Why Banks Aren't Lending

Remember the old story about commercial banks?  Commercial banks only lend to people who don’t need to borrow.

Well, that seems to be the “truth” about bank lending now.  The story going around is that the larger banks have increased their business lending, but the lending is really only going to those institutions that have a lot of cash on hand.  Otherwise, the commercial banks will sit on their excess reserves.

This also seems to be the story in Europe: commercial banks are just not lending anywhere. (http://www.nytimes.com/2011/09/23/business/global/financing-drought-for-european-banks-heightens-fears.html?ref=todayspaper)

And, the relevant question is not “Why aren’t commercial banks lending?”  The relevant question is “Why should commercial banks be lending at this time?”

The first reason why many banks shouldn’t be lending right now is that there is still a large number of banks who may be severely undercapitalized or insolvent.  Many commercial banks have assets on their balance sheets whose economic value is substantially below the value the asset is accounted for on that balance sheet.

The most notorious case of this is the sovereign debt issues carried on the balance sheets of many European banks.  The values that many of these banks have on their balance sheets for these assets have the credibility that the recent “stress tests” administered to more than 90 banks by European banking authorities. (Note that the European Union moved today to recapitalize 16 banks, http://www.ft.com/intl/cms/s/0/49d6240e-e527-11e0-bdb8-00144feabdc0.html#axzz1Yj4RAJ9F.)    

But, the problem is not limited to Europe.  How many assets on the books of American banks have values that need to be written down to more realistic market values.  For example, small- and medium-sized commercial banks in the United States have a large portion of their loan portfolios in commercial real estate loans.  The commercial real estate market is still experiencing a depression and market values continue to decline in many areas.  The write off of these loans can take large chunks out of the capital these banks are still reporting. 

The bottom line here is that commercial banks that still have problems are not willing to take on any more risk than they have to while they still have to “work out” these depreciated assets, or, at least, wait until the markets recover and asset values rise once again to former levels.  If you don’t make another loan…it will not go bad on you…so why take the risk of making a new loan.

And there are 865 commercial banks on the FDIC’s list of problem banks and many more surrounding that total that have not met the specific criteria of the FDIC to be considered a problem bank. 

The second reason why many banks shouldn’t be lending right now it that the net interest margin they can earn on loans is hardly sufficient to cover expense costs.  I have talked with many bankers now that say the only way to make any money through bank operations is to charge for transactions.  That is, to generate fee income. 

A general figure that represents the expense ratio of a bank is by taking expenses and dividing them by total assets.  Recent data indicate that this expense ratio is in excess of 3 percent, being around 3.15 percent to be more exact.  This means that on basic lending operations a commercial bank must earn a net interest margin of 3.15 percent in order to “break even”. 

Is there a problem here?  You betcha’!

Adding to this dilemma is the fact that the Federal Reserve has added on a new “operation twist” to the mix.  All these banks need is a flatter yield curve. (See my post http://seekingalpha.com/article/292286-will-bernanke-policy-destroy-credit-creation-bill-gross-is-worried-it-will.) 

There are two ways to respond to a flatter yield curve.  First, one can take on more risk in their lending. (See http://seekingalpha.com/article/293893-some-banks-are-stretching-for-risk.) Or, commercial banks can attempt to earn more money through additional fees, or principal investments (private equity or venture capital), or through the assumption of systematic risk taking. (See http://seekingalpha.com/article/292446-will-bernanke-policy-destroy-credit-creation.) 

Is this what the Fed wants?  The Fed seems to be caught in the bind that it must be seen as doing something, even though that something may not be very productive (QE2) or even counter productive (leading to bubbles and other speculative activity). 

The take on Fed behavior during the Great Depression has been that the central bank did not do enough.  Hence, Mr. Bernanke and crew are taking the position that history will not brand them with the same interpretation.  For the past three years they have operated so as to avoid the claim that they did not do everything in their power to counteract the forces causing a great recession, slow economic growth, or economic stagnation.

And, here they face the possibility of “unintended consequences”.  If the flattening of the yield curve results in even less bank lending than would have occurred otherwise, the Fed could actually be exacerbating the situation.  The stock market declined upon hearing the Fed’s policy.

The third reason why banks may not be lending now is the absence of loan demand.  Fifty years of government created credit inflation has resulted in excessive debt loads being carried by individuals, families, businesses, governments (at all levels) and not-for-profit institutions.  People, faced with under-employment, declining asset values, and income/wealth inequities, are attempting to de-leverage.  This de-leveraging will continue until people feel more comfortable with their debt loads, or, the Fed creates sufficient inflation so that people will start to take on more debt again. 

If the Fed achieves the latter, then we have returned to the credit inflation situation that has existed for the past fifty years.  This period of credit inflation has resulted in an 85 percent decline in the purchasing power of the dollar, more and more under-employment of labor, and greater income/wealth discrepancies within the society. 

The fourth reason is the uncertainty created in “the rules of the game.”  The Dodd-Frank financial reform act has created a great deal of uncertainty within the financial community.  For one, only about 25 percent of the regulations have actually been written and only a portion of these have passed.  As a consequence, commercial banks don’t know what rules they will have to follow…or, even more important, what rules they will have to find ways to circumvent.  Another new set of rules, these on taxation, were introduced by President Obama this week.  George Shultz, former Secretary of the Treasury, has argued that new, complex tax proposals not only lead to short-term uncertainty about what must be dealt with, but that over time “the wealthy and GE” will find ways to manipulate the tax laws in their favor. (See my posts of September 20 and 22:  http://maseportfolio.blogspot.com/.)  But, unfortunately, people, families and businesses, will devote time and resources to dealing with these “rules of the game” and not allocate this time and resources to more productive activities.

Again, I raise the question “Why should banks be lending?”, not the question “Why  aren’t banks lending?”   

Something is Missing...

The Dow-Jones Stock Index dropped almost 400 points today. European stocks also dropped substantially…the FTSE 100 dropped by over 4 and one-half percent. 

European sovereign debt continues to grab headlines a the interest spreads on ten year bonds of troubled countries versus the yield on ten year German bonds remained near peaks. 

Today, the Economic Union moved to speed up the recapitalization of banks that did not show well in the recent stress tests administered to more than 90 banks.  “The move would affect mostly mid-tier banks. Seven are Spanish, two are from Germany, Greece and Portugal, and one each from Italy, Cyprus and Slovenia.” (http://www.ft.com/intl/cms/s/0/49d6240e-e527-11e0-bdb8-00144feabdc0.html#axzz1Yj4RAJ9F)  But, there is little confidence that this move will resolve things because the stress tests were such a joke!

Moody’s downgraded Bank of America, Wells Fargo, and Citigroup…and a couple of days ago a few European banks…that passed the stress tests. 

And, the top officials in the European Union continue to argue over this issue and they continue to argue over that issue and resolve little…but still hope to kick the can down the street a little further.  No one seems to be facing the real issues because their solutions appear to be so painful.   

In the United States, Ben Bernanke and the Federal Reserve attempt to grasp another straw in the wind as they continue to throw “stuff” against the wall, hoping that some of it sticks.  For three years now the Fed has thrown “stuff” against the wall but it must be too wet…for very little is sticking to the wall.  The Fed’s current monetary policy is to make sure that they throw all the “stuff” they have against the wall so that no one writing future history books can accuse them of not leaving any unused “stuff’ in the …

And, President Obama has come up with his new economic re-election platform disguised in the form of a jobs program, which includes new proposals to finance the program with various tax increases.  Since this combination is a part of the re-election campaign it must contain a little of this and a little of that to appeal to different parts of his voter base.  The problem with something like this is that it just makes the tax code more complex and provides incentives for the more heavily taxed…in the words of George Shultz, the former Secretary of the Treasury, ”the wealthy and General Electric”...to find ways to avoid bearing the burden of the tax. (See my post from Tuesday, September 20, “The Case Against the Obama Taxes”, http://maseportfolio.blogspot.com/.)   

Something is missing!

My answer has been and continues to be, that the something that is missing is leadership!

The problem is that there are no easy answers…no painless answers. 

People in Europe and the United States have been living high for fifty years.  The goals of high levels of employment and income re-distribution through the spread of home ownership have produced their consequences…excessive amounts of debt in households, businesses, national, state, and local governments. 

The economic policy of almost consistent application of credit inflation for the past fifty years has produced, in the United States, an 85 percent reduction in the purchasing power of the dollar, an under-employment rate of at least 20 percent, and the widest skewing of the income/wealth distribution in recent history.  If this is what credit inflation achieves…I don’t want it. 

Continuing to apply the policies of the past fifty years to the current situation will only exacerbate things.  We are facing an extended period of economic stagnation, at best, and a double-dip recession, at the worst.  Little or no growth in this situation will be accompanied with continued increases in the under-employment rate.  And, of course, continuing with all this stimulation with little of no economic growth will result in even more decline in the purchasing power of the dollar.

And,  as a consequence of the uncertainty related to the attempt to solve these problems, volatility continues to plague the financial markets.  Experts predict that the volatility of these markets will not subside until things settle down on the policy side and some true leadership is shown amongst our governmental officials and regulators.  That is, the volatility will continue until someone steps up to the plate and initiates a real solution to the existing situation.

The problem is that the main job of politicians is to get re-elected.  It is very clear to most politicians that resolving the debt-situation is going to be painful and many are already hearing the discontent of their constituents.  Riots in the streets of Greece and Spain are just a small indication of the disruptions that the politicians fear.  But, there is the fear that if they do too much they will not get re-elected.  The are caught in the trap of having to do something…but not too much.   

The financial markets…the economy…are getting no clear vision of what the future may look like.  They don’t know what their taxes are going to be.  They don’t know what the rate of inflation will be. 

All the financial markets…and the economy…can do is go up…and go down…

Something is missing and the problem with this is that no one in the financial markets…or the economy…can identify where the leadership is going to come from. 

Can you?

European Banks Too Fragile To Afford Greek Default

Check this out...European Banks Too Fragile To Afford Greek Default...http://www.bloomberg.com/news/2011-06-06/european-banks-capital-shortfall-means-greece-debt-default-not-an-option.html.

And, read my post: http://seekingalpha.com/article/273108-on-european-and-u-s-credibility.

European Credibilty

In a solvency crisis, the question of credibility always arises.  The issue is one of trust…who can one trust?

The European Banking Authority (EBA), which opened for business this year, is now under the gun.

One of the jokes of the earlier European sovereign debt meltdown was the stress test that was administered to European banks.  The “stress” of the tests were not that stressful and the results were dismissed as irrelevant.

One goal the EBA set out to achieve was to administer a stress test that was credible and would provide a “realistic” view of how European banks would weather a new round of financial distress.

The tests were begun in March…the results of the stress tests were to be released in June.

The EBA has now asked banks to resubmit their information because “The EBA is currently assessing and challenging the first round of results from individual banks.  This will mean that another round of data will be required…Errors will have to be rectified and amendments made where there are inconsistencies or unrealistic assumptions.”

That is, there are “concerns that some countries and institutions made mistakes or used overly rosy assumptions.” (http://www.ft.com/intl/cms/s/0/cf770d00-8c6f-11e0-883f-00144feab49a.html#axzz1O1hWLIwZ)

But, there seems to be another problem imbedded in these European stress tests.  “As with 2010, the EBA has also failed to include the possibility of a sovereign debt default, in spite of bail-outs in Greece, Ireland, and Portugal.”

What?

Much of the discussion surrounding the issue concerning what the European Union should do about Greece and the restructuring of Greek debt hinges on the inability of European banks to handle a write-down of Greece’s sovereign debt. 

I quote from my Tuesday morning post:

“Moody’s Investors Service estimates the European banks hold about €95 billion in Greek sovereign and private debt—and could lose one-third of it in a worst case scenario.”

European banks hold some €630 billion in Spanish debt. If Greece defaults in any way, shape, or form, the question is, “What about Ireland? And, Portugal? And, Spain? And, Italy? And…?” (See http://seekingalpha.com/article/272549-how-long-will-the-bailouts-continue.)

Where is the credibility in the stress tests, even if the banks use more pessimistic scenarios in the information they resubmit to the EBA?

And, as I suggested yesterday, leaders in America should be paying attention to the lessons being generated by the events now going on in Europe. (http://seekingalpha.com/article/272746-european-choices-continue-to-narrow-more-debt-is-not-the-solution)

The monetary and banking authorities are facing a situation in which one out of every seven commercial banks in the country is on the FDIC’s list of problem banks.  About one out of every four commercial banks in the country is “troubled.”  The number of banks in the banking system dropped by 320 banks in 2010 and we are on track for the number of banks to decline in 2011 by about the same number, which is about 5 percent of the commercial banks in the United States. 

The American banking system is not that healthy.  And, as a consequence, commercial banks, as an industry, are not lending.  The housing market continues to sink.  And, commercial real estate continues to be listless.  There are big pieces of the economic picture missing.

Maybe the leaders in the United States need to admit to these problems.  Maybe they need to learn something from the European situation in which the severity of the banking problems are hidden in incomplete stress tests while the whole “relief” program for Greece…and others…are being based upon the weaknesses in the banking system. 

The credibility of the European leadership is not doing well in the face of their lack of transparency.

The credibility of American leadership is facing similar shortcomings.

Maybe this is why Sheila Bair is leaving the FDIC…the end of her term of appointment being just a convenient excuse.  Maybe Sheila Bair knows something that the current administration does not want out in the public domain. 

My friends tell me that if the way a person talks does not match up with the way a person walks…then there is a credibility problem!  That is, watch the hips…not the lips!

I see this problem in Europe.

I see this problem in the United States.  President Obama and others in his administration, Ben Bernanke and Tim Geithner, are explaining their actions in ways that do not seem to be consistent with the facts.  The result is public and investor confusion, uncertainty…and discontent…with their policies.

Europe does not seem to have anyone that can provide the leadership it needs…and this does not bode well for its future.

One keeps hoping that Obama will step up and provide the leadership for the United States.  But, I am afraid that this will not happen.  After all the number one responsibility of any government official is to get re-elected.  And, we are in that season.      

More Stress Tests Coming for the Banks of Europe

We have been given Quantitative Easing 2 (QE2) by the Federal Reserve System in the United States and now we are facing Stress Tests II (ST2) to be imposed on banking institutions in the European Union. (http://professional.wsj.com/article/SB10001424052748703994904575646903413631856.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj)

Will we eventually be facing Financial Reform Act II (FR2) that will incorporate the next round of regulatory reforms of the financial system of the United States?

I put this new round of stress tests for banks in the same place I put QE2 and the initial Financial Reform Act of 2010 and Basel III (B3)…in the dust bin. For my comments on QE2 see http://seekingalpha.com/article/234814-the-fed-s-850-billion-bet-negative-long-term-implications; for my comments on the Financial Reform Act see http://seekingalpha.com/article/206341-the-sound-and-fury-of-banking-reform; and for my comments on B3 see http://seekingalpha.com/article/225116-basel-iii-chuckle.

Regulators and reformers (R&R) just never seem to get it right!

One reason is that they are always fighting the last war. The current popular belief amongst the R&R is that the initial stress tests in Europe did not include tests on liquidity and this element of the banking structure needs to be examined to get a real view of how much “stress” the banks can take. The R&R intend to correct this omission in the next round of stress tests.

Just two points on this. First, liquidity is a market condition and not something that exists on balance sheets. One cannot look at a balance sheet and determine how liquid markets will be. Duh!

Second, if a bank cannot raise funds in financial markets because they have bad assets, this is a solvency problem and not a liquidity problem. In addition they cannot retain funds from market savvy customers

Hugo Dixon wrote in the New York Times yesterday that the Irish banks, Allied Irish Banks and the Bank of Ireland, were “excessively dependent on wholesale money from other banks and big investors.” These monies are very interest rate sensitive and very sensitive to credit risk. Even though these banks passed the earlier stress tests, when the smell of problems arose, the wholesale money “started to flee.”

However, the problem faced by these banks was not a liquidity problem. The problem arose because the wholesale depositors were concerned over the health of the banks and this is a solvency problem.

The situation here is that the R&R can only work with historical data and, consequently, are always behind the times. Their analysis is always static. The movement of the “wholesale money” is current market information and provides a forward looking assessment of the condition of a bank or banks .

What would be desirable would be current information that was “forward looking” and more accessible to the investing public. What would be desirable would be some kind of “forward looking” market information that reflected the viewpoint of market participants that were “betting” their own money.

In a recent post I included a chart that presented market information and was very current. (See http://seekingalpha.com/article/239296-market-behavior-at-odds-with-european-bailouts-liquidity-vs-solvency.) This chart shows information on Credit Default Swap (CDS) spreads on European banks as well as on Spanish banks. One can see that the price of these CDSs began rising in late 2009 in anticipation of the sovereign debt crisis of 2010 and began rising even more dramatically before the current crisis that Europe is now facing. It seems as if some market indicator like these CDS’s could be used as an early warning signal that trouble was brewing in the financial sector of an economy or in specific banks.

Note, that the information provided by the Credit Default Swaps could be used as an early warning signal that something was wrong and this “signal” could then set off further analysis of the institution, or institutions, involved that would be conducted by the regulatory agencies.

Just such a suggestion has been made by Oliver Hart is the Andrew E. Furer Professor of Economics at Harvard University. Luigi Zingales is the Robert C. McCormack Professor of Entrepreneurship and Finance at the University of Chicago, Booth School of Business. Two references to their work are “Curbing Risk on Wall Street,” http://www.nationalaffairs.com/publications/detail/curbing-risk-on-wall-street, and “To Regulate the Finance, Try the Market,” http://experts.foreignpolicy.com/blog/5478.

To quote from the latter article: “In our mechanism, when the CDS price rises above a critical value (indicating that the institution has reached an unacceptable threshold of weakness), the regulator would force the LFI (large financial institution) to issue equity until the CDS price and risk of failure came back down. If the LFI fails to do this within a predetermined period of time, the regulator will take over.”

In the former article the authors argue that “The financial crisis of 2008 resulted from a series of misguided policies, failures of regulation, and missed signals. Unfortunately, much of the conversation about regulatory reform since has revolved around ideas that would only extend and exacerbate all three.”

The problem with implementing a plan like this is it that it causes the R&R to feel like they are losing some of their control…their power. Furthermore, many people within the R&R have little confidence in financial markets…it does not fit within their worldview. This is why I ended up a recent post with this comment: “many politicians and certain economists don’t like the market system. Market performance often contradicts the world views held by these politicians and economists. And, that makes them angry”

In conclusion, I have very little confidence in a new round of stress tests and believe that ST2 will lead to ST3…and then ST4…and eventually ST(n) where n is any number you want to give it. To me the sign that an approach is not appropriate and will not be successful over time is that people continue to use the same system and attempt to make the system tougher and tougher. Their system never works because their worldview needs to be changed.

The European Situation and the Financial Markets

Are the financial markets the WikiLeaks of economics?

Politicians and economists and business people ignore what financial markets are saying at their peril.

The financial markets have not responded well to the “rescue” package for Ireland put together by the European Union. The news out of London: “The euro continued to slide Tuesday, falling to a 10-week low under $1.30 as Italian, Spanish, Portuguese and Irish bond-yield spreads all continued to widen relative to Germany.” (http://professional.wsj.com/article/SB10001424052748704679204575646211228101600.html?mod=WSJ_Currencies_LEFTTopNews&mg=reno-wsj)

“The euro had started the European day with a rally, helped by regular month-end flows in its favor. However, things turned sour again as it became apparent that the risks of contagion remained as strong as ever and that Italy is now being affected by the lack of investor confidence in the euro zone.

Like the debtor countries on the periphery, Italy watched the yield on its bonds rise relative to those of Germany as investors demanded greater returns for holding Italian debt.”

The Financial Times writes: “it is still hard to see how Ireland can repay all the debt it has now taken on. So it is unsurprising that the market sensed a fatal combination: governments lacked the means either to nix moral hazard or end the crisis by writing an enormous check.” (http://www.ft.com/cms/s/3/8540ea0a-fb9f-11df-b79a-00144feab49a.html#axzz16locxnQW)

The European banks still remain a problem. Not only do the banks have serious solvency issues facing them, the eurozone’s banking system is a much bigger proportion of the economy than the proportion found in other countries, especially the United States.

The financial markets are flashing a warning signal that the cost of insuring a bank default has risen severely in Europe and in Spain. Plus, given how large the banks are relative to the size of the economy, questions have arisen about the ability of these countries to continue to provide bailouts. The situation in the banking sector of Greece looks positively “great” relative to Ireland, France, Spain, and Portugal.

Yet people continue to ignore what the financial markets seem to be telling them. It is very easy to claim that the markets don’t really understand a situation or that the blame for a situation rests elsewhere. See, for example, the op-ed piece in the Financial Times, “Spain is threatened by a crisis made in Germany”: (http://www.ft.com/cms/s/0/bb515190-fbf2-11df-b7e9-00144feab49a.html#axzz16lsMDit2). Every time the author makes an argument that Spain stood up for Germany in earlier times, he only talks about individuals, not what was happening in the market place. He now makes the argument that Germany, out of short sightedness, is hurting Spain. There is nothing about markets or what markets are doing. It’s all personal, not business!

Spain has problems and the problems are of their own doing. Now they need to get their books in order. (See my post “Is the Euro Bad News for Spain,” http://seekingalpha.com/article/239065-is-the-euro-bad-news-for-spain.)

In the vast majority of cases I am familiar with, the people who ignore the information being generated by the financial markets end up losing. One needs to have an overwhelmingly strong case that the market is wrong before one places a bet. In fact, betting against the market is like setting up one-way bets for traders. (See my post “Interventionists are setting up one-way bets for traders”: http://seekingalpha.com/article/237076-interventionists-are-setting-up-one-way-bets-for-traders.)

Furthermore, when talking about the banks, we still find a lot of people not really understanding the difference between a liquidity problem and a solvency problem. A liquidity problem is a short-run problem pertaining to “asymmetric information.” Something happens, a bankruptcy in the case of the Penn Central situation, and the “buy-side” of the market begins to question the situation of other high-grade customers that have issued commercial paper. In cases like this a central bank provides liquidity to the market so that the buyers will return as prices begin to stabilize. But, this is a short-run event.

A solvency problem is much longer-term and the state of the organizations, banks in this case, is known in the marketplace. And, that is a problem as far as raising funds is concerned. Firms in this situation cannot raise funds because no one wants to lend to them due to their extremely weak financial condition. But, this is not a liquidity crisis, it is a solvency crisis. People would lend to the organization if they were not financially challenged.

Yet, this is what we read in the New York Times with respect to the European financial crisis: “Ireland’s banking problems are only the latest example of how seemingly solvent institutions can be brought to the brink because they cannot in the short term raise the cash needed to finance themselves. Only four months ago, Allied Irish Banks and Bank of Ireland were given a clean bill of health in the European Union’s official stress tests. One weakness of these tests was that they stressed solvency, not liquidity, although that may be remedied next year.

The two biggest Irish banks did not have a large enough base of stable retail deposits. The loan-to-deposit ratios at Allied Irish and Bank of Ireland stand at just above 160 percent, which made them excessively dependent on wholesale money from other banks and big investors. When that dried up, they had to turn to the European Central Bank. When deposits from corporate customers also started to flee, emergency action was required.” (http://www.nytimes.com/2010/11/30/business/global/30views.html?ref=todayspaper&pagewanted=print)

Maybe, just maybe, the stress tests were not strong enough, as many have claimed. Certainly “the markets” did not think that the banks were healthy. This is even admitted in the article: the banks were “excessively dependent on wholesale money” and “when that dried up” real problems ensued.

Come on…wholesale money is very sensitive to the financial condition of the banks. The banks may have passed the stress tests but they failed the market test. Who is kidding who? You believe the stress tests? I’ve got a bridge to sell you!

This is why many politicians and certain economists don’t like the market system. Market performance often contradicts the world views held by these politicians and economists. And, that makes them angry!

Bank Honesty is the Best Policy: the European Case

If the history of banking tells me anything, it tells me that banks are only fooling themselves if they think that they can hide bad assets and then outlast the drag these bad assets put on their performance.

Headlines read,” Europe's Banks Stressed By Sovereign Debts Regulators Ducked” (http://www.bloomberg.com/news/2010-09-06/europe-s-banks-stressed-by-sovereign-debts-eu-regulators-failed-to-examine.html) and “Europe’s Bank Stress Tests Minimized Debt Risk” (http://professional.wsj.com/article/SB10001424052748704392104575475520949440394.html?mod=wsjproe_hps_LEFTWhatsNews).

What do these people think they are doing? Who do these people think they are fooling?

Covering up a bank’s position always comes back to haunt the bank.

Now, we hear that not only have the bank’s covered up their positions, but regulators and government officials have covered up the real position of the European banks.

“Europe’s governments can’t afford to question the quality of bonds they’ve sold to banks, says Chris Skinner, chief executive officer of Balatro Ltd., a financial industry advisory firm in London. “Bankers have got Europe’s governments in their pockets, primarily because politicians cannot change the way lenders do business without undermining confidence in sovereign debt,” he says.

The secret of getting out of a financial quagmire is to identify everything, recognize and accept your problems, and then do something about them.

To me, this is one of the reasons why the restructuring of the American banking system is proceeding as well as it is. I believe that the FDIC (and others) has identified most of the problems in the commercial banking industry, and they are substantial. But, they are generally known. The FDIC, along with the Federal Reserve, is working to resolve these banking problems in an orderly fashion. The FDIC is arranging mergers and is closing banks on a regular basis and the Federal Reserve is subsidizing the banking industry by keeping its target interest rate close to zero and by maintaining massive amounts of excess reserves in the banking system.

One does not see this happening in Europe. As a consequence, clouds still hang over the financial markets as, for example, yields on 10-year Greek bonds are around 11.25 percent relative to yield of about 2.25 percent on similar German bonds. This is true on other debt issued by Eurozone countries and this risk issue also shows up in the spreads on bank bonds.

There are more questions about “when” Greece is going to default on its bonds rather than “whether” it will default on its bonds.

Economic recoveries cannot really take place until the banking system of a country is sufficiently healthy. (See my post, “No Banking, No Recovery” on the situation in the United States: http://seekingalpha.com/article/218027-no-banks-no-recovery.)

But this problem seems to go deeper. This is from the Bloomberg article.

“While they’re stuck with their government bond holdings, Europe’s banks are also still carrying much of the troubled assets they had during the 2008 meltdown. Euro-zone lenders will have written down about 3 percent of their assets from the peak of the credit crisis by the end of 2010, compared with 7 percent for U.S. banks, the IMF estimated in April. The steeper writedowns by U.S. banks are partly because they held a higher proportion of securities, the IMF said.

That doesn’t excuse the lack of candor shown by many European lenders about the unsellable assets on their books, says Raghuram Rajan, a finance professor at the University of Chicago. “European banks haven’t owned up to the large amounts of toxic debt that they hold,” says Rajan, who was chief economist at the IMF from 2003 to 2007.

“The stress tests weren’t severe enough,” says Julian Chillingworth, who helps manage $21 billion at Rathbone Brothers Plc, an investment firm in London. “Many bond investors aren’t convinced the Greeks are out of the woods.” And if the Greeks haven’t emerged from their crisis yet, then neither have the European banks that hold their debt”.

If we are going to have banking systems that are stronger and less subject to systemic risk, bankers, regulators, and public officials must realize that good risk management includes openness and transparency. Bankers, historically, have been among the leaders in securing the “cover up” of bank positions and the quality of bank assets. They do not need the help of regulators and politicians to reinforce this tendency.