Streetwise Professor

February 16, 2009

Bad in Their Own Way

Filed under: Economics,Politics,Russia — The Professor @ 11:06 pm

I’ve mentioned at times the huge exposure of European banks to Eastern European (including Russian) debt.  Ambrose Evan Pritchard has the gruesome details.  Evans-Pritchard has a tendency towards hyperbole, so it’s probably not as dire as he makes it sound, but even if you discount his story substantially, there is still room for considerable concern.  Here’s just one of the most sobering grafs (ooh, don’t he sound so journalistic):

Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets.

They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data).

Spain is up to its neck in Latin America, which has belatedly joined the slump (Mexico’s car output fell 51pc in January, and Brazil lost 650,000 jobs in one month). Britain and Switzerland are up to their necks in Asia.

Whether it takes months, or just weeks, the world is going to discover that Europe’s financial system is sunk, and that there is no EU Federal Reserve yet ready to act as a lender of last resort or to flood the markets with emergency stimulus.  

I don’t want to focus on the specifics here, important as they are for the future.  I just want to point out that the agonies of European banks–continental European banks–have important implications for the debate raging over regulation.  

American and British banks have rightly been excoriated for their lending and risk management practices.   The US-centric commentary in particular has attempted to identify some specific regulatory failing in the US (repeal of Glass-Steagal, the Commodity Futures Modernization Act, the failure to regulate CDS, the SEC permitting IBs to inflate their leverage) as the root cause of all that ails.  

But the experience of continental banks, including the supposedly staid Swiss, makes it clear that the banking crisis is not peculiar to the “Anglo-Saxon model,” or solely attributable to some deficiency in American regulation.  It is a worldwide phenomenon, and European banks supposedly subject to greater regulatory restrictions than their American and British counterparts evidently took on even greater risks.  Note the 50 percent greater leverage.  The concentration of risk in particular markets.  (Shades of American banks’ near death experience with Latin American debt in the 80s.)  

So, we shouldn’t fool ourselves that some change in US regulation is sufficient to prevent the recurrence of such problems (in that perhaps distant future when we have recovered from our current travails.)  Put differently, given the substantial cross sectional variation in banking regulation across countries and regions on the one hand, and the striking lack of variability in their assuming massive risks and suffering the consequences on the other*, it seems foolish to attribute the banking crisis to any one country’s regulatory failings.  Instead, it is more plausible that some common factor is responsible. And the most plausible candidate for that common factor is, in my view, overly lax monetary policies in the 2000s.  

So, perhaps we need somebody to update Friedman and Schwartz’s Monetary History of the United States.  Friedman and Schwartz laid the Great Depression at the feet of the Fed.  It is quite likely that their successors will do the same for the Great Whatever that is now impending.  The exact failings are quite different, but the results are sadly similar.  To paraphrase the first line of Anna Karenina, good central bankers are all alike; bad central bankers are bad in their own way.

* Though, as commentor Michel points out, Canadian banks appear to be an exception to this rule.

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1 Comment »

  1. Well, Frontline/PBS has laid this all at the feet of Paulson’s “refusal” to save Lehman Brothers. There it’s as simple as that.

    Ignore Sanders and World Savings, and the sale to Wachovia for $25 billion. Ignore that these boys HAD to know, everyone one of them, that the CDS’s were a game – they were being issued left and right by big and small alike, because the premiums were great, and “noone would ever default on the underlying mortgages” because the govt would step in to save FNMA and Freddie Mac and the underlying mortgages.

    According to Frontline, once Lehman tanked – and was not saved – the boys and girls at the “big banks” simply froze, refused to play nice, and refused to lend to each other on those short-term interbank loans – ah, yes, the very lifeblood of the credit system.

    Don’t pin the blame on Bawney Fwank and all the Dimwitcrats who were pushing “affordable housing” – blame it all on Paulson, who refused to use tax money to bailout out Lehman.

    All the regulation in the world did not save anyone from Madoff and now Stanford.

    Noone is going to tell me that the sophisticated boys and girls on Wall Street and the Royal Bank of Scotland and elsewhere did not know that when you buy CDS’s from a nobody named Bennie who exists only on an email somewhere, you’re paying for the illusion that your mortgage “investment,” no matter how many tiers and tranches it has, is not “insured.”

    Comment by elmer — February 19, 2009 @ 9:25 am

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