A second bailout of the banks is now inevitable


3:11 pm - September 13th 2011

by Richard Murphy    


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If you listened to UK politicians yesterday you would think the banking crisis was solved.

300 odd pages of report from John Vickers and a promise to implement plans after the effective careers of all currently involved in politics and banking are over and apparently the problem is solved.

With respect to all in question, no it isn’t.

Robert Reich, a former US Labor Secretary tweeted overnight:

50% probability Greek default. US banks counter-party debt huge. Prepare for another Lehman Brothers. Second big bank bailout on the way?

I’d argue on two counts. Greek default is inevitable. It’s disorderly default he’s referring to, I think. And there’s no question mark at the end: that’s also inevitable.

As the Guardian has said in an editorial on Vickers this morning:

The careful cost-benefit terms in which .. concession[s] to the bankers [are] justified stir deeper questions. The commission has measured every dimension of finance’s problems, but the crisis has bent the yardsticks. They talk of removing subsidies so risk can return to a market price, and yet investment risks are not currently priced by reason but by depressed animal spirits.

There are some really bold ideas for breaking from the slump, such as a national investment bank to put idle hands and idle money to productive work. The commission, however, opted to stick within the conventional wisdom, stating blithely on page one that it is never for the state but for “the private sector disciplined by market forces” to make investment decisions. But after all that has happened, it is not longer good enough to hold the old truths to be self-evident.

I agree: on blackboards in economics seminars markets great make decisions. In practice they’re made up of people with no magic power and no greater ability to know what to do than the state. Worse though, because they think they are superior they pay themselves more and still, as we’ve seen, get it spectacularly wrong.

All of which is why I argued yesterday that the state has to be ready now for another failure by bankers, as it is inevitable.

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About the author
Richard is an occasional contributor. He is a chartered accountant and founder of the Tax Justice Network. He blogs at Tax Research UK
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Reader comments


Life’s too short

Scum tories dont mind bailing out their mates. Look at lazy farmers. See tories like welfare just as long as tory scum are the ones getting it.

Sally I think you mean Eurocrats don’t mind bailing out their euro mates. I could be wrong, but I don’t think were going to see UK banks go under because of Euro defaults. Greek banks otoh, are fecked.

4. Frances Coppola

Luis, I think you are wrong. I agree that UK banks won’t go under because of Greek default. But if you think the Eurozone’s debt problems end there you greatly underestimate the situation. RBS is particularly at risk, and if that gets into trouble there is no alternative than full nationalisation. But most UK banks are significantly exposed to Italian debt, and of course Ireland is still waiting in the wings. Further bailout does indeed look likely to me.

I agree: on blackboards in economics seminars markets great make decisions. In practice they’re made up of people with no magic power and no greater ability to know what to do than the state. Worse though, because they think they are superior they pay themselves more and still, as we’ve seen, get it spectacularly wrong.

How to miss the point spectacularly. Are the small number of banks (small because regulation and government interference limit entry to the market but seem to allow buy outs – and limit the small players ability to expand) really a market. Strike me as more of a cartel, backed by government. The excessive pay for (state-guaranteed) returns suggests that to me as well – no real competition.

And the market does not imply magic powers. Mr Murphy’s lack of basic economic knowledge seems to go so far as to be unaware that markets work where states don’t by the simple process of being able to do different things at once – so those that work well then become widespread. The state can only do one thing at once, so whilst no worse than any individual element in the market (and quite possibly better than most) it is still considerably less likely to hit on the best way forward because it can only select one option at a time. It is also more likely to cause problems by chosing the wrong option – in a market this becomes apparent quickly, and damage is limited (at worst to the loss of the player in the market that selected the wrong option).

So whilst I am probably with Mr Murphy is not liking the idea of more bailouts, I’d suggest that before criticising the market he consider the fact that the banking sector is in no way a proper market – barriers to entry are high, cartel practices are pretty rife, and innovation is stifled by government. All of this leads to a complacency where those in charge are only in charge in title – they have no idea of what is really going on.

There is another option for the government of course – let the banks fail and simply guarantee the savings (which might help reduce the total levels of debt in the economy, always a good thing). Might cause chaos, but surely better than propping up the bloody inadequate system out of fear?

Sally,

Scum tories dont mind bailing out their mates.

Gordon Brown was clearly a scum tory then? Or is it possible you have once more failed to grasp the fact that the world is slightly more complicated than something envisaged by a five-year old?

7. Leon Wolfeson

@3 – Loool. No, we’re exposed, and unable to take ANY shocks.

(Oh, and it would remain cheaper to buy the fricking debt than to plunge, but…)

7. yes well it’s not going to be much of a shock if Greece defaults is it.

Italy and Spain, well if that happens I guess we are in for mega global financial crisis round 2, but if I was the ECB, I would use my printing presses to make sure that doesn’t happen.

Frances,

you may be correct.

here is my inflation generating solution to the Euro crisis, if keep Euro together at all costs is the goal:

ECB prints money and buy sovereign debt.
Sovereigns buy equity in banks holding lots of sovereign debt.
Sovereigns use their stake to force through partial write-offs of sovereign debt, which they can withstand having just been recapitalized by sovereigns.
ECB makes a stinking great loss, bank shareholders, outcome not clear, Germany goes mental.

[I have given that about 5 minutes thought]

It might just be worth it if we were to see a fundamental change in the economic politcal and social direction of the uk, but alas these people listen to no one. Democracy? Don’t make me laugh!

Well Murphy has made a solid prediction. How likely is he to be right for the right reasons?

12. Luis Enrique

Cherub,

he doesn’t specify what banks he’s talking about (UK, EU) nor what sort of bailout – indirect (ECB buys EU govt debt) or direct (sovereigns buying more equity in banks).

He’s very likely right the Euro crisis isn’t over yet, so something that could come under the banner of “bailing out banks” is likely to to happen, because anything designed to avoid another meltdown could be called that.

it’s also a bit rich to call it a failure by bankers when government imposed regulations dictate how banks treat sovereign debt – to a certain extent some banks were “made” to hold all this government debt. Not UK banks, so much, afaik which isn’t very far. Richard W or somebody probably knows more about what regulations mean for how banks hold sovereign debt.

A second bailout is inevitable for the simple reason that they got away with the first one without serious consequences to the bankers who walked away from (or stayed on after) the first disaster with bulging pockets. The prospect of reform in 2019, if it even happens, isn’t much of a threat. Until bankers themselves are made personally liable for their own greed and idiocy nothing will improve. In the 12th century England suffered an outbreak of shaved coins, the money changers responsible were summoned to London where they each had their right hand and right testicle removed. Fair punishment for modern bankers I think.

” 50% probability ”

The probability that can be implied from the CDS on Greek bonds is actually a 98% probability of default sometime over the next five years.

@ 12. Luis Enrique

The reason why the European banking sector is in such danger is because as a system it is highly leveraged. There is no leverage ratio requirement in Europe ,as they rely entirely on the Basle Accords. Basle allows the sovereign debt of OECD countries to be held with a zero risk weight requiring no bank reserves. Therefore, the bonds are held as the banks Tier 1 capital, reserving against other debt assets. Basle considered the bonds risk free with liquid government debt markets. Moreover, Basle applies capital requirements only to Risk-Weighted Assets and ignores the ratio of RWA to total assets (TA) in banks.

It made sense for EU banks to reduce their Risk-Weighted Assets and leverage up their balance sheets as that increases the profitability of the bank. That is why European banks hold so much sovereign debt as it had a zero risk weight. For example, the Basle Accords meant that a bank holding a corporate bond from a cash generative company like Tesco would have to assign a 100 percent risk weight on the bond, and zero for a Greek government bond.

For government bonds to be considered liquid, they should be treated by financial markets as a cash substitute or a cash proxy. Moreover, they should be liquid in all market conditions.That hardly describes the euro zone government bond markets over the last two years. Leveraging their balance sheets to work every euro of capital harder was good for the profits of the banks. Moreover, governments benefited from the banks buying their debt at low yields. Electorates benefited from getting states without the inconvenience of paying tax.

So, the banks are holding assets on their balance sheets with zero risk weight and the assets are quite clearly not zero risk. Therefore, many if not all of the EU banks are massively undercapitalised, as they do not have the Tier 1 capital ratios that they claim. A Greek default per se is not really the problem. That probably is already priced in to bank share prices and funding costs. Contagion as ever is the real problem and a great unknown. The market immediately will go searching for who is next and the incentives for default will rise for the rest of the periphery. How will they react when they see market participants happily buying restructured bonds and they are locked out of private capital markets? Greece is manageable, but any contagion and the whole of the European banking system will be insolvent.

This is good on the leverage of the EU banking system.
http://www.oecd.org/dataoecd/19/9/46970598.pdf

Watchman writes

Are the small number of banks (small because regulation and government interference limit entry to the market but seem to allow buy outs – and limit the small players ability to expand) really a market. Strike me as more of a cartel, backed by government. The excessive pay for (state-guaranteed) returns suggests that to me as well – no real competition.

Richard writes

the Basle Accords meant that a bank holding a corporate bond from a cash generative company like Tesco would have to assign a 100 percent risk weight on the bond, and zero for a Greek government bond……Leveraging their balance sheets to work every euro of capital harder was good for the profits of the banks. Moreover, governments benefited from the banks buying their debt at low yields.

Do you see the connection?

I am not postulating an active conspiracy between the two, but it is clear that banks and governments have a symbiotic relationship that is anti-market and anti-consumer. If the whole rotten edifice is not to come down, one or other side will have to fail and I think, on balance, it will have to be the banks.

In fact, we should have insisted on that happening in 2008.

16. So Much For Subtlety

I agree: on blackboards in economics seminars markets great make decisions. In practice they’re made up of people with no magic power and no greater ability to know what to do than the state.

No one I know suggests they have magical powers. But what they do have is undivided attention. Politicians want to get re-elected. Bankers want to make money which usually means making good loans. Politicians have a time frame of four years at the most. As can be seen by pretty much any policy you care to name – Blair’s Greenhouse promises, Obama’s budget cutting, whatever. Bankers may think as far away as their pension.

Which means that while in theory they have no greater ability than the State, in reality, they do. They do not loan their friends. They do not flood marginal constituencies with cash. They do not cave to powerful special interests and thuggish Trades Unions.

Which is why Britain is so feckin’ rich (as the OP may have noticed) and sh!tholes where politicians make economic decisions are not.

Worse though, because they think they are superior they pay themselves more and still, as we’ve seen, get it spectacularly wrong.

The State gave us the Great Leap Forward, Pol Pot’s Year Zero, Ukrainian famine, collectivisation everywhere Communism was tried. Tens of millions have died because of State economic policies. Even if we look to Britain, the State gave us famine in Bengal and Stagflation. The market has given us so much food that we are all eating ourselves to death. They may get it wrong from time to time, but their wrong is much less worse than the State’s wrong.

17. Steven Van der Werf

I argued quite some time ago that pay should be tied directly to performance. If your bank fails, your entire executive team should be bankrupt. No golden parachutes, no bonuses for failure.

Unsurprisingly I got flamed for that, people demanding I should live what I preach. But that’s fine, because I do. My entire professional career has involved pay by success. I see no reason why people capable of tanking a national economy shouldn’t live by the same rule.

But then again I’m not an economist. I’m just vaguely sensible, and don’t quite understand why you should earn millions for losing billions.

“on blackboards in economics seminars markets great make decisions. In practice they’re made up of people with no magic power and no greater ability to know what to do than the state.”

Gosh, that’s interesting. The State, just as clueless as markets then.

Except, of course, that markets have rather better incentives than States.

As a result, the only way for the French banks to be able to project a credible degree of solvency is for the Eurozone to inject a huge amount of money somewhere. Either it goes into the countries the French banks have lent to, and will then be used to pay back the French banks what they’re owed, or else it just goes into the French banks directly — the TARP solution. But if the EFSF isn’t beefed up and deployed very soon, we could see some extremely big French banks either collapse or get nationalized in very short order. And nobody wants to see where the chain reaction from that would lead.

sorry, that last one is a quote from Felix Salmon.

so lchances of an ECB or IMF bailout of French banks look high

If your bank fails, your entire executive team should be bankrupt.

I don’t think the abolition of the limited company is a very good idea, all things considered.

This dull divide between “state vs market” with oceans of child-like analysis and cheerleading on one side or another is not particularly helpful.

The OP’s analysis hits a new low in not shedding light on anything at all, other than his own ideological leaning.

Banks, particularly on the continent, operate hand in glove with the state. In the olden days political people called such approaches corporatism. Such strategies make a mockery of the idea that it’s all do with “the bankers”, or “the state”.

24. DisgustedOfTunbridgeWells

I don’t think the abolition of the limited company is a very good idea, all things considered.

Of course, incentives, much like the market are only supposed to work on the way up.

If you had to actually be held accountable for your actions, can you imagine? Turns my stomach just thinking about it.

23 – You think banning limited liability corporate status for banks is a good idea?

26. DisgustedOfTunbridgeWells

I think negative externalities and moral hazard are bad ideas.

It sounds, to me, that right-wingers now actively want to do away with the state entirely and have the entire system run by banks and “markets”.

Is that the ultimate goal?

What? There is a negative financial situation? Its time for critical action, correct lets bring this country to a stand still with prolonged strikes and lets introduce a financial transaction tax to save the plant from global warming!

I can not wait for those self appointed cluelessly opinionated selfish bastards to be wiped off the face of the earth with the coming dose of reality.

Enjoy.


Reactions: Twitter, blogs
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  5. Watching You

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