[kitchencabinetforum] DIVERSE DIVERSIFICATION OF BANKS

As much of the developed world continues to dig out from the impact of the 2008 financial crisis, a team of Harvard economists has created a model of bank failure aimed at helping economies avoid crashes. Their work highlights a fundamental dilemma for regulators: Improving the safety of individual banks may make the financial system as a whole more dangerous. http://venitism.blogspot.com

Central banks can go broke and have done so historically. Central bank insolvency may become an issue again, if central banks were to assume too many foreign-currency denominated liabilities in an attempt to support or bail out private banks and other financial institutions deemed to be too large or too interconnected to fail.

The model considers risks to financial systems rather than those faced only by individual banks. When many banks do the same thing, simultaneous bank failures become very likely. Banks in PIGS have unloaded risks amounting to one trillion euros with central banks. The central banks have distributed large sums to their countries' financial institutions to prevent them from collapsing. They have accepted securities as collateral, many of which are garbage.

These risks are now on ECB's books, because the central banks of eurozone are not autonomous but, part of the ECB system. When banks in PIGS go bankrupt and their securities are garbage, the euro countries must collectively account for the loss. Bundesbank, provides one third of the ECB's capital, which means that it would have to pay one third of all losses. http://venitism.blogspot.com

ECB accepted asset-backed securities (ABS) as collateral, amounting to one trillion euros. It was precisely such asset-backed securities that once triggered the real estate crisis in the United States. Now they are weighing on the mood and the balance sheet at ECB. ECB cannot jettison these securities without dealing a fatal blow to the eurozone. ECB is in a no-win situation now that it has become an enormous bad bank, a dumping ground for bad loans.

It is not enough to ensure that every bank is diversified and pursuing a low-risk strategy. You want the banks to be diversified, but in different ways, so that the conditions that would cause one bank to fail would be different than the conditions that would cause another bank to fail.

The too-big-to-fail (TBTF) banks that acted as middle men in the mortgage machine knew that the mortgage-backed securities (MBS) they packaged and sold to investors didn't meet the standards they claimed. In essence, MBS buyers were sold Ferraris but took delivery of Yugos. Because of these material misrepresentations, TBTF banks could be forced to repurchase hundreds of billions of MBS that they sold to investors. Since they don't have that kind of cash lying around, it's likely they will turn to their federal benefactors for another bailout.

Regulators should therefore promote diverse diversification, and encourage individual banks to pursue risk strategies that are distinct from those of their competitors, even if this increases the risk that any one bank might fail. http://venitism.blogspot.com

As the health of much of the global economy weakens on a daily basis, political leadership increasingly ignores the source of the malady and instead focuses on short term band-aid remedies. These measures which may buy a few months, or years, of relative wellbeing, will convince the public that problems have been solved and will thereby take pressure off governments to make the needed structural changes. The $1 trillion EU bailout is a perfect example of this band-aid approach. Napoleon Sarko threatened to pull out of eurozone, unless Merkel agreed to back the European Union's bailout plan!

The financial crisis has spurred regulators to think about the stability of financial systems as a whole. In this climate, banks should pursue more distinctive strategies in order to create a more resilient financial system. This can be achieved without a central authority directing the banks in particular areas.

Play misty to me! Central banks play a confidence game with us. A confidence game is defined as an attempt to defraud a person or group by gaining their confidence. The victim is known as the mark, the trickster is called a confidence man, and any accomplices are known as shills. Confidence men exploit human characteristics such as greed, vanity, honesty, compassion, credulity, and naivete. The common factor is that the mark relies on the good faith of the confidence man.

A regulatory scheme that encourages diversity by basing the amount of capital a bank is required to hold on the extent to which its investment strategy contributes to systemic risk. With the right regulations, market forces will encourage the banks to make a more robust system. But unless these problems are addressed, having a more uniform global regulatory system could actually make the next crash much worse. Individual bank-risk diversification does not add up to system diversification. The focus now is building a global alliance for financial and economic resilience.

Central bank's mission to instill confidence in us about the economy while simultaneously instilling confidence in us about the abilities of the central bank itself. Central bankers are almost always publically bullish and hardly ever publically bearish about the economy. The economy always looks good, if not great. If there are some problems, don't worry, the Fed will come to the rescue with truckloads of money, lower interest rates, and easy credit. If things were to get worse, which they won't, the Fed would be able to respond with monetary weapons of mass stimulation.

Central bankers are the people who said that there was no housing bubble, that there was no danger of financial crisis, and then that a financial crisis would not impact the real economy. These are the same people who said they needed a multitrillion dollar bailout of the financial industry, or we would get severe trouble in the economy. They got their bailout, and we got the severe trouble anyways. It is time to bring this game, this confidence game, to an end. http://venitism.blogspot.com

Central bank's artificial creation of credit is the culprit in the business cycle. As the boom turns into bust, the economy tries to readjust itself into a configuration that conforms to consumer preferences. That is why it is so essential for government to stay entirely out of the adjustment process, because arbitrary government behavior can only delay this necessary and healthy process.

Central banks must be abolished. Money needs to be defined by the government, perhaps as a quantity of gold as in the past, a basket of commodities, or something else in order to make payments and collect taxes. Once money is defined, the private sector is perfectly capable of creating the necessary quantity of money, as it did before the advent of central banks. http://venitism.blogspot.com