Holy smoke! My new best friend Carter the Examiner has more ideas than Carter's got Little Liver Pills! And they are thoughful and provocative. I'm not going to have enough time to respond to all the issues he has raised today (besides, not doing so gives me a subject for Monday), but let us jump right in and see how we can do.
Carter is of course correct in his outline of what, to make things shorter and simpler, I shall call "Bank funding" or simply funding. Longer is always better but let's face it, banks have been borrowing short and lending long ever since some Medici started the whole thing rolling in the 14th.--or was it the 15th. century. But the nature of the business is not the issue here. What I am trying to get at is what happens when we get to that point in time when a systemic risk is recognized (defined in prior writings as that moment when everybody gets the crap scared out of them at the same time). Having looked that in the eye a couple of time, although not to the same extent as in 2008, I question whether the light bulb is turned on by the intellectual realization that the marks might be a tad off or is it more of that wonderful scene from...was it the Song of Brian...when faced with a ferocious rabbit the reaction is "RUN AWAY!" The latter I think. With that in mind it makes no difference whether one has 8x coverage in standby facilities of overnight or 10 year funds; whether they are advised or unadvised; the certainy is they will be gone. Self preservation rules and we'll worry about what the lawyers say at some future date...if we are still around.
Now it is indeed a valid question to inquire as to the funding role of central banks ("CBs") when faced with "clients" if you will with a multiplicity of business lines and types of assets but as we sit in an environment when banking is defined as being "what bankers and banks do," the question is a bit moot. I also question how many players in the market today still do not realize that through the magic of accounting and difficulity of "Mark to market" (which has been found wanting over the years), that banks may indeed be carrying assets at values that may not necessarily be achieved in an open market place. But again, what I am focused on is that point when there is no market; i.e. the crisis period. We can argue the merits of future conduct and accounting at a later date and indeed a limitation on allowable banking activities may be the right solution. In the mean time, however, CBs just may have to grin and bear it.
I take Carter's point that all the PIGS' problems are not merely problems of liquidity. My thoughts were poorly phrased. What I was trying to point out that whatever the nature, liquidity provides time and as we have all learned, "A rolling loan gathers no loss." Liquidity is the magic that provides time which allows problems to be worked out in an orderly fashion. Be it a bank (see Latin America, 1983) or a country (Greece, 2010) time can cure a lot of things especially the ability to book a loss should that be required as I have often said will be the case at some point in Euroland. It is not a sufficent solution to be sure, but without time there will be no solution.
Yeah, you are of course correct, but in my defense I did write "global payments system" in lower case whereas your insightful comments are directed toward a "System." I was refering to the activity not the means by which it is accomplished. To be frank, I have been away too long to know what is in place at this stage but my feeling is that when one CB starts asking another CB for pre-cover in order to clear a commercial bank from CB #2 country in the morning as in fact did occur, perhaps a more formal set of agreements than what is in place may be needed. Personally, I think that would be a shame but the world has changed, not altogether for the better in my belief.
I'm going to pause here and reflect a bit more on what my new best friend has contributed. It's serious stuff and I'm going to work on it over the week-end. Carter, I'm delighted you are an examiner because now I'm far more sanguine as to the oversight of our (I hope you're with us) financial institutions are receiving. With thinking like this, I predict a bright future. I hope ol' Ben is still reading.
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Went to see "Inside Job" last night. It is a much more professional Michael Moore hit job on all the usual victims except the guy that REALLY gets hammered is Larry Summers. Who would have thunk it. It's a great show for folks who have no idea what the business is about but want to stay mad as to what happened. See it at your own risk. Have a great weekend...you too Carter.
Cantab says:
ReplyDeleteIt would seem to me that the gordian knot of systemic risk faced by central banks and by implication if not fact, governments, largely stems from two significant changes from the world as we knew it say 20 years ago:
- this is truly a global market which current technology has made infinitely more complex. The speed and sheer size of the computing capacity available to the market participants make the size and complexity of the transactions being conducted difficult to track and/or regulate. Because it is a global market, surely no one central bank or regulator can adequately monitor and intervene without a coordinated response from other countries' central banks. Indeed, one could argue that by the time a plan has been agreed between the various parties the crisis will have already progressed beyond salvation. We can argue about liquidity and mark to market etc all we want, but unless we address the larger issue(s) we will never get the details right.
- the power of an unregulated internet to circulate not only catual news but also rumour and speculation at the speed of light GLOBALLY means that market participants can and will create global "runs" which, while appearing coordinated, are merely a function of the distributive power of the internet.
If you take these two elements and then note that a very high percentage of the derivatives markets (for example) are NOT OTC and therefore subject to the creativity of subjective mark to market standards, you can begin to see the limitations of the current approach to regulatory limits. In this world is there ever enough capital and/or liquidity? At some point we are either back to Glass Steagall as a way to limit the size of the risk in any one institution OR the government(s) are explicitly going to have to stand behind those institutions deemed too big to fail. The third alternative is the global regulator............good luck on that one. I am a supporter of free markets, but it seems to me that we are past that and right now we have to move outside the box of traditional solutions. I have yet to see anyone capable of that appearing on the financial horizon.
"At some point we are either back to Glass Steagall as a way to limit the size of the risk in any one institution OR the government(s) are explicitly going to have to stand behind those institutions deemed too big to fail."
ReplyDeleteWell said.