By George Markides
IN ITS ANNUAL article IV consultation on the economy of the euro area in June 2014, the IMF said: “Weakness in banks’ balance sheets inhibits the flow of credit and corporate and household debt overhangs impede demand.” It suggested to European leaders to restore bank balance sheets.
In its annual report, the Bank of International Settlements (BIS) wrote that banks outside the euro area are making progress in recognising losses, offloading toxic assets, and are on the road towards normalising operations. The trend is not mirrored within the euro area.
Looking at the international environment we see that while the US Federal Reserve and the Bank of England are about to embark on monetary tightening thus ending measures taken in response to the financial crisis, the ECB is moving in the exact opposite direction, even taking the bold step of going into negative deposits rate territory (the only major central bank to do so).
Europeans refused to look at the root of the problem, the overexpansion of banks. BIS described the global financial crisis and the subsequent European crisis a “balance sheet recession”.
Europeans focused squarely on fiscal transgressions of countries such as Greece and Italy (again banks’ overexposure to Italian and Greek debt) while they refused to acknowledge that the problems in Ireland and Spain are due to the collapse of their banking sectors (overexposure to real estate).
It is worth noting that the Cypriot crisis is a mix of banking collapse and fiscal irresponsibility, as Central Bank of Cyprus board member
Professor Stavros Zenios said, “Cyprus created the perfect storm.”
The US authorities after Lehman Bros collapsed in September 2008 took a series of measures aimed at restoring confidence to their banking system.
Their strategy was a two-stage approach. Stage one: restore bank balance sheets by removing toxic assets, shrink the sector, recapitalise viable banks and shut down others. Stage two: initiate strict regulations and give supervising bodies more power to pre-empt any behaviours that can pose future threats.
The Levy Economics Institute of Bard College has issued a working paper on the FED’s bailout measures for banks. The numbers are simply staggering; more than 19 trillion US dollars were poured into banks bailouts by the FED. Before anyone cries “Money to Main Street and not to Wall Street,” the FED did something no other central bank did.
The FED spent close to 3 trillion US dollars to purchase asset backed securities (including residential mortgages). Effectively acting as a Lender of Last Resort it took away those risky subprime assets that caused the financial mayhem, leaving banks with a leaner healthier and more robust asset portfolio.
Other US regulators beefed up their ante. The Federal Deposit Insurance Corporation (FDIC) an independent government corporation that insures deposits in US banks, raised their insured deposit level from 100.000 US dollars to 250.000 US dollars to avoid bank runs.
The FDIC is also responsible for bank resolution (aka shut down), beginning from September 2008 (Lehman’s collapse) till August 2014 the corporation failed and resolved 493 banks across the USA (321 resolutions from September 2008 till December 2010), compared to just 37 bank resolutions from early 2000 till September 2008.
In just two short years US authorities had weeded out unviable banks, removed dodgy assets from banks’ balance sheets shrinking the total assets held by US banks and restored confidence in their banking system.
Upon initiating stricter regulations for banks, supervising bodies such as the Securities and Exchange Commission, FINRA, the US Department of Justice and other US bodies, have started scrutinising banks and slapping them with hefty fines. The Bankof America, the biggest bank in the
US , has so far paid more than 50 billion in fines to authorities (starting from 2009).
All the while banks in Europe have been getting the soft treatment, there are still many skeletons hiding in their balance sheets (some hope ECB will uncover with the AQR) and many of them are not viable, to say the least. European bank regulators were not as bold as their US counterparts.
It is for this particular reason the USA is refusing to include banks and financial services in their free trade talks with the EU.
The problem is not only about peripheral banks; even Europe’s big banks are problematic. For instance Thomas Hoenig vice chairman of the FDIC in 2013 called Deutsche Bank (DB) “horribly undercapitalised” and the Wall Street Journal revealed last August that the FED had found DB’s risk controls and reporting practices seriously lacking.
In a letter to DB’s senior management the FED listed a litany of problems that pose a “systemic breakdown” and “expose the firm to significant operational risk and misstated regulatory reports”.
The US response to the financial crisis while not without faults was far superior to the European response, it is no accident that six years after Lehman’s collapse the US and European economies are on different trajectories.
US authorities tackled banks early on while Europeans wasted precious time, allowing the problem to fester and spread across the euro area. Cyprus has paid dearly for not reining in its banks early on.
George Markides, BSc and MBA, is an economics researcher