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Central Banker Urges Lying To The Public About Bank Health

For years, many - and certainly this website - had mocked both European and US stress tests as futile exercises in boosting investor and public confidence, which instead of being taken seriously repeatedly failed to highlight failing banks such as Dexia, Bankia and all the Greek banks, in the process rendering the exercise a total farce. The implication of course, is that regulators, thus central bankers, openly lied to the public over and over just to preserve what little confidence in the system has left.

Now we know that far from merely another "conspiracy theory", this is precisely the policy intent behind the "stress tests" - as Reuters reports citing a paper co-authored by a Bundesbank economist, "banking supervisors should withhold some information when they publish stress test results to prevent both bank runs and excessive risk taking by lenders."

In other words: lie.

Essentially the authors recommend instead of being a useful measure of banking sector health, all stress tests should do is boost skepticism in the entire financial system since bankers are too scared and too insecure to admit the full extent of the ugly picture.

Or, as Jean-Claude Juncker put it: "when it gets seriousm you have to lie."

Why is this emerging now, and is it, well, about to "get serious"?

As Reuters notes, European banking authorities are due to carry out a fresh round of stress tests next year as they try to restore investor and depositor confidence in the continent's banks after the financial crisis. So the answer is probably "yes."

The paper, presented at a conference in Mannheim last week but yet to be published in its current form, says stress tests should be used to influence depositor behaviour and warns against giving too much away."

Said otherwise, regulators should outright lie to the public. Why? "If depositors know from the watchdog that banks are in trouble, they will withdraw their cash, threatening lenders' survival and causing the panic the supervisor is trying to avoid, the paper said.

Perhaps someone needs to explain to the Bundesbank central banker what the word "regulator" means: a quick scan through the thesaurus does not reveal "liar" as one of the synonyms. That, however, is irrelevant: the authors push on saying that the amount of information disclosed by supervisors should decrease the more vulnerable the banking sector is expected to be.

"The optimal level of 'informativeness' ... depends on the objective probability that the banking sector is vulnerable," authors Wolfgang Gick, from the Free University of Bozen, and Thilo Pausch, an economist with the Bundesbank, wrote.

"As we find, the higher the latter probability, the less informative the optimal disclosure mechanism should be designed.""

It gets better: central banks should, the authors allege, also lie about healthy banks: "giving banks a clean bill of health also carries risks, according to Gick and Pausch, by encouraging depositors to leave their money in banks. That would undermine market discipline and lead lenders to take excessive risks, they wrote."

For that reason, supervisors should always keep depositors on their toes by maintaining a degree of uncertainty about the health of banks, the paper concludes.

Brilliant: so on one hand, supervisors should lie about failing banks, but on the other "they should keep depositors on their toes."

And the punchline: "The optimal stress-testing mechanism will leave depositors with some amount of residual uncertainty."

When asked the Bundesbank said the paper does not necessarily reflect its view and is based on a specific theoretical model, noting different settings may produce different results. The European Central Bank declined to comment on the paper.

But others promptly agreed with the liars, pardon, the authors:

Richard Reid, a research fellow in finance and regulation at the University of Dundee, agreed that giving extensive details could lead to even bigger problems and rob regulators of a window to rectify problems, or make it harder for policymakers to deal with wider issues like sluggish growth.

 

"It's an age-old problem for regulators, how much transparency there should be," Reid said. "There is an argument of 'let's flush it out,' but in the current situation the weak upturn is a key concern to central bankers, and if you spook markets about banks, then it might further complicate the provision of credit to the economy."

True: it's best to lie to depositors until the last minute, and when everything fails, to pull a Greece and threaten the country with civil war as Alexis Tsipras recently did unless the capital controls imposed on all depositors are implemented.

So to summarize: earlier today the "smartest ECB banker in the room" confirmed it was unable to predict the inflationary or GDP future as far ahead as just one quarter, and now the "regulators" are suggesting that any information coming from central banks will be nothing but lies.

And yet in this bizarro world where the smartest people are actually the dumbest, and those supposed to be the most honest are the biggest liars, the fate of everything lies in the hands of the Fed's decision whether or not to hike rates from 0.0% where they have been for 7 years, to 0.25%...

Sorry, The Onion, but your IPO window is now forever gone.