There are all kinds of programs in various European countries to ‘save the financial system’.
There seem to be three different points in all of them:
- Injecting capital into banks that have lost so much that their capital base in now inadequate
- Guaranteeing interbank credit
- Regulatory ‘relief’
I get the first point. If done correctly, the banks will be triaged and only those who have a chance to survive and are really in need will be propped up. Their shareholders will be punished.
The second point I do not get at all.
The reason why interbank lending needs to be guaranteed, we are told, is because interbank lending has ceased. The reason for that is distrust between banks. The distrust is understandable as the fall of Lehman Brothers has hit its creditors pretty hard.
But there is a simple thing with credit. If lending is risky a higher risk premium is needed. The borrower will have to pay higher interest rates. That is what the recent rise in LIBOR (London Inter Bank Offer Rate) is expressing. I do not see anything wrong with this. This risk of lending to Lehman was obviously miss-priced. The risk is now high, so are the interest rates, so what? Some point out that the TED spread is high. That is the difference between LIBOR and the interest rates Treasury bonds are paying. But why is it supposed to be bad that the spread is high?
The Fed and other Central Banks are now lending to about every financial entity as much as those want. Why would banks borrow from each other at all if they can borrow much cheaper from the Central Banks?
I can see problems coming up when real economy entities need credit to run their business. If lending to them drys up, some otherwise valid business might shut down. But if that is the risk, why not attack that problem directly and issue credit to those real economy companies who need it?
The third point of ‘regulatory relief’ is outright dangerous. Banks have to mark assets to market prices. Now they will be allowed to mark those assets to whatever they think might be appropriate. Does this increase or decrease the risk of lending to them? It increases the risk as the real value of these banks can not be determined when they mark to model. Just like the immense Fed lending this policy is counterproductive to the aim of reigniting interbank lending.
The markets in Europe are rallying today. I see no reason for this but simple hype of the announced programs that are not even spelled out yet in full. Do future earning expectations in a likely recession environment really justify higher stock prices?
The German program was announced to be some €500 billion. It is in fact much smaller. But the commentators on various German newspaper sites, even conservative ones, are outraged. The political backlash will be immense. Only one in ten Germans owns stocks. To risk taxpayer money to prop up the markets is therefore very unpopular.
Where by the way is the U.S. plan? An what is it? Good to hear that Sherlock Holmes is now involved in solving that mystery.