Banks are global in life and national in death

Mervyn King gave this memorable quote and is mentioned in this superb speech by Andrew Sheng.

The speech looks at how badly things have become with respect to financial sector and its rescues.

He says things have changed greatly since 1971 when B-Woods broke and we have the current System:

What is different from 1971?
1.Power has shifted from authorities to market forces, as financial markets gain speed, size and leverage
2.Large capital flows (carry trades) are largely leveraged and monetary policy has lost efficacy. Add naked shorts and CDS make it very difficult for central banks to defend either FX or bond prices at ―stable‖ levels.
3.National governments not measuring shadow and offshore credit for monetary and financial stability concerns.
4.Collective Action Trap: No national government can control global money created through offshore shadow banking.
5.Huge moral hazard, as leading prime brokers/shadow banking are TBTF, so Heads I Win, Tails You Lose for defending central banks..

He points how financial markets have grown over the years. Missing the slide. This interconnected fin system with economies makes bailouts grow larger and larger (calls it non-liner escalation in IMF rescues :-)). IMF gave  Thailand $ 17 bn in 1997.The size of bailout (IMF + EU) to Ireland, Greece and Portugal is now $ 372 bn in total. Further if Spain and Italy go under:

• Spain – $2.2 trn, or 64.5% of GDP (-NFA -79.6% of GDP 2008)
• Italy – $2.5 trn, or 118% of GDP (NFA -23.1% of GDP 2008)
• Current size of rescue funds if Spain or Italy get into trouble will not be sufficient.
• Capital required for banks if PIIGS default – €300 billion ($408 bn. IMF GFSR Sep.2011)

He points how this shadow banking structure is a black hole with no oversight. Unless it is addressed, we just have more and more losses.

• Shadow banks are global in life and national in death.
• Creation of offshore shadow credit is regulatory arbitrage and cannot be constrained because the larger the credit, the lower the interest rate and risk premia (Global Banking Glut).
• When TBTF banks fail, loss are underwritten nationally.
• Unless this is addressed, present system is unsustainable Moral Hazard of escalating losses.

There is much more on what world economy should  do and Asia should do…

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