Friday, June 1, 2012

Warren Mosler — How to fix the euro banking system

Cross-posted from The Center of the Universe

How to fix the euro banking system
by Warren Mosler
June 1st, 2012
The banks need, and I propose, ECB deposit insurance for all euro zone banks. 
Currently the member governments insure their own member bank deposits and do the regulation and supervision.
 So to get from here to there politically they need to turn over banking supervision to the ECB.
Let me suggest that’s a change pretty much no one would notice or care about from a practical/operational point of view?
The political problem would come from losses from existing portfolios that, in the case of a bank failure due to losses in excess of equity capital, currently would be charged to the appropriate member nations. 
So under my proposal, for the ECB to suffer actual losses a member bank that it supervises and regulates would have to suffer losses in excess of its capital.
And none of the member governments currently think that their banks have negative capital, especially if they assume member governments don’t default on their debt to the banks.
And this ‘fix’ for the banking system would help insure the member governments don’t default on their obligations to their banks. 
The euro zone has three financial issues at this point. One is bank liquidity which this proposal fixes. Second is national government solvency, and third is the output gap. 
They need to allow larger government deficits to narrow the output gap, but that first requires fixing the solvency issue.
The solvency issue can be addressed by having the ECB guarantee all of the member government debt, which then raises the moral hazard issue. 
The moral hazard issue can be addressed by giving the EU the option of not having the ECB insure new government debt and forbidding its banks to buy new government debt as a penalty for violators of the debt and deficit limits of the Stability and Growth Pact.


Anonymous said...

Good old Silvio has an easier solution:

"I can’t remember a time in my life more difficult than this. People are really hopeless. What move can change the recessive spiral?

The economic crisis is not resolvable internally. The Government must pick up where we left off and change its political line.

We have to go to Europe to say emphatically that the ECB should start printing money. So change the economy. The ECB must change its mission, must become the guarantor of last resort debt and begin to print currency. Otherwise, we should be strong enough to say “bye, bye” to the euro and therefore leave the euro, while staying in the EU, or tell Germany to leave the EU if they don’t agree.

My crazy idea is that the Bank of Italy should either print euros or print our own currency. I invite you to explore this idea."

paul said...


One can only hope.

Hugo Heden said...

Something that intrigues me is this: Euro-denominated "Net Financial Assets" does not increase.

Again: Euro NFA are held constant. And NFA is an important money supply measure. NFA constitutes "default free" financial assets, on top of which the private economy can leverage over the business cycles.

That is one symptom of a severely screwed up monetary system. How is constant NFA supposed to support a growing economy in the long term?

This is contrary to how the dollar economy (for example) works, where NFA is constantly increasing when the currency issuer (the "government") issues new Securities etc.

When I say Net Financial Assets, I am talking about NFA of the Currency Users (i.e. NFA injected into the Currency User Economy by the Currency Issuer).

Who is the "currency issuer" in the Eurosystem? Not the member governments - they are Currency Users. If anyone, it's the ECB. And the ECB does not inject NFA into the currency user economy. A borked up system.

To support a forever growing economy with constant NFA requires ever growing *private* debt levels instead. Financial Instability Galore. That is not a sustainable growth path. Minsky.

(Does this sound correct from an MMT view point?)

Tom Hickey said...

I am not up on the EMU arrangements, but from what I understand the national government do have the capacity to issue euro with the restrictions of the treaty. I assume that the euro issued are liabilities on the books of the NCBs rather than the ECB.

Again, as I understand it, the ECB does not supply countries with euro other than through lending facilities. It's purpose is to provide liquidity rather than issue euro as the cb of a fiscal union.

The issue you are bringing up is one of sectoral balances. If a country is politically restrained from offsetting non-government saving desire by increasing NFA sufficiently through injection, then it loses policy space and the ability to influence the domestic economy in downturns, especially in crises where saving desire (delevering) in abnormally high. The architects of the EMU overlooked this.

So the net financial assets created by deficit expenditure in the various nations would be due to their own capacity. The states in the US don't have this capacity for instance and are true currency users, in that they have have to borrow to spend because they do not have central banks that can issue the unit of account in the US. The EMU nations are not currency users in the same sense if they can issue euro, albeit under politically agreed to restraints.

So the position of the EMU nations is different from what it would be on a gold standard, where countries gain and loss gold in the process of external trade. The proposed arrangement with Germany would move the EMU closer to a gold standard but it would not be a gold standard technically speaking.

But another issue is default-risk. The EMU nations are so politically restricted that they can default, since there is no mechanism for the ECB to fund them beyond the limits of the treaty and the NCBs cannot issue sufficient currency to meet obligations.

As you say, "borked up." What were they thinking of. Clearly, not thinking clearly. And they were warned at the time by a number of economists.