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Sunday, 22 October 2017

IMF's Lagarde, Mutti Merkel, and British economic suicide

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Anthony Peters, Swiss Invest Strategist

Anthony Peters, Swiss Invest Strategist

Is the IMF getting uppity or is it finding the courage to tell European governments what the markets have been telling them for the past year and a half but for which they have been accused of being vicious, vindictive and wrong? If you recall how adamant European authorities were that DSK had to be replaced by a European in order to assure the IMF’s continued sympathy for the financial situation of some of the eurozone members, then you might find the burgeoning conflict between the IMF and the Europeans of interest.

There is a sort of “How dare you….?” attitude which is being taken within European authorities when faced with external criticism. The position in which they find themselves doesn’t actually inspire a whole load of confidence in their understanding of what is besetting their financial system and, as I learnt many years ago from one of my bosses in my early career at Barclays, if you don’t know where you’re going, you don’t know when you’re lost. President Sarkozy was on the tapes again declaring that what he termed the markets’ “attacks” on Spain and Italy were unjustified; we have yet to hear anyone other than UK Chancellor George Osborne acknowledge that maybe the markets are right and the policies may be wrong. Alas, now that Christine Lagarde has swung her handbag at the European banking sector, we can expect Mutti Merkel to swing hers back.

Mandy Rice-Davies – ’They would, wouldn’t they?’

There was already discomfort with Mme Lagarde’s suggestion that Europe’s banks were suffering from a significant lack of capital. European politicians and regulators alike rounded on her for that comment but, in the immortal words of Mandy Rice-Davies, well, they would, wouldn’t they?They hold against her that the European banking sector has raised some €60bn in new capital so far this year and that banks which failed or just snuck in above the line in the stress tests in July have until October to submit plans for strengthening their capital base. However, the IMF is back on the attack with its impending Global Financial Stability Report (GFSR) which has the eurozone authorities back on the barricades before it is even officially published.

The analysis for the GFSR concludes that a full mark-to-market of European banks’ holdings of eurozone debt could wipe up to €200bn off their capital base. It goes on to suggest that if the cross-holdings in bank debt were added in, then the number could be considerably higher than that. ECB and governments have already rejected the number because the IMF had used a generic valuation based on sovereign credit default swap pricing which is too inaccurate for the purposes of calculating the value of sovereign bonds held on the balance sheet. Furthermore, I understand that they also question why, if the losses on peripheral bonds are being held high, why the concomitant profits on holdings of German Bunds are not being used to offset losses.

Business Secretary Vince Cable, the inquisitor and witch hunter-in-chief, wants to get his hands on the banks now. The banks are screaming blue murder and the CBI is backing them

There used to be a principle of valuing assets at the lower of cost or market. Germany held on to this for much longer than most as it took the view that a profit without a corresponding cashflow was dangerous. How, the thinking went, could you pay tax on a profit if you didn’t bring in money to do so. Therefore it regarded book profits as a damaging thing as a business’ cashflow could be strained for the wrong reasons. Bankers, of course, hated this because they spent their life paying themselves bonuses on positive marks rather than on realised profits. The games played with first loss pieces of RMBS structures are a case in point and one which should be a salutary lesson to proponents of strict mark-to-market.

The argument seems to me to be a bit like the one between the US Administration and Standard & Poor’s over the downgrade of US Treasury debt and the valuation of the cuts required. Borrowing and lending requires as much holistic thinking as it does science. Once again Jacobellis vs Ohio springs to mind and US Supreme Court’s Justice Potter Stewart’s words on pornography “I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it….”

Of course, banks need very clear rules as to how to value assets and report exposures but just because the rules are clear it does not logically follow that they are right. The IMF might not be making life easy for the eurozone and its way of assessing the needs of the banks may not be the same as that of the European authorities, but given the mess into which existing structures have permitted the system to fall, the wholesale and vitriolic dismissal with which it has been met does the battered credibility of the Europeans no favours and might even inflict yet more damage.

All the while, here in the UK, there is a running debate about what has become known as “ring fencing” which is supposed to split the risks of investment banking and retail commercial banking. That is nothing more than a very watered down version of the Glass-Steagall Banking Act of 1933. Business Secretary Vince Cable, the inquisitor and witch hunter-in-chief, wants to get his hands on the banks now. The banks are screaming blue murder and the CBI is backing them. Having lived through May Day, Big Bang and all that and having seen Glass-Steagall dismantled, I must confess to thinking that it was probably a mistake to deregulate the entire shooting match and rolling back deregulation might not be such a bad idea.

However, to try to do it in one country and one which is so dependent on being the home of one of the world’s top three financial centres without global co-ordination looks like another classic act of British economic suicide driven by moral ideology rather than business logic.   

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