Here's What's Wrong with the Banking Sector

Major banks around the world hold trillions worth of “toxic” securities that they need to get off their balance sheets. The U.S. government thinks it might be able to rescue U.S. banks by finding a market for these securities. Here’s the problem: Most of this paper is deeply illiquid — when it was written there was most likely only one plausible buyer and one plausible seller — and the transaction was a function of the inflating credit bubble.

Here’s an analogy: Imagine you invested $100,000 in a hotdog cart on Wall Street, reasoning that with thousands of hungry traders passing every day, you’d have a constant stream of customers and profits. This is a highly liquid transaction because any sane capitalist would be glad to take this business off your hands and earn the same money you were earning. Here’s the thing: the constant stream of customers is a fundamental function of the transaction: without it there is no business.

Say al-Qaida sets off a dirty bomb on Wall Street and makes the area poisonous to human occupation. Your $100,000 hotdog stand is still sitting there, waiting for customers who will never return. Your 100 grand is now 100 percent illiquid, and you have to write off the investment because the conditions enabling the original transaction don’t exist anymore.

My theory (refutations welcome): the recently collapsed credit bubble was the stream of customers that enabled the market for these now-toxic securities. No credit bubble, no market for toxic paper.

Everybody on Wall Street knows this, especially the banks. They know they have to write these assets off as lost causes, but they cannot bear the damage such write-downs will inflict on their credit ratings, because if their credit ratings sink too low, they risk a run on their assets that are still worth something.

In a way I’m glad that I can visualize simplistic, hotdog-stand scenarios that seem to make sense. In reality, these securities are a radioactive Brillo pad the size of Manhattan. Think about being charged with trying to clean that up for a while and you’ll be first in line for the next opening for a greeter at Wal-Mart (WMT).

Comments

[Bob Jones:]

Most banks have been moving money every quarter to the loan loss
reserves and are preparing to take the loss. Not all banks have these
toxic loans so lets not lump all banks into this category. Finally the
government has the time and money to hold these types of loans
long enough to see a recovery and will buy most of these loans from
the banks. In conclusion if Wall street becomes toxic then put your
hot dog stand into a truck and move to another area don't give up.

Feb 11 08:54 AM

[Ranger:]

Excellent example. I will use it going forward.

Feb 11 08:55 AM

[Fabien Hug:]

But if you uncle is rich, you can let you hod dog stand waiting for better days and live with him.

Feb 11 03:21 PM

[M dub:]

Good, except they killed the stream of customers by feeding them with radioactive hot dogs.

Or, if you will, i'd compare it to the Chinese milk that was pumped with melamine, which was good for the company and its profits but killed (literally) its customers. The powdered milk market was no bubble industry, but when you murder your customers it sure looks like one afterwards.

Now we all know what was happening to regulatory capital and accounting equity and all the of balance sheet CDO's and the funny money games and "models" where past performance apparently guarantees future results......... since banks want fees and haven't desired the low returning bore called lending for while, they leveraged themselves to the hilt with "fee" (wink wink) income, and that indeed was a bubble.

Overconfidence at its worst, especially after how we shrugged of 9-11 without a bruise.

But if they weren't feeding poison to their customers for four years like a tube-fed goose being fattened for foie-gras i'm not sure we would have ended up exactly all the way down here in economic hell, so far so fast.

Feb 11 04:01 PM

[norom:]

Best analogy I've read so far.

I'm sure somebody somewhere is making a best of and worst of list of analogies.

I think the problem began with the segamenting of business. Arther Anderson collapsed not because of enron, but because it had two very profitable segements competing with one another, the consulting division trying to outsmart the auditing division. And they did.

AIG had a financial arm operating independant of the rest of the company. A small hole can sink a big ship.

Feb 11 04:14 PM