Citigroup Chief Economist Explains Brexit
The chief economist of Citigroup is not your average economist. Yes, Willem Buiter studied plenty of economic theory at Yale and Cambridge, but then he says funny things like the New York State Driving Test was his “greatest educational achievement.”
He is also very outspoken for someone who works for one of the biggest banks in the world. He thinks Citigroup “must have decided that it was better to have somebody who tells the truth occasionally than to have somebody who tells what people want to hear.”
Epoch Times spoke to Mr. Buiter about Brexit and its consequences, bankrupt banks in Europe, and how bailouts should be done without getting the taxpayer involved.
Epoch Times: Why is Brexit responsible for the share price decline in European banks and volatility in financial markets?
Willem Buiter: The European banking sector, with some exceptions, but across the board, is undercapitalized right now. This can be hidden, suppressed in an extend and pretend, delay and pray manner as long as market conditions are orderly.
People forget about the risk posed by massive leverage ratios and by risk-weighted capital ratios that are probably overstating the amount of capital you have because the risk weights are highly dodgy but also likely to evaporate when the risk actually goes up.
So Brexit was a reminder of the fragility of the European Union (EU), including the eurozone. If Brexit can happen then Frexit could happen. That immediately affects the cross-border banks, the banks that have had significant exposure in different parts of the euro area. They could be suddenly subject to wild currency fluctuations as new currencies are created out of nothing.
It hits the European banks just as the fragility of the U.K. and its risk of breaking up hits the British banks first and foremost.
Epoch Times: What will happen to Britain?
Mr. Buiter: Well, for the pound you know the consequences, right? It was trading in the mid $1.40s when they started, and it is now at $1.30 and will probably go down further.
So no doubt this is a big blow, a big recessionary, contractionary blow to economic activity in Britain simply because of the uncertainty about what is next.
What is the new relationship with the European Union, the new trading relationship with the rest of the world outside the EU, what is going to happen to the U.K.?
Capital expenditure will tank; saving rates will go up in the face of the increasing uncertainty. The most affected sector is likely to be London. If London is not the beneficiary of passporting into the EU, then the British banks will be at a significant competitive disadvantage.
If the EU-27 will try again to restrict the ability of London to trade euro derivatives and euro instruments internally, that will be a blow for London.
To a certain extent you can compensate for that. The Chancellor of the Exchequer has already announced a plan to cut corporate tax rates to almost Irish levels.
The key is that they can start the regulation war with the EU offering terms and conditions for banking and financial institutions that will make it attractive to be there.
So these things have consequences too. If you become a deregulated paradise, you will become financially fragile. We have seen that before. So I think there really is no hiding place. This is thoroughly bad news for the U.K., for London.
Especially if it spreads and if there is a risk of it spreading a further unraveling of the EU, it is going to be bad news for the rest of the EU. The same uncertainty will take hold.
Investments will be subdued, saving rates will go up, and the willingness to take risks will be diminished. So this is thoroughly bad news. There is no good side to it.
Epoch Times: Why are European banks so vulnerable?
Mr. Buiter: There has been no adequate recapitalization of the euro area banking system. There are still huge capital holes which are being covered with the mantle of love and discretion. The extend and pretend game gets challenged periodically and this is one of these times.
The Italian banks are at risk now. There is worry about the German banks. Unless this problem is finally tackled and the banks are properly recapitalized, there will be bank consolidation. There are fewer banks but more cross-border banking through the integrated European banking sector.
Unless we have that, [European banks] will be a drag on growth and a source of systemic financial instability not just in Europe but worldwide for years to come.
Epoch Times: How could European banks end up in this position of having very little capital against a lot of potentially bad assets?
Mr. Buiter: National regulatory supervisors apparently are not up to the job. There has been large-scale regulatory capture of banking regulators by the entities who they are supposed to supervise.
The European Central Bank (ECB) has now taken over the supervision of the 128 larger banks. It will take a while before it gets captured. This is the time to really implement reforms. I am somewhat hopeful there is an opening now that national interests can no longer automatically stop the necessary consolidation, recapitalization, and indeed closing down of banks because there are too many banks in Europe.
There is a chance now that the necessary amount of capital will be injected, but where the capital is coming from is the key question.
The banks will be very happy to recapitalize if the taxpayer puts the money in. If it has to come out of the pockets of the unsecured creditors [that is, holders of the banks’ bonds], then, of course, the banks don’t want to know about it because it means, technically, that they are in a situation of insolvency.
Even though that need not last long and could be resolved over a weekend, the willingness to address the capital inadequacy by making those who should be paying for it—unsecured creditors rather than taxpayers—pay; that is still a war being fought very ferociously in Europe.
The right solution from an incentive perspective is clearly to bail-in the unsecured creditors whoever they may be. The institutional investors, the wholesale investors, will take a hit and that is right. That is what the Lord made them for.
When you are willing to take the high yield, you know you have to take the risk and you can’t have one without the other, at least it shouldn’t be one without the other.
In Europe, the banks have been used for decades to have the de facto backing of the sovereign, which has allowed them to take risks that they shouldn’t have taken—in the full knowledge and certainty both of their creditors and the banks themselves that they will be bailed out. It is time to kill that culture.
Epoch Times: What about U.S. banks?
Mr. Buiter: I think there, too, if banks are not adequately capitalized to the extent of the shocks that they are facing, then the first recourse should be the unsecured creditors. But there has to be a mechanism in place that you can do that without destroying banking. You should be able to collect the dues from the bank’s creditors, from the bank’s shareholders, without destroying the intermediation provided by the banks.
I doubt whether this could be done in practice yet. I think there still is a distinct “too big to fail” issue in the United States, in Europe, and not just for the banks but in many other financial institutions as well.
Remember it was insurance companies, it was government-owned entities like Fannie Mae and Freddie Mac in the United States that turned out to be too big to fail, and they were bailed out by the taxpayers. It really is time to stop this from a fairness perspective and from an efficiency perspective because it misaligns risk. And no rewards for those who are willing to take a free ride at the cost of the taxpayer.
Follow Valentin on Twitter: @vxschmid