Friday, February 13, 2009


The link is here. I have reprinted the enture story because of its importance.

Large U.S. banks on edge of insolvency, experts say

By Steve Lohr

Friday, February 13, 2009

Some of the large banks in the United States, according to economists and other finance experts, are like dead men walking.

A sober assessment of the growing mountain of losses from bad bets, measured in today's marketplace, would overwhelm the value of the banks' assets, they say. The banks, in their view, are insolvent.

None of the experts' research focuses on individual banks, and there are certainly exceptions among the 50 largest banks in the country. Nor do consumers and businesses need to fret about their deposits, which are insured by the U.S. government. And even banks that might technically be insolvent can continue operating for a long time, and could recover their financial health when the economy improves.

But without a cure for the problem of bad assets, the credit crisis that is dragging down the economy will linger, as banks cannot resume the ample lending needed to restart the wheels of commerce. The answer, say the economists and experts, is a larger, more direct government role than in the Treasury Department's plan outlined this week.

The Treasury program leans heavily on a sketchy public-private investment fund to buy up the troubled mortgage-backed securities held by the banks. Instead, the experts say, the government needs to plunge in, weed out the weakest banks, pour capital into the surviving banks and sell off the bad assets.

It is the basic blueprint that has proved successful, they say, in resolving major financial crises in recent years. Such forceful action was belatedly adopted by the Japanese government from 2001 to 2003, by the Swedish government in 1992 and by Washington in 1987 to 1989 to overcome the savings and loan crisis.

"The historical record shows that you have to do it eventually," said Adam Posen, a senior fellow at the Peterson Institute for International Economics. "Putting it off only brings more troubles and higher costs in the long run."

Of course, the Obama administration's stimulus plan could help to spur economic recovery in a timely manner and the value of the banks' assets could begin to rise.

Absent that, the prescription would not be easy or cheap. Estimates of the capital injection needed in the United States range to $1 trillion and beyond. By contrast, the commitment of taxpayer money is the $350 billion remaining in the financial bailout approved by Congress last fall.

Meanwhile, the loss estimates keep mounting.

Nouriel Roubini, a professor of economics at the Stern School of Business at New York University, has been both pessimistic and prescient about the gathering credit problems. In a new report, Roubini estimates that total losses on loans by American financial firms and the fall in the market value of the assets they hold will reach $3.6 trillion, up from his previous estimate of $2 trillion.

Of the total, he calculates that American banks face half that risk, or $1.8 trillion, with the rest borne by other financial institutions in the United States and abroad.

"The United States banking system is effectively insolvent," Roubini said.

For its part, the banking industry bridles at such broad-brush analysis. The industry defines solvency bank by bank, and uses the value of a bank's assets as they are carried on its books rather than the market prices calculated by economists.

"Our analysis shows that the banks have varying degrees of solvency and does not reveal that any institution is insolvent," said Scott Talbott, senior vice president of government affairs at the Financial Services Roundtable, a trade group whose members include the largest banks.

Edward Yingling, president of the American Bankers Association, called claims of technical insolvency "speculation by people who have no specific knowledge of bank assets."

Roubini's numbers may be the highest, but many others share his rising sense of alarm. Simon Johnson, a former chief economist at the International Monetary Fund, estimates that the United States banks have a capital shortage of $500 billion. "In a more severe recession, it will take $1 trillion or so to properly capitalize the banks," said Johnson, an economist at the Massachusetts Institute of Technology.

At the end of January, the IMF raised its estimate of the potential losses from loans and other credit securities originated in the United States to $2.2 trillion, up from $1.4 trillion last October. Over the next two years, the IMF estimated, United States and European banks would need at least $500 billion in new capital, a figure more conservative than those of many economists.

Still, these numbers are all based on estimates of the value of complex mortgage-backed securities in a very uncertain economy. "At this moment, the liabilities they have far exceed their assets," said Posen of the Peterson institute. "They are insolvent."

Yet, as Posen and other economists note, there are crucial issues of timing and market psychology that surround the discussion of bank solvency. If one assumes that current conditions reflect a temporary panic, then the value of the banks' distressed assets could well recover over time. If not, many banks may be permanently impaired.

"We won't know what the losses are on these mortgage-backed securities, and we won't until the housing market stabilizes," said Richard Portes, an economist at the London Business School.

Raghuram Rajan, a professor of finance and an economist at the University of Chicago graduate business school, draws the distinction between "liquidation values" and those of calmer times, or "going concern values." In a troubled time for banks, Rajan said, analysts are constantly scrutinizing current and potential losses at the banks, but that is not the norm.

"If they had to sell these securities today, the losses would be far beyond their capital at this point," he said. "But if the prices of these assets will recover over the next year or so, if they don't have to sell at distress prices, the banks could have a new lease on life by giving them some time."

That sort of breathing room is known as regulatory forbearance, essentially a bet by regulators that time will help heal banking troubles. It has worked before.

In the 1980s, during the height of the Latin American debt crisis, the total risk to the nine money-center banks in New York was estimated at more than three times the capital of those banks. The regulators, analysts say, did not force the banks to value those loans at the fire-sale prices of the moment, helping to avert a disaster in the banking system.

In the current crisis, experts warn, banks need to get rid of bad assets quickly. The Treasury's public-private investment fund is an effort to do that.

But many economists and other finance experts say that the government may soon have to move in and take on troubled assets itself to resolve the credit crisis. Then, they say, the government could have the patience to wait for the economy to improve.

Initially, that would put more taxpayer money on the line, but in the end it might reduce overall losses. That is what happened during the savings and loan crisis, when the troubled assets, mostly real estate, were seized by the Resolution Trust Corporation, a government-owned asset management company, and sold over a few years.

The eventual losses, an estimated $130 billion, were far less than if the hotels, office buildings and residential developments had been sold immediately.

"The taxpayer money would be used to acquire assets, and behind most of those securities are mortgages, houses, and we know they are not worthless," Portes said.


jon said...

the article glosses over what happens when you abandon the mark-to-market rule and pretend like you still have valuable assets during a crunch, which is that you take existing capital and bailouts and dump it into payroll, among other things, and keep paying the very people who have failed to foresee the very real possibility that their assets would become worthless -- for more of that same quality labor!

neither a lender nor a borrower be.

Anonymous said...

Of course they're insolvent. Anyone who has any clue about how fractional reserve banking works takes it as an axiom.

Get as much money as you can out of the bank, convert it to tangible precious metals, keep these tangibles in a safe place, and leave only what you need in the bank.

Even the wizards running the Federal Reserve can't print more gold and silver, thereby devaluing it.

Anonymous said...

We are so screwed!

The author of this article clearly nails what the problem is. The problem is the government interference in the markets. They began by lowering interest rates, pushing sub-prime mortgages out to insolvent borrowers, and refusing to charge the players with fraud. We are not talking about more or less regulation, but a flat out refusal to deal with absolutely corrupt fraud.

The government then tried to solve the problem that THEY created by refusing to let banks fail. So now we have a growing horde of zombie banks (that are truly insolvent) that continue to have blood pumped through them but the brain has been long dead.

When you study the derivatives market (betting on bank assets) you realize that short of drastic intervention (declaration that any players in the game have just lost all their 'chips') there is no possible recovery for the system. I don't see that this government of demopublicrats sees the problem, much less the solution.

They are merely arguing over HOW to spend the money, not whether or not to spend it!

There is a great commentator on the markets over at:


MALTHUS said...

"The [banking] industry...uses the value of a bank's assets as they are carried on its books rather than the market prices calculated by economists."

Please, someone tell me what other industry would be allowed to value its assets as the HIGHER of cost or market? FASB accounting standards require businesses to value their assets as the LOWER of cost or market.

As Jon has noted, when you abandon mark-to-market valuations, the banks' assets are able to be inflated on the their balance sheets so as to maintain the illusion of solvency. The reason that fedgov has to loan money to banks is because their assets are worth less than their liabilities--in effect, they are insolvent.

Anonymous said...

Yes, I am once again necro-posting:

"None of the experts' research focuses on individual banks, and there are certainly exceptions among the 50 largest banks in the country. Nor do consumers and businesses need to fret about their deposits, which are insured by the U.S. government."

Let's take a basic look at how depositors' insurance works:

Q: Who pays the premiums?

A: The banks.

Q: Where do you they get the money?

A: From profits based on investing deposits and fees.

Q: If the bank is insolvent, where does the money come from?

A: You'll love this: the U.S. Treasury.

Q: Where does the Treasury Department get that money?

A: From your taxes.

We're bailing out ourselves. This is an enormous scam, whereby the bureaucrats are simply standing between us and our wallets, and making it more expensive and prone to waste and graft. The deposit insurance fund was recently only 1 percent of its capacity. That's because they've been dumping it in the general fund for years.

I've been saying if for a while now: the state now exists solely to preserve itself. When the state talks about safety, security or the common good, they mean only those employed by the state.

WV = "refile"; refile this under more imaginary solutions by faith-based command economy believers.