For some reason markets managed to half-convince themselves last week that Ben Bernanke was about to pull another quantitative easing rabbit (QE3) out of his hat. This never made any sense: Bernanke was speaking at the Kansas City Fed's annual financial markets conference in Jackson Hole, Wyoming, and it would have been unprecedented for him to unveil a major policy announcement there.
As it turned out, Bernanke went to the opposite extreme. His speech at Jackson Hole was almost unforgivably dull and platitudinous. (You can find it, if you really want to, on the Fed's website). He chided politicians for their recent fiscal brinkmanship, but the only thing to which he committed the Fed was a two-day meeting next month, instead of the usual one-dayer.
Journalists who had made the long schlep out to The Hole got much better value from the new head of the IMF, Christine Lagarde. The Economist provides a good summary of her remarks here. Mme Lagarde's wide-ranging agenda included calls for fiscal rebalancing (to reflect the fact that a revival in growth is essential if deficits are to be reduced), action to reduce the level of foreclosures in the US housing market, and steps to recapitalise Eurozone banks in order to head off a fresh liquidity crisis.
The last of these is clearly the most urgent. There have been sustained declines in European banks' stock prices in recent weeks (triggering a ban on short selling in several countries, led by France) and persistent rumours (and some actual evidence) of a drying-up in inter-bank liquidity, forcing at least a few institutions to rely more heavily on ECB funding.
It's hard to escape the feeling that the situation is only heading for a crisis because markets have decided that it should; in many respects there's a disconnect between how the markets are acting and what's actually going on. While Mme Lagarde's call for banks to be better capitalised is undoubtedly prudent, and while there are signs of stress in the inter-bank markets, a number of large lenders (including ING and Unicredito) have successfully raised long-term capital at attractive rates in the last few weeks, even as equities have been falling. As for the EU fiscal shortcomings that are supposedly at the root of all the problems, it's worth keeping the facts in mind. For example, "beleaguered" Italy has a budget deficit of about 4% of GDP this year, compared to more than 10% in the US -- and, for that matter, in the UK, which Chancellor George Osborne regularly and riskily likes to portray as a safe haven.
What's really striking is how little has changed in the global banking system since the near-death experiences of three years ago. Interconnectedness (no major country except perhaps Japan has a purely national banking industry any more) and reliance on wholesale funding remain cornerstones of the system. The short-term liquidity problems in the Eurozone largely stem from a repatriation of money by US money market funds (the flipside of which is that some US banks are starting to complain of being awash with deposits). Why have the money market funds been doing this? Because they are worried that Eurozone banks have too much exposure to European sovereign debt, even though, as suggested above, the Eurozone is starting to get its fiscal house in order and European banks are bolstering their capital reserves. It should be clear anough by now that wholesale markets will always act like this.
This all seems to bolster the case for separation of retail (or utility) banking from riskier investment activities, and for strictly limiting the extent to which retail banks can rely on the wholesale markets for funding. It's not as if this would be damaging. After all, if we take the UK as an example, the main effect of the rapid rise in wholesale funding on the housing sector was not a surge in new home construction, which would have been entirely welcome, but a completely unproductive inflation in the price of the existing housing stock. Housing markets in countries as diverse as the US, Ireland and Spain were also badly distorted by the flood of wholesale cash.
Mme Lagarde did not call for the break-up of the universal banking model in her speech last week, more's the pity. Then again, she might have been wasting her breath if she had. As The Economist sadly notes at the conclusion of its report, "No other top policymaker has spoken so bluntly about the risks to the world economy or called so bluntly for a co-ordinated plan to address them. Now the question is whether governments will listen to her".
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