Fri Mar 6th, 2009 at 11:08:20 AM EST
This letter, written by one Professor Mason and published in December 2008 on a rather idiosyncratic (yes, I know it takes one to know one) consultancy site
...(no relation to migeru, as far as I know)...is interesting in relation to the development of banking in the last 15 years.
Monetary policy effectiveness relies crucially on banks' willingness to lend, which all agree is now sorely lacking. The important consideration, however, is why?
The fact of the matter is that, without adequately transparent financial measures investors and banks alike will not allocate funds to any borrower. With over fifteen times "off-balance sheet" exposures as "on-balance sheet" exposures in US and European commercial banks and the demonstrated possibility for those "off-balance sheet" items to unexpectedly come back "on-balance sheet" in times of distress, investors and banks are loathe to lend and will remain so until the absurdity of "off-" and "on-balance sheet" distinctions is put to rest.
The sheer scale - and this is only dollar denominated debt - of this trend to off-balance sheet "shadow banking" is starkly illustrated here
This outsourcing of credit risk by banks to investors has been on a truly cosmic scale.
As the Professor says....
Policymakers, investors, and regulators have all learned recently that off-balance sheet isn't really off-balance sheet because it can come back on-balance sheet in times of financial distress, at which point the bank will have to raise capital to fund the exposure at current regulatory capital requirements.
Such absurdity has investors and banks alike wondering the full extent of off-balance sheet arrangements and the probability that additional significant exposures can come back to banks in the near term, similar to movements associated with SIVs last summer, ARMs this spring, and now potentially RMBS in the Countrywide settlement.
Even more important, however, is the fundamental fact that the sheer magnitude of off-balance sheet exposures precludes their being recognized at even de minimus capital requirements, especially in today's markets.
and he concluded his letter by saying
Hence, it is off-balance sheet shenanigans that maintain banks' and investors' reluctance to lend, but the widespread adoption of such arrangements in the years since Enron now makes it almost impossible for regulators and accountants to recognise the arrangements and appropriately capitalize commercial banks without tremendous economic disruption.
As the UK permanent secretary famously said ....
Richard Mottram - Wikipedia, the free encyclopedia
|We're all fucked. I'm fucked. You're fucked. The whole department is fucked. It's the biggest cock-up ever. We're all completely fucked.|
... at least we are in the absence of something a little bit more radical than mere nationalisation of banks.