No Return To Normal - the Galbraith article | 96 comments (96 topical, editorial, 0 hidden)

Are there European banks that are insolvent? (4.00 / 5)

Hmm.

The big banks are insolvent and pumping more money into them will only prolong and worsen the crisis.

This can be true only to some degree. If you pump enough money into banks at some point they have to become solvent again. Their liabilities are not infinite.

Without gov't assistance? Marked to market and not fantasy?
At least 7 out of the ten largest banks in Germany would be insolvent.

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

by Martin (weiser.mensch(at)googlemail.com) on Fri Mar 20th, 2009 at 04:58:18 AM EST

Re: Are there European banks that are insolvent? (4.00 / 5)

Their liabilities are not infinite

No, but they are not static either. The worsening of the economic situation increases risk (and actual default) which continues to degrade banks' balance sheets.

by afew (afew(a in a circle)eurotrib_dot_com) on Fri Mar 20th, 2009 at 05:09:23 AM EST
[ Parent ]

Re: Are there European banks that are insolvent? (4.00 / 3)

Assuming you mean assets, not liabilities, because the solvability problem concerns the value of assets.

by afew (afew(a in a circle)eurotrib_dot_com) on Fri Mar 20th, 2009 at 05:14:13 AM EST
[ Parent ]

Re: Are there European banks that are insolvent? (4.00 / 4)

The assets cannot lose more than their face value.

The liabilities, on the other hand, can grow infinitely. But, in a climate of deflation and low interest rates, liabilities grow slowly.

So the problem is that some assets are maybe worth zero. All you need to do is add free cash to the assets until the assets are worth enough. Normally this would be done with an equity injection, which would mean a share of ownership. If the share of ownership becomes more than 50%... tough for the management!

This is the way to deal with this mess: Turning Bad Bank / Good Bank on its head (Update) by BruceMcF

OK, now, suppose we do it this way. Bank examiners do "stress testing", which is to say, a real world audit instead of the fantasy audits that we have been doing in order to avoid official recognition of the depths of the problem. And banks that are in too much financial peril to be allowed to continue operating as they have been doing ... are put into receivership.
Now, the US government strips out the liabilities that we wish to protect ... the account liabilities ... and takes over the "good" assets. If that is a net plus, the government pays the original bank for the positive net assets. If that is a net minus, the government makes up the difference with the new Good Bank, and takes a compensating Senior claim in the old Bad Bank.
Then the residual of the old Bad Bank is run through ordinary Chapter 11 proceedings ... in most cases the shareholders will be zeroed out, the bondholders will become shareholders, the new shareholders are quite likely to sack the old senior executive management, and the old Bad Bank will see what they can do to recover whatever value can be had in the trash that forms their asset base.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith

by Carrie (migeru at eurotrib dot com) on Fri Mar 20th, 2009 at 05:18:57 AM EST
[ Parent ]

Re: Are there European banks that are insolvent? (4.00 / 7)

I agree that the solution could work, but the problem is that the liabilities HAVE grown, and will ocntinue to grow massively, given that they included tons of bets that a lot of stable institutions would not fail - several already have, and more could follow them).

The asset side of the mess could be plugged by Fed injections, but the liabilities side cannot (and yet this is what is being done via AIG).

Whatthis means, though, is that lots of people (like Paulson) are making outrageously large profits from having bet on supposedly rare failure events - and this money is being created for them by the Fed.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Mar 20th, 2009 at 05:50:35 AM EST
[ Parent ]

Re: Are there European banks that are insolvent? (4.00 / 5)

Credit default swaps could be delared null and void in a fell swoop of the legislative pen and the effect wouldn't be too serious.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith

by Carrie (migeru at eurotrib dot com) on Fri Mar 20th, 2009 at 06:00:17 AM EST
[ Parent ]

Agreed 100%. (4.00 / 6)

Then declare them illegal - maybe all short sales, too. At least, re-institute the one-uptick rule in the U.S.

The only problem is that we're discussing things that: 1) won't happen, because the U.S. Congress is what they are; and 2) won't help, because this mess is way beyond re-regulation. Rationalization - i.e., socialism for the monopolistic/oligopolistic elements of the economy - is the only solution that can offer progressive outcomes at this point. And that ain't going to happen without a real fight - not Apple vs. Microsoft.

I support Chris Cook's ideas in every way, except that they won't happen either at this juncture. We're just not evolved enough, however much some of the objective conditions call for his approach.

paul spencer

by paul spencer (paulgspencer@gmail.com) on Fri Mar 20th, 2009 at 03:22:32 PM EST
[ Parent ]

Re: Agreed 100%. (4.00 / 2)

paul spencer:

I support Chris Cook's ideas in every way, except that they won't happen either at this juncture. We're just not evolved enough, however much some of the objective conditions call for his approach.

I think it depends on how the propositions are put across. And I don't think we actually have a choice, because the system of credit is terminally fucked IMHO.

First, Peer to Peer investment though unitisation offers a mechanism that wipes the floor with secured debt. Any bank or investor that does not use such a Debt/Equity swap mechanism to exit their crap loans will be at a disadvantage to those who do.

And the more who use it, the more liquid the "Pool" of Rental Units becomes.

Second, Peer to Peer unsecured credit which is interest-free, but not cost-free. What's not to like?

The Carnegie Institute liked the ideas....

Peer-to-Peer Finance: A Flight to Simplicity

Credit and investment may be achieved without the intermediation of banks. Since bank capital will be further depleted as the credit crunch spreads into the productive economy, peer-to-peer finance offers a solution from an entirely unexpected direction.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Mar 20th, 2009 at 04:36:43 PM EST
[ Parent ]

You know that I like it. (4.00 / 7)

Don't know how it is in northern England, southern Scotland currently, but it's getting tense here. (Old guys like me, who have stuck their minority opinions into controversial situations, have an acute sense of dangerous levels of tension.)

I'm actually still working on your/our principles. If you can help me find $300k, we can do the land phase of workforce housing in Carson, WA with a guaranteed 5% for investors. I'm good for $30k, and Steve N. might be interested. LLC with builders and suppliers at-cost for labor and materials with (reasonable) profit as their buy-in on the long term.

Another (producers') co-op project involves chipper, dump truck, and track-skidder for forest-health/fuel-reduction thinning operations cum woody biomass energy-source purpose. I'd diary that and several related topics, but I just don't have time at present. I'm going off to Texas April 7 for a visit, then driving back over 8 days. Should be able to elaborate then.

paul spencer

by paul spencer (paulgspencer@gmail.com) on Sat Mar 21st, 2009 at 02:27:02 AM EST
[ Parent ]

Re: You know that I like it. (4.00 / 2)

Paul,
Send me a link or links so I can educate myself. And do diary this, with time frame ASAP.

Capitalism searches out the darkest corners of human potential, and mainlines them.

by geezer in Paris (risico at wanadoo(flypoop)fr) on Sat Mar 21st, 2009 at 04:57:30 AM EST
[ Parent ]

I'd love to do it now, (none / 1)

but I really do not have time. I barely manage to come by ET and sample the diaries.

paul spencer

by paul spencer (paulgspencer@gmail.com) on Sat Mar 21st, 2009 at 11:06:21 AM EST
[ Parent ]

Re: You know that I like it. (4.00 / 2)

Commendable - at least someone is putting some ET talk into action.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith

by Carrie (migeru at eurotrib dot com) on Sat Mar 21st, 2009 at 05:12:04 AM EST
[ Parent ]

Re: Are there European banks that are insolvent? (none / 0)

That is why the New Good Banks / Bad Old Banks plan pulls out protected bank depositary liabilities to be the liabilities of the "New Good Bank" and the sound assets to form its assets, makes up the shortfall if there is one, against a Senior stake in the Bad Old Bank ...

... in the case that there are more sound assets than deposit liabilities to be protected, the surplus sound assets can be left as a part of the asset base of the Bad Old Bank. Shareholders are still likely to get wiped out, but bondholders in those institutions will get more cents on the dollar ...

Then the Bad Old Bank can be moved from receivership to bankruptcy, and the management of the Good New Bank can be taken over via an LLP/LLC with an existing bank that managed itself with enough prudence to be solvent in the middle of such a severe recession.

Geithner is protecting the wrong part of the finance sector ... which is not surprising, since he is from the Anglo Disease part of the finance sector ...

... since finance companies that survive will have trimmed their sails substantially, small and medium sized businesses are going to need a functioning banking system if they are going to be able to respond effectively to any upturn in demand that should occur and consumers are going to need a functioning banking system to be able to respond to any stabilizing of household income.

Indeed, if we are going to hope to bring as many banks OUT of receivership as we will need to do, it will have to be in the context of a recovery, and waiting to clean up the mess until the recovery happens means we are caught in a vicious circle, since the lack of confidence in the solvency of large money center banks makes recovery less likely.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Sat Mar 21st, 2009 at 07:48:02 PM EST
[ Parent ]

Re: Are there European banks that are insolvent? (none / 0)

Indeed, if we are going to hope to bring as many banks OUT of receivership as we will need to do, it will have to be in the context of a recovery, and waiting to clean up the mess until the recovery happens means we are caught in a vicious circle, since the lack of confidence in the solvency of large money center banks makes recovery less likely.

My own prediction is that, for instance, the stock markets won't hit bottom unless and until the banking sector is repaired.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith

by Carrie (migeru at eurotrib dot com) on Sun Mar 22nd, 2009 at 04:21:42 AM EST
[ Parent ]

Re: Are there European banks that are insolvent? (none / 0)

My own prediction for the US is that with the stock market in the toilet (whether or not it hits bottom), many medium sized companies that could raise funds in equity markets will need bank lending for working financial capital should there be a prospect of new orders.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Sun Mar 22nd, 2009 at 11:34:14 AM EST
[ Parent ]

Re: Are there European banks that are insolvent? (none / 0)

Well, stock prices are underpinned by earnings, and for as long as earnings are perceived to be falling there won't be anything underpinning stock prices.

We're into second order effects now. If people are out of jobs then it doesn't matter much what the mortgage rate is or the market rent - they won't be able to pay.

So a second wave of defaults on apparently "prime" mortgages gathers pace.

I cannot see any conventional way of stopping the spiral we are in. The numbers are too fucking big.

Better try something unconventional, eh?

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Mar 22nd, 2009 at 11:44:36 AM EST
[ Parent ]

Size of liabilities (4.00 / 3)

See this article I quoted in the other thread:

Accordingly, his funds generally eschew leverage, or making bets with borrowed money. He insists that his fruitful subprime trade, far from being stunningly clever, was a no-brainer for anyone who bothered to analyse the complex securities' underlying collateral. "It was obvious that a lot of the stuff...was practically worthless at the time of issuance," he says. He finds it "perplexing" that the banks holding the higher-rated tranches could not see this danger, and that so few others were prepared to believe that Wall Street's finest could have miscalculated so badly.
Another motivating factor for Mr Paulson was the alluring asymmetry of shorting credit. The most you can lose is the spread over some benchmark rate. Yet if the bond defaults, the gains can be mouth-watering. He targeted BBB-rated tranches, the lowest in subprime securities. With credit spreads so low because of a liquidity glut, his possible upside as a buyer of protection using credit-default swaps (CDSs) was as much as hundred times the potential downside. One $22m trade is said to have netted him $1 billion when Lehman Brothers went bust. Though the CDS market has been good to him, he believes it "blew out of control" and needs to be regulated and moved onto exchanges, with margin requirements to limit excessive speculation. He also advocates tighter oversight of hedge funds.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Mar 20th, 2009 at 05:53:43 AM EST
[ Parent ]

Re: Are there European banks that are insolvent? (none / 0)

Their liabilities are not infinite.

True. So who has $165 Trillion in spare change? According to the FDIC, that is the amount of off balance sheet" liabilities in the financial system as of 2007, excluding CDOs, SIVs, etc. etc. Certainly not infinite and not ALL of it will be total worthless. Lets say it is worth 70 cents on the dollar.

Then the question might better be: "Hey buddy, got a spare $50 Trillion?" If so, then perhaps they will know who to call when the CDOs, SIVs, etc blow up.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Mar 22nd, 2009 at 06:08:00 PM EST
[ Parent ]

Re: Are there European banks that are insolvent? (none / 0)

If it are off balance sheet vehicles, maybe it is possible to default with the vehicle without defaulting the balance. What is the point of having a balance if most of the liabilities aren't in it?
I have often seen these huge sums of outstanding CDOs, but who has sold them except AIG, that has only a tiny fraction of them?
If the sum is so well known, I guess there are as well some informations, on who has sold them. But I have never seen a good hint on that. And shouldn't we see the pain right now? If AIG pays out, shouldn't we see other institutions in pain as well, due to CDOs?
I'm of course not sure, but I guess, that those banks, that don't have troubles with CDOs so far, probably don't have sold them and therefore they aren't likely to suffer a lot in the future from them, only indirect by having lent to institutions that are going into bankruptcy.

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

by Martin (weiser.mensch(at)googlemail.com) on Sun Mar 22nd, 2009 at 06:22:10 PM EST
[ Parent ]

Re: Are there European banks that are insolvent? (none / 0)

JP Morgan has also sold fantastic amount of CDS. They invented them. And they're still peddling them.

Anyway, from the FDIC's site: Off-Balance Sheet Activities

Additionally, swaps, futures, forwards, and option contracts are derivative instruments whose notional values are carried off-balance sheet, but whose fair values are recorded on the balance sheet.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith

by Carrie (migeru at eurotrib dot com) on Sun Mar 22nd, 2009 at 06:24:53 PM EST
[ Parent ]

Re: Are there European banks that are insolvent? (none / 0)

Additionally, swaps, futures, forwards, and option contracts are derivative instruments whose notional values are carried off-balance sheet, but whose fair values are recorded on the balance sheet.

And of course these "fair values" are conservatively estimated, which is why these off balance sheet items only come back on the balance sheet when things do not go according to the script, as, for instance, at the present time.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Mar 22nd, 2009 at 06:49:36 PM EST
[ Parent ]

Re: Are there European banks that are insolvent? (none / 1)

I don't think those $150 trillion are money that has been created already as Chris Cook claims in the diary you linked to a couple of posts upthread.

If I bet you $1M on some rare outcome and then I can't pay up, the $1M never existed, you never added it to your balance sheet except at "fair value" which might have been something like $1k, so if it goes away the only outcome is that I go belly up and you get to fight it out with the other creditors, but you don't go belly up (most likely).

So I am a little puzzled by the whole thing.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith

by Carrie (migeru at eurotrib dot com) on Sun Mar 22nd, 2009 at 06:56:32 PM EST
[ Parent ]

Re: Are there European banks that are insolvent? (none / 1)

Yeah, the table does better at identifying what it is not than what it is. But I recall some statistics about "shadow banking" that indicated that CDSs were a relatively small part of a $500 Trillion pie. And I have been suggesting, and TBG has been sort of agreeing for four or five months that dissolution of credit default swaps by governmental agencies would be a good thing.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Mar 22nd, 2009 at 07:20:17 PM EST
[ Parent ]

Re: Inside the FDIC sausage factory. (none / 1)

More from the FDIC's Risk Management Manual

Risk Management Manual of Examination Policies
Section 3.8 - Off-Balance Sheet Activities
Introduction
Off-balance sheet activities encompass a variety of items including certain loan commitments, certain letters of credit, and revolving underwriting facilities. Additionally, swaps, futures, forwards, and option contracts are derivative instruments whose notional values are carried off-balance sheet, but whose fair values are recorded on the balance sheet. Examiners reviewing off-balance sheet derivative contracts will find resources such as the Capital Markets Handbook, the Consolidated Reports of Condition and Income (Call Report) Instructions, Senior Capital Markets Specialists, and capital markets and accounting subject matter experts helpful.
Off-balance sheet fee producing activities can improve earnings ratios, at a faster pace than on-balance sheet fee producing activities. Earnings ratios typically use assets as a component. Since earnings generated from these activities are included in income, while total asset balances are not affected, ratios appear higher than they would if the income was derived from on-balance sheet activities. Because these types of activities remain off the balance sheet, capital to asset ratios (with the exception of risk-based capital ratios) are not adversely affected regardless of the volume of business conducted. But, the volume and risk of the off-balance sheet activities needs to be considered by the examiner in the evaluation of capital adequacy. Regulatory concern with off-balance sheet activities arises since they subject a bank to certain risks, including credit risk. Many of the risks involved in these off-balance sheet activities are indeterminable on an offsite-monitoring basis.
-Skip-
General guidance regarding the risks involved with derivatives instruments and the proper recording and accounting are outlined below. Expanded guidance is delineated in the Capital Markets Handbook and the Call Report Glossary and the instructions for RC-L - Derivatives and Off-Balance Sheet Items.
Off-Balance Sheet Lending Activities
An evaluation of off-balance sheet lending activities should apply the same general examination techniques that are used in the evaluation of a direct loan portfolio. For example, banks with a material level of contingent liabilities should have written policies addressing such activities adopted and approved by their board of directors. The policies should cover credit underwriting standards, documentation and file maintenance requirements, collection and review procedures, officer and customer borrowing and lending limits, exposures requiring committee or board approval, and periodic reports to the board of directors. Overall limits on these contingent liabilities and specific sub-limits on the various types of off-balance sheet lending activities, either as a dollar amount or as a relative percentage (such as a percent of total assets or capital), should also be considered. (my bold)

It seems clear why the banks like "off balance sheet activities" and why the FDIC devoted an entire section of their Risk Management Manual to the subject. Less clear is the rationale, if any, for the FDIC to approve this practice.

It would appear that the particular types of off balance sheet activities referenced in the table Chris cited can be quite varied. The "hopeful" assumption that they may be credit default swaps seems at best unproven at this point. I don't know whether to be pleased or afraid. The direction things are going the terms of every default swap ever written could well be fulfilled by the end of the year. More rich people to bail out?

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Mar 22nd, 2009 at 09:19:27 PM EST
[ Parent ]

Re: Are there European banks that are insolvent? (none / 1)

Considering that:

Many of the risks involved in these off-balance sheet activities are indeterminable on an offsite-monitoring basis. (My Bold)

...and considering that many, if not most, of these activities may be based on transactions with institutions registered in tax havens such as The Isle of Mann, Grand Turks, etc., to which the FDIC may not have access...can you define the term "Regulatory Arbitrage?"

Surely, prior to the failure of Bear Sterns, insistence by the FDIC on viewing the complete documentation of transactions based in off shore tax havens would have constituted the very essence of "burdensome regulation."

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Mar 22nd, 2009 at 09:31:42 PM EST
[ Parent ]

No Return To Normal - the Galbraith article | 96 comments (96 topical, 0 editorial, 0 hidden)

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