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Posts Tagged ‘Too Big To Fail’

So says Jon Huntsman:

More than three years after the crisis and the accompanying bailouts, the six largest American financial institutions are significantly bigger than they were before the crisis, having been encouraged to snap up Bear Stearns and other competitors at bargain prices. These banks now have assets worth over 66% of gross domestic product—at least $9.4 trillion, up from 20% of GDP in the 1990s. There is no evidence that institutions of this size add sufficient value to offset the systemic risk they pose.

The major banks’ too-big-to-fail status gives them a comparative advantage in borrowing over their competitors thanks to the federal bailout backstop. This funding subsidy amounts to roughly 50 basis points, or one-half of a percentage point in today’s market.

Read the whole thing.

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The Drudge Report is currently linking (in red and in CAPITAL LETTERS) to a breathless front-page New York Times “News Analysis” by Landon Thomas Jr. and Nelson D. Schwartz, proving once again that the Times is never the best place for financial news — or responsible “analysis” for that matter.

Unfortunately the piece, “In Euro Zone, Banking Fear Feeds on Itself“, does not give readers the basic facts or background to understand  financial institutions in general, the history and structure of the Euro and the Central European Bank, the current European economic and political climate, or general economic principles.  That’s what’s so breathtaking about this article.

The authors refer repeatedly to Lehman Brothers, its failure in 2008, and their comparison to it and contemporary European banks.  The comparison sets the basis for many of their assertions, but left out of the analysis are facts that turn this front-page article into a dangerous diversion.  For example:

  • Lehman Brothers
    • Lehman Brothers was an investment bank, and as such, American law prohibited it (by and large) from offering cash deposit accounts, and thus did not require insurance from the FDIC for up to $100,000 per account (the guaranty was raised to $250,000 during the Bush administration).  The lack of FDIC insurance significantly reduced incentives on behalf of the United States to ensure the bank remained solvent because there were no guarantees on deposits.  Moreover, there was no concern of a “run on the bank” from panicked depositors.
    • European banks (some of which also act as investment banks) have billions in cash deposits, which are insured — not by a pan-European entity (like the federal FDIC in the United States) but by the nation in which the banks reside.  Some countries, such as France and Germany, have no limit of insurance on each account.  Have a million in your checking account?  No problem, if your French bank fails, the country’s tax payers insure every euro.  Obviously every nation with a troubled big bank with insured deposits has a vested interest in seeing any weak banks remain solvent.
    • The authors assume Lehman’s failure caused a world-wide financial panic in 2008.
      • The failure of Lehman Brothers was a symptom of the economic crisis of 2008, not the cause of it.
      • After the U.S. government bailed out Bear Stearns earlier in 2008, the market assumed it would do the same for the too-big-to-fail Lehman Brothers.  This is what economists call “moral hazard”.  So what a surprise it was when the government said it didn’t have the legal authority to do so and refused, allowing the bank to fail.  Investors started to ask if JPMorgan Chase, Citigroup, or BofA could also fail, thus panic ensued.
      • The panic subsided only when government officials began taking actions that provided expectations that these large institutions were indeed too big to fail and would ultimately enjoy a bail out if need be — much of what we’re witnessing now in Europe.
  • Deposit insurance
    • If an Italian or French bank fails, it is the responsibility of Italy or France to insure the deposits, not some European entity based in Frankfurt or Brussels.  European policy makers may be “determined to avoid such a catastrophe”, and “are prepared to use hundreds of billions of euros of bailout money to prevent any major bank from failing”, but do these “policy makers” have the legal standing to do so?  A German court will tell us on Wednesday.  But even if the court approves, what are the political ramifications?  The Times analysis fails to tell us.  How many euros will Germany provide to shore up a French bank?  Or an Italian or Greek bank?  Who leaves first?  Greece?  Portugal?  Or Germany?
  • The authors go on: “Turmoil in Europe could quickly spread across the Atlantic because of the intertwined nature of the global financial system. In addition, it could further damage the already struggling economies elsewhere.”  This is rich.  Later in the article, the authors say, “Investors also continued to seek the safety of United States Treasury bonds.”  Do the authors realize the percentage of Treasurys purchased by European banks, investors, and governments?
  • Quoting George Soros, identified only as a “hedge fund investor”, the Times notes how he cites the lack of an authoritative pan-European body to handle a banking crisis of this severity. “That is why the problem is so serious. You need a crisis to create the political will for Europe to create such an authority, but there is still no understanding as to what the authority will do.”  Really.  George Soros opines in a New York Times “analysis” with nothing, I suppose, at stake for such an opinion?
  • Cross-border exposure, as noted by the authors, does not specify the assets held by American financial institutions, but the reader is left guessing if it’s government exposure?  Bank exposure?  Is it collateralized?  Guaranteed?  We’re left wondering.

I could go on, but what’s the point?  There’s no question that the Euro debt crisis is real and the consequences are significant, not only economically, but politically; not only in Europe, but here in America.

So how about a shout-out to Messrs. Thomas and Schwartz?  Here goes:

  • The financial complexion of a bank is simply a result of the underlying economy in which it operates.
  • The market continues to believe that most large European (and American) banks are too big to fail.  The expectation remains that governments will bail them out if necessary.
  • There are only so many taxpayer funds available to provide bailout money to large banks.  It’s quite conceivable that politicians will one day realize the limit of tax dollars and concede that there aren’t enough to save all of the banks.  If that happens, there will be another liquidity crisis, only worse than what we witnessed in 2008.
  • That European banks are in crisis is a symptom.  The problem is that governments have borrowed too much.  And governments are reflective of the electorate.  When forced with austerity measures, the Greeks decide to riot.  And so do other Europeans.  And yes, so do Americans.  Don’t believe me?  Read Ann Althouse for the best commentary on Wisconsin’s realty check.
  • Worldwide de-leveraging is a deeply painful process.  No Soros-promulgated  “authoritative pan-European body” or other bureaucratic panaceas will ease the pain of understanding that asset prices must reach equilibrium.  Individuals, municipalities, states, and nations have all borrowed more than they can comfortably repay.  Borrowing from our children and grandchildren is not the road to prosperity for us or for them.
  • Again, taxpayer bailout money is finite.  Every tax euro (or dollar) must be earned before it’s available to government entities.
  • If a bank (or any financial institution) is too big to fail, then it is simply too big.

As this sophomoric “analysis” article ends, the authors apparently believe the simple answer is more bank capital.

Huh.  More bank capital and our troubles are over.

If only it were that easy.

UPDATE:  From CNBC:  Stocks Soar as Italy and Greece Act on Austerity

Despite the fact that George Soros is warning the euro zone debt crisis could be worse than the Lehman Brothers crisis, stocks across Europe rallied Wednesday following news from Athens and Rome on how they plan to tackle their budget deficits.

On Tuesday, Silvio Berlusconi’s government unveiled how it plans to make up the recent concessions on austerity spending it had promised a number of special interest groups.

Italy’s value added tax (VAT) will be raised by 1 percentage point to 21 percent. Those earning over 500,000 euros (US$705,000) will be subject to at 3 percent levy, which Reuters reports will raise 35 million euros (US$49 million) next year and 88 million euros (US$123.4 million) a year from 2013.

The measures where welcomed by the European Commission, which said they showed Italy’s determination to meet its fiscal targets and deal with its deeply rooted structural weaknesses.

STILL MORE:  Germany’s Top Court Throws out Anti-Euro Bailout Lawsuit

However, the judges did say parliament’s budget committee must have a bigger say in any future bailouts.

“The government is obliged to get the approval of the parliamentary budgetary committee in cases of large expenditures,” said presiding Judge Andreas Vosskuhle.

The ruling was a victory for Merkel’s government policy

The decision will likely make it more difficult for Germany, and therefore Europe, to move quickly on future eurozone bailouts.

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