Tuesday, March 03, 2009

Dead Banks

So Citi wants yet more money, and AIG needs another huge infusion. None of the Treasury's efforts so far have had any effect on all those toxic assets. The really disturbing assumption on all this was quoted by Paul Krugman today, from a blog called Tim Duy's Fed Watch. The Tim Duy article is interesting if dense, but here's what you really need to know (emphasis mine):
Policymakers are assuming that restoring proper functioning in credit markets - and confidence in general - is equivalent to a housing price rebound. They seem incapable of envisioning a world in which this is not the case. This tunnel vision prevents policymakers of trying to devise policy which assumes that the many of the assets in the banking system are simply “bad.” For Bernanke and Geithner, there are no bad assets. Only misunderstood assets.
Think about this. We are in this mess because too many people borrowed more money than they could pay back on overpriced houses. The houses were overpriced. House prices have been falling for awhile; they have farther to fall to reach their "true" price, which is the price paid to a willing seller by a willing buyer, who will be paying an acceptable fraction of his total verified income to a willing lender. With people losing jobs left and right, willing buyers haven't got the money to throw around that they did a few years ago.

Meanwhile, many of the oversized mortgages taken out on overpriced houses are in default. In a real world, this would mean that the securities built around those mortgages are worthless. The security owners bought them, assuming they would get a specified income stream; not gonna happen. But if we all admit these securities are worthless, then the banks that own them have to write down their asset value; they should be doing it anyway, it's called "marking to market," and the banking industry is desperately, maniacally fighting doing it. And given the amount of dud securities that were sold, it's odds on that the banks doing the writedowns will have to admit publicly that they are - insolvent. Broke. Stony. They owe more than they own.

The government - two administrations now - has been trying for 6 months to figure out what to do about these "toxic assets" because they "can't establish a value for them." What they really mean is that they need to figure out a way to put a value on them that will allow the banks holding them to maintain the illusion of solvency. You know and I know that the value on the basic mortgage-backed securities is maybe 15 cents on the dollar (I made that up; but it won't be high, whatever it is); the value of the derivatives on them, like CDOs and CDO-squared (see the glossary on Planet Money), is effectively zero. Zilch. Since they're electronic, they won't even make good wallpaper. The latest government scheme, also quoted by Krugman from a blog called Calculated Risk, is to involve "public-private partnerships". Once again, here's the gist:
By offering low interest non-recourse loans, these public-private entities can pay a higher than market price for the toxic assets (since there is no downside risk). This amounts to a direct subsidy from the taxpayers to the banks. It is amazing how many different ways they've tried to recycle the same bad idea.
This is yet another effort to avoid admitting that one or more "major" banks, "too big to fail" banks, are - insolvent. Broke. Their capital and assets won't cover their liabilities.

I'm sorry - I think we need to admit that some of these institutions are dead, and bury the carcasses. Will there be fallout? Yes. Do I know how bad it'll be? No. But if we continue to try to prop these dead institutions up, in the hope that some day the economy will recover and housing prices will return to where they were in 2006, and all the mortgage-backed securities will miraculously have value again, we will fail; and we will bankrupt ourselves and our descendants in the process. We all need to get used to the fact that housing prices may never return to where they were in 2006.


  1. Throughout the 1980's and 1990's, America was bleeding jobs and capital to overseas venues.

    Meanwhile, the "assets" of ordinary Americans was being buoyed by false valuations of the real estate market, as well as growing debt (credit cards, etc.).

    Despite our population growth, the real income of American families, and the American economy in general, was steadily shrinking. This was masked, or camouflaged, by our indebtedness. In other words, despite a fake "prosperity" during the two Clinton Administrations, and the first Bush II term, our actual net worth was rapidly shrinking. This was evident in our balance of payments, and growing National Debt, as well as the decline in household real income.

    The mortgage crisis was the result of everyone pretending that people actually could "own" properties that were probably twice, or three times, what they could actually afford. The mortage-backed securities were, therefore, obviously overvalued (for the same reason).

    The American banking system, operating on these fraudulent premises, obviously got in over its head.

    Is it "too big" to fail? Well, what are the "real" consequences of major banking and insurance failures? Probably a depression on the order of the 1930's.

    I'm not optimistic.

    I expect that people with cash in the bank are going to do a lot better than people with "empty" assets, like houses, and stock and bonds. Gold may to up to $2000 an ounce.

    Likely: 25% unemployment. The trucking and railroad and commercial airlines all disappear. American banks fail. We go back to bread lines and jingling charity bells.

    You heard it first here.

  2. Karen, nice writing!

    btw, the NPR program Fresh Air (Terry Gross) has a recent interview you may find interesting also, in which someone that should know suggests delaying fixing the banks might cost around 20% of GDP!