Mon Nov 24th, 2014 at 12:20:30 PM EST
Vicious Circle(s) 2.0 While trying to sever the sovereign-banking link, we may be disregarding vulnerabilities from banks' mutual interconnectedness Silvia Merler Breugel H/T NC
Since the beginning of the crisis - and more so since 2010 - Europeans have been looking at the sovereign-banking "vicious circle", tying the dismal fates of States and banks together. This has emerged as a characteristic disease during the euro crisis, and one of the stated objective of the European Banking Union project was precisely to remedy it. The idea was basically to achieve this goal in a twofold way, ex ante and ex post. On one hand, by imposing stronger and harmonised supervisory requirements (e.g. on capital) and by empowering a third-party, independent and hopefully high-quality, supervisor to oversee their fulfillment, thus rebuilding trust in supervision and in the financial sector's health. On the other hand, if a crisis turned out to be unavoidable, the second principle consisted in limiting recourse to taxpayers' money as much as possible therefore preventing doubts about the damage that bank rescue would inflict to the state of public finances.
The first principle was translated into practice by the creation of a Single Supervisory Mechanism (SSM) under which, on the 4th of November, the ECB took over supervisory responsibility for banks in the euro area. The second principle concretized by the introduction of the Bank Recovery and Resolution Directive (BRRD) which gives a framework for resolution of troubled banks, and by the creation of a Single Resolution Mechanism (SRM), who should ensure consistent and homogeneous application of it. Among the other provision, the BRRD contains a set of rules for the application of bail-in in bank resolution, strengthening the involvement of private creditor that de facto is already introduced by the amended State Aid framework.
Hence, there has been a remarkable shift in the European mindset about banking crisis, from a first phase in which bail-in was a taboo, to a second one in which it is considered as a new normal and welcome practice. And there is in principle nothing bad about this idea, but the question is whether in rapidly overturning the approach, European policymakers have not overlooked important weaknesses that still exists in the system and could have important consequences in the perspective of applying these new rules.
Twenty percent of EU banks' capital has as counterparties other EU banks and in Italy and others much of the state debt is held by its private banks.
The US Federal Reserve has not bough into the 'bail-in' scheme, but, as Yves notes, neither have they developed any workable alternative. The problem is the lack of political will to do anything but tap the credit of the nation as a whole, which doesn't work in Europe as it devolves into a debtor nation taping a creditor nation. And none of the USA/Fed, the EU/ECB nor the politicians leading relevant states have shown the will to identify and go after those non-state actors who have the ability to pay, who have involvement in the events that led to the present situation and who have benefited from the crisis. What remains is the pretense of attempts at a solution.
Even if we look at the costs to date as sunk costs is there any way to prevent the next financial crisis? Certainly prudential regulation is needed, but, as recent revelations about the New York Fed have shown, the regulators are hopelessly captured. Changing that situation lead directly back to the will to challenge financial incumbents. What am I missing?