More on the insolvency of the European banking system

2011-09-04

This post is archived. Opinions expressed herein may no longer represent my current views. Links, images and other media might not work as intended. Information may be out of date. For further questions contact me.

European banks are verging on insolvency. The sooner EU officials accept there is a problem, the better, since they will start searching for solutions. Image Source: econintersect

I have for months now been advocating that the current crisis is systemic and one of its three dimensions is the banking sector crisis. The European banking system is verging on insolvency. It is a system filled with zombie banks that only exist thanks to the liquidity of the ECB. It is a system that acts like a black hole since it absorbs all the liquidity that is thrown its way. Only a few days ago and after the chief of the IMF Ms. Lagarde admitted what I have long been saying about European banks, I wrote an article in which I evaluated the condition of the European banking system. Also on September 3 world-renowned economist Dr. Nouriel Roubini offered an interview to the Financial Times Brussels Blog in which he says what everybody in the markets knows: that European banks are in serious trouble and the stress tests were a joke. (I would like to embed the video here alas Financial Times does not allow such actions. You can click here to be directed to the FT Brussels Blog where you can watch Nouriel Roubini talking about European banks.)

It is a common secret that European banks are balancing on insolvency. Yet there is a solution to the banking sector crisis. One that will achieve three things: (a) put an end to the maladministration of taxpayer money that end up in the black holes of the system, (b) detoxify the EFSF that now has a very degenerative role, (c) restructure private debt together with public debt. The above three principles can be met with ease since the solution is quite simple: Transform the EFSF into a mechanism that will have the responsibility to

1. carry out objective stress tests across the euro area so that we can finally discover how deep in the hole private banks are
2. use its funds (that come from taxpayer money) in a very productive and efficient way, to re-capitalize private banks in exchange for shares

This means that the private sector will lose control of many banks, which will allow European authorities to restructure their debt (together with sovereign debt) so as to cleanse them from the toxic waste they have accumulated in their books. Once cleansed they can be privatized again with profit since their shares will meet high demand. In that way private banks will no longer act like parasites that depend on the “generosity” of the European taxpayer. They will be cleansed, their debt restructured and taxpayers will finally see their money being multiplied instead of being wasted. Moreover the EFSF will be given a very productive function that currently does not exist in the architecture of the Euro and is much needed.

There are of course other things that need to be done in parallel with the above. Measures that will address the other two dimensions of the crisis, the debt crisis and the under-investment crisis, yet those need not be included here (for more you can view my articles The real reasons EU delays a solution to the Euro crisis and Questions and Answers on the Eurobond – Full analysis). The point is that there are solutions to the systemic crisis of the euro. Solutions that do not require Treaty amendments nor the creation of new mechanisms/authorities/agencies. The sole prerequisite is political willingness to accept that the crisis is systemic and requires system-wide solutions.

Alas EU officials deny that the crisis is systemic and in this case that European banks are in serious trouble. This does not surprise me since they have accustomed us to all sorts of statements that are completely detached from reality. They naively assume that by pretending there is no problem, will calm down the markets, will ease investors and will eventually stem the crisis. I understand that EU officials do not wish to cause a panic, yet they must accept that the current pretend and extend policy is ridiculous and only succeeds in producing adverse effects since it is a common secret that what they say is completely inaccurate.

The sooner they accept there is a problem, the better, since they will start searching for solutions to it. Now they are simply allowing it to grow and instead produce other problems in their attempt to hide the insolvency of the European banking system.