The Elephant In The (European) Room

When are we going to stop pretending that banks are solvent when they really are not?

This morning we’re treated to two articles in the Journal bearing on the issue; we’ll start with this one:

BRUSSELS—European politicians signaled Tuesday that there is no quick fix to the row over Finland’s insistence on receiving collateral for taking part in Greece’s second bailout, even as the European Commission insisted talks were yielding progress.

Euro-zone governments are looking into alternative forms of collateral to meet Finland’s demand in order for the country to contribute to Greece’s second bailout, after a cash deal reached earlier between Greece and Finland was rejected by key member countries, including Germany and the Netherlands.

Why should Finland provide any more money to Greece at all?  Greece has proved that it will lie, cheat and steal to get what it wants from the rest of the Euro zone, and it’s not alone.  The Euro Zone treaty obligations to keep deficits to no more than 3% of GDP are not suggestions.  Of course they’re treated as such, for one simple reason: Nations have gotten away with this sort of crap for years, and banks have gotten away with helping nations to lie.

Nobody has faced sanction, say much less indictment, for what amounts to deception upon the public and the other nations in Europe (and elsewhere.)  Yet this sort of deception is well-recognized in the corporate space as actionable conduct – so why isn’t it at this level?

Ultimately the problem is that currency unions don’t work well without some sort of enforcement mechanism, and that enforcement mechanism is problematic when you have nations with disparate economic fortunes.  The premise that opening the door to trade benefits everyone and thus currency union is a good thing because it obviates exchange-rate differences and potential tariff problems is a chimera – some nations will inevitably be bled of capital if there are differences in productivity, social spending and economic health between the members.  Bereft of the adjustment that normally takes places when one has floating currencies in the presence of these capital flows the incentive to cheat becomes strong, as the alternative is an admission that what you did originally wasn’t workable.

Unfortunately what has happened here is more-complex, in that in addition to pretending that nations could pay infinite debts when they in fact could not banks were also given the ability to mark their portfolios to a fantasy, provided they claimed their financing of profligate nations debts were done “to maturity.”  Then these nations and the ECB severed their own femoral artery by allowing banks to consider government bonds as “risk free” and thus they became part of a leverage chain that has turned into a monstrous outrage and yet another fraud upon the public:

Twenty months into the euro-zone’s sovereign-debt crisis, this ought to be obvious. The main reason that the specter of an unruly default keeps policy makers up at night is its likely consequences for Europe’s banks, whose balance sheets hold some 45% of Europe’s government bonds. Repeated stress tests by bank regulators have ignored the vast majority of those bonds that are held to maturity.

This flatters bank balance sheets by pretending that a sovereign default in Europe is impossible, but it has done nothing to increase investor confidence. The recent volatility in bank stocks and the trouble some European banks have faced getting all but the shortest-term financing in the private markets underline the skittishness.

The solution to this problem is to not let banks do that crap

That is, institutions should be forced to both mark to the market nightly for all instruments where there is a price, and where there is not, the “market price” is taken to indicate that the entire loan is unsecured.  If you then force banks to hold one dollar of actual capital for each dollar of unsecured lending they do at all times then there is no systemic risk.

There’s also no levered 50:1 returns, or 20:1, or 30:1 of course, but is this a good thing or a bad thing?

For the banksters it’s a bad thing.  But for society as a whole, the stability of the markets and sustainable economic policies it is a very good thing.

If banks can’t withstand their balance sheets being marked to the truth then shut them down.  That’s why we have bankruptcy – to cover exactly this contingency.

Of course Lagarge argued over the weekend that these institutions should be “recapitalized” – including by financially raping you, your children, grandchildren and those not yet born if necessary.  But financial rape is really no different than the more-pedestrian sort, in that both take place through the use of force.  That we have sharply-dressed protagonists in one case and a sweaty, disgusting example of a thug in the second doesn’t change a thing about the essential character of the act – in both cases you are violated, being forced to do something for the pleasure of another at gunpoint.

Four years into blindingly-obvious examples of this abuse by Treasury Secretaries, Congress, Presidents and international organizations such as the IMF, each of which has endeavored to protect those who took knowingly and outrageously unsound actions and asset-stripped the populace through these practices we are long past the point in time where the public’s reactions to such jackals at the door should be to slam said door on their fingers – or necks.

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