The Hindu Business Line : Can Govts, central banks take out risk?

It started with delayed mortgage payments, delinquencies and foreclosures, soon spread to credit seizures in interbank markets as banks realised the illiquidity of their mortgage assets and CDOs (not to speak of their toxicity) and the perilous condition of institutions which had sold credit protection.

In the beginning, it seemed the issue was banks being unable to fund these assets.

But, soon, the Fed, ECB and Bank of England provided much-needed lifelines. Still, the problems only got worse. The size of the ‘bad’ and illiquid asset portfolios of banks grew by the day.

Central bank lending to salvage the situation multiplied (collectively) into trillions of dollars of asset buy-outs, capital infusions and takeovers. Stock markets crashed. It was more than governments and central banks could take.

Govts’ babes

Throwing in the towel, they have guaranteed all bank deposits and liabilities. The UK is about to own more than half of two of its biggest banks and the US too is on the verge of acquiring stakes in its major banks. All sides of the balance sheet (and off balance sheet) are now governments’ babies.

The collapsed banking system is now effectively government-controlled in the world’s richest countries and free market economies.

Illusory profits

Its vast profits of the past were illusory. But the dividends and bonuses paid, stock options awarded, exercised and sold and mansions, second and third homes, luxury goods and yachts forming the life style of bankers were real. The bills are being picked up by the man on the street.

Capitalism is supposed to be about risk and rewards, but its modern version has turned out to be the biggest con game and rip-off in history.

The funny thing is there is no choice but to rescue those who have gotten into trouble, otherwise all of us will go down. Governments, central banks and the public may seethe with rage, but the fact is they have been outsmarted and nothing can be done except to grin and bear it.

The remedy

Have the problems been licked? What is needed is banks lending to one another freely at or near the interest rates of central banks - the US Fed’s 1.5%, ECB’s 3.75% and Bank of England’s 4%. Credit risk spreads on non-bank and mortgage lending must back down. In short, business appetite among banks must increase to pre-crisis levels, even as we battle the crisis.

That means governments and central banks have to take risk out of the economy and financial markets if they are to get the credit wheels moving and back to normal quickly.

That is going to be a worthy test of their innovative and radical thinking.