June 21, 2010

Here comes the stress test, but who’ll shut the banks?

Posted in Banks · 32 comments ·

In the 30 years from 1973 to 2003, Ireland got €17 billion from the EU in structural funds.

In the 30 weeks since Anglo’s new board came up with a new plan, we have lost €22 billion in the bank.

Do I need to remind you that Ireland’s banking insiders described Anglo as having been ‘‘well stress-tested’’ at the top of the boom?

I heard from that old friend again last week for the first time in ages. Yes, the ‘‘banks tress test’’ is back. You might remember it from bust banks, such as Anglo, AIB and Bank of Ireland.

The famous stress test was used to assuage fears about the Irish banking sector in 2007. But the mighty stress test proved to be useless. The Irish banks are now bust, with a hole in their collective balance sheets in the region of €200 billion.

You’d have thought the stress test wouldn’t be mentioned again for a long, long time. But no, EU leaders (this time) were back at the stress-testing malarkey this weekend.

The reason is that the interbank market in Europe is seizing up again. No bank trusts another bank because of exposure to debtor countries like the Greeks, the Spaniards and us.

According to a BIS report last week, French and German banks had exposures of $958 billion (€776 billion) to Greece, Spain, Ireland and Portugal, including $174 billion (€141 billion) of government debt.

This is the sort of debt that could destroy the German and French banking system.

The markets realise this, and it is this threat that has the politicians and central bankers back chattering on about stress tests.

The EU’s politicians have announced they are going to stress test 25 of Europe’s banks but, without any of these banks being declared bankrupt after the stress test, the test is merely another symbolic – and credibility-draining – gesture.

Are they prepared to say which banks are bust and which are not? The tests will have to identify those banks that need an immediate injection of equity. If they don’t do this, the markets will conclude that the banks are all in a mess, and sell them all accordingly.

Any further sell-off of European bank shares tightens the credit crunch further, and the interbank market gets less liquid. This is the economic backdrop to this weekend’s meeting of our EU leaders in Brussels. Amazingly, the leaders are yet again driving an agenda to cut budget deficits right back. With no signs of internal demand and a banking crisis, where do these guys think Europe’s growth will come from?

The Baltic Dry Index, one of the most reliable indicators of global trade, has weakened for the past 15 days as demand for freight and raw materials has dropped in Europe and America. Without growth, the EU’s recovery will falter. If this happens, the peripheral EU countries – Ireland included – will not be able to pay the huge bank debts built up in the credit splurge, and we will default.

This default will initially be a cumulative process in the private sector but will eventually pass to the sovereign government. After all, the sovereign is only the aggregation of us – the private citizens – so, once we wobble, the state does too.

This fundamental economic truth seems to evade our politicians. They don’t seem to realise that the more blank cheques they write to shore up the European banking system, the more they are burdening us with future taxes. This tax burden causes the economies to contract more. Writing cheques to bail out Europe’s banks won’t help anyone, apart from the creditors of the banks – who should suffer anyway. This is how capitalism works.

The lender is as culpable in a crisis. Was that not the capitalism you learned too?

If the government increases spending to invest in productive assets, like education or infrastructure, it means that, on one side of the balance sheet is debt, but on the other side is an asset, the productive investment which increases the long run growth of the country. This is beneficial spending, because it increases productivity and thus offers a return on investment.

If, on the other hand, governments are spending money to shore up the balance sheets of the banks because the banks have made bad investments in Greece, Spain or Ireland, this is a waste of public money. In this case, the debt is on one side of the balance sheet while, on the other side, instead of productive asset, we have collapsed property loans.

Thus it is easy to see now how the ECB is operating a proper ‘‘cash for trash’’ scheme. Worse still, the ECB is fuelling a new Ponzi scheme to keep the banks afloat. Here’s the deal: the ECB is making credit available to the banks at historically low rates of interest.

The banks are then using that money to buy higher yielding government bonds to try and rebuild their balance sheets. So the ECB is sponsoring what is called in finance a European-wide ‘‘carry trade’’, which is when you can borrow cheaply and lend out more expensively.

This is the strategy to keep the banks alive. So if this is the central banks’ strategy, why are governments cutting back now? Surely the thing to do now is issue more debt, avail of cheap credit and rebuild the banks’ balance sheets – and a few bridges, literally.

It is now time for big infrastructural projects, with the state doing what America did in the 1930s and spending money to turn the economy around. This is what the ECB is tacitly inviting politicians to do with this new form of quantitative easing.

The best policy for now would be for the stress test to reveal a few bankrupt banks and for these banks to be closed down immediately, with consequences for the exposed creditors. Once that has happened, the markets would be assuaged and they would come back in to support fewer, stronger European banks.

All the while, the better banks could be allowed to rebuild their balance sheets using higher yielding government securities.

The quid pro quo would be that government capital expenditure would rise, not fall. In fact, capital expenditure should be accelerated, not decelerated.

Once growth resumes and the banks are in better shape, the state can cut back.

But in the EU the left hand doesn’t know what the right hand is doing. The ECB is implicitly saying ‘Go for it’, and the politicians are saying ‘No, halt everything’. This proves that crises produce the oddest of turnabouts.

Traditionally, central banks tell the politicians not to spend, that money is tight and that we have to keep credit manageable. Today, however, politicians are acting like tight-arsed central bankers, and the central bankers like free-spending politicians.

All the while, bad banks are kept open, when closing them down would be the first stage of the recovery.

  1. Malcolm McClure

    I am intrigued by the analogy between BP’s problems with its Macondo well and the banks’ dizzying debts. And between the Macondo Blow Out Preventers (BOPs) and the banks’ Stress Tests as last ditch defences against disaster.

    David writes: “The famous stress test was used to assuage fears about the Irish banking sector in 2007. But the mighty stress test proved to be useless. The Irish banks are now bust, with a hole in their collective balance sheets in the region of €200 billion.”
    €200 billions is ten times the amount BP has had to put in escrow to cover the costs of compensating businesses at risk from the oil spill and cleaning up the entire Gulf of Mexico coastline. (Ten times what is considered ‘A Lot of Dough’, which was enough to drop BP’s credit rating by three notches to A2).
    The BOP was there to provide a last ditch protection against disaster as was the2007 bank stress test. Officials of both organizations relied on these to shortcut all the other safeguards carefully established by generations of painful experience. The result in both cases was an uncontrollable disaster.

    Now we are being told by the ECB that the new stress tests will provide security in future.
    Just like the oil companies are hoping that an uprated BOP will get them back to business as usual in the Gulf of Mexico.

    We never learn.

  2. Oil – commodity or utility?

    Credit – commodity or utility?

    So far, both are handled as commodities and so profiteering results, and with oil and credit provision alorra bounty to be had if you can keep the ‘small people’ at bay.

  3. David says : …..’the private citizens so, once we wobble, the state does too.’

    The Land of The Wobble

  4. drick

    just a comment on a different subject, earlier i read the irish goverment will issue certfificates of irish heritage, it really is embarrasing as an irish citizen here in australia that the goverment would stoop to this level of revenue collecting. IS THIS ALL FARMLEIGH COULD MUSTER?? I REALLY AM ASHAMED!! IF THEY WANT TO SOMEHOW TAP INTO THE DIASPORA ,THIS IS NOT THE WAY. SHORT TERM GAIN AS USUAL.

  5. SM

    Is it true that AIB was bailed out in the 1980s and they never paid it back?

  6. SM

    Ah yes, ICI. Reason for the 2% levy on insurance.

  7. Philip

    This is definately the most apocalyptic article to date. As well as vindicating by 110% the assertions of the financial ponzi scheme conspiracists (Wills being the most vocal and direct)it also seems to directly align with the 4 weeks of moon wobbling a la John Allen. And then Malcolm tops it off nicely with a rather worrying comparison with the BO disaster.

    However, I think I know what is fundamentally different now. This kind of crap went on for ages in somebody elses back yard. Argentina, Bhopal etc. Now that it’s in the nice cuddly US and Europe, the rules are different. Not easy to ignore anymore and the politicans now have a local smelly issue on their hands and they are not used to making courageous decisions. This is the real crisis lads. A crisis of spineless leadership – leadership and power obtained by nepotism and cronyism for decades and without question or crisis and the hens have come home to roost.

    • Philip

      BO=BP (Mex Gulf)

    • Philip, its gone mainstream now the idea a Ponzi racket is running Ireland’s economic and political policy once it’s put through Davids writing mill.

      David the article I think is spot on. Clear deductive and concise in common sense and real facts and telling it like it is cooly, calmly and no effects.

      Looking at all of this through a ‘Ponzi racket’ len’s really makes sense of the decisions been made by the insiders occupying the power centers behind the central bank money making castle walls, it really does.

      I reckon the ‘insiders’ view paper money and fractional reserve banking credit making as counterfeit currency and view oil as the real currency and play pretend too the outsiders that paper money is anything other than what their experts always call it ‘liquidity’. These insiders know paper money and banking credit is valueless and meaningless and limitless and its all a game of *confidence* and *illusion* making / a type of kabuki theatre given to the masses / outsiders spellbinding the paper money illusion on the masses in order to keep the feudal two tier system in place business as usual.

      The real currencies like oil and mineral wealth behind the fiat paper money economy spoofed onto the outsiders the insiders get to keep and so get to keep in power and in endless real wealth and out of reach from the eejits fooled into thinking the economy is all held together by paper money.

      • Also, is it no wonder the insiders hold in contempt the outsiders when all they see is people sellign their integrity up the swanee for more and more profiteering, profiteering for what…??? More paper money for god sakes…….!! the outsiders need to wake up and see paper money is a con job and stop playing into the paper money illusion holding the central banking tyranny in place.

  8. Greetings from the hols in Vegas:) Great article from D. USA Today, Money Section, ‘Rate of bank failures double that of ’09′, puts number so far at 83. ‘By this time last year regulators had closed 40 banks’. ‘The number of bank failures this year is expected to peak this year and be slightly higher than the 140 that fell in 2009. Meanwhile on CBS this morning stocks are up, economy is doing fairly well bolstered by news the yuan is about to be allowed to float, this should help both US exporters into China and be a boost for home produced goods competing against Chinese imports.

    Allowing banks to fail is a healthy part of the economic cycle when bad policy and management decisions are at fault. Putting taxpayer money into unhealthy and badly managed banks is a disaster for taxpayers and the economy.

    According to D, ‘According to a BIS report last week, French and German banks had exposures of $958 billion (€776 billion) to Greece, Spain, Ireland and Portugal, including $174 billion (€141 billion) of government debt.’ Its possible the figure could be much larger with Spanish caja banks having an exposure of up to 2.5 trillion. The stress testing of the cajas in particular should show the real exposure but as D says the exercise in the past has proven to be fault prone to the extreme.

    I believe the stress testing is an exercise to decide which banks are worth supporting with the ECB bailout fund. Banks that fail the test, about which we need greater clarity on the precise terms of the tests, will like Cajasur we allowed to wind down and fail. ECB is not unilaterally going to support every bank so there will be a dolly mixture of shoring up as D describes and wind down. Whether ECB has enough collateral to cover all bets is another matter.

    Regarding the disasterous decision to shore up the failed Anglo which by any test, legality of its operations, competence/legal observance of management, failed business model, enough said.

    Our Government is choking itself and our economy to death. It may appear foolish to do as D says to spend money on infrastructural projects and not impose austerity measures in this area. Great value can be had from construction projects at the moment, much would return in tax, live register disaster could be averted, we need a tracheotomy or the patient may die!

  9. Mad as Hell – Kown opens a China Town in Athlone right on his doorstep .Limerick is experiencing the 2nd Broken Treaty from Fianna Fail .Limerick has more infrastructure than Athlone and deserves it .

    Just a Kow Kam Kown only good for Kuick Koop

  10. Franca Flak – I was talking to my foreman in Nice today and he wanted the update on French economy .He said the French are only talking about Soccer now and nothing else.I told him French banks are burst .He confirmed he would believe it as the propaganda suffered by the French now is greater than what we have to experience.He went away worried.

  11. Whiteboys – these were the earlier nucleus that believed in a mind of their own and acted upon it .

  12. Tull McAdoo

    1.Patrick Sneary the Financial Regulator has some very serious questions to answer. A very simple warning sign used by Regulators to identify a Bank exposed to increased risk is rapid balance sheet growth. An annual growth rate of 20% real is often taken as the trigger. Each of the guaranteed Banks had at least 1 year where that threshold was triggered, but Anglo triggered in 8 of the 9 years between 1998-2008 with an annual growth rate of 36%( yes you have read correctly). Irish Nationwide triggered in 6 of the 9 years with average of just over 20%. So this was a very obvious and public danger sign not only for these two Banks, but because of the destabilizing effect of RECKLESS competition on the entire sector. (Ref. Honohan jan 2009)
    2. In March 2006 Sneary increased capital requirements for Banks.The requirement would be for “Banks to set aside MUCH more capital” to back 100% loan to value ratio mortgages. He moved the capital requirement fom 4% (wait for it folks) to 4.8% or an extra 4 grand on a 500,000 loan.
    3. While stress testing loans in 2006(results are dubious) it was found that between 1.6 and 6.1 % had LTV of more than 92% by the end of 2007 that figure had gone up to 60% greater than 92%LTV.with terms of 30 years and greater having become commonplace for first time buyers. It was not clear if developer loans were explicitely looked at in the stress tests. His published findings do not state if all Banks would have remained solvent under stress test. P.S. The stress tests performed in CBFSAI (2006) were predicated on house falls of 20%.
    4. Any calls for more Capital reserves now will mean a withdrawl of money from circulation at a time when we are experiencing a downward deflationary spiral. Honahan knows this and this will be a test for his ability, to do what should be the Academic exercise of setting aside capital, with the political effects this has in the broader community. Honohan should know that money taken out now will lead to a further contraction of GNP, which will feed back into his stress tests or in the words of Bertie the Ditherer “ make them more stressier” HA .

    • TULL, you nailed it there. Right there under the nose, expanding business at a ‘rate of knots’ for a bank which flashes a warning light something is up. ANd in this case we now know an engineering of a property POnzi bubble making a band of brothers extremely rich and making debt very deep and hollowing out the celtic tiger into a slush puppy.

  13. Colin

    “It is now time for big infrastructural projects, with the state doing what America did in the 1930s and spending money to turn the economy around.”

    I couldn’t agree more. Its badly needed. Hand all the landowners (where new projects are to proceed through) a green jersey instead of a cheque with 6 figures on it.

    Make the cyclist the dominant mode of transport in the city. Protect this hero who reduces traffic congestion, reduces obesity rates, improves work performance, reduces polution (noise and air)in the urban area and saves time on the part of everyone. Encourage parents to opt for school buses instead of taxi runs to and from school.

    • Greetings from the hols Grand Canyon South Rim Village:) Saw the Hoover Dam today. What an engineering project 1931-35? So where’s the eco friendly, large scale infrastructural project targeting energy supply, construction, live register. from the dead Amish on dead Ireland Inc. OT, Tull thumbs up, Wills + 1 above. No life jackets from the FF dead end, last stop.

  14. Gege Le Beau

    Some industrious person has done some of the work………..

    Families in the Orieachtas (I like they way they say people ‘inherit’ the seats…….wonderful democractic process we have)

  15. coldblow

    Another excellent article from DMcW which again captures the situation in simple terms: central bankers trying to rescue the sitation while politicians (presumably stampeded by the media) are more and more obsessed with deficits and balancing the books. I mean, it’s worrying to say the least when the only people with any ‘vision’ might be in the ECB.

    I thought the lessons of beggar-your-neighbour policies attempted 80 years ago were reasonably uncontroversial. Isn’t retrenchment at this point a bit like sending Paras into Derry after already witnessing the results in West Belfast of similar actions six months earlier? (‘These people are breaking the law, they must be taught a lesson.’ – looked at technically they might have had a point but in real life terms it was clearly mad.) What’s going on? How has Clegg done a U-turn on this issue, apparently after a private meeting with Mervyn King? Have they all been ‘training at altitude’?

    And just to take up the point about the culpability of lenders. If this were recognized in law with appropriate penalties, how’s that for a mind-boggling idea?

  16. John.Finnan

    I recently did some quick back of the envelope calculations to see how much it would cost to supply Irelands energy needs under solar power. A section of land 8km by 12km covered in 90 watt solar cells would do it. Cost would be around 50 billion euros.

    For the same amount of money, we got NAMA.

    If we had taken that money, and produced the 120 million of solar panels we’d need, we would have a new green industry, with jobs. Mass production on such a scale might even bring the cost down, and we’d be virtual world leaders in solar panel production overnight.

    Or, NAMA.

    It’s an easy choice, I suppose. Bankers must be fed.

    http://www.spiritofireland.org – Energy independence within 30 years.

  17. coldblow

    Recent article from Roubini:


    This bit applies to Ireland:


    Seventh, in countries where private and public debt levels are unsustainable – such as household debt in countries where the housing boom has gone bust and debts of governments, like Greece’s, that suffer from insolvency rather just illiquidity – should be restructured and reduced to prevent a severe debt deflation and contraction of spending.

    I can’t follow the syntax. I think he means debt should be restructured and reduced.

    The other recommendations, eg for the likes of Germany to stop saving, require interantional coordination.

  18. coldblow

    And here’s the site where I found the above link:


  19. In the last two weeks Pery Square and around the Park in Limerick is Empty of cars parking .In the past any driver would have to fight very hard to find a space of any kind.Many I have met are commenting and there is an eerie feeling of something worse to come.
    The Void of Emptyness

  20. coldblow

    Me again.

    This link to an article by Michael Hudson taken from his website is easily the best global analysis I have seen to date. No doubt others will have posted this here before and I will have missed it.


    Sums up and explains an awful lot of stuff that had been going through my mind. It’s long – it takes a good hour to read. Can’t quote as I wouldn’t know where to finish.

    The following recent article by Hudson is also relevant here:


    Here’s the start:
    “The “Greek bailout” should have been called what it is: a TARP for German and other European bankers and global currency speculators. The money is being provided by other governments (mainly the German Treasury, cutting back its domestic spending) into a kind of escrow account for the Greek government to pay foreign bondholders who bought up these securities at plunging prices over the past few weeks.
    They will make a killing, as will buyers of hundreds of billions of dollars of credit-default swaps on the Greek government bonds, speculators in euro-swaps and other casino-capitalist gamblers. (Parties on the losing side of these swaps now will need to be bailed out as well, and so on ad infinitum.)
    This windfall is to be paid by taxpayers — ultimately those of Greece (in effect labor, because the wealthy have been untaxed) — to reimburse Euro-governments, the IMF and even the U.S. Treasury for its commitment to predatory finance. The payment to bondholders is to be used as an excuse to slash Greek public services, pensions and other government spending.
    It will be a model for other countries to impose similar economic austerity as governments run up budget deficits in the face of falling tax collections from the financial sector being enriched by the translation of junk economics into international policy. So the bankers for their part will have little trouble meeting their bonus forecasts this year. And by the time the whole system collapses, they will have spent the money on hard assets of their own.
    Financial lobbyists are using the Greek crisis as an object lesson to warn about the need to cut back public spending on Social Security and Medicare. This is the opposite of what the Greek demonstrators are demanding: to reverse the global tax shift off property and finance onto labor, and to give labor’s financial claims for retirement pensions priority over claims by the banks to get fully paid on hundreds of billions of dollars of recklessly bad loans recently reduced to junk status.
    Bank lobbyists know that the financial game is over. They are playing for the short run. The financial sector’s aim is to take as much bailout money as it can and run, with large enough annual bonuses to lord it over the rest of society after the Clean Slate finally arrives. Less public spending on social programs will leave more bailout money to pay the banks for their exponentially rising bad debts that cannot possibly be paid in the end. It is inevitable that loans and bonds will default in the usual convulsion of bankruptcy.
    Greek labor is not yet so pessimistic as to give up the fight. What it recognizes that its American counterparts do not is that somebody will control the government. If labor — the demos — loses its spirit, power will be relinquished to foreign creditors to dictate public policy by default. And the more the bankers’ interest is served, the worse and more debt-burdened the economy will become.
    Their gain is bought at the price of domestic austerity. Scheduled payouts by Greek pension funds and government social spending programs must be to replenish German and other European bank capital.”

    And the end:
    “Will the belated shift of German voters to back the Social Democrat red-green coalition with the Green and Left parties do much to stem matters? Probably not. Greek President Papandreou acquiesced in the cave-in despite being head of the Socialist International. So the question is whether Greece really is checkmated, destined to see its public spending, pensions, health care, schooling and living standards rolled back in the way that the Baltics have experienced. They have been an experiment in neoliberal central planning. If they are an example of what the future is to bring, the world will soon see a wave of Greek emigration, Baltic-style.
    That evidently is what stock markets around the world anticipated when they soared on Monday morning at the news of Europe’s trillion-dollar bailout.
    What really was bailed out is the principle that economies should be stripped so that finance capital may rule.
    But the fight surely is not yet over. It will escalate for the remainder of the 2010s, because it is nothing less than an attempt to roll back the history of the 19th and 20th century’s struggle to replace the power of vested property and financial interests with principles of progressive taxation and public enterprise.
    Is this where Western civilization really is supposed to be leading? Confronted by parliaments controlled by aristocracies, the 19th-century reformers sought to take them over on behalf of democracy. Classical political economy was a reform program to tax away the “free lunch” of land rents, monopoly rents and financial interest extraction. John Maynard Keynes celebrated this program in his gentle term, “euthanasia of the rentiers.”
    But the vested interests have fought back. Calling social democracy and public regulation “the road to serfdom,” They are trying to set Europe’s economies on the road to debt peonage. Making an end-run around national elected governments to impose the Washington Consensus IMF and EU institutions have gained fiscal and economic control over governments and their tax policies to cut taxes on wealth — and borrow from it to finance the resulting fiscal deficits.
    America’s Tea Partiers and anti-tax rebels have given up the fight to reform governments. Squeezed by debt from which they see no escape, they demand lower taxes — and are willing to see the highest brackets become the major beneficiaries in an even more regressive tax shift. Faced with the corruption of Congress by lobbyists acting on behalf of the vested interests, they reject government itself and seek safety in local gated communities. They see Congress and parliaments throughout the world losing autonomy to the IMF, the EU and other Washington Consensus organizations seeking to impose austerity and shift the tax burden onto labor and industry, off property and off predatory finance.
    The only way to prevent a regressive tax shift and debt squeeze is gain control of governments on behalf of the spirit of classical economic and Progressive Era reforms. At least, that is what Greek labor is rioting for. Someone must control government, and if democratic forces withdraw from the fight, the financial sector will tighten its grip.
    Last week is still only the beginning of how this drama will play out. The response by the post-Soviet economies, which have retained their own currencies, is to come this summer and autumn.”

    It’s plain to see what the oligarchs are at. What on earth are our politicians at?

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