Are We Different From The U.K.?

Reading Liam Halligan’s article today on the economic plight of Britain kind of felt like walking through a graveyard. You get this creepy feeling and hope it’s only superstition not something more substantive.

He recounted the surprising news that came out earlier this week of the country’s 0.8% decline in output when most were forecasting something far more modest and then points to the banks as the source of the malaise:

Far more significantly, though, UK banks continue to hold the rest of the country to ransom, refusing to extend credit on reasonable terms, despite replenishing their balance sheets off the back of taxpayer largesse.

Regular readers will know what’s coming next. But repetition doesn’t make a fundamental truth untrue. The UK’s inter-bank market remains gridlocked largely because banks are still unwilling to lend to each other. That gums up the wheels of finance, starving credit-worthy firms and households of the cash they desperately need.

This inter-bank torpor stems from fear of counter-party risk, because our banks continue to sit on billions of pounds of toxic liabilities which they still refuse to reveal.

A wiser government, a braver government, would have forced the banks to “fess-up” these losses before splashing the bail-out cash, so purging the system and allowing a genuinely restructured banking sector to dust itself down and start again. It’s called “creative destruction”. It’s not pretty, but it’s the only thing that works.

These GDP numbers expose the City’s talk of “green shoots” as nonsense. A full recovery won’t happen while the UK remains burdened by our newly created Japanese-style “zombie banks”.

He goes on to talk about the frightening rise in public debt and the increasingly dysfunctional gilts market. For me though, the talk of the banks was what caused my discomfort.

Like the U.K. there is talk about in this country that the worst of times are over and though it may be a long road, recovery is on the way. Indeed, we may find ourselves luckier than Britain and enjoy a quarter or two of positive growth during the rest of this year, yet there is a voice in the back of my head that keeps saying watch out for the banks.

Yes, Chairman Bernanke and others tell us that the financial system is getting stronger and the threat of meltdown is now just an historical incident but all of that is based on an analysis of a banking system that functions somewhat normally due to massive support from the Fed. Banks superficially accept each others credit but that may be based more on the assumption that the government stands behind the institution than an belief in the fundamental soundness of the institution.

Like the U.K. our banks have yet to “fess up” to their problems. For now, all seem content to declare the forest fire contained and ¬†assure that over time the smoldering embers will die out. The question being how long will that take and of what use will the banks be while we wait for the day when they do return to business as usual.

Perhaps our fate is different. Perhaps the Fed can engineer us through this thing and the banks with their government hyped earnings will emerge strong enough to handle their barrel full of bad assets. I hope that’s the case but I still feel a little haunted by Halligan’s article.

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