Posts Tagged ‘fareed zakaria’
James Baker of all people sums up precisely why the current government approaches to fixing banks’ problems is flawed. As you will have gathered I fall in the Niall Ferguson/ Martin Wolf camp that says this situation is not just worse than we think but more importantly it is different than the prevailing wisdom. We risk fixing the wrong problem in other words.
‘How Washington can prevent ‘zombie banks’ | Financial Times
Beginning in 1990, Japan suffered a collapse in real estate and stock market prices that pushed major banks into insolvency. Rather than follow America’s tough recommendation – and close or recapitalise these banks – Japan took an easier approach. It kept banks marginally functional through explicit or implicit guarantees and piecemeal government bail-outs. The resulting “zombie banks” – neither alive nor dead – could not support economic growth.
A period of feeble economic performance called Japan’s “lost decade” resulted.
Unfortunately, the US may be repeating Japan’s mistake by viewing our current banking crisis as one of liquidity and not solvency. Most proposals advanced thus far assume that, once confidence in financial markets is restored, banks will recover.
To prevent a bank run, all depositors of recapitalised banks should be fully guaranteed, even if their deposit exceeds the Federal Deposit Insurance Corporation maximum of $250,000 (€197,000, £175,000). But bank boards of directors and senior management should be replaced and, unfortunately, shareholders will lose their investment. Optimally, bondholders would be wiped out, too. But the risk of a crash in the bond market means that bondholders may receive only a haircut. All of this is harsh, but required if we are ultimately to return market discipline to our financial sector.
Baker suggests quick and decisive action, and I agree.
This is a crisis of debt and bubble asset values. The asset values are being re-stated in the equity markets and housing markets as we see evey day. That horse has left the barn, as they say. The result is a set of debt around the world on the balance sheets of companies and consumers that is too high relative to the asset base.
The prevailing theme of government and therefore consumer belief is that government stimulus plans will address the economic shortfalls, and return us to growth later in 2009. But what does that mean, even if successful?
The key is to define “growth” and what that means. That would mean GDP, that mix of consumer, government and businesss expenditures and investments is no longer dropping. There are two key points that have to be said here. Even if growth in GDP returns, that does not mean asset values will return to 2007 levels – no-one can believe that now. Despite a return to normal patterns of consumer, business and government expenditures sometime in the next 2 years, house prices will not rise by the 25 – 50% that would be required to attain 2007 levels, nor is it likely that the stock markets will grow the 100% + that will be required to return to 2007 levels. Those things are possible, but we have to believe unlikely in the near term (5 – 7 years)
As Baker states clearly above, this is a crisis of solvency. A liquidity crisis merely means value is tied up in assets that are not quickly useable as cash. Solvency means debt exceeds asset values. The banks have a solvency crisis. That brings be back to Niall’s point. This is a crisis of debt.
The delusion that a crisis of excess debt can be solved by creating more debt is at the heart of the Great Repression. Yet that is precisely what most governments propose to do. (Niall Ferguson/ LA Times Feb 6th, 2009)
A crisis of solvency has requires help for debtors and there is some relief coming on that for US people mortgages, although the plans are not yet completed.
But the worry is the banks. As Baker says above, and Wolf said yesterday on the Fareed interview on CNN banks are frozen in a state of inaction by virtue of potential asset value losses that exceed their capital base. They also cannot generate new assets, ie lend, because they do not have an adequate capital base to support. Enter, what I have been calling financial utilities, and Baker calls zombie banks. Banks that are moribund and merely exist to provide very basic functions under the guidance and auspices of their bureaucrat overseers. This does not bode well for innovation, nor new and better services.
Relevance to Bankwatch:
The good news is that the opportunity remains for those that choose to accept it. This timing of this economic mess is not co-incidence and although few predicted the precise date, many knew a day of reckoning was to come [link to The Upside of Down]. When Thomas Homer-Dixon wrote that book in 2005 the characterisations of stress in the world he saw were these.
Homer-Dixon contends that five “tectonic stresses” are accumulating deep underneath the surface of today’s global order:
- energy stress, especially from increasing scarcity of conventional oil;
- economic stress from greater global economic instability and widening income gaps between rich and poor;
- demographic stress from differentials in population growth rates between rich and poor societies and from expansion of megacities in poor societies;
- environmental stress from worsening damage to land, water forests, and fisheries; and,
- climate stress from changes in the composition of Earth’s atmosphere.
With the benefit of hindsight it is easy to see he was correct in the assessment. More imporantly though these stresses point to a systemic shift in the world that requires different and better solutions, if we are to mitigate future crises, economic and otherwise. For example it is all very well to point to the Keynesian approach of replacing consumer spending with government spending to address the problem, but what ought the government spend its money on, if the target is a different and better system than we have today?
Going back to the banks’ – the information we have just summarised strongly suggests they are not going back to the way things were before. What better opportunity to rethink strategy. We are now in a period of an experential economy, powered by customer empowerment. Internet has seen to that and that change is also systemic.
If a big bank can really, and I mean really, grasp the power of internet, and the associated cost benefits associated with customer empowerment, ie, customers willingly doing the work for them, in return for better value, and banking on their terms. just perhaps a bank could join in the disruption for banking that is surely upon us.
The always clear thinking Fareed wrote this piece on the Canadian Banking system and how it is the envy of the world. The facts outlined are indisputable and the distinctions between the US and Canadian systems that favour care and moderation in Canada are all true.
However there is one other event he does not mention, that has quietly gone on for the last 14 months and in fact just completed in January this year with the announcement noted below on the E&Y site dated Jan 21st, 2009.
The story here goes back to December 2007, when I first noted it here. At that time the Canadian government strong armed the Banks in a prescient move to avert crisis in the Canadian component of the ABCP crisis. Recall that ABCP is lending by Canadian banks managed off balance sheet therefore not subject to capital requirements.
The arrangement in effect froze $25 Bn in Asset Backed Commercial Paper by transferring them into a series of trusts. [note this link is to a pdf on the E&Y site]. It explains ABCP, and explains the arrangement. In particular note this little gem on page 6 entitled “Alternative to the Plan”. They have turned off copying so I saved the screen shot here, and typed the first few words …
The Investors Committee believes that failure of this plan would likely lead to the forced liquidation of billions of dollars in assets that back ABCP …. the value of the affected ABCP in the context of a forced or voluntary sale is uncertain because there is currently no public market for the notes.
This financial trick was managed with the hesitant support of bank credit lines, and essentially (as I understand it) tooremoved the immediacy for settlement from the paper. However that paper remains contingent off balance sheet debt of the Canadian Banks.
The reason I raise this now, is that the Fareed article suggests that Canadian Banks are perfect, but the Pan-Canadian Investors Committee manouvre hides part of that truth that ought to be factored into the picture for completeness.
Here are the equity bases of the Canadian Banks from Google Finance – how significant is the $32 Bn – you can judge for yourself. In particular note that pre this arrangement, TD and I think one other were not engaged in ABCP as much, so the percentage would be much higher (worse) against those ABCP participating banks.
Royal $ 31Bn
BMO $ 19 Bn
Scotia $ 22 Bn
TD $ 32 Bn
CIBC $ 14 Bn
$ 32 Bn as a percentage of $118 Bn = 27%
Most recent update on the E&Y site relative to the euphemistically named Pan-Canadian Investors Committee.
Canadian Commercial Paper : Ernst & Young
For Immediate Release
ABCP Restructuring Completed
Plan to Be Implemented on January 21, 2009
Toronto, January 16, 2009 – The Pan-Canadian Investors Committee for Third-Party Structured Asset-
Backed Commercial Paper is pleased to report that all of the principal legal documentation needed to
implement the restructuring plan affecting $32 billion of third-party ABCP has been finalized and is being
signed today by all of the necessary parties.
Final reconciliations and verifications are now being conducted and the Court-appointed Monitor is
expected to file the certificate required to implement the Plan and complete the closing on January 21,
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