Friday, October 07, 2011

Moral Hazard

Under the striking sub-headline from South Sea Bubble days:

"… For Carrying Out An Undertaking Of Great Advantage, But Nobody To Know What It Is...

...Acting Man blog yesterday tackled the issue of moral hazard, which near the posting's end, carried this clear warning against the increasingly mad mouthings of the EU's central bankers, appointed Commissioners and political leaders:

.... guarantees and backstops are precisely what creates the moral hazard situation. Neither do the banks have to fear a bank run, nor do their customers fear for the safety of their deposits. Most depositors are of course aware at some level that not all depositors can really be paid in extremis. They only trust that they themselves will be paid, either via this system of guarantees or by dint of recognizing in time when trouble strikes and being among the first to demand their money back. Our point is that this state-supported system of fractionally reserved banks has been invited to take risks that far exceed its capacity to withstand adverse developments. Thus it has now been discovered – practically overnight – that the system is 'short of at least € 200 billion of capital'. This is however a not very stringent assessment as you can see from the numbers we have cited above. In reality, the banks are de facto insolvent vis-a-vis their depositors. To make good on their promise to pay all sight deposits on demand, they would have to massively shrink their asset base in order to bring the amount of uncovered money substitutes down to a level where they are fully reserved. Governments and central banks are eager to avert a deflation of  the extant fiduciary media, not least because they are in part used to fund the sovereign debt holdings the value of which is now imploding due to the debt crisis.

All well worth considering as the weekend is about to begin, with Merkel and Sarkozy now scheduled to meet, but openly disagreeing over help for the banks and Moody's downgrading a whole swathe of European Banks, including the following in the UK:

Ratings agency Moody's cut its rating on Royal Bank of Scotland by two notches, downgraded Lloyds by one notch, and cut its ratings on Santander UK, the UK arm of Spain's Santander, the Co-Operative Bank, Nationwide Building Society and seven other smaller British building societies.



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