The world economy remains more or less motionless or even recedes six years after the financial meltdown, because the banking industry has not yet decided what’s best for its interests. Continue leveraging itself (borrowing) on central bank liquidity in a stagnating environment, or start deleveraging and send the world to another deep recession, if not a major crisis? The Banks insist that for every percentage point of their deleveraging (less borrowing) the real economy is to lose an equal percentage of GDP.
This is a direct warning to policy makers, governments and monetary authority chiefs alike, in case they stop supplying the banks with abundant liquidity at zero or even negative real interest rate cost. This unthinkable some twenty years ago situation was endorsed last week by the bank of the banks, the Bank of International Settlements.
Less borrowing means less GDP?
The BIS says that the latest strengthening of capital adequacy levels and the cutbacks of leverage limits rates imposed on banks by regulators, forced the lenders to raise more capital or cut down assets and leverage (borrowing) or both, with negative repercussions on the real economy. According to this logic, the GDP would fall by a similar rate as the reduction of the leverage limit. In basic mathematics this means that a 1% GDP fall is to follow after an equal reduction imposed by the authorities on the limit of the leverage (borrowing) a bank is allowed to reach.
Free leverage leads to crisis
In short, what the bank of banks says is tantamount to an open threat, telling the governments that if they want safer banks the real economy has to pay the price. Under this ‘theory’ the banks should be left free to spin around the liquidity they get from the monetary authorities many tens of times their own capital, inflate their balance sheets to bursting point and borrow freely until the whole financial sector bursts.
And all that for the banks to be allowed to build a highly dangerous financial bubble associated with just a meager increase of the GDP. Exactly as it happened when the Lehman Brothers went bust at the point where it had borrowed and accordingly ‘invested’ almost seventy times its own capital. Of course there were more major banks, almost all of them, which by 2008 had spinned tens of times their capital through totally careless leveraging.
Who wants safer banks?
In many ways and despite the timid efforts by regulators to make the banks safer in both shores of the Atlantic Ocean, the lenders still remain unconstrained in perusing their perilous games in the derivatives and every other market. In the US and the EU the major banks are still considering the taxpayers’ money as their security in case they go bust.
The ugly construction of the European Banking Union and the US banks’ elusive obligation to draft tenable bankruptcy plans (‘living wills’) have changed nothing. In both cases bankers are still counting on public money to pay their creditors in case of bankruptcy.
Banking Union for whom?
The European Sting’s latest comment on the European Banking Union was that this is “a mechanism to safeguard the systemic banks”, not aiming at relieving the taxpayers from the obligation to save the imprudent lenders. The Sting’s writer continued asking the following critical question, “…who will pay in case the so called Single Resolution Mechanism and Fund (the central mechanism of the Banking Union) cannot save a ‘systemic’ bank in a case of crisis?” Everybody knows that the Fund will be able to start playing a modest role in this game only after eight years.
Last week however, it became apparent that the same problem also haunts the American financial system. According to major US media, the US regulators found that five out of the eight ‘too big to fail’ American banks (JP Morgan, Wells Fargo, Bank of America, State Street Corp and Bank of New York Mellon) are still counting on taxpayers money to pay for an eventual bankruptcy.
The banks which ‘cannot’ fail
The other three banks which…cannot fail (Citigroup, Goldman Sachs and Morgan Stanley) seem to have more but again probably rather less trustworthy resolution plans. In any case, the first five giants’ contingent plans are found clearly elusive and not relevant in such a nasty occurrence.
As a result, the US regulators dismissed those ghost contingent plans and told the five lenders to amend them and make them concrete and credible until 1 October or face the consequences. It will be quite interesting to follow this affair, because if the five banks do not produce reliable schemes for an eventual bankruptcy without the help of taxpayers, they may have to break up.
This would be a major structural change in the western financial universe. The American financial giants would have to break up in two. A regular bank, being trustworthy to accept deposits, and an investment company ‘free’ to go bankrupt without touching on taxpayers’ money.
Free to go bankrupt
However, if the US finally comes to the point of breaking its own banks, Europe will have to do the same because the euro area banks are at a much worse financial state than their American counterparts. The IMF in its latest Global Financial Stability Report published last week, makes a special point about the problems of the Eurozone banks.
It says, “In the euro area, market pressures also highlight long-standing legacy issues. Banks urgently need to tackle elevated nonperforming loans using a comprehensive strategy”. The amount of those non performing loans is estimated to be in the region of €900 billion, of which a round sum of 80 to 90 euro billions appear on the balance sheets of the Greek banks. This is a tremendous weight for Europe’s systemic banks.
The IMF says it indirectly
There is no doubt that the western financial system has to undergo a deep structural reshuffle. The IMF puts it very mildly for understandable reasons. However, it says that “Many banks in advanced economies face significant business model challenges. The report estimates that these banks account for about 15 percent of bank assets in advanced economies”.
In plain English this “business model challenges” means that those banks have to change their ‘modus operandi’, because if they continue on the same model, they are bound to go bankrupt. It’s not by accident that this IMF report appears at the same time as the US banking watchdogs so forcefully castigated the eight ‘systemic’ American banks. These are the lenders which are officially considered by the Washington government as ‘too big to fail’ and consequently are still favored by the guarantee of the American taxpayer.
Will the US break its banks?
It seems then that at least in the US the authorities have set a new goal; to change that. In the face of it, the US politicians and regulators say that the taxpayers cannot continue supporting the insatiable greed of the imprudent financial sharks. Incidentally, the IMF seems to know or even to collaborate with the US authorities towards this direction. It’s not the same between the IMF and Europe though.
That’s why the Fund has such strongly worded advice for the EU, telling Europeans to work towards this direction. It says that “Finally, Europe must also complete the banking union and establish a common deposit guarantee scheme”. The IMF says rather plainly here that the Eurozone lacks a common banking system.
The EU has to follow the US
There might be many reasons why the IMF is so harsh with the Eurozone. The main one is rather that the other constituent part of the western financial system, namely the US, seems to have set a new concrete course to purge its financial system. Not Europe. But this has to be done in full coordination between the US and the EU, because the European and the American banking systems are too closely related and have to draw on the same ‘modus operandi’.
The Americans cannot and surely would not break their own banks and let Europe keep their leviathans intact like Deutsche Bank, BNP Paribas and Credit Agricole. The most probable development then would be, that things are to remain as they are for quite some time, to the detriment of the American and the European taxpayers. There are things that divide the American and the European leaders, probably not as many as uniting them. And a European would hate to say that the indifference about taxpayers belongs to the first category, with the American leaders caring more.