Telegraph's Ambrose Evans-Pritchard: Eurozone and UK banks are insolvent, face up to it

When dealing with a bank solvency crisis, it is always nice to know how the markets perceive the current state of bank solvency.

The Telegraph's Ambrose Evans-Pritchard summarized the market's perception of the current state of bank solvency as:

In [Standard & Poor's] view, financial institutions ... face pressure where the quality of ... assets is deteriorating. 

Deleveraging by European banks is intensifying, as they reduce their balance sheets amid worsening funding conditions, look to bolster their capital ratios, and address concerns about deteriorating asset quality among their borrowers. 

By our estimates, a sample of 53 large eurozone banks from 12 countries will face bond market maturities of an historic record of over 205 billion euro in the first quarter of 2012." 

I might add that EMU banks have a loan-to-deposit ratio of almost 1.2 (like Japan before the Nikkei bubble burst), compared to 0.7 in the US. They are much larger in aggregate, much more leveraged, and mostly underwater already on EMU bonds if forced to mark to market. 

In essence, the whole eurozone is already insolvent. Face up to it. 

(Yes, yes, before you all scream over there, Britain is insolvent too by the same yardstick. That is why it is useful to have the magical instrument of a sovereign central bank in such circumstances – and one willing to act – to conjure away the awful truth.) 

Euroland’s crisis is not about Greek pensions or Italian labour laws, but about a vast and catastrophically ill-designed edifice of interlocking bank debt and sovereign debt.
You cannot separate the two. The sovereigns are destroying banks, and the banks in turn are destroying sovereigns. The two disasters are feeding on each other. This will continue until there is a circuit-breaker, both to act as lender of last resort and to end the slump.

Actually, there is a circuit breaker other than the central bank, which really is designed as a circuit breaker for liquidity problems and not solvency issues.  That circuit breaker is regulators also acknowledging that the banks are insolvent.

When that happens, the options available for addressing the solvency crisis expand.  Specifically, they expand to include this blog's blueprint for saving the financial system - have the banks take the losses on the excesses in the financial system and have sovereigns invest in economic policies that restore growth.

Acknowledging that the banks are insolvent immediately raises the question of 'by how much'.  The only way to answer this question is to require banks to disclose their current asset, liability and off-balance sheet exposures.  This is the data that is needed so market participants can assess how much the book value of the bank's liabilities exceeds the market value of its assets.

It is also the data needed to restore confidence in and market discipline of the banking system.

Acknowledging insolvency also means acknowledging that banks can continue to operate for years with a negative book value.  After all, the banks have effectively been doing this since the start of the credit crisis on August 9, 2007.

Thank you Mr. Evans-Pritchard making your comment on bank insolvency and providing the global financial policy makers with the freedom to fix the solvency crisis.

WSJ: Regulators create systemic risk

In an editorial on the Basel capital requirements, the Wall Street Journal observed that through these requirements regulators are creating systemic risk.

Regular readers know that the global financial regulators are a source of systemic risk because of their monopoly on all the useful, relevant information for assess the risk of a bank.

The WSJ identifies yet another way that the global financial regulators create instability.

In this case, the regulators do it by the risk weightings they put on different asset types that banks hold.  These risk weightings encourage banks to have similar portfolios.  As a result, a problem with one asset type is likely to permeate the entire banking system.

The Basel capital requirements themselves are the product of banking regulators in the 1980s attempting to help banks generate a higher Return on Equity so that the banks could attract capital. [I know as I worked on Basel I.]

The idea of risk weights was developed to allow banks to take on more leverage.

The idea of a risk-free asset that would have a zero risk weight has always been fundamentally flawed.  The only asset that a bank holds that fits this criteria is cash in its vaults.  All the other assets have a component of risk:  including credit, interest rate and liquidity.

It is well known that zero risk weight sovereign debt is definitely not risk free.  For example, a large bank in the US managed to lose over half of its book value from a position in long term US Treasuries.

Standard & Poor's Monday night put nearly every country in the euro zone on notice for a possible credit downgrade ... European officials denounced the announcement as counterproductive and somehow politically motivated, but the rating agencies are merely catching up to the reality that sovereign debt isn't a risk-free asset.  

This same realization may even be dawning at last on the international banking regulators in Basel, Switzerland. Business Week reports that the authors of the Basel standards, which set capital and liquidity requirements for large international banks, are reconsidering rules that all but require banks to hold large amounts of sovereign debt. 

Unfortunately, the rules under review concern only the new liquidity buffers that banks will need to hold under the forthcoming Basel III standards. Under this new requirement, banks are supposed to have a 30-day supply of funds available in case lending markets seize up as they did in the fall of 2008, and 60% of that supply is supposed to be in high-quality, highly liquid assets, such as, believe it or not, government bonds....

Under Basel's risk-weightings, government debt of your home country is assigned a zero risk under both the old rules and the new. 

The rationale is that a government can always tax more or print more money to pay off its debts, at least nominally. So a country that issues debt in its own currency should in theory never be forced into actual default, even if it has to resort to inflationary money printing to avoid it. 

On this, the Basel gnomes have a point, even if it's taken everyone too long to realize that this option wasn't open to the likes of Greece and Italy. 

But even when correctly applied, those rules create systemic risk by nudging large banks toward holding similar assets. This reduces diversity in the system, increasing the odds that if one bank is in trouble, all or most of them will also be in trouble. 

A normal market has a balance of buyers and sellers, longs and shorts, bulls and bears. But risk-weightings put a thumb on the scale. 

Recall that the Basel rules also assigned a very low risk-weighting to triple-A-rated mortgage-backed securities, which helps explain why sleepy banks in Dusseldorf loaded up on the stuff during the housing bubble and lost billions during the panic. 

And now here we are doing it again with sovereign debt. 

In a paper commissioned by the European Parliament in 2010, former Commerzbank Chairman Achim Kassow notes dryly that "The regulatory incentive which results from the 0% risk weight is apparent: banks in Member States are effectively encouraged to place their most liquid assets into the worst possible government debt, maximizing the yield with a regulatory capital requirement of zero." 

It's encouraging that the Basel rule makers are considering even a limited climb-down from pushing banks into government bonds, but the whole policy needs revision.

Senator Sherrod Brown calls for greater transparency in oversight of Wall Street

Re-iterating many of the themes of this blog, Ohio Senator Sherrod Brown called for greater transparency in the financial system.

“For too long, Wall Street has been permitted to operate in the dark, putting our economy at risk and leaving taxpayers on the hook,” Brown said. “Transparency makes markets work and helps improve oversight.  We need a financial system that benefits all Americans – not just the companies that want to enjoy private profits and bonuses, and make taxpayers cover their losses.” 

Senator Brown then cited several examples of the Wall Street Opacity Protection Team's handiwork.

Brown’s call follows repeated stonewalling by federal regulators after Brown raised a red flag over a risky new practice employed by Bank of America and five of the six of our nation’s largest bank holding companies. In October, Brown was joined by U.S. Rep. Brad Miller (NC-13) in questioning the decision by the Federal Reserve and other regulators to allow these institutions to transfer their risky derivatives operations into bank affiliates insured by the federal safety net.  Section 23A of the Federal Reserve Act restricts transactions between banks and their nonbank affiliates, placing limits on the amount of each transaction relative to a bank’s capital and prohibiting purchases of certain “low-quality” assets. 

Last week, Bloomberg Markets magazine reported that 190 institutions made $13 billion in profits on $1.2 trillion in secret, below-market rate loans.  Previously, Bloomberg reported that the Federal Reserve also relaxed its standards for acceptable collateral, accepting “junk” bonds and stocks against its loans. 

In August, Brown wrote a letter to the Federal Reserve questioning a $5 billion purchase by Berkshire Hathaway of 50,000 shares of preferred stock in Bank of America, with annual dividend payments of $300 million.  

Last week, the Fed responded, refusing to answer whether Bank of America will be required to submit new plans to raise equity as a result of this arrangement, which the Fed would then approve, stating that the answer constitutes “confidential supervisory information.”

This blog has called for making the Fed ultra transparent in all its dealings with the banks.  Ultra transparency would bring an end to the idea of 'confidential supervisory information'.  Anything that is happening at a financial institution that the regulators should know about, all market participants should be informed about at the same time.

Otherwise, we end up with the situation we are in today where market participants do not have access to all the useful, relevant information in an appropriate, timely manner for assessing the risk of or investing in a financial institution.

Instead market participants are reliant on the regulator to accurately assess and communicate the risk.  Clearly, the current financial crisis showed that there was a problem either with the regulator's assessment or communication of risk.

Equally clearly, because market participants are dependent on the regulator there is a moral obligation for the government to bailout any investor in the banks.  After all, the investor relied on the government's declaration that the bank was solvent in assessing the risk of investing in the bank.

It is only with ultra transparency (a bank is required to disclose on an on-going basis its current asset, liability and off-balance sheet exposure details) that investors become responsible for both gains and losses on their investments in banks.  It is the potential for loss that gives an investor the incentive to use the disclosed information to independently assess the risk of the bank.

Bernanke letter on Fed lending programs confirms need for Fed to be ultra transparent

The Federal Reserve posted a letter from its Chairman, Ben Bernanke, to Congress attempting to explain the Fed's version of its secret lending programs.

The letter confirms the need to end opacity at the Fed and require that the Fed, like the banks it supervises, be required to provide ultra transparency for all of its dealings with the banks.

How does the letter confirm that the Fed should be required to provide ultra transparency for all of its dealings with the banks?

The letter reflects an argument over what should be indisputable historical facts that market participants needed to have at that time if they were to have access to all the useful, relevant information in an appropriate, timely manner for making investment decisions in the banks.

For simplicity sake, I ask the readers to imagine a simple loan database that any lender must have.  The loan database has all the information on the Fed's loan programs in it.  This database would include on a daily basis the name of any borrower, the amount borrowed under each of the programs, the interest rate paid and the date the loan was repaid.

There is nothing in this database that is disputable.  It is all historical facts.

Since the data is in a database, it is easy to share with all market participants so that they can see how much was outstanding in total, by program or by borrower on a daily basis.  

Furthermore, it is easy to see what a borrower's average cost of funds was.  If the Fed truly lent at a premium it should be easy to verify.

As this blog has discussed previously, market participants knew that the banks were and still are insolvent (it is scary if the Fed examiners did not confirm this fact) as solvency is a function of the relationship between the market value of the bank's assets and the book value of its liabilities.  

The moment the Fed adopted regulatory forbearance (think extend and pretend) and supported suspension of mark to market accounting, the Fed confirmed this insolvency.

Hiding the details of the loan programs did not alter this perception of insolvency.  Market participants are not stupid, they knew the banks were overexposed to opaque toxic securities, second mortgages to sub-prime borrowers and commercial real estate loans.  

All the Fed's secretive activities achieved was to highlight the need for banks to provide ultra transparency so that market participants can assess the risk of an investment in a bank again.

This is a lesson that any scholar of the Great Depression should know!

Former Fed Governor Kevin Warsh adds his support to requiring ultra transparency

In a Wall Street Journal column, Former Fed Governor Kevin Warsh discusses how global policy makers are preventing informed judgments.

His solution is providing market participants with transparency.

Financial markets are in a precarious place, with European banks and sovereign balance sheets in the cross-hairs. Bank regulators are becoming increasingly aggressive, and euro-zone borrowing costs are rising as the debts of years past are coming due. 

In this environment, policy makers are finding their authority, credibility and firepower being tested. In turn, they are finding it tempting to pursue "financial repression"—suppressing market prices that they don't like. But this is bad policy, not least because it signals diminished faith in the market economy itself. 

Markets are not always efficient, but the market-clearing prices for stocks, bonds, currencies and other assets (like housing) are critical to informing judgments, in good times and bad. 

Market-determined asset prices often reveal inconvenient truths. But the sooner the truth is revealed, the sooner judgments can be rendered and action taken. 

By contrast, government-induced prices send false signals to users and providers of capital. This upsets economic activity and harms market functioning. 

Markets that rely on governmental participation will turn out to be less enduring indicators of value. 

In environments of financial repression, businesses are keener to retrench than recommit their time, energy and capital to new projects. Trillions of dollars of private capital remains on the sidelines. And the private-sector engine that drives prosperity sputters. 

Consider a few recent examples of this policy in practice: 

In Europe, share prices are falling among the largest banks, but these prices are little more than a symptom. European banks suffer from a lack of capital to offset future losses, and a lack of transparency that makes it futile to try to judge their financial wherewithal. 

This also applies to banks globally.

Until banks are required to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details, market participants will not be able to judge their solvency.

The bank problem is not some unfounded attack by greedy speculators, so a leading proffered solution—extending the ban on short-selling shares in big banks—obfuscates rather than informs. It also delays the necessary private-sector recapitalization....

Financial repression is sometimes the effect of policy even if it is not the intent. It manifests itself, for example, when policy makers react more forcefully to declines in asset prices than to increases. Price increases tend to be treated with benign indifference. But declines often lead policy makers to respond with force, deploying fiscal stimulus and monetary accommodation.... 

Efforts to manage and manipulate asset prices are not new. But history provides little comfort that these practices work. Interfering with market prices occasionally buys time, but rarely do policy makers seize the window of opportunity to enact structural reform. 

Financial repression embeds the wrong incentives—obfuscation begets delay, and a robust recovery becomes unattainable. 

The path to prosperity requires taking the long road. It requires policy reforms that make the economy less reliant on the preferences of government and more responsive to the market. 

That means prioritizing long-term growth over fleeting market stability, and giving precedence to structural reforms over temporary stimulus and market manipulation.

Nothing would be a bigger structural reform than requiring ultra transparency.

Corzine's rebuff of internal warnings on risk shows why ultra transparency is needed

A Wall Street Journal article documented how Jon Corzine rebuffed MF Global's chief risk officer and his concerns over the Eurozone debt trade.

Mr. Corzine's ability to rebuff the chief risk officer and the board of directors shows why ultra transparency should be required of all financial institutions.

If market participants had access on an on-going basis to MF Global's asset, liability and off-balance sheet exposure details, they could have assessed the risk of the Eurozone trade.  As the risk of the trade to the firm increased, they could have exerted market discipline by requiring higher returns on their investments.

Seeing his cost of funds increase would have acted as a break on increasing the Eurozone debt trade.

MF Global Holdings Ltd.'s executive in charge of controlling risks raised serious concerns several times last year to directors at the securities firm about the growing bet on European bonds by his boss, Jon S. Corzine, people familiar with the matter said. 

The board allowed the company's exposure to troubled European sovereign debt to swell from about $1.5 billion in late 2010 to $6.3 billion shortly before MF Global tumbled into bankruptcy Oct. 31, these people said. The executive who challenged Mr. Corzine resigned in March. 

The disagreement shows that concerns about the big bet grew inside the company months before the trade rattled regulators, investors and customers. 

Inside the company, they had access to the information on the trade.  Outside of the company, the information on the trade was limited.

The executive, Michael Roseman, whose title was chief risk officer, also expressed concerns directly to Mr. Corzine in meetings of just the two men and with other people present, people familiar with the situation said. 

Mr. Roseman contended MF Global didn't have enough spare cash to withstand the risks of its position in bonds of Italy, Spain, Portugal, Ireland and Belgium. He also presented gloomy hypothetical scenarios of what could happen if MF Global's credit rating was downgraded because of the exposure. 

Mr. Corzine, who started betting on the bonds shortly after arriving as chief executive in March 2010, responded to Mr. Roseman's concerns that some of the scenarios were too extreme and likely impossible, people familiar with the matter said. The former New Jersey governor and Goldman Sachs Group Inc. chairman said MF Global's exposure was limited, adding that the likely profit was worth the risks, these people said. 

Boardroom disagreements in which the CEO's decisions are questioned by a lieutenant are rare. The situation at MF Global is even more unusual because it came just six months after directors hired Mr. Corzine to turn around the struggling brokerage firm.

Is Spain going to be the first European country to implement this blog's blueprint for saving financial system?

A Wall Street Journal article suggests that Spain is going to be the first European country to implement this blog's blueprint for saving its financial system.

Under the blueprint, banks would be required to recognize the losses on their bad assets by taking reserves against losses.  The market already expects these banks to have negative book values.  Formally recognizing the losses removes any guesswork about the exact magnitude.

To restore market confidence and show that they have come clean, banks would also be required to provide ultra transparency.  Market participants can use this disclosure to confirm that all the losses were recognized.

With ultra transparency in place, Spanish banks can continue in operation for several years while they retain their earnings and rebuild their capital.  This saves the Spanish government from having to provide the funds immediately.

By disclosing on an on-going basis their asset, liability and off-balance sheet exposures, market participants can also to a better job of assessing the Spanish banks as an investment opportunity.  This makes the Spanish banks more attractive for investment.

Ultra transparency also allows the market participants to exert discipline to ensure that the banks do not try to gamble on redemption by increasing their risk levels.

Finally, by making the banks recognize their losses on their bad assets, Spain's government preserves its own financial capacity to a) credibly back-up its guarantee of bank deposits with an assist from the European Financial Stability Fund and b) invest in programs to spur economic recovery.

Spain's incoming prime minister, intent on curing the country's ailing banking sector, is considering cleanup plans that could dwarf the cost of previous efforts, including ... a move to force banks to dramatically boost loan-loss reserves, people close to the situation say. 

Prime Minister-elect Mariano Rajoy has said he wants to speed up the process of dealing with €176 billion ($236 billion) of impaired real-estate assets from Spain's housing bust, although he played down the potential cost of his plans ahead of last month's elections. 

The bad assets are choking off the flow of credit and making international investors wary of the euro zone's fourth-largest economy.... 

"It makes sense to give restructuring a push by cleaning up balance sheets; it signals things are moving along," said Tano Santos, a finance professor at Columbia University in New York. "That has been one of the most damaging things in the Spanish crisis: the lack of movement." 

A more aggressive response won't come cheap. Analysts estimate a quick fix, such as setting up the bad bank or forcing banks to dramatically boost loan-loss reserves and providing government capital to backstop them, could cost the Spanish state as much as €100 billion. 

That sum raises concerns that the effort could break the government's finances, as happened to the Irish government when it recapitalized its banks and blew out its deficit to 32% of gross domestic product in 2010. 

But a growing chorus of economists and policy makers say the risks of failing to act decisively now are even greater; a new recession could further stress banks, and investor concerns about euro-zone debt problems threaten to scupper the common currency. 

Previous cleanup efforts of the outgoing government of Socialist Prime Minister José Luis Rodríguez Zapatero have fallen short, largely because they were designed to spread the cost over time and avoid a big one-time hit to the government's finances. 

Mr. Rajoy isn't expected to publicly disclose his plans for dealing with the collapse of Spain's decade-long housing boom before taking his oath of office sometime around Dec. 19. 

But some people close the situation say the fastest way to deal with the problem would be to create a bad bank that purchases the impaired assets from lenders at discounted prices. This would force the institutions to recognize losses. It also would likely undermine their solvency ratios and require further funds to shore up their capital bases. 

According to analysts at Morgan Stanley, Spain could acquire the entire €176 billion pile of impaired real-estate assets at the 58% discount applied by Ireland's bad bank, or a cost of €73.9 billion. This could be funded by swapping new government debt for the banks' soured real-estate assets. 

However, the state would have to raise sufficient funds from investors to provide the banks with an estimated €28.5 billion in new capital to absorb losses that the banks would take in selling the assets at a steep discount. In all, the cost of the plan to the Spanish state could be €102.4 billion, or around 10% of Spanish GDP. 

Still, if the €28.5 billion proves difficult to raise from private investors, given current market conditions, Mr. Rajoy has said he is open to the idea of requesting funds from the European Financial Stability Facility, the euro zone's bailout fund, to help finance the new capital needs. That is one of the facility's new mandates after it was revamped earlier this year. 

Mr. Rajoy seemed to pour cold water on the bad-bank idea when, in the heat of his pre-election debate with Socialist rival Alfredo Perez Rubalcaba, he pledged not to give the banks a "single cent." 

But one person close to the situation said Mr. Rajoy's team is studying the possibility of using Spain's deposit guarantee fund, which holds €6.59 billion and is financed by contributions from the banks, to pay for necessary capital injections. That wouldn't go against his campaign pledge because the bank-financed fund, not the government, would provide the cash. 

Requesting money from the EFSF, however, would because the EFSF is funded by Spain and other euro-zone countries. 

Spain's outgoing government approved new regulations on Friday that will double banks' annual contributions to the deposit guarantee fund to around €1.5 billion. These are paltry sums compared to the banks' likely capital needs, but a system could be devised whereby the deposit guarantee fund repays over time any monies the government injects in the banks now, the person said. 

On the sidelines of a conference last week, Spain's central bank chief said the country's banks need further "restructuring" and urged the government to consider approaches that had previously been ruled out because of their high cost, including the creation of a bad bank. 

"This mechanism should be studied…situations change," said Miguel Angel Fernández Ordóñez, noting that the EFSF was now on hand to provide financing.

Concerned about the freeze in interbank lending, Bank of England introduces new liquidity facility

A Telegraph article reports that the Bank of England has introduced a new facility to make sterling available to the banking system if UK interbank lending freezes further.

Once again, a central bank treats the symptom of a solvency crisis with liquidity.

The reason that banks refuse to lend to each other is that they cannot tell if the borrowing bank is solvent or not.  They cannot assess solvency because banks are not required to provide ultra transparency.

Without on-going disclosure of each bank's asset, liability and off-balance sheet exposure details, banks cannot assess the risk and solvency of their competitors.  When banks cannot make this assessment, they cannot lend to each other because of concern they may not be repaid.

Another way banks show they do not trust in the solvency of other banks is in the repo market.  Here, the bank with cash to lend requires better collateral and higher haircuts - a higher haircut is another way of saying the lending bank requires more collateral to support a given loan amount.

In the repo market, the symptoms of the solvency crisis express themselves as a shortage of collateral.  This particular problem is exacerbated by quantitative easing which sees the central banks purchasing the better collateral and making it unavailable to the repo market.

The move comes just days after the BoE joined the US Federal Reserve, the European Central Banks and other major central banks to boost the global supply of dollar liquidity by making it cheaper to borrow. 

However the Bank stressed today there was no "short term" shortage of sterling for UK banks. 

The Bank said its new Extended Collateral Term Repo (ECTR) Facility would enable it to offer banks 30-day loans of sterling on an ad hoc basis. 

"There is currently no shortage of short-term sterling liquidity in the market. But should that position change, the new facility gives the Bank additional flexibility to offer sterling liquidity in an auction format against the widest range of collateral," the BoE said in a statement. 

The Bank said its new facility came "in light of the continuing exceptional stresses in financial markets" and that its design had been influenced by feedback from market contacts.... 

The new ECTR Facility will have an auction format, with loans available for 30 days against collateral. 

The BoE accepts as collateral sovereign debt, residential mortgage-backed securities, securitised credit card debt, student and consumer loans and some types of asset-backed commercial paper, amongst other assets.

Occupy Wall Street embraces ultra transparency for banks

According to an FT Alphaville post, Occupy Wall Street embraces ultra transparency for banks.

Presented below is a note prepared for the December 4th meeting of the Occupy Wall Street General Assembly by its alternative banking working group. We present it – without comment – as a document for understanding the aims of OWS... 

This note has been prepared by the alternative banking working group of the Occupy Wall Street (OWS) movement. The note is for discussion with the OWS movement and more broadly. 

The purpose of this note is to describe the characteristics of an ideal bank that embodies the values of the OWS movement. 

The current banking system lies at the heart of our current economic crisis of increasing volatility and inequality. To change that system, we need to replace it with a better bank. What would be the characteristics of this bank? 

None of these features is new, and many are already evident in credit unions, community banks and “mutuals”. But our purpose is to imagine something that might have a broader reach and impact – that might transform the banking system, and thus, by its example and through its operations, potentially create an economy that is fairer, more inclusive, democratically managed and stable....

6. Transparent – the opacity and unintelligibility (even to those working in finance) of the financial system have contributed to the “credit crunch” collapse. The operations of this bank would by contrast be wholly transparent, thus again helping minimize any risk caused by its operations.... 

In establishing the bank, the principles embodied in the characteristics outlined above should be followed as much as possible (“the means are the ends”). ... If there is general consensus within OWS and perhaps more broadly on the desirability of such a bank, the Alternative Banking group will set itself to the design and perhaps construction of the bank, drawing on the examples and experience – and perhaps the assistance – of similar such banks around the world. But there is no monopoly here: anyone is free to take inspiration from these ideas and embark upon the same challenge.

Former Chief Accountant of SEC takes on Wall Street's Opacity Protection Team

In her NY Times column, Gretchen Morgenson discusses the Fed's secret bailout of the banks as seen by Lynn E. Turner, a former chief accountant at the SEC.

Mr. Turner takes on Wall Street's Opacity Protection Team and calls for transparency to both prevent a repeat of the secret bailout and, more importantly, to change bankers' mindset so that they do not get in trouble in the first place.

In short, Mr. Turner endorses ultra transparency as proposed by your humble blogger.

The fact is, investors didn’t know how dire the situation was at these institutions. At the same time that these banks were privately thronging the teller windows at the Fed, some of their executives were publicly espousing their firms’ financial solidity. 

During the first three months of 2009, for example, when Citigroup’s Fed borrowing apparently peaked, Vikram Pandit, its chief executive, hailed the company’s performance. 

Calling that first quarter the best over all since 2007, Mr. Pandit said the results showed “the strength of Citi’s franchise.” 

Citi’s earnings release didn’t detail its large Fed borrowings; neither did its filing for the first quarter of 2009 with the Securities and Exchange Commission. Other banks kept silent on these activities or mentioned them in passing with few specifics. 

These disclosure lapses are disturbing to Lynn E. Turner, a former chief accountant at the S.E.C. Since 1989, he said, commission rules have required public companies to disclose details about material federal assistance they receive. The rules grew out of the savings and loan crisis, during which hundreds of banks failed and others received government help.

The rules are found in a section of the S.E.C.’s Codification of Financial Reporting Policies titled “Effects of Federal Financial Assistance Upon Operations.” They state that if any types of federal financial assistance have “materially affected or are reasonably likely to have a future material effect upon financial condition or results of operations, the management discussion and analysis should provide disclosure of the nature, amounts and effects of such assistance.” 

Given these rules, Mr. Turner said: “I would have expected some discussion in the management discussion and analysis of how this has had a positive impact on these banks’ operating results. The borrowings had to have an impact on their liquidity and earnings, but I don’t ever recall anybody saying ‘we borrowed a bunch of money from the Fed at zero percent interest.’ ”... 

Of course, there is stigma associated with a company tapping into federal assistance programs. This is the Fed’s main argument for keeping its operations under wraps. And companies want to avoid frightening investors by disclosing their reliance on this type of emergency cash, even if it is only temporary.

This argument is fundamentally flawed.

Prior to the introduction of deposit insurance in the 1930s, banks would routinely disclose 'all their accounts fit to print'.  This was a sign of a bank that could stand on its own two feet.

It is only with the arrival of the regulators that less information was made available to deposit holders and investors.

If banks were required to provide ultra transparency, market participants would know if they needed to use a Fed program and if the need was temporary or a reflection of a true solvency problem.

But keeping this information from shareholders is no way to engender their trust. And a lack of investor confidence often translates to depressed valuations among companies’ shares.

Actually, a lack of investor confidence often translates into a run on the bank.  One symptom of this is investors fleeing the bank's stock.

If investors doubt that a company is coming clean about its financial standing — the current worry is how exposed our banks are to European debt woes — its stock price will suffer. This is very likely one of the reasons that big bank stocks trade at such low price-to-earnings multiples today.

Today, investors know that banks are not coming cleaning about their financial standing.  The Fed's secret bailout was just one of the ways that bank financial statements were manipulated.

At the beginning of the financial crisis, regulators adopted a raft of programs to distort bank financial statements.  These include regulatory forbearance (extend and pretend on loans), suspension of mark to market accounting, and adoption of mark to myth accounting (management values securities based on hope rather than prevailing market prices).

It will be interesting to see whether the S.E.C. does anything to enforce its rules that companies disclose federal assistance in financial filings, either in the recent past or in the future.

Highly unlikely as the SEC is a card carrying member of Wall Street's Opacity Protection Team.

This blog has frequently documented how the SEC, despite its mandate to ensure that market participants have access to all the useful, relevant information in an appropriate, timely manner, has repeatedly endorsed opacity in the financial system.

For example, disclosure for structured finance securities is covered by SEC Regulation AB.  Under this regulation, investors only have access to the underlying loan performance information once per month.

This contrasts with the centuries old banking industry standard for monitoring a loan portfolio of looking on a daily basis for any observable events with the underlying loans.  An observable event includes a payment, delinquency, default or borrower filing for bankruptcy.

This regulation also legalized for Wall Street what was the equivalent of an insider's trading advantage.  They were able to trade on tomorrow's news today as Wall Street ran the firms that did the billing and collecting of the loans backing the structured finance securities and therefore had access to data on a daily basis.

You could certainly argue that requiring such disclosures is even more important nowadays, given that so many banks are considered too big to fail and that the taxpayer will undoubtedly be asked once again to rescue them from their mistakes.  

 “These banks and the Fed have never believed in transparency,” Mr. Turner said. “I actually think their thought process is sorely flawed. If the banks knew this stuff was going to be made public they’d behave differently. Instead of runs on the bank you’d have bankers doing things intelligently to avoid getting into trouble.” 

What an idea!

Yes, one that your humble blogger has frequently shared with regular readers.