The U.S. Banking System is Effectively Insolvent 16 comments
-
Font Size:
-
Print
- TweetThis
I have said before that a systemic response is necessary to deal with the present banking crisis in the United States. This crisis has nothing to do with subprime assets and little to do with things like predatory lending. Those are issues that populists will use to prosecute the scapegoats we are likely to see down the line. The crisis has everything to do with low interest rates, zero regulation and a credit bubble of monumental proportions.
The banking system of the United States is effectively insolvent. Buying up $700 billion in assets is not going to solve this basic fact. A systemic response is needed. If we do not address these issues, we may see significant dead-weight loss as many institutions fail.
After Lehman Brothers (LEH) was allowed to fail, on Sep. 16th I said the following (Lehman's bankruptcy: putting the cart before the horse?): As I survey this situation in serene tranquility away from market turmoil, I realize that I am very troubled by how the Lehman Brothers bankruptcy was handled. In my estimation, it was like putting the cart before the horse - allowing a financial institution to fail before you have worked out a mechanism of how to deal with that failure.
This one action will expose the global financial system to enormous additional risk.
Hank Paulson at the US Treasury and Ben Bernanke at the US Federal Reserve wanted to avoid the moral hazard of supporting the acquisition of a failed institution with government funds as it had done when JP Morgan Chase bought Bear Stearns. Therefore, Paulson and Bernanke were both fairly adamant about not offering any backstops for a Lehman Brothers takeover.
This is the principal reason both Bank of America and Barclays decided not to pursue a takeover of the firm. And this is also the reason Lehman Brothers failed. Had the US government offered guarantees on Lehman's debt, Barclays or Bank of America would have bought Lehman Brothers. In fact, I reckon BofA would have preferred to buy Lehman Brothers over Merrill Lynch as the price tag was much lower.
Were Paulson and Bernanke correct? After some time to digest events, I must answer no. They were wrong.
They were wrong for three principal reasons:
Rather than learning from the Great Depression, we are likely to repeat it.
I believe I have been proven right as all of the chaos we are now seeing is a direct result of the chain of events resulting from Lehman's bankruptcy. But, I say again, he time for adhoc partial proposals is over. What we need now is a comprehensive solution. And this is NOT what we are getting from Congress.
Last Tuesday, I warned (The $700 billion Paulson Plan is dead on arrival): Paulson's plan is a trap
Whether you like Paulson's plan or not, Paulson has been very crafty in making his proposal. He is obviously a good negotiator because he has anchored the discussion around a false set of goals. Congress, which had been unable to present its own proposal, will probably take the bait and use this proposal as a baseline from which to craft legislation, rather than start from scratch with their own initiative.
Moreover, it remains to be seen whether this proposal will ultimately cost a measly $700 billion. Experience with Iraq War funding proposals and the history of Japan's experiences after their property bubble burst tell us that this is the first of many handouts that will be requested. And once the first request is passed, it will be very difficult for legislators to admit that the handouts were not money well spent. So, additional handouts are likely to pass as well.
If Congress allows this plan or some other remedy like it to pass, it will have confirmed its uselessness to the American citizenry. Just as with 9/11, Congress will have allowed the executive branch to usurp powers that are constitutionally held in the legislative branch. Therefore, in the end, when this proposal ends up costing much more than $700 billion, I will hold Congress to blame more than the Bush Administration.
And indeed events are unfolding according to script, with Congress taking Paulson's proposal as a baseline from which to craft legislation. This is lazy and incompetent. If America wants to know what a real comprehensive bill looks like, we should look to Sweden, Finland, and Norway for the answer. But, as markets move very quickly, we could have entered debt deflation by the time Congress gets the will to act.
Posts addressing real systemic solutions
Related Articles
|
Find People on SA
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largest
increase in followers
in the last 7 days-
1
David Fry
-
2
Philip Davis
-
3
Bill Gross
-
4
Tyler Durden
-
5
TraderMark
Fastest Climbers » -
1
-
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most activeSee all
Instabloggers.
Top Instabloggers » -
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 16 comments:
Liquidity is the problem and the fact that no one wants to lend to anyone else because they're not confident that they'll still be standing tomorrow.
All this turmoil is horrible for the markets, investors and taxpayers, but its needed. You need to clean the wound before it can start to heal and what we're going through right now is a great big popping of an abscess!! YUCK!
The corporations that emerge from this period will be stronger than likely what we've seen for a long time. When that occurs no one knows, but we're reaching complete capitulation here so one has to wonder that a bottoming is occuring if not inevitable very soon.
The foreclosed houses are now flooding the market, and that excess inventory will be sold over time, then the normal supply and demand will work within the housing market.
This situation does not justify a $700,000,000,000 bailout for the banking institutions. The banking institutions that invested in these mortgages made a terrible mistake. The American System of capitalism allows people to make mistakes and go out of business. That’s the way the System Works.
If Congress agrees to the $700,000,000,000 bailout, this will bring the total government intervention to approximately one trillion dollars. This is a huge amount of money.
Forget any type of universal Health Care, look for downside adjustments in Social Security, Medicare and veterans benefits. There will now be significantly less money, for things we really need, like university education, infrastructure, dealing with catastrophic climate change, and all of the other things that we depended upon the Federal government to help finance.
Let’s give a thought to what would happen if the United States defaulted on its debt? I personally believe it’s not a question of if, it’s a question of when. Economic experts have predicted that the total cost of the war in Iraq, including long-term care of the seriously disabled veterans, will probably reach three trillion dollars. Plus you add the $700,000,000,000 bailout, to our already enormous debt, over $10,000,000,000,000. And of course we have the baby boomers starting to retire, this huge bubble in our population now starting to retire, will put a huge financial burden on Social Security and Medicare. I think we are in grave danger of not being able to afford even the interest payments on that debt, and default may be the ultimate answer. So if you believe the above scenario, now we are looking at a real financial disruption for the entire world economy.
As far as a lack of liquidity in our economic system, this basically means loans. Making loans to home buyers to and corporations is a profitable and legitimate business. There are many institutions in the world that are in the business of lending, they have sufficient liquidity to make the loans that America needs. We need to think globally in the global marketplace. Like it or not that is the reality of the world today.
Modern economics dictates that when bad decisions are made in business those businesses usually fail, and other businesses will take their place. Some will make it some will not. If there’s profit to be made, and capital available somewhere, capital will come and the job will be done.
Markets will prevail, we really do not need to bail out the rich guys one more time; on the backs of the working people and the taxpayers.
Neil Davis in Rocklin California
ronna_and_Neil @ hotmail.com
Hence...subprime...but also the origin of the laxening of lending standards -- institutions were threatened with the cries of discrimination against minorities and the poor if they refused to slacken the standards. And so it began. No downpayment necessary. That led to those normally credit-worthy obtaining further loans for 2nd and even 3rd houses, as with the increasing (but not affordable) demand, price increases escalated and they were encouraged to flip houses. But even all this is not the root cause.
The government *did* already have a framework - one that is market-based, in fact...and ought to be allowed to function now. The FDIC is there to insure deposits, and the courts have bankruptcy procedures to handle foreclosures. Home prices need to be allowed to deflate to natural levels...not be propped up.
The ultimate root cause is that the average American is *FAR* overtaxed, and had become accustomed to a credit-based life as a result. Government needs to be cut in half...or more...and taxes cut at least in half as well. That sounds radical, but things should never have gotten this far. Enough socialism. It doesn't work. I pay over 15% off the top of each check for Social Security and Medicare alone!! Noone should be paying 15% *total* to the federal government! THAT is why Americans cannot afford mortgages...they are far too huge of a percentage of what income is left.
The solution to the current mess is not another government agency, but *fewer* government agencies, and drastically more of their own money back to the people!!!
It is clear to me, that the people have just spoken to Congress on this...and the House GOP, at least, has heard them!!
www.youtube.com/watch?...
socialism over my DEAD body
Try to get jobs for the average guy...giving a tax cut will do more than a bail out for the wealthy..stop squandering money on a unnessasary war and start trying to be all things to all people mostly the big money gamblers....start taking care of the average American by providing the intrastructure nessasary for success...schooling and research so we can face the world...stop fighting medical research that has nothing to do with government and stay out of our houses and bedrooms.
video.google.com/video...
For anyone who thinks that subprime is the reason we are in this mess, this video will dispel that. By the time you finish watching it, you will completely come to understand who really owns and runs our country and why this crisis was decades in the making.
Congress has abrogated its responsibility to you and me. for the last four years, the finance and economic legislation has been limited to renaming federal buildings and putting peoples faces on coins. they must pass legislation to prevent this type of crisis from occurring again.
and there needs to be major changes to the election funding laws because it is very obvious their allegiance is not to me or you.
Real estate value is not a moment in time but decades of time. To drive our mortgage institutions to insolvency by this valuation method is self perpetuating and self defeating. Real property needs to be valuated based on something like a ten year average. Doing so will not only prevent premature insolvency but it will stop banks from giving out unsafe equity loans based on the highest value as well.
The criteria used for assigning real property valuation needs to be
reconsidered. The current method is fundamentally flawed, but
it is carried forward in an effort to provide transparency and honesty.
However, it is a fundamentally flawed concept to apply it as the primary
criterion for institutional health. American society allows its regulators to move from one extreme to the other -- from making decisions based
on non disclosure to making them based on full disclosure as though
financial markets can survive the transition following the same set of valuation rules. At the very least, we can say a home is not really valued until it is sold.
Congress is dysfunctional.
Or, if you wanted your article to be more than four times as long:
Congress has handed its power to the Executive Branch for twenty pieces of silver.
Dave