Home > Predictions > Credit Crunch II vs. QE2

Credit Crunch II vs. QE2

Basel III will require banks worldwide to double their cash reserves, according to the UK’s Daily Telegraph.  Wow.

Details of the Basel III regulations were unveiled last night in a move designed to prevent banks from running out of liquidity as they did in the autumn of 2008. The new rules, to be phased in between 2015 and 2018, demand that banks hold 4.5pc of common equity and retained earnings. The current minimum for core Tier 1 capital is 2pc.

They also insist on a “buffer” of 2.5pc to be built up in good times, taking the total capital required to 7pc. Banks can dip into the buffer in times of hardship, but if so, they must restrict dividend payments.

Jean-Claude Trichet, President of the European Central Bank and chair of the committee, called the agreement “a fundamental strengthening of global capital standards”.

The new requirements may prompt a new wave of rights issues in Europe, kicked off by Deutsche Bank’s record €10bn (£8.2bn) issue announced yesterday. Deutsche Bank’s giant cash call is partly to fund a greater move into retail banking through buying a bigger stake in Postbank, but it is also aimed at shoring up its balance sheet.

Look for more banks to be issuing mega bonds.  Look for some banks to blow up because of cost pressures and bad debts.  And look for tighter credit conditions in the next 18 months – two years. 

The WSJ is pushing the line that the tighter capital requirements will not result in second credit crunch because they are phased in over 8 years.   But if everyone knows the building is going to be on fire in 8 years, they will all start moving to the exits now.  Slowly at first.  And then at pace.  Regulators don’t realize the power of simultaneous changes to market conditions.  This worldwide, across the board, tightening of credit standards will inevitably cause a second credit crunch, despite the phase-in and despite a possible QE2.  Why?  Because the debt markets are interconnected, one bank’s credit tightening is another bank’s bad debt.  And when they move together, these effects are exacerbated.

That’s why I can guarantee Credit Crunch II will kick in by 2013, despite whatever QE2ing the world’s central banks implement to offset these effects.  A solvency crisis cannot and will not be contained by QE2, which can only deal with a liquidity crisis.

Central banks are about to get a harsh lesson on the effects of the centralization of economic power.  They wanted it.  They got it.  Be careful what you wish for.

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