastings, Janofsky & Walker LLC. “There is a little bit more sense of urgency as a result of what’s going on in Europe.”

If the Fed needs this data to understand what is going on, don't the other market participants?  Without this data, how exactly is JP Morgan suppose to manage its exposures by assessing the risk of other banks?

... U.S. banks are starting to provide a 4G report and they are being phased in this month, said Karen Shaw Petrou, managing partner of Washington-based Federal Financial Analytics Inc.

“The report requires rapid and in some cases daily data on a banks’ assets, liabilities and potential claims to measure the degree to which the bank could be caught in the classic borrow- short, lend-long squeeze,” Petrou said. “The 4G is one of the tools to reveal liquidity risk.” 

The forms aren’t public, according to Petrou, and the New York Fed declined to provide a copy.

This is a classic example of the regulators protecting their information monopoly.  Clearly, this is data that market participants need for assessing the risk of each bank.  However, the NY Fed is deliberately blocking its dissemination and subjecting the global financial system to financial instability.

... Regulators lack access to data on foreign institutions operating in the U.S. that would allow them to “make informed judgments about the adequacy of such firms’ capital and liquidity buffers,” William C. Dudley, president of the Federal Reserve Bank of New York, said in a Sept. 23 Washington speech. 

Mr. Dudley's statement describes why the "Mother of all financial databases" needs to be global.

Regulators in each country should be able to assess the performance of any financial institution doing business in their country.  This is particularly true if those financial institutions are going to access any type of support from a country other than the country that hosts their headquarters.

Thank you Vikram Pandit: Disclosure needed for market discipline, proper pricing of risk and eliminating surprises in financial system

A Heard on the Street column by David Reilly ("Ghosts could be lurking in banking machines") neatly makes the case for requiring banks to make current asset and liability-level disclosure.

When it comes to banks, what you don't know can definitely hurt. 

That's a hard-learned crisis lesson and helps explain, in part, why big U.S. banks have taken such a pounding of late. As Europe wobbles, investors in firms like J.P. Morgan Chase, Citigroup, Goldman Sachs, Bank of America and Morgan Stanley, are again trying desperately to figure out their euro-zone risks. Morgan Stanley, in particular, suffered for this reason Friday. 

A big problem for investors is varied, sparse or confusing disclosure about derivatives exposures—even after the financial crisis showed that the inter-connectedness of firms is often as big a threat as their size.... 

Granted, executives offered some detail on European exposures when reporting second-quarter results, saying they were manageable. But investors were often given net, not gross, exposures, and can't tell how exposed the banks' massive derivatives portfolios may be to big European banks through counterparty risk. 

The only way that market participants will ever be able to understand the exposures is if they are given each bank's current asset and liability-level data.

This is true for both the investors and, more importantly, the banks.  Without this data, how can a bank properly assess the risk of another bank that it might be doing business with?

Even bankers acknowledge shortcomings. 

In a recent speech, Citigroup CEO Vikram Pandit noted derivatives "remain too opaque." He added, "Lack of transparency inhibits market discipline, obscures risk and leaves nasty surprises buried in the system." 

Please re-read Mr. Pandit's comment.

His comment makes the case for adopting the FDR Framework and fully implementing its disclosure requirement!

If only Citi walked Mr. Pandit's talk. 

During the bank's second-quarter call, analyst Mike Mayo of Credit Agricole asked about the bank's exposure to troubled European countries. "What is the gross number and what's the difference between the gross and the net?" Citi CFO John Gerspach replied: "I don't think that the gross number is relevant." 

But it is. 

As Morgan Stanley found Friday, confusion over gross and net exposures can spook investors. The difference is usually due to cash and collateral held against loans as well as derivatives used as hedges. Yet investors often don't know how big the hedges are—an important point since hedges often aren't perfect— or who the counterparty is. 

Divining counterparty risk and concentrations of it is tough and disclosures vary. Morgan Stanley gives a country breakdown of derivatives exposures. J.P. Morgan doesn't do that, but does give a derivatives breakdown based on region. In its second-quarter filing J.P. Morgan said it had net derivatives assets with exposure to Europe, the Middle East and Africa of $35 billion. 

But there is no similar geographic breakdown for the firm's gross derivatives assets of nearly $1.4 trillion. 

If a counterparty fails, gross figures may prove more important for investors. "The asset can disappear and you're left with the liability," explains Credit Suisse accounting analyst David Zion. 

Plus, during periods of extreme market turmoil a problem with a counterparty's counterparty—something almost impossible to measure—can come to haunt even banks that have chosen their trading partners well.

Actually, the combination of 21st century information technology with asset and liability-level data would make it very easy to determine the risk posed by a counterparty's counterparties.

Given the difficulty in gauging which banks hold what risks, investors are often choosing to simply sell bank stocks.

A wise decision when investors cannot answer the question of who is solvent and who is insolvent and therefore assess the risk of any exposure to the banks.

That leaves banks with a choice as third-quarter reporting season approaches: provide more and better information about derivatives and European exposures, or continue to get tarred with the euro-fear brush.

If we are ever to restore confidence in the global financial system, banks must not be left with the choice between transparency and opacity.

Under the FDR Framework, banks would not have this choice.  Governments would require them to disclose their current asset and liability-level data.

Given that we have effectively reached the limits of fiscal and monetary policy, it is time for policy makers and regulators to adopt a new approach to ending the solvency crisis.  This approach is adopting and implementing the FDR Framework and its disclosure requirements.

Will Morgan Stanley join BNP Paribas and Societe Generale and turn to disclosure to restore investor confidence?

Last week, the Wall Street Journal ran two articles (see here and here) on how Morgan Stanley was coming under pressure, lower stock price and increased cost to access funds, as a result of its exposure to Europe.

Will Morgan Stanley join BNP Paribas and Societe Generale and turn to disclosure to restore investor confidence?  Specifically, will it provide the current asset and liability level data needed for market participants to evaluate the risk of this exposure?

While in far better financial shape than in 2008, Morgan remains .... to some extent most vulnerable of the big, U.S. financial institutions. It also has a tendency for trading stumbles, even if it bucked that trend in the second quarter. 

This goes part of the way in explaining why its stock and credit-default swap spreads have been getting hit far harder than peers on fears related to Europe, the slowing global economy and a trading downturn. And it may also be why Morgan seems more susceptible to market chatter. 

On Friday, Morgan's shares tumbled 10% and its CDS spreads continued to widen due in part to confusion over its exposure to Europe. A report pegged its "net" exposure to French banks at $39 billion, although this was actually a "gross" figure. On a net basis, which takes into account collateral and hedges, its exposure is zero, according to a person familiar with the matter. And the $39 billion figure is for the end of 2010; the latest gross figure is $21.6 billion

In short, market participants have no way to evaluate the risk of Morgan's European exposure.  They are left to guess.

The decrease in Morgan's share price and the increase in its funding costs are well deserved given that Morgan could make use of existing 21st century information technology and provide all market participants with access to the relevant information as of the close of business yesterday.

By not doing so, Morgan is telling market participants that it has something to hide.

... So although much of the current fear looks overdone, and Morgan's about 50% discount to tangible book value seems unwarranted, the storms clouds aren't likely to part anytime soon.

Actually, the storm clouds will part as soon as Morgan adopts a policy of letting in sunshine through disclosure of its current asset and liability level data.

With this data, market participants will be able to assess the risk of Morgan and see if their fears are overdone and the 50% discount to tangible book value is unwarranted.

Leading European banks refusing to increase capital buffers confirms need for implementing FDR Framework

According to a Telegraph article, leading European banks are refusing to increase their capital buffers and are therefore putting the plan to rescue the EU at risk.

This negotiating by the banks with the European policy makers and financial regulators confirms the need for the EU to immediately implement the FDR Framework with its current asset and liability-level disclosure requirement for banks.

Under the FDR Framework, these negotiations are replaced with market discipline.

Banks that are not adequately capitalized will find themselves with less access to funding and a higher cost for the funds they can access.  This market discipline, with its direct impact on the bottom line and the bank's stock price, should provide sufficient incentive for banks to increase their capital buffers without regulatory encouragement.

Senior sources said that leading European lenders are pushing back against international efforts to force them to recapitalise. 

Instead, they are insisting their problems are solely to do with liquidity and are calling on the European Central Bank (ECB) to flood the system with massive amounts of two-year funding to see them through the crisis. 

The liquidity problem the European banks are facing is a symptom of their solvency problem.

Without disclosure of each bank's current assets and liability-level information, market participants cannot tell who is solvent and who is insolvent.  Rather than wait and find out if their investment is in a solvent or insolvent bank, they have an incentive to withdraw their money from all the European banks.  This "run" on the European banks is causing the banks to have liquidity problems.

In 2008, the central banks, including the Fed, ECB and BoE, listened to the banks and addressed the year-old solvency crisis by injecting massive amounts of funding.  This policy failed to end the solvency crisis as shown by the current concern over the European bank solvency.

This policy was also one of the foundation blocks for creating the moral hazard of Too Big to Fail.

... Recapitalising the banks is central to a three-pronged strategy to restore market confidence in Europe...

Regular readers know that without disclosure of each bank's current asset and liability-level information, European policy makers and financial regulators will not be able to restore market confidence.

Without this information, market participants cannot do their own analysis to answer the question of who is solvent and who is insolvent.  If market participants cannot independently verify the answer to this question, it is impossible to restore market confidence.

Europe’s banks want the European Financial Stability Facility (EFSF) bail-out scheme’s firepower increased to more than €440bn, possibly by using the funds as a “first-loss” guarantee on ECB or private sector purchases of sovereign debt; the ECB to provide banks with two-year funding; and an agreement struck for a credible Greek rescue plan. 

Insiders said the banks would be willing to increase the “haircut” on their holdings of Greek sovereign debt from the agreed 21pc to 50pc so long as the rescue package was convincing enough to firebreak the crisis at Athens. 

They would only consider a recapitalisation if it was imposed across Europe as a form of “backstop” facility on which the banks could draw if the crisis escalated by engulfing Italy. 

One top banking source said: “The governments don’t want to put money into the banks. They see that as a last, last resort.” 

Europe’s banks claim that raising capital privately is almost impossible due to new Basel regulations on liquidity that are preventing them from increasing lending. As a result, they cannot justify the cost of raising new capital. 

Rather than debunk each of the banks' arguments one at a time, let me just say that each argument supports the need for Europe's policy makers and financial regulators to immediately implement the disclosure requirements of the FDR Framework.

For example, the banks offer to write-down their Greek debt to existing market prices if there is a big enough rescue package.  Under the FDR Framework, whether or not banks formally write-down their Greek debt, market participants would mark Greek, Italian, Irish, Spanish and Portugese debt to existing market prices.  They would do so because assessing the risk and determining the solvency of each bank requires comparing the market value of its assets with the book value of its liabilities.

Since market participants have already marked the assets to market, the banks negotiation with the regulators and policy makers is effectively ended and rescuing the EU is no longer held hostage by the banking industry.

How bad is the situation in Europe? Germany would like to know!

As we come to the end of a work week, I found myself reflecting on three interesting data points concerning the European financial crisis.

• Less than 3 months ago, the European financial regulators suggested that as a result of the latest round of stress tests, European banks needed to raise less than 10 billion euros in new capital.

• Less than 2 months ago, the IMF suggested that European banks needed to raise between 200 and 300 billion euros of new capital.

• Less than 1 month ago, US Treasury Secretary Tim Geithner suggested that between European banks and at-risk sovereigns, there was a need to raise 2 trillion euros.

Admittedly, the European financial regulators did not consider a sovereign default in their stress tests, so their estimate of how much capital is needed is probably too small.

However, and this is a big however, their estimate is the closest of the three estimates to being constrained by what is actually happening at the banks.  The stress tests were run on some of the banks' assets and liabilities.

Unless the results of the stress tests are completely fictional, the tests suggest that European banks have the capacity to absorb a significant amount of write-downs without requiring governments or the European Financial Stability Fund to recapitalize them.

The economists at the IMF estimated capital needs based on what they thought were the most likely levels of write-downs as a result of sovereign debt restructuring.  

Admittedly, the IMF economists did not know the extent to which sovereign debt positions might be hedged so capital needs could be lower if banks had hedged their positions.

Again, we have an estimate of capital needs that suggests that Europe can handle the problem with in its current plans.

Finally, we have Mr. Geithner's estimate.

Admittedly, it includes funding for sovereign bailouts.  However, it strains credibility to believe that it includes the European financial regulators' estimate of capital needed by the banks and not the IMF's.

If the IMF and Mr. Geithner's estimate is right, it suggests that European policy makers and financial regulators have seriously misled market participants.  Is that true of all European policy makers and financial regulators?  Is it possible that Germany's policy makers and financial regulators did not mislead market participants?

Given the US experience with stress tests, I am not naive enough to believe that the results of the tests provided to the public did not understate the amount of capital the tests actually found was needed.  I just do not believe that the financial regulators would release numbers that are off by a factor of 10.  It is far too likely that the market will quickly discover the shortfall and the resultant loss in the financial regulators' credibility will fuel the fear of just how bad shape the global financial system is in.

What Germans would like to know is which of these three estimates is right! 

There is only one way to find out and that is disclosure of each bank's current asset and liability-level data.  Market participants can analyze this data and assess how much, if any, capital each bank needs.