Saturday, December 31, 2011

Deposit Guarantees: Does it matter what the actual level is?

On the last day of the year, the Telegraph confirmed one of the central elements of this blog's blueprint for saving the global financial system.  Specifically, it confirmed how depositors view deposit insurance.

The Telegraph ran an interesting article showing that four out of five UK depositors don't know the compensation limits for the government's deposit guarantee program.

Why should they given that in times of financial crisis, policymakers extend the guarantee to cover all deposits?

What makes the article interesting is that it highlights the difference between the implied 100% deposit guarantee -- if there is a crisis, no depositor will lose money -- and the actual level of deposit guarantees.

The bottom line is that depositors assume a 100% guarantee.

Since the Great Depression and the introduction of deposit guarantees, there has been an implied 100% deposit guarantee in times of financial crisis.  As FDR said in his March 1933 fireside chat following the US bank holiday, it is safer to put your money in a bank than into your mattress.

In point of fact, since then governments have acted as if there is a 100% deposit guarantee.  Just look at what happen at the start of the financial crisis in 2008/2009.  Global policymakers pledged the full faith and credit of the government in the form of blanket deposit protection.  Case in point, Northern Rock in the UK.

Compare and contrast this with the actual level of deposit guarantees.  Deposits above this level are at risk to the solvency of the financial institution if the institution is not considered Too Big to Fail.

The reason for talking about implied versus actual level of deposit guarantee is to highlight how depositors already assume they are covered.  This is one of the reasons that the Eurozone banks have not experienced a major run on their deposits [if depositors think their money is protected, they don't care about the bank's balance sheet].

Requiring banks to provide ultra transparency and disclose on an ongoing basis their current asset, liability and off-balance sheet exposure details, would reveal all the bad debt in the financial system.  Once revealed, this bad debt can then be addressed.

At the same time, depositors already assume they are protected, so the banks can continue to operate with significant negative book equity.
One year after its introduction, only 21pc of consumers are aware of the compensation limit for deposits and savings, new research by the Financial Services Compensation Scheme (FSCS) shows. 
On 31 December 2010 new rules were introduced across Europe which increased compensation limits to €100,000 (£85,000). Despite the uncertain climate, four in five of those questioned were not aware the limit was £85,000, with 45pc admitting they didn't know it. However the awareness level of 21pc is up from the 17pc of people who knew the improved limit ahead of it coming into operation a year ago. 
Last week, the Financial Services Authority stepped in to ensure that all banks, building societies and credit unions prominently display how much compensation savers could claim in the event of an institution failing. 
Ever since the Northern Rock debacle in 2007, savers have feared that their life savings could be in danger if a bank collapsed. Yet, despite these fears, many are still in the dark on the compensation scheme and how their money is protected....
Mark Neale, chief executive of the FSCS, said:"The £85,000 limit is good news for every saver in the country, with 99pc of accounts now covered. Although there have been no high profile failures over the last 12 months it is important for financial stability that savers are aware of the protection that is available to them. 
"As only those financial institutions authorised by the FSA are covered by the FSCS guarantee it is vital that customers check their financial products are safe and remain within the limit. Although the industry has made significant progress in the information it provides to consumers about the FSCS, there is still much more to do. 
"What is more, the FSCS can now undertake to return money to most savers in seven days of a failure. So not only will no one lose a penny of protected, deposits up to the £85,000 limit, people can also count on getting their money back quickly." 
The importance of knowing the limit was exposed in 2011 as a small number of depositors with a failed institution had funds over the protected limit but only received £85,000 from the FSCS. 

Friday, December 30, 2011

Transparency and the invisible hand: Economics 101 does include it after all [update]

In two earlier posts (see here and here), I discussed how transparency is the necessary and sufficient condition for the invisible hand of the market to operate properly.  One might say that transparency is the foundation on which markets are built.

I asserted that it is only when buyers have access to all the useful, relevant information in an appropriate, timely manner that the invisibile hand of the market can properly set market clearing prices.

The clear corollary to this statement is that any form of opacity interferes with the ability of the invisible hand to properly set market clearing prices.  Opacity is the ultimate market imperfection.

I then asked my readers for help on whether this was covered in Economics 101 lectures, discussion sections and textbooks.

One of my readers sent me an e-mail describing where and how transparency is discussed with regards to the invisible hand.

The requirement for transparency in order for the invisible hand result to hold is usually mentioned in textbooks...The text below is from Macroeconomics:  Understanding the Wealth of Nations by David Miles and Andrew Scott)… 
the key phrase is  But market outcomes would only be efficient under certain circumstances: when agents understand the nature of the goods that are being offered for sale;”
You will find something like this in any textbook…economics texts always make clear that efficient market outcomes require that people know about the good being traded, in other words there has to be transparency  (which holds for all goods, including financial products).
From the textbook,
The political economist Adam Smith had a truly profound insight.  The free operation of forces in decentralized markets would lead not to chaos but to order:  resources would tend to be allocated to produce goods that society valued most.  He likened the operation of these forces to the workings of an invisible hand.
Smith argued that market mechanisms coordinate the actions of companies and households - all serving their own self-interest - to produce things that people want in the right quantities.  It was as if some giant benevolent, but invisible hand were guiding and coordinating the millions  of economic decisions made each day.
 But market outcomes would only be efficient under certain circumstances:  when agents understand the nature of the goods that are being offered for sale; when those agents behave rationally; when goods are produced under competitive conditions (i.e. no monopolies); and when all commodities that have value are offered for sale (i.e. when markets are 'complete').
 Efficiency here has a special, and unusual, meaning.  The allocation of resources is efficient if a reallocation of resources (perhaps as a result of government intervention) is unable to make anyone better off without making someone worse off.  We call such a situation Pareto efficient, named after the Italian economist Vilfredo Pareto (1848-1923).
The idea that market forces encourage the efficient use of resources is immensely powerful.  There is also a simple intuition behind it:  free markets tend to be efficient in this sense, because if they were not, then profitable opportunities would not be exploited.  But the conditions required to operate this invisible hand efficiently are demanding.
Please re-read both sections of highlighted text from the textbook again.

The first condition for the invisible hand to operate properly is transparency.

Of equal importance is that fact that opacity is not on the list of conditions for the invisible hand to operate properly nor is it used to qualify the transparency condition.

This naturally leads back to the Queen's Question:  why did the economics profession not see the financial crisis coming when everyone was talking about opaque structured finance securities?


My sons observed that while transparency is the first condition for the invisible hand to operate properly, unlike no monopolies, it is not specifically mentioned.  Rather it is implied. I confess that I missed this as I  relied on the interpretation provided by my reader.

They further observed that by not specifically mentioning transparency in the textbooks, is sets up the idea that information asymmetry and accounting control fraud are separate market imperfections as oppose to examples of ways that opacity is expressed in the marketplace.

Thursday, December 29, 2011

Ireland has done what the IMF wanted, but where is its reward?

A Guardian column looks at the issue of Ireland has done what the IMF wanted, but where is its reward?

I bring this column to readers attention not to debate the merits of Keynesian or Austerity based economic policies, but rather to highlight that there is a choice whether to socialize the losses in the banking system in the first place.

I have spent considerable time on this blog focused on the fact that policymakers have a choice in whether or not to socialize the losses of their banking systems.

This blog has looked at previous financial crises and documented that, when deposits are guaranteed, bailing out banks is not necessary. [think Great Depression and Savings & Loans]

In fact, this blog has been the first to suggest that when deposits are guaranteed by the government banks actually have a safety valve function.

They can act as a circuit breaker between excesses in the financial system and the real economy.  They can do this because they can operate for years with negative book capital.

When they act as a circuit breaker, the result is the banks' future earnings pays for the losses in the financial system.

So the choice facing policymakers today really comes down to make the banks pay or make the nation's real economy and its taxpayers pay.

Returning to the Guardian column, we see a discussion of what happens when policymakers choose to make the nation's real economy and its taxpayers pay.
Austerity policies are now widely regarded as having failed, and this failure is increasingly obvious in the country elected to act as Austerity's Child. The banking collapse, and the legacy bequeathed by the Irish state's extraordinary September 2008 bank guarantee, has seen society in Ireland reshaped as a petri dish for IMF, European commission and ECB experimentation. 
Successive waves of cuts have been stipulated bythe Troika in return for its loans, but implemented without resistance, and arguably, a degree of enthusiasm, by the two governments of the "post-sovereign" era. 
The fiscal adjustment, according to economist Karl Whelan, is the equivalent of "€4,600 per person… the largest budgetary adjustments seen in the advanced economic world in recent times". With annual "adjustments" of €3-4bn flagged until 2015, the euphemism of "purposeful austerity" cannot long camouflage the concerted assault on the – already minimalist – social contract. 
With this havoc in its fourth year, it is difficult to recall that 2008 promised what David Graeber describes as "an actual public conversation about… the financial institutions that have come to hold the fate of nations in their grip". As David McNally documents, this promise was merely a preface to the "neoliberal mutation" that insists on states slashing spending to "ensure that working-class people and the poor will pay the cost of the global bank bailout". 
In Ireland, this fleeting public conversation never materialised. Accelerating fiscal deterioration overlapped with the political unravelling of the historically dominant Fianna Fáil party, and the destructive intimacy of bankers, developers and ruling politicians became the prime focus of public anger. As Illan Rua Wall argues, the cathartic defeat of Fianna Fáil in February's election ensured that "indignation burnt itself out at the ballot box", with little public reflection, let alone mobilisation, on the possibility of confronting the new government's effortless adoption of austerity. 
This relative lack of popular opposition is difficult to explain. Official narratives – both domestic and EU – have praised the "maturity" of the electorate; pitted public and private sectors against each other in a "race to the bottom"; and insisted that "we all partied", a moralising patriotism deployed to draw the politics from the socialisation of bank debt, and from serious consideration of alternative approaches. The current Fine Gael/Labour coalition has invested heavily in being "not Greece"; by showcasing further and faster deficit-reduction, Ireland would be rewarded with interest rate cuts, an earlier than predicted return to the bond markets, and thus regain "sovereignty". 
Costas Douzinas recently documented how the IMF blames the failure of its growth predictions, and austerity measures, on the impact of Greek public resistance. Yet in well-behaved not-Greece, the same bad medicine has resulted in a rising deficit, stagnant growth, sustained emigration, and unemployment at about 15%. In its latest quarterly report, the IMF praised Ireland's "exceptional" efforts to meet its targets, but this praise comes at a time when the fiction of a reward for good behaviour is falling apart....
It is clear that "austerity" primarily involves rapidly socialising as much bondholder debt as possible, in advance of a possible default. The recent European council summit meeting may result in making permanent much of the current framework of external oversight of the Irish public finances. The fiscal compact, if passed into law, would constitute the most revolutionary development in the Irish economic landscape in the history of the state. The strengthening of budgetary surveillance by the European authorities, the balanced budget amendment, and the inclusion of automatic, treaty-prescribed sanctions for transgression, could condemn Ireland and other eurozone countriesto lengthy periods of economic stagnation.

You can have opacity and herd goats or you can have transparency and an industrial economy

In a post on Interfluidity that has received considerable attention in the blogosphere, Steve Waldman asks why is finance so complex.  His answer is that complexity is a way to rationalize opacity.

He then goes on and attempts to make the argument for why opacity is good.  In doing so, he manages to confirm why opacity needs to be eliminated from the financial system.

Finance has always been complex. More precisely it has always been opaque, and complexity is a means of rationalizing opacity in societies that pretend to transparency.
Actually, finance has not always been opaque.  It only tends to have a great deal of opacity during those times preceding financial crises.
Opacity is absolutely essential to modern finance. It is a feature not a bug until we radically change the way we mobilize economic risk-bearing.
Your humble blogger and the economics profession think that opacity is a bug and not a feature.  The invisible hand requires transparency and not opacity to work properly.
The core purpose of status quo finance is to coax people into accepting risks that they would not, if fully informed, consent to bear.
This is a very large assumption.  
Financial systems help us overcome a collective action problem. In a world of investment projects whose costs and risks are perfectly transparent, most individuals would be frightened.
And this is a problem why?  There are still going to be individuals willing to take risk.
Real enterprise is very risky.... 
One purpose of a financial system is to ensure that we are, in general, in a high-investment dynamic rather than a low-investment stasis. In the context of an investment boom, individuals can be persuaded to take direct stakes in transparently risky projects. But absent such a boom, risk-averse individuals will rationally abstain. Each project in isolation will be deemed risky and unlikely to succeed. Savers will prefer low risk projects with modest but certain returns, like storing goods and commodities. Even taking stakes in a diversified basket of risky projects will be unattractive, unless an investor believes that many other investors will simultaneously do the same....
If only everyone would invest, there’s a pretty good chance that we’d all be better off, on average our investments would succeed.
Hmmm...pretty much everyone invested in Dutch tulips and they were better off how?
But if an individual invests while the rest of the world does not, the expected outcome is a loss.
That is another major assumption.  
There are two equilibria, a good one in the upper left corner where everyone invests and, on average, succeeds, and a bad one in the bottom right where everybody hoards and stays poor. If everyone is pessimistic, we can get stuck in the bad equilibrium. Animal spirits are game theory. 
This is a core problem that finance in general and banks in particular have evolved to solve. 
A banking system is a superposition of fraud and genius that interposes itself between investors and entrepreneurs. It offers an alternative to risky direct investment and low return hoarding. Banks guarantee all investors a return better than hoarding, and they offer this return unconditionally, with certainty, without regard to whether other investors buy in or not... 
Wait a minute, banks are senior secured investors.  They are not providers of venture capital.
Bankers make the world a more prosperous place precisely by making promises they may be unable to keep. (They’ll be unable to honor their guarantee if they fail to raise investment in sufficient scale, or if, despite sufficient scale, projects perform more poorly than expected.)... 
Like so many good con-men, bankers make themselves believed by persuading each and every investor individually that, although someone might lose if stuff happens, it will be someone else. You’re in on the con.  
If something goes wrong, each and every investor is assured, there will be a bagholder, but it won’t be you. Bankers assure us of this in a bunch of different ways. First and foremost, they offer an ironclad, moneyback guarantee. You can have your money back any time you want, on demand. At the first hint of a problem, you’ll be able to get out. They tell that to everyone, without blushing at all.
Second, they point to all the other people standing in front of you to take the hit if anything goes wrong. It will be the bank shareholders, or it will be the government, or bondholders, the “bank holding company”, the “stabilization fund”, whatever. There are so many deep pockets guaranteeing our bank! There will always be someone out there to take the loss. We’re not sure exactly who, but it will not be you! They tell this to everyone as well. Without blushing. 
Actually, governments guarantee the deposits.  They do not guarantee the bank.
If the trail of tears were truly clear, if it were as obvious as it is in textbooks who takes what losses, banking systems would simply fail in their core task of attracting risk-averse investment to deploy in risky projects. Almost everyone who invests in a major bank believes themselves to be investing in a safe enterprise.
No.  Depositors don't make a judgment on whether the bank is a safe enterprise or not.  They put their money into the bank because it is guaranteed by the government and therefore perceived to be a safer place to store cash than their mattress.
Even the shareholders who are formally first-in-line for a loss view themselves as considerably protected. The government would never let it happen, right?
The response to the current financial crisis would appear to support this point.  However, governments did make shareholders realize losses when they took over the failing savings and loans.
Banks innovate and interconnect, swap and reinsure, guarantee and hedge, precisely so that it is not clear where losses will fall, so that each and every stakeholder of each and every entity can hold an image in their minds of some guarantor or affiliate or patsy who will take a hit before they do. 
Look at all that activity that has nothing to do with banks providing funds to entrepreneurs.  The point of all this activity is to hide the risk that the bank is taking.
Opacity and interconnectedness among major banks is nothing new. Banks and sovereigns have always mixed it up. When there has not been public deposit insurance there have been private deposit insurers as solid and reliable as our own recent “monolines”. “Shadow banks” are nothing new under the sun, just another way of rearranging the entities and guarantees so that almost nobody believes themselves to be on the hook. 
This is the business of banking. Opacity is not something that can be reformed away, because it is essential to banks’ economic function of mobilizing the risk-bearing capacity of people who, if fully informed, wouldn’t bear the risk.
Actually, opacity is not something that is essential to banks' economic function.  A government's deposit guarantee is not opaque. Either a bank has the FDIC's permission to say its deposits are guaranteed or it does not.

As for what the bank "invests" in on the asset side of its balance sheet, that too does not require opacity.  It is up to the discretion of the bank what it invests in.

What a bank gains from opacity is the ability to hide the true extent of the risks it is taking from investors.  As a result, it is highly likely that investors are not fairly compensated for the risk they take and are over-invest in the banks.

Mr. Waldman is right that opacity allows banks to mobilize the risk-bearing capacity of people who, if fully informed, wouldn't bear the risk.  This is not a good thing.
Societies that lack opaque, faintly fraudulent, financial systems fail to develop and prosper. Insufficient economic risks are taken to sustain growth and development. You can have opacity and an industrial economy, or you can have transparency and herd goats.
Actually, the real world appears to suggest that you can have transparency and an industrial economy or you can have opacity and herd goats.

A simple comparison of the Eurozone to Africa would appear to confirm this.  In Europe, the banking system tends to be more transparent  and we have what I suspect he would refer to as an industrial economy.
A lamentable side effect of opacity, of course, is that it enables a great deal of theft by those placed at the center of the shell game. But surely that is a small price to pay for civilization itself. No? 
Actually, civilization does not need opacity and would be better off if the theft made possible by opacity did not occur.

Bank of Spain says economy shrunk in the final months of 2011

Bloomberg reports that the Bank of Spain says the Spanish economy shrunk in the final months of 2011.

Perhaps I am the only one who feels this way, but given the choice, and it most certainly is a choice, between investing funds in some form of a bank bailout or investing funds in programs to get the economy growing again, I always would invest in growth.

Regular readers know that this choice exists because there is an alternative to bailing out the banking system.

The alternative is to allow the banks to continue to provide loans and payment services even when they have negative book equity.

Everyone knows that the banks are currently holding more bad real estate debt than they have book equity.  Despite this, there has been only a modest run on deposits in the banking system.

Why would acknowledging the real value of the bad real estate debt and showing negative book equity cause depositors to run from the banking system?

The reason that depositors have not staged a full scale run on the banking system is that they think the government will guarantee the safety of their deposits.  This guarantee does not change if the banks have a negative book value.

In fact, the guarantee is enhanced by the Spanish government not bailing out the banks.  Clearly, the Spanish government has more capacity to borrow if it doesn't have to borrow to recapitalize the banking system.

Not borrowing to bailout the banks also means the government can instead focus on pursuing economic policies that support growth.

As for the banks, they should be required to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.  Market participants can use this data to assess the riskiness of the banks and exert market discipline less the banks try to gamble on redemption while they are rebuilding their book capital through retained earnings.

The Bank of Spain said available data suggest the euro area’s fourth-biggest economy contracted (SPNAGDPQ) in the final months of the year, a day before Prime Minister Mariano Rajoy is set to unveil his first budget measures. 
The central bank said in its December monthly bulletin published today that tourism and exports showed signs of weakening from October while household spending and investment worsened, adding the data aren’t yet complete. 
Spain’s fragile recovery in the first half was sustained by exterior demand as the most drastic austerity measures in three decades pushed unemployment to a 15-year high. 
The Bank of Spain confirmed earlier forecasts that the economy is worsening as Rajoy, who holds his second Cabinet meeting tomorrow, has said he’ll announce his plans to carry the nation through until a 2012 budget is presented in the first quarter. 
Rajoy’s People’s Party, which inherited a stalled economy from the Socialist government after winning in a landslide on Nov. 20, now faces the double challenge of tackling the euro area’s third-largest budget deficit (EUBDEURO) and Europe’s highest jobless rate (UMRTEMU)
“After the Spanish economy stalled in the third quarter, available data show that activity contracted in the last months in an environment of strong tensions in the financial markets” and weakening growth prospects in the euro area and the rest of the world, the central bank said. 

Wednesday, December 28, 2011

Dodd-Frank: Three levels of containment

Bloomberg published an excellent editorial on the Dodd-Frank Act.  In particular, the editorial focused on how it uses three levels of containment to build a fail-safe system.

Regular readers know that I dislike every element of Dodd-Frank except for Elizabeth Warren's Consumer Financial Protection Bureau.

I think readers might find it interesting to see what Bloomberg saw as a positive and why I think Dodd-Frank is a series of one off solutions that do not address the real issues.

The vilification of Dodd-Frank is odd, given that most of the law has yet to take effect. The law firm Davis Polk & Wardwell LLP estimates that as of Dec. 1, only 74 of the 400 required rules had been finalized, and 154 had missed the law’s deadlines.
Actually, the vilification is justified.  The law was written before the watered down version of a "Pecora Commission", the Financial Crisis Inquiry Commission, reported to Congress on what it saw as the causes of the credit crisis.

As a result, there is little chance that it actually addresses what went wrong and a substantial chance that it reflects smoke and mirrors that let the financial industry continue along as if nothing happened.
Most people, quite understandably, haven’t had the time or patience to wade through the law’s 848 pages. As a service to them, we did so. What we found, admittedly cloaked in eye- glazing language, was an elegant core of sensible ideas. Consider it a fail-safe system with three levels of containment.
For those keeping score, the Pecora Commission resulted in a fail-safe system with one level of containment.  We know that simple system worked successfully for 70+ years.

The question is "in all of these new levels of containment, did Dodd-Frank fix what went wrong with the system based on the Pecora Commission's work?"
Level 1 is designed to make disastrous mistakes at financial institutions less likely. One central element is transparency: Bank stress tests, centralized reporting of derivatives trades and a data-analysis arm called the Office of Financial Research will give regulators, investors and journalists more information. They can use it to identify dangerous concentrations of risk in banks, investment firms, insurers and other financial entities.
Look at that, the central element of the level designed to make disastrous mistakes at financial institutions less likely is transparency.

Look at the benefit that transparency offers: the ability to identify dangerous concentrations of risk and, by implication, to adjust the amount and price of the market participant's exposure to those dangerous concentrations of risk

Is the Bloomberg News organization a fan of this blog?

However, the Dodd-Frank version of transparency comes straight from the Opacity Protection Team.  This is easy to show using the three examples provided by Bloomberg.

By themselves, bank stress tests provide no useful information.  Bank of America stock price appears to suggest that the market does not buy the results of its successfully passing the first Fed stress test and narrowly missing getting back its ability to increase its dividend under the second Fed stress test.  This problem with stress tests is global, just look at Dexia passing the European Banking Authority's stress test and needing to be nationalize 2 months later.

Regular readers know that the whole premise behind stress tests is flawed.  Rather than make each bank disclose its current asset, liability and off-balance sheet exposure details and let the market independently stress test each bank, the Fed does it for them.  Since when are the 100+ PhDs at the Fed better at analyzing data than the market which employs 1,000s of experts?

Even worse, when the Fed provides the results of its stress tests, it is explicitly offering investment advice and taking on the moral hazard that comes with offering this advice.  Once the Fed says that the banks are solvent and can pay dividends the Fed is on the hook for bailing out the banks for any solvency problems.  After all, why should any market participant believe the Fed is wrong given that it is the Fed that had access to all the current asset, liability and off-balance sheet exposure details?

Stress tests do not provide transparency, they maintain the reality that banks are, to quote the Bank of England's Andy Haldane, 'black boxes' to all non-regulatory market participants.  Black boxes are by definition opaque.

Call stress tests a victory for the Opacity Protection Team.

Next on the list is centralized reporting of derivative trades.

Regular readers know that there are two forms of transparency:  valuation and price.  Valuation transparency is defined as the buyer having access to all the useful, relevant information in an appropriate, timely manner so that they can assess what they are buying.  Price transparency is defined as showing the price of the last trade for a financial instrument.

Centralized reporting of derivative trades addresses price transparency, but not valuation transparency.

Everyone knows that price does not equal value.  As Warren Buffett says, price is what you pay and value is what you get.  With price transparency by itself, you do not know if it was a fair trade or the price a greater fool was willing to pay.

It turns out that in Economics 101 they teach that valuation transparency is the important form of transparency.  It is a requirement for the invisible hand to operate properly that buyers know about the good being traded.

This makes sense because before buying or selling a security, a buyer needs to assess the value of the security to see if they are getting a fair deal.  For example, if a buyer values a security at fifty cents, they are certainly not going to spend a dollar buying it.

Centralized reporting of derivative trades does not provide valuation transparency as the instruments being traded are still 'black boxes' (think opaque, toxic structured finance securities).

Call centralized reporting a victory for the Opacity Protection Team.

Last on the list of examples cited by Bloomberg is the data-analysis arm of the Office of Financial Research (OFR).  I personally think that OFR was the Opacity Protection Team's finest hour.

Just like stress tests, OFR is a barrier between the market and the disclosure of all the useful, relevant information by financial firms.

Once again, a government agency is being substituted for the market.

Please tell me why the PhD's who work for OFR are going to be superior to the PhD's that work at the Fed in their ability to analyze all the useful, relevant information for financial firms.  Then, please explain why they are going to be better at analyzing this information than the market with its 1000's of experts including competitor firms!

I call OFR the Opacity Protection Team's finest hour, because they were able to preserve the opacity in the financial system when everyone knew that valuation transparency was required.

For banks, transparency is the disclosure on an on-going basis of their current asset, liability and off-balance sheet exposure details.

For structured finance securities, transparency is disclosure of the terms of the deal as well as the current performance for each of its underlying assets.

Valuation transparency appears no place in the Dodd-Frank Act and quite simply, that is why I dislike it.
The law also rearranges some incentives. By stipulating that lenders must hold a portion of the mortgages they originate, Dodd-Frank reduces the temptation to make bad loans and sell them off to greater fools.
So long as there is valuation transparency, it is up to the buyer to determine how much exposure they want to 'bad' loans.

Stipulating the lenders hold a portion of the mortgages they originate simply increases their risk for no benefit.  If they want to hold 'bad' loans, they can do it directly in their loan portfolio.
By forbidding federally insured banks from engaging in speculative trading for their own accounts, the so-called Volcker rule limits a taxpayer subsidy that has encouraged traders at such banks to take outsized risks.
By requiring the banks to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details, market discipline can be applied to end proprietary trading without the need for regulation.

It is a trader's worse nightmare to have to disclose their positions.  Rightly or wrongly, they believe that the market will trade against them.

At a minimum, disclosure of the positions makes it easy for the market to identify market making activities and proprietary trades.
By requiring executives to write credible living wills describing how their institutions can be dismantled in bankruptcy, the law leans against banks getting too large or too complex to manage.
There is no such thing as a credible living will.  What we learned during the 2008/2009 period of the financial crisis is that there are no buyers at any price when market participants believe the problem is not specific to only one entity.

Requiring disclosure of their current asset, liability and off-balance sheet exposure details is far more effective at addressing banks that are too large or too complex.

Simply put, with access to the data, market participants become responsible for all gains and losses on their exposures to these banks.  This will put banks under significant pressure to reduce their size and complexity.  This is the result of the simple fact that the harder it is for market participants to analyze a bank, the riskier they perceive the bank to be and the higher the return they need to invest in the bank.

Bank management is very attuned to increases in its cost of funds.  As a result, they have an incentive to reduce the size of the bank (think assets that are no longer profitable to hold when the cost of funding increases) and complexity.
Level 2 aims to make financial institutions better able to survive when mistakes do happen. 
The crucial piece here is higher capital requirements. Like equity for a homeowner, capital allows a bank to stay solvent if the value of its investments falls. 
Capital requirement without transparency are, as the OECD observed, meaningless.

Everyone knows that banks have been practicing extend and pretend since the beginning of the credit crisis.  In addition, mark-to-market accounting was suspended.  Net result, bank assets and capital are over-stated.  Dividing one over-stated number by another over-stated number provides a meaningless number.

The failure to provide transparency in Level 1 means that higher capital requirement in Level 2 is of de minimus benefit.
Stress tests conducted by the Federal Reserve play a role, too. By simulating how a bank would fare in worst-case scenarios, they help ensure that banks don’t report fictitious capital....
Were he alive today, Mark Pittman would point out to Bloomberg's editors that the same Fed that concealed its loans to banks has no trouble with banks engaging in fictitious reporting.  After all, the Fed knew of these loans to the banks and the fact that the banks did not report them.

Remember, this Fed knew of the loans to less developed countries on bank balance sheets and never required these loans to be written down to market value.  If that is not comfort with reporting fictitious capital, I do not know what is.
Level 3 seeks to make sure that if a financial institution does fail, it won’t bring down the whole system. The law gives the Federal Deposit Insurance Corp. the power to take over a troubled institution and wind it down in a way that limits contagion -- a task made easier by living wills and better information on how financial institutions are linked....
Actually, the way the financial system is designed when there is transparency is that every participant protects themselves by limiting their exposures to what they can afford to lose.  There is seventy years of history showing that this is a robust solution.

The current financial crisis is the direct result of making the financial system dependent on a single point of failure.  In this case, the single point of failure was the bank regulators and their monopoly on all the useful, relevant information for financial institutions.

For whatever reason, the regulators failed to properly assess the risk in the financial system and communicate this risk to investors.

As a result, investors, including competitors, under-priced the risk and over-exposed themselves to losses.  It is this over-exposure that set up the situation where the failure of one bank could bring down the entire system.

The only way to limit contagion is by requiring the banks to provide ultra transparency.  It is with this data that market participants can assess the risk of each bank and properly set the amount of their exposure to it relative to its risk and the market participant's ability to absorb losses.
Dodd-Frank deliberately lacks a Level 4: It forbids the use of taxpayer money to bail out institutions whose failure could bring down the system....
Everyone believes that Congress will immediately vote to end this restriction should we face another systemic financial crisis -- after all, not doing so plunges us into a Great Depression.

However, because there is some chance that Congress will be so dysfunctional that it cannot vote to end this restriction, its inclusion in the Dodd-Frank Act is more than enough reason to repeal the Act in its entirety today.

Here is a case of Congress gambling with financial stability.
The solution is not to repeal Dodd-Frank. It is to construct its containment system as quickly as possible. The uncertainty over how the law should be implemented is probably its greatest flaw. The sooner rules are written and enforced, the sooner banks can learn to live with them and get on with the business of helping the economy grow.
Actually, the solution is to repeal Dodd-Frank.  A simpler, better containment system can be erected by requiring ultra transparency.

Spanish mortgage market continues to collapse [update]

A Bloomberg article reports on the on-going collapse of the Spanish real estate market.

According to the article,  the value of mortgages funded in Spain decreased by over 40% since last year.  At the same time, house prices in Spain declined by 7%.

All this while the banks were allowed to hide their bad real estate exposures.

As previously discussed on this blog, it would make sense for the Spanish government to require banks to provide ultra transparency as part of the effort to address the real estate exposures.  By requiring banks to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details, all market participants could see that the real estate exposure is properly valued.

The advantage to the Spanish government of requiring ultra transparency is that the Spanish government will not be required to a) bailout the banks or b) set up a bad bank to acquire the assets.

Instead, the banks can workout the bad real estate assets while all the market participants watch!

Spanish residential mortgages decreased for an 18th month in October as banks reined in lending amid a surge in borrowing costs and bad loans. 
The number of home loans fell 43.6 percent from a year earlier after a 42 percent drop in September, the Madrid-based National Statistics Institute said in an e-mailed statement today. Total capital lent on all mortgages fell 40.6 percent, it said. 
Spain is struggling to digest a glut of 700,000 unsold new homes since the collapse of the building boom that has pushed the unemployment rate to 23 percent. 
Prime Minister Mariano Rajoy... has pledged to bring back tax rebates for mortgage holders and clean up an estimated 176 billion euros ($230 billion) of soured assets linked to real estate from the books of the country’s banks. 
Bad loans as a proportion of total loans by Spanish lenders jumped to a 17-year high 7.42 percent in October, the Bank of Spain said on Dec. 19. 
The average price of Spanish houses and apartments declined 7.4 percent in the third quarter from a year earlier, the National Statistics Institute said on Dec. 15.

Thanks Ignacio for the link!

20pc of Irish mortgage holders behind on their payments

The Irish Times reports that 20 percent of the Irish mortgage borrowers are struggling to make their monthly payments.

This figure is staggering.

According to the article, more than one-third of all Irish mortgage borrowers from four banks are underwater.  For the borrowers in the 2004-2008 boom, more than one-half of them are underwater.

This suggests that there is going to be on-going downward pressure on Irish house prices.

So how is the bailed out banking system holding up under all of this bad mortgage debt?

ALMOST 155,000 mortgage holders are now struggling to repay their homeloan each month.
New figures show that one-in-five homeowners across the country are in trouble with their mortgage repayments. First-time buyers tend to be the worst affected by home-loan difficulties, especially those who bought between 2005 and 2008. 
Almost 63,000 homeowners are in arrears for three months or more. On top of this, close to 70,000 people have been forced to do deals with their lenders to lower monthly repayments. 
When other homeowners who are in arrears for less than three months are added in, it means that one-in-five mortgage holders are struggling to pay their mortgage, Central Bank figures quoted in the latest International Monetary Fund report on Ireland reveal. 
The IMF report states: "On top of the arrears of 90 days or more, there are a significant number of borrowers who have restructured loans or delinquent payments of less than 90 days, bringing the total affected to about 20pc of borrowers at end-2010." 
There are a total of 773,420 residential mortgages, according to separate Central Bank figures. Multiplying this figure by 20pc means that more that 154,684 mortgages are either in arrears or have had to be modified to lower the repayments. 
Most of those who have had to modify their mortgage terms are now on interest-only payment arrangements.
The IMF report points out that 40pc of those who are in arrears for three months (90 days) or more have now been behind on their repayments for a year or more. This works out at 25,188 mortgage holders. 
The value of the average amount of arrears has been calculated by the Central Bank at €27,000, with these borrowers having €200,000 each outstanding on their mortgages. 
More than a third of owner-occupier borrowers from AIB, Bank of Ireland, EBS and Permanent TSB are in negative equity, where the value of the mortgage is greater than the value of the home. But this rises to half of those who bought during the 2004 to 2008 boom. A similar percentage of buy-to-let investors who bought in the bubble are in negative equity.... 
Only half of those who are in arrears are in negative equity. Personal finance experts said this meant that it should be easier for banks to restructure loans. 
The average negative equity amount for those who are not in arrears was €68,000, the Central Bank data from the end of last year, quoted in the IMF report, shows. 
Borrowers who are in arrears owe an average of €84,000 more than their property is worth.

The euro: happy new year!

A Guardian editorial lays out what a fantasy rescue of the euro would include and concludes that it would be almost impossible to achieve.

Regular readers know that your humble blogger has laid out a blueprint for saving the euro and restoring solvency to its members and their banking systems that would be politically popular with the voters and easy to achieve.

Unlike the Guardian's fantasy rescue, this blueprint is based on banks performing their safety valve function between excesses in the financial system and the real economy.

Banks would absorb these losses.  This just happens to also have been the recommendation given by Professor Ben Bernanke to the Japanese when their credit bubble burst.

What dooms the Guardian's fantasy rescue is that it instead forces the real economy of the Eurozone to absorb the losses on the financial excesses.

The blueprint recognizes that banks can operate for years with negative book capital.  With the advent of deposit insurance in the 1930s, depositors don't care about the bank's balance sheet.  They only care that the government or entity back-stopping the government guaranteeing their deposit can make good on the guarantee.

It also recognizes the need to require banks to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details so that banks are not tempted to gamble on redemption while they are retaining earnings to recapitalize themselves (just look at the US Savings and Loan crisis for why this level of disclosure is needed).

Let us fantasise that this festive quiet conceals dervish-like activity by euroland policymakers, gathered in Washington, under the watchful eye of Christine Lagarde from the IMFand Tim Geithner of the US treasury. Beijing, Tokyo and Delhi are on speed dial (David Cameron gets the occasional round-robin email). 
Because these elite minds surely know that the holidays are the ideal time to tie up a package of measures to be launched early on the first big day of trading. On Monday 2 January, as financiers are settling down in front of their Bloombergs they will be hit with a barrage of commitments and cash designed – and here we really are in the realms of the wishful – to save the euro. What would be inside such a bundle of policies? 
First, it would have to be designed for immediate release....
Our fantasy euro rescue would also have to be clear about where the backstop is. When investors buy bonds from Italy or Spain or a growing number of governments under financial distress, they have no idea whether they are guaranteed by the eurozone or not. That goes double for banks based in Milan or Madrid; whereas in Britain anyone dealing with a big bank knows that it has a government treasury sitting behind it. 
One obvious but near-impossible solution to this would be to have common European bonds issued from a eurozone treasury, with the countries with the best credit backing up those with the worst. Similarly, when dealing with a continent-wide banking system that looks insolvent in some places (Greece being the best example), our policymakers will have to come up with a common plan to take over bust banks and thoroughly stress-test others to show the world they are sound trading partners. Finally, there will need to be a series of long-range economic policies: an end to counterproductive austerity, a new mandate for the European Central Bank to encourage growth. 
We could list more measures to hold the eurozone together. These are just a taster, yet it is already clear most of them would be quite beyond any policymakers attempting a last-ditch effort to save the euro. That gives some idea of the impossibility of the task, and the difficulties facing the continent in the new year.

Tuesday, December 27, 2011

Is there reason for optimism about the Eurozone?

I like to think that there is reason for optimism about the Eurozone and its eventually addressing the solvency crisis.

My optimism is rooted in the simple fact that it is becoming exponentially harder for Eurozone policymakers and financial regulators to adopt policies that kick the solvency problem into the future.  This is a very good thing.

As this blog previously stated and Japan has definitively shown, the cover-up of the solvency problem in the financial system makes the situation much worse than acknowledging and dealing with the solvency problem.

Not only has it become exponentially harder to kick the solvency problem into the future, but the German government continues to move towards forcing the Eurozone to come clean about its solvency problem.

Its tool for achieving this is forcing austerity onto countries.  It is the countries that are facing austerity that will lead the recognition of the solvency problem.

Countries being forced into austerity face a simple choice: depression for their citizenry or inflict massive losses on the Eurozone banking system which was designed to be a safety valve and absorb these losses so as to protect the real economy from the damages of financial excess.

It is a question of time before the Spanish, Italian and Greek governments decide that French and German banks being forced to recognize their losses on their sovereign debt exposures is not nearly as bad an outcome as forcing a depression on their citizenry.

My expectation is that Italy and Greece will come to this decision sooner than Spain.  These countries currently have unelected technocrats running their governments.  Since they are unelected, these governments do not have popular support.

Frankly, the citizenry will rapidly figure out that they can vote both the technocrats and austerity/depression out of office and vote into office banks absorbing losses and economic expansion.  It really is not a hard choice for the citizens to make.

It is a question of time before everyone realizes that the Eurozone banks can continue to operate and provide loans and payment services while having negative book equity.  Remember, no one thinks they are solvent now because of their exposures to troubled assets.  Confirming this fact is not going to undermine depositor confidence!

I realize that bankers like to whisper fears of contagion into policymakers' ears, but ultimately these fears are nothing more than a bluff to keep the gravy train of bailouts and bonuses going.

A bluff that is easily ended by simply requiring banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.  Remember, banks routinely made this type of disclosure before the days of deposit guarantees as it was a sign of a bank that could stand on its own two feet.

The Euro crisis deepens

In his Guardian column, Aditya Chakrabortty lays out all the facts that support his observation that the Euro crisis is getting worse.

He then asks the question of why have the Eurozone policymakers and financial regulators been unable to end the crisis.

The answer is that the Eurozone and the rest of the global financial system are facing a solvency crisis that they have been treating as a liquidity crisis since 2008.  Treating the symptom is kicking the can down the road and not curing the cause.

Europe's leaders have spent most of the euro crisis denying there's a euro crisis....
The denialism ended this summer, as the financial bushfire moved to Italy and even began to menace Belgium and France.... If the rhetoric and the not-so-faint snobbery have vanished, to be replaced by panic about "a last wakeup call" and "a crucial crossroads", the actual policy-making is as clueless as ever.... 
The eurocrats can impose austerity, and bring in Goldman Sachs employees such as Mario Monti to run newly impoverished economies; but anything that might actually break the fire still eludes them. 
In the meantime, the crisis has just kept growing. 
Which is exactly what you would expect given that they are focused on treating the liquidity symptoms and not the underlying solvency cause of the crisis.
In February 2010, Greece needed to raise just €53bn for the entire year; now euro leaders are looking for a trillion euros and counting. Compare and contrast: in his memoirs, Alistair Darling recounts that it took ministers and officials 10 days and one curry-fuelled all-nighter in autumn 2008 to hammer out the complex and costly combination of ready cash, loans and guarantees that saved the British banking system....
Actually, they did not save the British banking system.  They kicked the can of solvency down the road.

Incidentally, these same policies were adopted by both the US and the Eurozone.

Does anyone really believe that the large British banks are solvent given the fact that their exposure to Eurozone governments and banks vastly exceeds their equity?
A good rule of thumb in this crisis is that when a European state pays more to borrow than an ordinary taxpayer shells out for a bank loan, the government eventually has to call in the rescue brigade. 
For much of November, Italy was borrowing at a rate of 7% – and probably the only thing that has kept interest rates from going higher still is that the European Central Bank (ECB) has been buying Rome's IOUs. 
In other words, the markets trust the Italian state – with its own tax-raising powers – less than it does a couple in Kettering who'd quite like a new kitchen. Which, given that Italy plans to roll over more than €360bn (£310bn) of debt next year, is hardly sustainable for the new prime minister Mario Monti. Indeed, on 1 February, Rome will have to either repay or renew €28bn of loans. Even now, no one has the faintest idea how it will do that.  
Over the next couple of months, Italy's crisis can go one of three ways: either the ECB keeps on buying its bonds, with the blessing of northern-European voters and markets; or ECB head Mario Draghi pledges to fund financially distressed eurozone governments; or Rome gives in and calls for a bail-out. If the last even looks likely, financiers will almost certainly panic that Italy is about to default on its debt. With about a third of the country's bonds held abroad, this could wreak chaos in world markets – including in Britain, which is by far the biggest foreign owner of BTPs. That's the sort of event Barack Obama has in mind when he remarks that Europe's crisis is "scaring the world". 
The idea that owners of Italy's debt might have to take a haircut is not what scares the world.  What scares the world is no-one knows who is holding onto the losses.  It is the possibility of contagion pulling down the global financial system that scares the world.

Regular readers know that the way to eliminate the fear of contagion pulling down the global financial system is not more expensive bailouts, but disclosure.  Specifically, every bank must be required to provide ultra transparency by disclosing on an on-going basis their current asset, liability and off-balance sheet exposure details.

With this data, everyone knows who is holding the losses.  More importantly, market participants can take steps to adjust the amount and price of their exposure so that they do not lose more than they can afford to lose.

As for the banks in any country that sees its sovereign default, what is needed is a backstop to the sovereign's guarantee of the banks' deposits.  In Europe, this backstop could be provided by the EFSF or the ESM.  The backstop is needed to prevent a run on the banks.

It must be remembered that history has shown that banks with negative book equity can continue to operate and provide loans and payment services.
Rome's not the only government whose finances are in jeopardy; Madrid is in the same boat, while Brussels and Paris have also seen a surge in loan rates. 
Less often talked about is that many of Europe's banks, even well-known French names, are unable to borrow unless from the ECB. "You have European banks nowadays claiming they're not European at all because they're worried the very word will scare away investors," says Grant Lewis, head of research at Daiwa Europe. That credit crunch cannot carry on for much longer without causing either a full-scale banking crisis or throttling economic growth. 
Not that there's much growth to be had, because the prescription of austerity for sick economies simply makes them sicker. By the IMF's own projections, 2012 will be Greece's fifth straight year in recession, which by now should really be termed a depression...

Nervous Eurozone banks park even more funds with ECB

The Telegraph reports that Eurozone banks parked a record amount of funds with the ECB in a further sign that the banks are becoming increasingly wary of lending to each other.

Regular readers know that this is a direct result of inadequate disclosure by the banks.

Every bank knows that their competitors have exposure to troubled assets.  What they do not know is exactly what this exposure is and therefore they have no way to assess the riskiness or solvency of their competitors.

If banks were required to provide ultra transparency they would disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.  This data could be used by their competitors to assess their riskiness and solvency.

Based on this assessment, competitors could adjust the amount and pricing of their exposure to each bank.  For some banks that are currently unable to access interbank loans, the market would reopen.

The record amount was deposited just a week after the ECB lent 523 eurozone banks a total of €489bn in cheap loans in an attempt to keep credit flowing through the economy and prevent a full-scale credit crunch. 
Banks borrowed the money at the ECB's benchmark rate of 1pc, but receive an overnight rate of just 0.25pc, well below what they could earn in wholesale markets. 
This means lenders are depositing any new cash back with the ECB at a loss in order to guarantee safety. 
This takes Mark Twain's observation about being concerned about the return of his principal and not on his principal to an extreme.

It is a clear sign that confidence in the Eurozone banking system is disappearing.
Banks will also be searching for safe havens in an attempt to reduce their risk profile for end-of-year accounts, as was seen during the end of 2008. 
Please note that banks are aware of end of year window dressing and how it is used to "hide" the real risk of the bank.

One reason that ultra transparency is provided on an on-going basis is to remove the practice of window dressing to minimize the perception of risk.

Monday, December 26, 2011

UK Treasury working on plans for euro failure

The Telegraph reports that the UK Treasury is working on contingency plans in the event that the Eurozone breaks up.

My attention was drawn to what the UK would do in the event that depositors in the Eurozone elected to deposit their money in the UK.

Regular readers know that Eurozone depositors are already pulling their money out of banks in Greece, Ireland, Spain, Portugal and Italy.  The first place they transferred their deposits to was Switzerland, but Swiss authorities have been aggressive about stopping this inflow.  The second place they transferred their deposits to has been Germany; shown by the massive recirculation of euros through the German central bank.

While I only have anecdotal evidence, it appears that the way the Eurozone depositors are transferring their funds to the UK is through the purchase of high end real estate.  This is not surprising given that the rich would move their money first.

The Treasury is working on contingency plans for the disintegration of the single currency that include capital controls. 
The preparations are being made only for a worst-case scenario and would run alongside similar limited capital controls across Europe, imposed to reduce the economic fall-out of a break-up and to ease the transition to new currencies. 
Officials fear that if one member state left the euro, investors in both that country and other vulnerable eurozone nations would transfer their funds to safe havens abroad. 
Capital flight from weak euro nations to countries such as the UK would drive up sterling, dealing a devastating blow to the Government’s plans to rebalance the economy towards exports. 
Earlier this year, Switzerland was forced to peg its currency to the euro to protect the economy after a massive appreciation in the Swiss franc due to spiralling fears over Europe.... 
Britain’s response to the possible break up of the euro would reflect measures taken by Argentina when it dropped the dollar peg in 2002, according to sources. 
In addition to the risk of an appreciating currency, dealing with potential UK corporate exposures to the euro poses a considerable challenge for the Treasury. 
Britain’s top four banks have about £170bn of exposure to the troubled periphery of Greece, Ireland, Italy, Portugal and Spain through loans to companies, households, rival banks and holdings of sovereign debt. For Barclays and Royal Bank of Scotland, the loans equate to more than their entire equity capital buffer. 
Under European Union rules, capital controls can only be used in an emergency to impose “quantitative restrictions” on inflows, which would require agreement of the majority of EU members. Controls can only be put in place for six months, at which point an application would have to be made to renew them. 
Capital controls form just one part of a broader response to a euro break-up, however. Borders are expected to be closed and the Foreign Office is preparing to evacuate thousands of British expatriates and holidaymakers from stricken countries....

A break up of the euro would have a devastating impact on the UK. HSBC economists have warned that it could trigger a global depression and forecasters at the Centre for Economic & Business Research reckon it would knock about a percentage point off UK growth – plunging the country into a full-blown recession in 2012. 
The scale of economic problems alongside the existing debt burden would leave the Government with little in its armoury to combat the collapse, making capital controls one of the few viable options.

Regulators covering up condition of banks: Dexia

The elephant in the room has begun to stir.  As this blog has observed repeatedly, regulators have an information monopoly on all the useful, relevant information about each financial institution.

With this information monopoly comes the responsibility to both assess this information and to convey to the market the risk of each bank.

Please re-read the previous sentence as it is important to understand that regulators have an obligation not to hide information from but to share information with the market.

Call it the Volcker legacy, but his preference for handling troubled institutions behind closed doors set the precedent for regulators endorsing banks materially misrepresenting their financial condition to market participants.

I understand that the justification for handling troubled institutions behind closed doors was the fear of a bank run, but this fear was never supported by the facts.

Quite simply, so long as depositors and other creditors believed there was a 100% implied guarantee of their exposure by the government, they were never going to stage a run on the bank to withdraw their funds.  Factual confirmation of this comes from the savings and loans who operated for years even though they were clearly insolvent.

In the aftermath of the financial crisis, this secrecy about the true condition of the banks has taken on new proportions.

For example, regulators refused to publish in real time exactly how much any bank was borrowing from the central bank under all of the central bank programs.  In fact, it took a lawsuit by Mark Pittman and Bloomberg to force disclosure on some of these programs in the US.

Banks took their cues from the regulators and also refused to tell market participants about what they were doing.  They did this despite SEC regulations that required the banks to disclose this information.

The elephant that in the room that is finally stirring is the lawsuits caused by intentional misrepresentation by bank management of the bank's financial condition.

The first stirring was by the SEC and its suit against Fannie and Freddie over their sub-prime mortgage disclosure practices.

The next suit is against the management of Dexia, a recently nationalized bank in Europe, that insisted from the time of its 2008 bailout that everything was ok.

As reported on Business Insider,

The ultimate costs to Belgian taxpayers will be huge and long-term, given how small the country is. Yet there have been no legal consequences for those responsible. Until now.... 
Lynx Capital, a Belgian investment firm, has sued Dexia SA and former CEO Pierre Mariani for "spreading false and misleading information" and “market manipulation.” 
The amount in the case is small—and irrelevant. Lynx purchased 5,350 shares on September 5, 2011, for €1.46 per share and lost 82% of its investment over the next few months. But in a potentially significant development for Belgium, where class-action law doesn’t exist, Bernard Delhez, CEO of Lynx, is now trying to encourage other shareholders to join the cause. 
The complaint alleges that Mariani and Jean-Luc Dehaene, Dexia’s former president, issued reassuring statements about the financial condition of the bank from the time they took over, following its bailout in 2008, until September 2011. 
Because the bank was in a precarious situation throughout and engaged in high-risk activities, the information in those reassuring statements was false and misleading and was intended to artificially inflate Dexia’s share price. 
Hence, Dexia and Mariani engaged in market manipulation. 
Moreover, Mariani must have known that the information was false and misleading. For example, Mariani confided in Dehaene in 2008 that Dexia was "not a bank but a hedge fund" (L’Expansion). Dehaene spilled the beans on this conversation last October during the presentation of the breakup plan. 
Among the others reasons why Mariani must have known about the true condition of Dexia was a note that Luc Coene, Governor of the National Bank of Belgium, had sent to Dexia last August, in which he recommended that Dexia be dismantled. 
For Robert Witterwulghe, Lynx’s lawyer, the facts demonstrate that Mariani knew as early as October, 2008, that Dexia was in a precarious situation, and that the reassuring communications since then were willfully false and misleading. 
The court action is based on the law of August 2, 2002, concerning insider trading and market manipulation. But: "Why impose a system for everyone when it is not applied in certain cases?" Delhez said (L’Echo), perhaps to justify in part why he is pushing the case though his investment is small and his legal expenses will pile up quickly. 
When a bank collapses, the lies behind its financial statements come out of the woodwork—and Dexia is no exception: a report surfaced with the damning results of an earlier investigation by French regulators. And what happened then? Nothing.... Regulators Knew of Dexia's Problems But Were Silenced.