Dancing Around the Issues

Can you hear it? The clock ticking? It’s the depression clock that recently seemed to “spring forward” as the economy was clearly “falling back.” As the bank examiners were looking at the internal financial information of the 20 biggest banks, I wondered if they were required to wear any special protective clothing to assess those truly toxic assets. We kind of know what they are going to find, and it won’t be pretty.

As long as those toxic assets – like overvalued foreclosed properties, subprime mortgage derivatives carried at prices which will never sustain, really obviously bad classified loans (“suspect” loans like those where the interest may be current, but there really is no way for the borrower to pay back all or a significant part of the note), credit default swaps that will generate a loss when a likely default occurs, etc. – are on the books of those behemoths, they are impaired financial institutions and cannot function to unfreeze the credit markets. As smaller banks get the next federal “look-see, stress test,” I suspect we will find more “bad”… but small local banks have more of a foreclosure issue than a bad investment strategy.

I have argued that we already have a nationalized banking industry – FDIC charges its 8,305 member banks to guarantee depositors up to $250K, the Federal Reserve controls the flow of money and effectively price of loans, the Comptroller of the Currency (along with the other federal institutions listed above) controls the ratio and quality of assets required for a bank to lend money, and the Department of the Treasury has spread massive direct federal investment (the TARP bailout) into the banks themselves. Taking over full ownership, true “nationalization” as most people see it, has not occurred yet, but when a bank goes under, the FDIC pays off its depositors to the extent required and shoves the operations into a surviving bank, we get very, very close.

The fact is that the impairment of toxic assets described above literally prevents the subject banks from having the right ratios to release loan funds in sufficient amounts to make a difference. So whether we effect true nationalization – let the government take over ownership of the biggest banks whose collapse would literally drop the stock market way below current horrific levels if we let them fail (look what the September 15, 2008 collapse of Lehman Bros. did to our economy – the real beginning of the market crash that still falls to this economy) – or some euphemistic alternative “bad” bank/good bank” scenario – where toxic assets are either insured by the government or placed into a Resolution Trust Corp. (where we placed failed thrifts in the 1990s) owned by the government or simply split our existing banks into bad and good operations (letting the latter fail or get government assistance), or allows backs to create and then separate “bad banks” internally – the government is going to have to effect “one of the above” soon.

Some argue that government ownership of the biggest banks – the pure nationalization scenario – gives those banks an advantage over those financial institutions that remain private, and of course. that the government cannot nationalize the entire sector (nor does it need to). Writing in the March 8^th NY Times, Alan S. Blinder is a professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve notes: “SO, on closer inspection, the best-sounding arguments for nationalization are really arguments for bullet-biting. Worse yet, even talk about nationalization can be harmful if it puts bank stocks under further selling pressure. After all, who wants to own a stock whose value is heading toward zero? Which is why Mr. Bernanke [Federal Reserve Chairman] and Mr. Geithner [Treasury Secretary] have taken pains to beat down rumors that nationalization is coming…

“Let’s first at least explore what is called the ‘good bank, bad bank’ approach. [T]basic idea is to break each sick institution into two. The ‘good bank’ gets the good assets, presumably all the deposits and a share of the bank’s remaining capital. As a healthy institution, it can presumably raise fresh capital and go on its merry way as a private company.

The ‘bad bank’ inherits the bad assets and the rest of the capital — which, after appropriate markdowns of the assets, will not be enough. So, again, someone must fill the hole. And, realistically, given the mess we’re in, much of that new capital would likely come from the taxpayers.”

In my own words, “government, pick one of the above” and soon – the longer we wait, the more it will cost taxpayers – and then let’s get on to the issue of how to get loan money to borrowers who may no longer be qualified for loans under current standards but must receive loans unless you really want to see a full-on depression.

I’m Peter Dekom, and I approve this message.