How Do You Recapitalize $1.8 Trillion in Bank Loan Losses?

I've been having a look at Nouriel Roubini's estimate of a total of $1.8 trillion of losses in the US banking system, compared to just $230 billion in TARP recapitalizations to date and $200 billion of new money from private-sector sources. And while I might niggle with a few of the numbers he uses to reach that $1.8 trillion number, there's nothing there which is obviously crazy: it's very much within the realm of possibility.

There's no one huge number which accounts for most of the $1.8 trillion, although the single scariest one is probably the $295 billion that Nouriel reckons banks are going to lose on their commercial and industrial loans -- a number which doesn't even include another $35 billion in leveraged loan losses or $127 billion in mark-to-market losses on high-grade and high-yield corporate debt which ended up on US banks' balance sheets despite the fact that it was securitized.

Nouriel uses a naive view of the Markit ABX, TABX, and CMBX indices to work out the mark-to-market value of asset-backed bonds; I'd quibble with that. On the other hand, there are lots of potentially dodgy assets which Nouriel isn't including in his calculations, including sovereign debt, municipal debt, and -- biggest of all -- loans extended by US banks to foreign companies and individuals. We've already been through a round of European banks taking big losses on their US assets; we haven't even begun to see US banks take losses on their European assets, or their loans to formerly-flush companies in commodity-rich countries like Russia, Brazil, and Australia.

It's worth bearing Nouriel's numbers in mind when reading Tim Geithner's testimony from this morning:

The tragic history of financial crises is a history of failures by governments to act with the speed and force commensurate with the severity of the crisis. If our policy response is tentative and incrementalist, if we do not demonstrate by our actions a clear and consistent commitment to do what is necessary to solve the problem, then we risk greater damage to living standards, to the economy's productive potential, and to the fabric of our financial system.
Senators, the ultimate costs of this crisis will be greater, if we do not act with sufficient strength now.

In a crisis of this magnitude, the most prudent course is the most forceful course.

"The most forceful course" is clearly not the incrementalist one of adding to Paulson's TARP here, throwing in a few tax cuts there, announcing some big public works, and hoping for the best. The cost of recapitalizing the banking system alone -- to say nothing of the losses elsewhere within the shadow banking system -- might well be larger than Obama's entire stimulus plan.

Now those costs don't need to be paid for in cash dollars. Government guarantees, whether they arrive implicitly, through nationalization, or explicitly, through loan acquisition and the creation of a ring-fenced "bad bank", can do a lot of good at zero up-front cost. But given the commitment that both Obama and Geithner have made to transparency, I do hope that they're very clear about the real present value of such guarantees -- a sum of money which could easily run into the hundreds of billions of dollars.

But most of all, given the implosion in the Citigroup (C) and Bank of America (BAC)share prices after they got bailed out with government loan guarantees, I hope that Geithner has learned that ad hoc solutions are a recipe for disaster. I look forward to an announcement, soon, of something big, coherent, consistent, and transparent. Not that Geithner gave any hint of having any such thing in mind during today's testimony.

Comments

[Jubilee Year:]

So, now that we know the world's banking system is totally broken and insolvent, why not just hit the reset button: cancel all the debt and start fresh.

Jan 22 10:55 AM

[Jason Rines...:]

I would love to see that happen but it's wishful thinking. The worst offenders will walk off Scott-Free. The banking misdeeds tie directly back to government. Look at Bernie Madoff, sitting in his luxury apartment after $50 B Ponzi after shattering thousands of lives. He should be doing hard time for life. It will be a long time before confidence returns to the financial sector.


On Jan 22 09:31 AM James Wilson wrote:

> You take a really close look at who wrote the mortages that are now
> bad. Then you pulll all those loans and check 5 % of them for accuracy
> then put the lenders who wrote them in jail for breaking the RICO
> ACT.
>
> Then you take all their money, sell their homes, cars, pimp out the
> wife and find all the offshore property claim it and sell it.

Jan 22 12:16 PM

[margel:]

I know you are an advocate of nationalization, but I fear that the US Government does not have the capacity to organize and manage such a transformation. There are 2 approaches either (A) nationalize, take out the bad assets and then recapitalize the remainder of the bank; or (B) nationalize and liquidate. (B) will take too long even if only 4-5 banks are nationalized. Plus what does one do with the employees, systems and business relationships built up over time? Note one reason FDR simply recapitalized the existing banks during the New Deal is that the federal government did not have the means or time to reorganize the system as a whole. The top priority was to stabilize the banking system quickly. (A) is preferred, but if we go this route, why not do it through a bad bank or ring-fencing scenario. To buy the bad assets at more than fair value would be tantamount to nationalization with recapitalization. It is cheaper and less and include some other banks which are pretty good (like USB and some regional banks) and strengthen the broader system.

Jan 22 01:33 PM

[PROXIMO:]

Especially pimp out the wife.


On Jan 22 09:31 AM James Wilson wrote:

> You take a really close look at who wrote the mortages that are now
> bad. Then you pulll all those loans and check 5 % of them for accuracy
> then put the lenders who wrote them in jail for breaking the RICO
> ACT.
>
> Then you take all their money, sell their homes, cars, pimp out the
> wife and find all the offshore property claim it and sell it.

Jan 22 01:44 PM

[prudentinve...:]

"I look forward to an announcement, soon, of something big, coherent, consistent, and transparent."

You forgot an important adjective: FAIR

Jan 22 02:25 PM

[raytayzmd:]

...oh, wow, 1.8 trillion in losses!...why, that's almost as much as what the Iraq war will end up costing us!...funny, I don't recall anyone getting sqeamish when THOSE estimates were being tossed around 6-7 years ago...why, that "toxic asset" didn't bother hardly anyone -- not even Obama was particularly disturbed as I recall...and THAT did 1.8 trillion bother Nariel Roubini?...I suspect not -- it wouldn't have got him any publicity back then...but NOW 1.8 trillion is going to bankrupt us all!...HA!...how times change!...well, here's MY prediction: when it's all finally over, the rich will end up richer and everyone else will end up poorer...why, I bet you could even take that to the bank.

Jan 22 02:25 PM

[Socialism c...:]

And Big Government is a huge part of that whole "root cause overspending on credit" thingy. Needs taking down to size, not a ramp-up in spending!!!


On Jan 22 10:28 AM Smarty_Pants wrote:

> Sadly Geithner's error, like all gub'mint bureaucrats, is misdiagnosing
> the problem in the first place.
>
> The root cause of the 'crisis' has been the extensive use of credit
> as a foundation for growing the economy.
>
> The only sustainable solution is to shrink the economy back to a
> size that is capable of supporting itself without credit. That's
> what recessions are all about. People who borrowed and did foolish
> things lose, and those who didn't borrow get a chance to buy the
> foolish mistakes at a discount using savings instead of credit.

>
>
> The 'most forceful course' is only a bandaid on a sucking chest wound.
> It won't help for long, if at all.

Jan 22 03:17 PM

[Socialism c...:]

At least we're getting something for the Iraq war! There's a fledgling democracy in the middle east, where private citizens are now starting business and women can now go to school. In contrast, we just heard that "giant sucking sound" as banks absorbed gargantuan sums of tax dollars...into a black hole...and failed to report where it went. Bloomberg even sued to get a report from the Treasury, but has been denied.


On Jan 22 02:25 PM raytayzmd wrote:

> ...oh, wow, 1.8 trillion in losses!...why, that's almost as much
> as what the Iraq war will end up costing us!...funny, I don't recall
> anyone getting sqeamish when THOSE estimates were being tossed around
> 6-7 years ago...why, that "toxic asset" didn't bother hardly anyone
> -- not even Obama was particularly disturbed as I recall...and THAT
> did 1.8 trillion bother Nariel Roubini?...I suspect not -- it wouldn't
> have got him any publicity back then...but NOW 1.8 trillion is going
> to bankrupt us all!...HA!...how times change!...well, here's MY prediction:
> when it's all finally over, the rich will end up richer and everyone
> else will end up poorer...why, I bet you could even take that to
> the bank.

Jan 22 03:20 PM

[CJJ:]

Jubilee,
Resetting all the debt would just be too damn easy. Actually its funny because this is such a simple thing and no one ever talks about it because it doesn't fit anywhere in their stupid econ books.

Socialist,
You're kidding about Iraq, right? Tell me you don't really think anything positive has come out of Iraq. When a country like Iraq decided to fight terrorists on their own, then we can cite progress. How about Hamas in Gaza? You can't tell me the people in Gaza do a darn thing about Hamas running them. I always loved people who complained about the US only going to Iraq for oil. THAT would have been a GOOD reason to go there.

Jan 22 05:34 PM

[Tony Petroski:]

On the Iraq matter, I agree with Socialism. It's not so much that we got a payoff from improving the lives of Iraqis. It's that we killed a lot of terrorists in the streets of Iraq rather than having countless Mumbai massacres in U.S. malls. What was the cost of shutting down the U.S. airspace for one week post-9/11 and then the resulting losses to the airlines and the U.S. economy? Think about that when one of the inhabitants of Gitmo ends up in a crowded U.S. mall shooting everyone and then blowing himself up.

Jan 22 05:45 PM

[PROXIMO:]

That line about going to war for oil in Iraq always cracks me up too. Like we couldn't have taken it when Iraq surrendered to H W Bush and Schwarzkopf in the first Gulf war.
On Jan 22 05:34 PM CJJ wrote:

> Jubilee,
> Resetting all the debt would just be too damn easy. Actually its
> funny because this is such a simple thing and no one ever talks about
> it because it doesn't fit anywhere in their stupid econ books.

>
>
> Socialist,
> You're kidding about Iraq, right? Tell me you don't really think
> anything positive has come out of Iraq. When a country like Iraq
> decided to fight terrorists on their own, then we can cite progress.
> How about Hamas in Gaza? You can't tell me the people in Gaza do
> a darn thing about Hamas running them. I always loved people who
> complained about the US only going to Iraq for oil. THAT would have
> been a GOOD reason to go there.

Jan 22 06:40 PM

[Moon Kil Woong:]

Technically speaking if you dump another $350 billion in government equity in them they can bleed $60 billion in losses for a year and still use $180 billion to help improve their horrible reserves. As long as they aren't forced to recognize the losses they know about they will be fine for a while before going to the public trough again.

In the meantime they will use any interest payment to pay off more bad loans and refuse to lend out their reserves. So after 10 or 20 years we will be fine as long as they don't do something stupid again (I wouldn't bet on it). You would think they would have learned from the 1987 crash about the risk of derivatives. Or you think they would have learned from the 2001 drop about the risk of overextending credit. After all it was this time that they asked for off sheet balance sheet accounting to hide their losses (they were suppose to clean them up then but haha... they were just kidding).

This economy is suffering a death by a thousand cuts caused by bankers and their banking oligopoly called the Fed that shelters them with Federal Reserve low interest rate Fed funds rate fakery. As it stands now, I think most big conglomerate banks should be paying higher interest than corporations. I don't see too many corporations that will go bankrupt if they have 4% default payment rates.

Jan 22 09:10 PM

[AllStreets:]

With all the financial expertise out there, given the general recognition that the banks are all insolvent, it's mind boggling that hardly anybody mentions that, even if you recapitalize the banks completely, that does absolutely nothing to rescue the bad underlying assets or their borrowers. A bank bailout is an attempt at a "top down" solution. It can't work. Who would the recapitalized banks lend to? Not the 25% or more of homeowners who have zero or negative equity. Not the commercial real estate investors whose loans are too high and balooning.

It's the drop in housing values that caused the insolvency, and now falling commercial real estate values, and unsupportable corporate debt are adding to the problem. Neither TARP, nor tax cuts, nor public works will alleviate the underlying housing and mortgage crisis that is destroying consumers and the economy. Those programs may have a stimulative effect in the longer term, but by the time they do, a huge portion of consumers and businesses will be bankrupt, and so will their lenders. TARP may not even succeed in stopping the national banking crisis since it continues to worsen even as some of the lost capital is replaced. Nationalization of the banks doesn't do anything at all for the underlying problem.

In my humble opinion the best, the fastest, the fairest, and the least cost solution is a program of low-interest, long-term loans directly from the government to all citizens and their mortgage lenders to convert excess mortgage debt to loans not secured by the properties, and for other purposes for those who don't have a mortgage. That will rescue the housing market, consumers, mortgage loans, lenders, and mortgage securities all at once. Please see the very detailed AllStreets Bailout Plan at www.themortgagenews.in.... The damages to consumers and businesses of all kinds that continue to worsen are largely irreversible (bankruptcies and foreclosures). If Congress doesn't do something soon to directly save the consumers, not the banks, a depression is likely for many years.

Jan 22 09:13 PM

[SW Richmond:]

One man's debt is another man's asset.


On Jan 22 10:55 AM Jubilee Year wrote:

> So, now that we know the world's banking system is totally broken
> and insolvent, why not just hit the reset button: cancel all the
> debt and start fresh.

Jan 23 06:53 AM

[Andrew Hughes:]

"The tragic history of financial crises is a history of failures by governments to act with the speed and force commensurate with the severity of the crisis."

I think what Geithner meant to say was ..

"The real history of financial crises is a history of SUCCESSES by governments who acted with speed and force to inflate severe and unsustainable bubbles that lead to crises for the taxpayers"

Jan 23 08:29 AM

[JOETRADER:]

PIMP OUT THE WIFE FIRST. EXACTLY!


On Jan 22 09:31 AM James Wilson wrote:

> You take a really close look at who wrote the mortages that are now
> bad. Then you pulll all those loans and check 5 % of them for accuracy
> then put the lenders who wrote them in jail for breaking the RICO
> ACT.
>
> Then you take all their money, sell their homes, cars, pimp out the
> wife and find all the offshore property claim it and sell it.

Jan 23 09:07 AM

[1234987:]

Housing solution!

I, Remove 2 million homes from the MLS (for Sale) that financial institutions currently have
for Sale. Any Institution that received TARP funds will be required to first offer the home
to the RTC for purchase. RTC will not purchase any home above $417,000. No Jumbos.

2, Government Resolution Trust will purchase these homes from these institutions for 20%
less than original first Mortgage amount. No negotiating.

3, 600 billion dollars to buy these homes (app $300,000 each average) will come from the sale
of long term 30 year bonds. (Currently app 3-5%) issued by Government.

4. RTC will send these homes to the local HUD offices for disposition thru voucher program
(rentals). $5000 will accompany each home for repairs & upkeep. eventually as the MLS
system reaches certain inventory levels (i.e. 30-60 days) HUD will be allowed to place these
homes on the sale market. If the inventory increases HUD will remove homes accordingly.
This will be a local HUD market decision, differing from region to region. Rental Income will
help cover expenses such as maintenance, insurance and property taxes.


Pro's:


Supply/demand economics will create a bottom in the housing market once 2 million homes
for sale are removed. Prices will start to increase.

Local governments will see a bottom in declining values and revenue will increase as values
slowly stabilize and slowly increase.

Individual homeowners as well as other sellers will find a housing market ready and able
to absorb the inventory.

Banks will now have a fresh source of funds to lend on homes that are not declining in value.

Banks will be able to clean balance sheets of hard to liquidate assets.

Lending/leverage/credi... markets will slowly begin to return to normal. Applications will
increase, appraisals, home inspections, title work, all types of stimulating activity for business.

As home prices stabilize and increase the local HUD agency selling homes over a 3-7 year time
frame will see prices rise for properties purchased by the RTC. HUD will only be required to
return to RTC the original amount of the purchase price plus the 20%. Or the original amount of the
selling banks first mortgage.

Once the RTC is closed and all homes sold, all losses (if any) will be covered proportionately
by the selling institutions. All financial Institutions selling homes to the RTC will share the loss
at the RTC as a percentage of total homes purchased and homes sold to the RTC. That percentage
will be the Banks percentage for covered losses. These losses will be paid by the banks over a 30 year period liquidating the original bonds sold to finance the purchase.

Other agenda items:

Mark to Market accounting will only apply to non performing assets.

Spend 50 billion each year for the next 3 years rebuilding infrastructure. Bridges, Roads, tunnels,
water plants, dams, levies anything to create jobs.
Stimulus checks for $300 only help pay a credit card bill once.

Any comments?

Jan 23 11:52 AM

[TexasBill:]

JoeTrader,

Cons: Where are the 2 million homeowners/renters going to come from? There's going to be a huge sucking sound of tenants leaving their existing homes/apts to take advantage of your gov't deal.

What are you going to do about the financial damage that your plan transfers to the landlords that own the homes these people are living in now? Seems to me that you are just hiding the pea under a different shell.

Jan 23 11:00 PM

[Kunst:]

Oh no, that war will be over in no time and will cost a small fraction of that. Besides, other countries will pay for part of it. By the time Iraq's oil gets factored in, we'll probably make a profit. Don't you remember?


On Jan 22 02:25 PM raytayzmd wrote:

> ...oh, wow, 1.8 trillion in losses!...why, that's almost as much
> as what the Iraq war will end up costing us!...funny, I don't recall
> anyone getting sqeamish when THOSE estimates were being tossed around
> 6-7 years ago...

Jan 24 01:30 AM

[Kunst:]

Amazing, just amazing.


On Jan 22 03:20 PM Socialism cannot compete! wrote:

> At least we're getting something for the Iraq war! There's a fledgling
> democracy in the middle east, where private citizens are now starting
> business and women can now go to school.

Jan 24 01:33 AM