Short-Term Loan Tsunami Could Break Global Banking “System”

July 20 2010. By David Caploe PhD, Chief Political Economist, EconomyWatch.com

People often wonder why we take such a grim view of both the current and future state of the global financial system.

Our most basic criticism has been the inability and / or unwillingness of international organizations and political leadership in nearly every country –

with the notable exception of China, a view which in turn has given us the reputation of being uncritical Sinophiles –

July 20 2010. By David Caploe PhD, Chief Political Economist, EconomyWatch.com

People often wonder why we take such a grim view of both the current and future state of the global financial system.

Our most basic criticism has been the inability and / or unwillingness of international organizations and political leadership in nearly every country –

with the notable exception of China, a view which in turn has given us the reputation of being uncritical Sinophiles –

to force big, so-called Too Big To Fail banks to become completely transparent in their operations and record-keeping,

something we think all banks would be anxious to do,

but which, for some reason, they generally resist as if being told to boil themselves in oil.

We frankly don’t see why banks shouldn’t open ALL their books,

so all stakeholders with an interest in them –

investors / regulators / the “thinking” media [admittedly a nearly microscopic group] /

ordinary customers and citizens whose jobs depend on the free and on-going flow of both cash and credit –

can see the state of the institutions that hold their individual money,

and, in so doing, constitute part of the world-wide system in which money moves at faster-than-lightning speed across not just national borders but continents.

We don’t see the controversy in being able to give anyone with a mind to understand what’s going on a chance to evaluate

the strengths and weaknesses of the institutions that are clearly central to the maintenance of life throughout the world –

a fact that, if we didn’t know this before the global financial meltdown of Black September 2008, we should all certainly know by the middle of 2010.

Still, people ask, “Why do you talk so much about zombie banks –technically dead, ie, bankrupt,

but which still manage to throw their weight around politically,

making sure the toxic little secrets on their books don’t see the light of day???”

Or, they say, “Everybody lies, especially when it comes to money.

Why do you give banks and the people who ‘regulate’ them such a hard time about not telling the truth?

They have a right to make a living too.”

Well, maybe.

But we think the key fact that people continually miss is a relatively simple one to state:

the more of society’s resources that are commanded by the financial sector –

whether in the form of excess profits or compensation, or stock valuations –

the fewer resources there are for the rest of society –

especially innovators in ALL fields, not just technology –

to have a chance to create the new inventions and innovations that, in the end, create real effective economic demand.

Put bluntly, the more money bankers have, the less there is for everyone else –

which is tragic not only in terms of the human suffering and misery caused by the lack of an even minimal standard of living,

but also because it creates stagnation and fear among the very people whom society needs most to empower,

since it is they who will move things forward for everyone else.

If we don’t insist on this kind of transparency and basic justice,

we run the very real risk of creating economic systems – at both national and global levels –

that rewards the most cunning and devious, rather than the most ingenious and inventive.

And that is not only a tragedy in itself,

it also leads to precisely the kind of insane situation in which the world is going to find itself in the next two years,

as so-called leaders / bankers / regulators et al try to deal with the tsunami of

“short-term” banking obligations that are about to come crashing over our heads between now and 2012.

The European Central Bank, the Bank of England and the International Monetary Fund

have all recently warned of a looming crunch.

Their concern is that banks hungry for refinancing will compete with governments —

which also must roll over huge sums —

for the bond market’s favor.

As a result, credit for business and consumers could become more costly and scarce,

with unpleasant consequences for economic growth.

“There is a cliff we are racing toward — it’s huge,”

said Richard Barwell, an economist at Royal Bank of Scotland and formerly a senior economist at the Bank of England, Britain’s central bank.

“No one seems to be talking about it that much.”

But, he added, “it’s of first-order importance for lending and output.”

Banks worldwide owe nearly $5 trillion to bondholders and other creditors that will come due through 2012,

according to estimates by the Bank for International Settlements.

About $2.6 trillion of the liabilities are in Europe.

U.S. banks must refinance about $1.3 trillion through 2012.

While that sum is nothing to scoff at, analysts seem most concerned about Europe

because the banking system there is already weighed down by the sovereign debt crisis.

How banks will come up with the money is an open question.

With investors worried about government over-indebtedness in Greece, Spain, Ireland and other parts of Europe,

many banks have been reluctant or unable to sell bonds,

which they typically use to raise money that they lend on to businesses and households.

The financing crunch has its origins in a worldwide trend for banks to borrow money for shorter periods.

The practice of short-term borrowing and long-term lending

contributed to the near-collapse of the world financial system

in Black September 2008, when short-term financing dried up.

Banks suddenly found themselves starved for cash,

and some would have collapsed without central bank support.

Government bank guarantees extended in response to the crisis

also inadvertently encouraged short-term lending.

The guarantees were typically only for several years,

and banks issued bonds to match.

Other banks took advantage of the gap between short-term and long-term rates,

borrowing cheaply from money markets or central banks and

lending to their customers at higher, long-term rates.

A study in November by Moody’s Investors Service found that

new bond issues by banks during the past five years matured in an average of 4.7 years —

the shortest average in 30 years.

Since then, worries about Greek and Spanish debt and

whether Europe is headed for another recession have caused new problems.

Investors are unsure which institutions are in good shape and

which are sitting on piles of bad loans and potentially tainted government bonds.

Bond issuance by financial institutions in Europe plunged to $10.7 billion in May,

compared with $106 billion in January and $95 billion in May 2009,

according to Dealogic, a data provider.

Bank stress tests being conducted by European regulators could help if they succeed in convincing markets most banks are healthy,

which would have to mean they were different from the joke “stress tests” Geithner’s Treasury conducted in the US during spring 2009.

Bank regulators plan to release results of the tests, covering 91 large banks this week, on July 23.

That could add pressure on the weakest banks to merge, seek government help, or scale back their activities.

Some might even fold.

The Landesbanks in Germany, savings banks in Spain or other institutions that have struggled

may be forced to confront difficult choices.

A shortage of bank finance also could create quandaries for the European Central Bank,

which appears anxious to wean banks from the cheap cash that it began providing in the heat of the global financial crisis.

If institutions are unable to raise the money that they need on the open market,

the European Central Bank would have to decide whether to continue to prop them up.

“Banks that have trouble tapping new funding sources will have to shrink,”

the Bank for International Settlements said in its annual report in late June.

The institution, based in Basel, Switzerland, brings together the world’s main central banks.

Banks insist they enjoy the trust of the markets and will be able to raise the cash they need.

Even if there is no market meltdown – now that’s reassuring – banks still face a transition

to a period of higher interest rates that will weigh on profits, according to this article in the New York Times.

The cost of borrowing is likely to rise faster than banks can pass it on to customers, analysts say.

Jean-François Tremblay, a Moody’s vice president who has studied the refinancing issue, said that

so far banks had managed to roll over debt better than expected.

They have increased customer deposits, drawn on cash from central banks,

or simply reduced their lending and their need for new financing —

which is exactly what some economists feared,

since that is precisely the kind of action that inhibits “recovery,”

and leads towards the dreaded “deflationary spiral.”

The Bank of England estimates British banks will need to issue £25 billion in bonds every month to meet their refinancing needs,

which the central bank puts at £800 billion, or $1.2 trillion.

That means banks will have to sell new bonds at DOUBLE the rate they have been issuing so far this year.

“There is a risk that banks alleviate their own funding pressures by further constraining credit conditions for customers,”

the Bank of England said last month in its Financial Stability Report.

“That would dent economic recovery and so raise credit risk for all banks.”

And, of course, the credit risk of all people and companies who depend on those banks for money and / or credit.

Given this, the absence of the kind of transparency we talk of at the start

is the core problem the global financial system faces with the short-term banking tsunami.

But someone with political power has got to take the lead in forcing this on the banks –

and there don’t seem too many realistic candidates on any visible horizon.

 

David Caploe PhD

Editor-in-Chief

EconomyWatch.com

President / acalaha.com