Comments on: Bailouts: catching a falling knife

By: s243a

s243a — Mon, 26 Jan 2009 04:39:26 +0000

Anarchus, I hope the house prices don't have another 20-40% to go. However, if they do then maybe they are trying to use currency devaluation to cover the remaining gap.

By: Edward Harrison

Edward Harrison — Sat, 24 Jan 2009 20:05:56 +0000

I am not suggesting a Lehman-style approach is the way forward. I think a comprehensive review followed by an FDIC-style seizure or forced meger will be the best way in 90% of the cases. Sometimes, liquidation or nationalization will be best, but ultimately it needs to be a well-crafted and orderly process. Savers have been given guarantees and the FDIC-like process of letting another bank take over the deposits is the right approach so that there is no effect on large savings deposits. The banks fund the FDIC scheme in the U.S.

In the U.K. the Lloyds-HBOS link up was botched because HBOS turned out to be in considerably worse shape than anticipated. Now, Lloyds customers and shareholders are feeling the pain. This is the kind of thing that needs to be avoided.

By: Anderson

Anderson — Fri, 23 Jan 2009 18:08:55 +0000

Very good post. Another consequence of the bad banks buying good banks to shore up their balance sheet, is that after they fail, their will be less good banks left to help the economy recover, further prolonging the depression.

By: Trans_Atlantic (Michael)

Trans_Atlantic (Michael) — Fri, 23 Jan 2009 02:41:15 +0000

Was not my quote, but I like it… Edward Harrison @ http://tinyurl.com/7fmabn

By: Anarchus

Anarchus — Thu, 22 Jan 2009 22:35:54 +0000

The fundamental problem as I see it is that on a national basis, the home prices underlying trillions of dollars in mortgages and derivatives got wildly inflated relative to income levels. and now the value of said mortgages and derivatives is going down, down, down until home prices fall to a solid, sustainable level relative to incomes. Based on my back-of-the-envelope calculations that's another 20%-to-40% down from here, and the issue is complicated by the facts that (a) markets have a tendency to overshoot fair value when prices are moving with a lot of momentum, and (b) incomes themselves are likely to be under dramatic pressure and move downward for a while.

In any case, the reason that bank capital continues under assault is that financial institutions only have about $1 in equity for every $20 in assets and the value of mortgage-related assets still has considerably further to decline. As an aside, the government would do better to encourage home prices to fall quickly to sustainable levels rather than attempting to keep home prices up at valuations that make no sense. The pain would be immediate and harsh, but there's no avoiding that regardless. Watch FNM and FRE . . . . . .

By: Anarchus

Anarchus — Thu, 22 Jan 2009 22:35:36 +0000

Insightful post.

One interesting datapoint to watch going forward will be the results posted by FRE and FNM. As you clearly point out, it's just not feasible to ask financial institutions to lend (or guarantee) aggressively when the capital base is impaired and the trend in asset quality is going south rapidly – in part because it doesn't make economic sense. So. I think anyone who expects that the financial results of FRE and FNM are going to be improved by government stewardship is living on the same la-la side of town as Stanley O'Neal and dancing CEO Charles Percy.

By: SoMuchMore (SoMuchMore)

SoMuchMore (SoMuchMore) — Thu, 22 Jan 2009 18:19:21 +0000

Bailouts: catching a falling knife http://tinyurl.com/7fmabn from: @edwardnh http://ff.im/I4mm

By: SoMuchMore (SoMuchMore)

SoMuchMore (SoMuchMore) — Thu, 22 Jan 2009 18:18:59 +0000

Bailouts: catching a falling knife http://tinyurl.com/7fmabn from: @edwardnh

By: Stevie b.

Stevie b. — Thu, 22 Jan 2009 11:01:43 +0000

Ed – "first the deflation and deleveraging and then the inflation…etc".

I'd be really interested to get your views on the following and the implication that inflation may not be as easy to -create- as I had thought:

http://ndknotepad.blogspot.com/2009/01/us-cant-un...

The whole thread including responses is a bit long but hopefully really thought-provoking?

By: wagdog

wagdog — Wed, 21 Jan 2009 23:35:05 +0000

Wouldn't letting bad banks fail increase the risk of bank runs? There may be FDIC in the US and FSCS in the UK, but there is still the psychological fear of losing access to your funds, if only temporarily. The fact that Icesave took on average two months to sort out scared a lot of depositors that lots of savers began spreading their money around. 7 bank accounts and more was not unheard of in the MoneySavingExpert forum. So much so many people were familiarising themselves with password management software – something they never thought they needed.

By all means, let investors who made bad decisions lose their shirts, but are savers to be counted among these investors? Will savers have to pay as close attention to their bank's health as do the shareholders? Savers and consumers will be waking up to a risk they weren't even aware of before – counterparty risk – and that by itself can make them hoard cash and withdraw their spending.

Who funds the FDIC scheme? In the UK it's the taxpayers who have to foot the FSCS bill.

By: edwardnh (Edward Harrison)

edwardnh (Edward Harrison) — Wed, 21 Jan 2009 23:29:26 +0000

Bailouts: catching a falling knife http://tinyurl.com/7fmabn

By: Edward Harrison

Edward Harrison — Wed, 21 Jan 2009 20:41:24 +0000

That's a good question. My take: first the deflation and deleveraging and then the inflation. That means that for the foreseeable future the financial services sector will be in a shrinking mode — shrinking assets and credit growth along with them. Inflation is not going to be a factor in that environment. So inflation cannot inflate away the real burden of banks' own problems. Down the line, it may help debtor consumers, but it won't help the banks.

In my view, banks need to get a handle on how much they have coming in writedowns first and foremost. Then they need to find a way to get adequate capital to deal with those writedowns. On some level, who cares where this capital comes from, because when they have it: we can return to some sense of normalcy. However, if we keep propping up these zombie institutions, the writedowns are going to increase and that will put us further away from our goal.

By: s243a

s243a — Wed, 21 Jan 2009 20:22:52 +0000

I remember reading your past comments when I was watching squeezeplay last night:
http://watch.bnn.ca/squeezeplay/january-2009/sque...

And so many of your comments::
Pushing on a string:
Insolvent banks:

today your post remind me of some points I saw on the show. Another point that Kevin made on squeeze play is that the recapitalization of banks dilutes shareholders earnings and for that reason he would rather buy debt the equities. The prospect of banks being insolvent after considering future loan loses is scary is scary. However, is there a chance that future inflation could inflate the value of assets and help counteract loan losses?