“Thoughts” by Jean-Pierre Landau

I am gradually coming to a general rule on actually reading the speeches published by the BIS - the less interesting the title is, the more likely it is that the speech is actually worth reading.

This one "Some thoughts on securitization and financial turbulences" by Jean-Pierre Landau, Deputy Governor of the Bank of France, is a good example. Fairly boring title - quite good content. His (or, more likely, his underling's)  analysis is robust, with a good idea of what happened over the last few months. He is also right that the worst is currently behind us as the real problem was always the liquidity freezing up, not the size of the actual losses.

Where I feel he is wrong, though, is in the policy prescription:

Strong capital will not guarantee liquidity in all circumstances. There can be panics and sudden increases in the demand for liquidity. That's the job of Central Banks to help in those circumstances. But a strong capital base in the system – and in all its components – is likely to limit future liquidity shocks.

The first two sentences are perfectly correct. Capital is simply not a substitute for liquidity. The next two, though, are wrong - and they do not logically flow from any of the analysis in the rest of his "Thoughts".

Bank regulators commonly get fixated on capital as the be-all and end-all of bank risk management. The attitude commonly seems to be more risk (of any type)? More capital needed. Liquidity, though, is not improved by having more capital; in fact, it may be hurt.
The best capitalised bank in the world will not be able to pay its debts as and when they fall due without liquidity - i.e. it will be bankrupt.

Liquidity management is, and always should be, considered separately from capital management.
He is right that a well capitalised bank will find it easier to get liquidity in a liquidity poor market - but Northern Rock was, by the standards of the industry, well capitalised and profitable. Having to go to the Central Bank (the Bank of England) was what destroyed them. Adequate liquidity would have meant that they had no problems and no need for the Bank of England's help.

The message? Good capital will help - but in a liquidity crisis what you actually need is liquidity. Also, don't always believe that a Central Banker is right.