The Economist Magazine's latest view of the current solutions and future prospects

As usual, The Economist Magazine this week (9th - 15th May 2009) is disarmingly accurate in at least parts of its analysis.

For example, it says: "Governments are endorsing high leverage and guaranteeing huge parts of the financial system, so (it gets) to keep the profits and palm off the losses on the taxpayer."

In other words, governments are looting taxpayers to enrich financial institutions.

That is the single reason the "threat of nationalisation has receded, reinvigorating the banks’ share prices. Money is cheap, deposits plentiful and borrowers desperate, so new lending promises handsome margins. Back before the crash, banks’ profits just looked big; today they might even be real."

The Economist goes on to say that "promises to leave finance to fail tomorrow are undermined by today’s vast rescue. Because the market has seen the state step in when the worst happens, it will again let financiers take on too much risk. Because taxpayers will be subsidising banks’ funding costs, they will also be subsidising the dividends of their shareholders and the bonuses of their staff". This is of course an entirely unfair subsidising of one sector of the economy, which had grown too big, and will once again grow too big unless checked.

How can it be checked? The Economist Magazine rejects simple structural solutions, such as banning any company (not simply any financial services company) from being more than say 0.5% of GNP. That sort of simple solution is labelled "Luddite" by The Economist, on the grounds that it would be a "horribly complex and lengthy task".

One must ask: has the current crisis been any less "complex and lengthy" than the disentanglement of large companies would be?

If the "complex and lengthy" task of disentangling "too large" companies will save taxpayers the cost of rescuing these companies again, why is that too much for The Economist?

Instead, The Economist pins its faith on "two more fiddly things that could produce fairly radical results: regulation and capital".

However, after jabbering for three paragraphs, first on one side and then on another, it eventually concedes: "The more a financial system depends on the wisdom of regulators, the more likely it is to fail catastrophically."

In other words, The Economist does not have two solutions. It only has one solution: "Banks should be forced to fund themselves with a lot more equity and other risk capital — possibly using bonds that automatically convert to equity when trouble strikes. Higher capital requirements would put more of the shareholders’ money at risk and, crucially, enable banks to absorb more losses in bad times. Think of it as a margin for regulatory error".

So, at least The Economist has one answer: more capital. But it demurs from answering the question: how much more?

If the so-called "stress tests" (which are better described as "relaxation tests") of the US government are any clue, not very much more capital.

So The Economist (and governments) don't want to face the messy job of really cleaning up the system, but want to continue to fool us into thinking that the system has been cleaned up.

How many years to the next big rescue: anyone? Sphere: Related Content