Greg's Note: Panic is never a good thing, especially when it is coming
from some of the word's most powerful central banks. Adrian Ash explains
why so many countries are hitting the panic button and how this sweeping
bailout could wind up costing us more. Is there any end in sight? Enjoy,
and send any comments to your managing editor here:
Whiskey & Gunpowder
March 14, 2008
By Adrian Ash
London, England, U.K.
The True Cost of This Crisis
HOW TO KEEP YOUR HEAD when everyone around you is losing theirs?
"Steer clear of the new gold rush," urges Jason Zweig, a senior
columnist at Money magazine.
"Don't give in," says Janice Revell, another senior hack at CNN's glossy
monthly. "Step out of the stock market, even temporarily, and you may
miss the whole point of owning stocks."
"Aw, just lend! Lend! LEND!" screams the Federal Reserve. Sporting its
usual crystal meth grimace, it's stumping up $200 billion in Treasury
bills for desperate New York brokers to kick-start the world's capital
markets. And now they can use flakey mortgage-backed bonds as
Stepping in "to address liquidity pressures" like this - and getting
your chums at all the other top central banks to do the same - looks
like the next best thing to buying mortgage-backed bonds altogether. But
while central banks surely don't want to become "home buyer of last
resort," it's got to be better than doing nothing. Right?
Acting early and often must work out cheaper in the end. Mustn't it?
Well, you'll never guess what. As anyone who ever fell for interest-free
vendor financing knows only too well, the cheapest option - always and
everywhere - is to avoid spending any money at all.
As a professional economist would put it, "We find no evidence that
accommodating policies reduce fiscal costs." That's how two senior
economists at the World Bank put it in a 2002 report studying 30 years
of systemic banking crises across 94 countries.
Borderline crises hit 44 nations. And on average, the World Bank
economists found, "governments spent an average of nearly 13 percent of
GDP cleaning up their financial systems" as a result of the bailout
programs they tried to implement.
"Indeed, each of the accommodating measures examined," they continued -
citing "open-ended liquidity support, blanket deposit guarantees,
regulatory forbearance, repeated (and thus initially inadequate or
partial) recapitalizations, and debtor bailout schemes - appears to
significantly increase the costs of banking crises."
Weird like pineapple on pizza, don't you think? Because the seven
central banks jumping to hit the panic button this week are all members
of the World Bank. They actually helped found it back in 1944. More than
that, the central banks led by Ben Bernanke, Jean-Claude Trichet, Mervyn
King, and the rest all figure in this 2002 report.
All except the Swiss National Bank, that is...
1. S&L USA: The slow-motion savings and loan collapse in the United
States destroyed some 1,400 institutions and took another 1,300 banks
with it between 1984-1991. Direct cost to the U.S. taxpayer? Some $180
billion, or three percent of annual economic output.
2. Europe's Bad Banks: Staff at the European Central Bank might
like to recall the Greek and Italian bailouts of the early 1990s...or
the $10 billion failure of France's Credit Lyonnais in 1995...or
Germany's Girobank crisis in the mid-1970s?
3. Japan's Lost Decade: The 1996 rescue of Japan's zombie banks
cost more than $100 billion in public funds. Two years later, the Obuchi
Plan spent another $500 billion of taxpayers' money - some 12 percent of
Japan's GDP - on loan losses, bank recapitalizations, and depositor
4. The U.K.'s Repeat Failures: From the "second line" crisis of the
mid-1970s to the collapse of Johnson Matthey in 1984, BCCI in 1991,
Barings in 1995, and now Northern Rock in 2007, the U.K. authorities
have repeatedly failed to spot trouble before wading in with taxpayers'
5. Canada, 1985: The Bank of Canada itself notes how the failure of
15 members of the Deposit Insurance Corp. - including two banks -
accounted for less than one percent of the total banking system. Yet it
led to long-term liquidity loans, funded by the public, plus 15 years of
expensive court wrangling.
6. Sweden's Systemic Crisis: In the early 1990s, two banks
accounting for one-fifth of all Swedish banking assets were declared
insolvent. By 1994, five of the six largest banks faced serious
problems, costing taxpayers four percent of GDP in government support.
Don't the current heads of the world's biggest central banks ever flick
through World Bank research reports while waiting to get their teeth
straightened or beards trimmed?
But given the current collapse of real estate markets, banking models,
hedge fund credit lines, and short-term liquidity the world over since
last August - back when gold bullion traded one-third below today's
current price - who in their right mind would bother to read a study of
113 truly system-wide banking crises in 93 countries between 1970-2000?
No one running monetary or fiscal policy in the G-7 group of top
economies, that's for sure!
"If the countries in our sample had not pursued any such [supportive or
bailout] policies, fiscal costs [borne in the end by the taxpayer] would
have averaged about one percent of GDP - little more than one-tenth of
what was actually spent," write Patrick Honohan and Daniela Klingebiel
in their report, published in January 2002.
What's more, trying to bail out or support failing banks did nothing to
reduce the economic drag that followed, according to Honohan and
Klingebiel's analysis. The so-called "output dip" never responded to
government meddling - not unless the central bank stepped in to ease
liquidity problems at crisis-hit banks with unlimited cheap loans.
That kind of support - exactly the support given to Northern Rock as it
went belly up in September last year - is only one step removed from the
marketwide support now being offered to New York brokers today. Yet it
"actually appears to have prolonged crises," write the two World Bank
bean counters, "because recovery took longer" following liquidity loans
to effectively insolvent banks.
In other words, the only sure way of prolonging a financial crisis is to
try to delay it. Say, by putting taxpayers "on risk" with $200 billion
in mortgage-backed loans.
"Things could have been worse," the World Bank goes on. If every country
hit by a systemic banking crisis during the 30 years to 2000 had piled
in with liquidity support (like the G-7 central banks are offering
today) or blanket depositor guarantees (as the U.K. government did with
Northern Rock), the final bill of trying to clear up the mess early
would have risen sharply.
Throw in regulatory forbearance - letting "zombie" banks continue their
operations, even though they're technically bust - plus repeated
recapitalizations and debtor bailouts, and "fiscal costs would have
reached more than 60 percent of GDP."
Nasty rumors keep whacking "living dead" bank stocks in London, Tokyo,
Frankfurt, La Defense, and Wall Street right now. And so far, taxpayers
aren't on the hook for recapitalizations; UBS and Citigroup have gone to
Asian and petro-wealth funds for that. Ben Bernanke has so far only
demanded that subprime lenders write off the value of outstanding loans,
rather than calling on Congress to issue the checks directly.
But if the authorities sat on their hands during this crisis, the fiscal
cost might equal one percent of GDP, the World Bank report suggests.
Donning a cape, tights, and mask, instead - and pretending they can
unwind the mal-investments caused by record low-interest rates from the
Fed after the tech stock bubble burst - the cost may rise 60 times over.
That's more than a 98 percent saving, if only the G-7 authorities would
sit back and let the failed banks fail.
Put these findings to one side, however. Because what's most remarkable
about the World Bank study - other than the fact central bankers are so
clearly ignoring it - is that anyone could ever imagine things
Throwing "good money after bad" is a moral hazard that everyone's
grandma knows to avoid. And just like the truly historic bubble in
credit that created it, the endgame for today's official response to
this historic banking crisis looks as inevitable as it's sure to prove
"Fiscal outlays are not the only economic costs of bank collapses," note
Honohan and Klingebiel. "The losses covered [by taxpayers] - which are
caused by bad loan decisions - reflect wasted investable resources.
Furthermore, a government's assumption of large, unforeseen bailout
costs can destabilize fiscal accounts, triggering high inflation and a
currency collapse - costly in themselves - as well as adding to the
dead-weight cost of taxation."
High inflation and a currency collapse, you say? As a rule, smarter
investors spotting this trouble in good time can switch into hard
currency to hedge their domestic inflation risk.
But today's systemic banking crisis crosses all developed
economies...from North America to Japan and Australia onto Europe and
the United Kingdom. So unlike the Asian crisis of 1997, you can't flee
the Thai baht by hedging with dollars today. Nor can you flee the
Hungarian forint for the safety of French francs or Deutsche marks, as
you could when 25 percent of Budapest's banking assets were caught in a
mass bank failure in 1993.
Where to go? What to use as a hedge against all currency risk?