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“Too big to fail” is still with us

Published at: 14-09-2018

Posted on: September 14th, 2018 by RaduC No Comments

Ten years after the Lehman Brothers collapse a question is on everyone`s lips: can this happen again?

The worries around such a possibility are completely justified by the crisis that Ben Bernanke, a former FED Chairman deemed the worst in mankind`s history, surpassing, therefore, the Great Depression which broke out in 1929. The reason is first and foremost, the speed with which it spread across the US and the world`s economy. Let us not be fooled by the fact that, unlike the 1929 crisis, its consequences were mitigated by governments and central banks, as the long-term impact of their measures is yet to be fully understood.

Moreover, the effects will linger for quite some time, if, of course, the economic system does not find ways to adjust itself. One cannot help wondering about what will finally happen with the vast amount of new money printed by central banks in the developed countries, in general and by the Fed in particular. At the end of the day, it was and still is an experiment dictated by the despair of preventing the meltdown of the global financial system and an economic crash. But it is an experiment whose final outcome we are about to find out.

Has it been worth it? Has the house been at least put in order? At first glance, the economies of the main economic areas seem on the rebound. Moreover, the US economy shows signs of overheating as the number of available jobs currently exceeds the number of American jobseekers. And yet, the long period of low interest rates has again led to bubbles, with the US housing industry being the bubble déjà vu, re-inflated by excessive consumer debt.

Well, you might say, this time around, however, US and European banks will be on their own. There will be no bailing them out from public money on the ground that they are too big to fail. Alas, news is bad. The Economist pointed out in a recent article that the world`s top five investment banks, with one exception, are the same as 11 years ago and have a similar share of total revenues of 32.6%.  The five largest commercial banks in the US are the same as those prior to the crisis. Furthermore… The large commercial banks got even larger than before the crisis after taking over some of the small or mid-sized banks that had gone under.

It is true that there is still a silver lining. Unlike what happened in the run-up to the crisis, bank capitalization is much better after central banks imposed new standards. Tier 1 capital, as a percentage of risk-weighted assets, rose from 8.8% to 14.7% in the eurozone, while the US saw an increase from 9.8% to 12.9%. Meanwhile, the Fed is considering further tightening of capital requirements. At the same time banks base more of their core business on funding from customer deposits and less on debt.

Does this mean that top banks can no longer fail? They will most definitely have a harder time doing so which is headway which deserves recognition. And yet the “too big to fail” remains a huge challenge for Europe. This time is not even about banks. It`s about states. Countries whose default cannot be accepted without casting doubt on the very existence of the eurozone and even the EU. The European Central Bank`s requirements may be compulsory for banks, but not for states. Furthermore, larger states can afford to do what no bank could, namely resist the ECB, and the European nationalist and populist trends simply increase this likelihood.

This takes us to one of the major consequences of the crisis which seems to get rather worse than better: the financial impact of the crisis on people, in general and the middle class, in particular. And the overlapping migrant crisis does nothing but reinforce nationalist and populist movements as long as mainstream parties remain unable to understand the priorities and concerns of European citizens, either for being short-sighted advocates of some economic elites, or due to extreme political correctness.

And so we arrive at the first „too big to fail” state which announced that it cynically plans on playing this card till the end: Italy.

On August 13, as investors sold off Italian bonds worried by the ruling coalition`s budget policy, the president of the League nationalist party and of the parliamentary Budget Committee, stated: „I am as serene as the rainbow. Either the European Central Bank will guarantee Italy’s debt, or everything will be dismantled”. A statement coming from a eurosceptic leader of a nationalist party which boils down to ”we are too big to let us fail so you have no other choice than to bail us out irrespective of the decisions that we take”.

That is exactly the nightmare that any central bank would like to get rid of once and for all.

Have a nice weekend!

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