October 08, 2012

There is too much of getting back at the banks, and too little of getting the banks back on track.

Sir I refer to Wolfgang Münchau´s “Relentless austerity will only deepen Greek woes” October 8. It is yet an example of a push for public bureaucracy administered stimulus, which much ignores the essential role of the banks in helping out. 

Regulators stupidly allowed the banks to hold very little capital against assets which were ex ante officially considered as “not risky”. Now many of those assets, precisely because those low capital requirements and erroneous ex-ante risk perceptions inflated these into bubbles, ex-post they have turned out to be very risky. 

And, as a result the banks stand there naked with no capital, and in need of enormous capital injections, if they are to cooperate in the recovery and not be instead, as they mostly are now, a drag on the recovery. 

And regulators, by not being able to explain in credible terms when enough new bank capital will be enough new capital, insist in scaring away new capital and instead provides stimulus for counterproductive balance sheet contraction of the banks. 

This is so because the first thing you do not want to do as an investor is to put your money into a venture where you risk your money will not suffice, and you will have to beg others for mercy in the future. 

Münchau writes “The reform that would matter the most – the closure of the unprofitable banks and the consolidation of the entire sector – is not happening for political reasons”. That sounds more about having to do with wanting to get back at the banks, or to create more too-big to fail-banks, and less to do with getting the banks back on the right track. 

What would be needed for that? Simply, much more bank capital, much less bank leverage, and much less regulatory distortions, which means a complete different action plan for our banks.