The Simple Math of Bank Insolvency

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machinehead's picture
Status: Diamond Member (Offline)
Joined: Mar 18 2008
Posts: 1077
The Simple Math of Bank Insolvency

Jon Markman explains 'Why the bank bailouts are doomed' --

The math is not complicated. Bank losses from the write-offs of bad
loans and busted derivatives tally up to $1.5 trillion so far. In
addition, $5 trillion to $10 trillion worth of off-balance-sheet
businesses such as structured investment vehicles -- leveraged lending
vehicles used by big banks to fatten their profits in boom times -- are
being forced back to banks' balance sheets by regulators. Rules require
banks to keep a base of real shareholder capital amounting to 10% of
those funds. So banks need to find up to $1 trillion within the next
year to meet that objective.

Add the $1.5 trillion in losses to
$1 trillion in needed new reserves, and you can see that banks need as
much as $2.5 trillion in new capital to remain solvent under current
rules. I know that we throw around words like "trillion" like they're
nothing, but that is a lot of money. Consider that the entire
world banking system had only $2 trillion in shareholder capital in
2007, before everything blew up.

In aggregate, therefore, the entire system is simply insolvent, as
liabilities are greater than assets. Governments aren't forcing banks
to admit this, but investors are, and that is why big banks' shares
have lost half of their value this year. Governments, meanwhile, are
trying desperately to help banks plug the gap, but they're coming up
short. When you add the $500 billion from sovereign wealth funds to the
$500 billion from the first tranche of the Troubled Assets Relief
Program, it's only $1 trillion. That's already been provided. So that
leaves a gap of $500 billion to $1.5 trillion.

You can't very well have a bankrupt banking system, however, so the
market has spent the first three weeks of the new year pricing in the
inevitable next step: nationalization of most large banks. The reason
is simple: If your owner can print money, you don't need to keep any
Problem solved.

Markman hits the nail on the head with his appalling summation that
if you can print money, you don't need to keep reserves. Of course,
banking is just as risky for government as for private owners. To
prudently conduct a banking business, you NEED reserves. But the siren
song of fiat currency gives government the ability to raise capital
when no one else can, by effectively confiscating part of the money
supply with an inflation tax. Obviously, such an economy is going to be

Bloomberg provides a market-based confirmation of what Markman wrote --

Feb. 3 (Bloomberg) -- Bond investors’ bets on bank
nationalizations are hindering already reduced lending by the
world’s biggest financial institutions.

The market for securities with characteristics of both debt
and equity that Citigroup Inc., Bank of America Corp. and other
financial companies used to bolster their capital is in freefall
on concern governments will stop banks that took public cash
from paying interest. The hybrids, which typically count as
regulatory capital to cushion against losses, fell 11 percent
last month in the U.S., more than they did in all of 2008,
according to Merrill Lynch & Co. index data. Citigroup and Bank
of America bonds lost as much as 34 percent of their value.

Only $694 million of preferred securities were sold in the
U.S. since September, when the government closed the market by
seizing Fannie Mae and Freddie Mac. That compares with about $44
in the first three quarters of last year, according to
data compiled by Bloomberg.
Hybrid notes, whose interest can in some cases be deferred
without penalty at the borrower’s discretion, have plunged around
the world since the U.S. took control of Fannie and Freddie, the
largest mortgage-finance companies. When former U.S. Treasury Secretary Henry Paulson took
control on Sept. 7 of Washington-based Fannie and McLean,
Virginia-based Freddie, he scrapped dividends on their preferred
stock and put $200 billion of new securities owned by the
government ahead in the capital structure of the companies.

Putting it all together, it's obvious that if Geithner inists on
proceeding with a 'cash for trash' plan, the ultimate cost will be
north of a trillion dollahs. Some portion of the resulting huge wodge
of new Treasury debt will be monetized by Ben-Baby at the Fed. Moreover, it's
well known that inflation reduces the real burden of debt, when it can
be repaid in devalued dollars. If you accept the premise of fiat
currency -- that governments have the sovereign right to devalue the
currency -- then it would be insane not to inflate under the current
conditions, when the debt load is eating us alive, and we're piling on even more of it.

Money mouthInflate and die Money mouth



Gadfly's picture
Status: Silver Member (Offline)
Joined: Dec 5 2008
Posts: 127
Re: The Simple Math of Bank Insolvency

I concur with your final statement about Fiat currency. I have been watching this Federal Reserve Release for almost a year due to curiosity (it hasn't killed this cat yet). I have kept a close eye on the "Non-borrowed assets" and it appears (on paper) they have dealt with the insolvency issue. However, I fear it may erode back to the October numbers if this snowball keeps rolling.

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