No lessons learned

About a year ago, the German government hailed itself as the hard-line regulator of the financial markets. For one, it unilaterally banned naked short selling – that is, speculating with securities, stocks and bonds that the seller doesn't own.

Berlin was also able to get its own way on a European level by banning Credit Default Swaps (CDS) – a type of insurance policy that could be bought by anyone without holding the loan instrument in question and without having any direct "insurable interest" in the loan. Some analysts linked a surge in CDS trading to the collapse of major companies like Bear Stearns and Lehman Brothers.

No sign of a new beginning

But Thomas Heidorn, a professor at the Frankfurt School of Finance, says the CDS ban was not as effective as regulators claim.

"Studies by both the European Central Bank (ECB) and the German Federal Bank have shown that there is no link," he says. Instead, Heidorn says the moves were little more than politically-motivated actions designed to make it look like something was being done.

Clemens Fuest, an economist at the University of Oxford, has a similar opinion. He says that three years after the Lehman catastrophe, there's no sign of the "new world financial architecture" world leaders promised to create.

While Basel III, the new global regulatory standard for banks agreed by the members of the Basel Committee on Banking Supervision, reinforces existing rules, it is just a first step, according to Fuest. More reforms are necessary.

Banks and states hold each other hostage

Heidorn says he supports rules that require banks to hold more capital reserves. "What's unclear is where that equity is meant to come from in the current market turmoil and economic circumstances."

That's a good question. World stock markets lost one fifth of their value between the end of July and the end of August 2011. On average, shares in European banks lost one third of their value. That's down to Europe's debt-ridden nations, whose loans have eaten away at the banks' balance sheets. The International Monetary Fund is warning that European banks are carrying losses of 200 billion euros ($273 billion).

For Fuest, these ties that bind banks to state budgets are the crux of the problem. "We have to get to a situation where the banks hold much fewer state loans," he says. "There's no reason why insurance companies or pension funds can't hold state debt."

He says that would have one important advantage: "If they make losses through state debts, that wouldn't immediately have systemic consequences."

The fate of many European banks still depends on whether certain countries can get their debts under control. At the moment, the atmosphere is marked by suspicion. Banks are warily eyeing one another, just as they did after the fall of Lehman Brothers.

The banks are choosing to put their surplus liquidity into the ECB, rather than lending it against interest to other banks. The total amount of cash currently tucked away at the ECB is now around 170 billion euros.

Shortly after the Lehman bankruptcy that figure was much higher - 300 billion euros. That's not the only reason why the situation is not comparable to the dark autumn of 2008, according to Heidorn. "We don't have a sub-prime bubble in the market at the moment," he says. "If we find a good political solution to the state debt crisis, the banks won't have any worries."

Clouds gather

But that is precisely where doubts have arisen in the past few months. The prospects for the world economy are darkening. Without robust growth, it will be even more difficult for indebted countries to get their interest payments under control.

Italy is the latest country whose ability to pay its debts is being questioned. The European Union's bailout fund would be much too small to save its economy, which is the third largest in the eurozone.

Fuest says it would be much better to stabilize the financial sector than to save a nation from bankruptcy. "That would make us much less vulnerable to blackmail," he says.

At the moment, Fuest adds, the countries doing the bailing out are losing control of the situation, because indebted countries like Italy know they will probably receive aid if they don't balance their own books.

"If you concentrate on stabilizing the financial sector, then the finance ministers have much more incentive to get their house in order," he says.

Fuest believes if state debts balloon once again as a result of huge bank bailouts, pushing the world economy into another recession, then we shouldn't simply blame the banks. "After all, it's years of missed reforms and continual borrowing that have put nations into this vulnerable position," he says.

Author: Zhang Danhong / bk
Editor: Sam Edmonds