“Liquidity is not the issue”
There was a logical flaw in Sir Mervyn King’s Mansion House speech last night, announcing a new liquidity splurge for the UK’s banks.
The Bank Governor kicked off his address with some scathing comments about the European Central Bank’s own recent liquidity operations:
“No central bank has done more in recent months to flood the system with liquidity than the ECB – one trillion euros injected through two long-term refinancing operations. Those two operations demonstrated that liquidity is not the issue because after a few months we are back to where we were. The problem is one of solvency. Where there are debtors who cannot afford to repay, there are creditors who will not be repaid. Until losses are recognised, and reflected in balance sheets, the current problems will drag on. An honest recognition of those losses would require a major recapitalisation of the European banking system.”
In other words, the ECB’s emergency lending operations won’t do any good, according to Sir Mervyn, because many eurozone banks are effectively bust. Only recapitalisation can end the continental credit crunch. These are the strongest terms in which the Governor has made this point, and confirms the rumour I picked up a while ago about the Bank’s deep reservations about the ECB’s Long-Term Refinancing Operations (LTRO).
So why is it OK for the Governor to sanction what is, in effect, an LTRO for the UK? The obvious answer is that the UK’s banks – unlike many of those on the continent – are not insolvent. They were recapitalised and cleaned up in 2008/09. Their borrowing costs are only rising because of a general financial market panic, springing from fears over the eurozone.
Yet elsewhere in the Sir Mervyn’s speech, talking about UK banks, he implied he doesn’t really believe this:
“In present circumstances banks face acute challenges of liquidity, funding and capital – and the greatest of these is capital. Difficulties in liquidity and funding are often a reflection of insufficient capital.”
So Sir Mervyn King implies that UK banks, like their Continental counterparts, don’t have enough capital – and that this is the reason their own borrowing costs are going up (costs which are, in turn, are being passed on to British borrowers).*
The logical conclusion from King’s reasoning is that this new UK liquidity push will be just as useless as the ECB’s since here in the Britain, just as in Europe, “liquidity is not the issue”.
I suspect this is indeed what the Governor really believes, and that he has been forced into the so-called “funding for lending” operation by an increasingly desperate Treasury.
*Robert Jenkins of the Financial Policy Committee regulator has made a similar argument, saying that UK banks are struggling because the markets don’t believe they have enough capital.
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