The Myth that the Banks are Solvent

By Marshall Auerback

Cross-posted from New Deal 2.0

Banks will likely have too much cash by 2019 as a result of the Basel III global banking rules, UBS AG Chief Executive Oswald Grübel said Thursday. “In the next 10 years, at the end of 2019, we will have overly liquid, overcapitalized banks,” he said, addressing a business audience at a conference. “However this also means we won’t have a lot of growth.” Mr. Grübel was discussing changes in the global balance of power and what the possible consequences would be. The CEO has said that investment banking could shift to the U.S. and Asia if stricter capital requirements are enforced in the U.K. and Switzerland. The basic economic tenet, however, remains that “power goes where the money is,” he said.

This is consistent with the fallacy that the banks are basically solvent and able and ready to extend credit if only these darn regulators would get out of the way. As James Galbraith has argued, the problem is said to be no more serious than some clogged plumbing. A bit of Drano in the form of government handouts and guarantees should be sufficient to get credit flowing again. Most major banks are not insolvent, this story goes, but rather have a temporary liquidity problem induced by malfunctioning financial markets. Time will allow market mechanisms to restore the true, higher value of “legacy” assets. Once the banks are healthy, the economy will recover.

Nonsense. Private debt loads remain too high, income and employment continue to fall, and delinquencies and foreclosures continue to rise. Assets are overvalued even at current depressed prices. Many financial institutions (probably including most of the big ones) are hopelessly insolvent, holding mountains of toxic waste that will never be worth anything.

So why are we busy implementing policies that simply maintain a credit-based economy? All around the world, policymakers continue to foster the fiction that all we have a temporary illiquidity problem, not a problem of excessive leverage, excessive debt, and a legacy of assets that were vastly overvalued based on economic scenarios that had no chance of coming to fruition. Given the inappropriate premises under which policy makers in the U.S., the U.K., and the euro zone have dealt with the leverage of financial institutions, it’s obvious that problems will continue to languish if the administration does not change its course of action. This will heavily constrain the global economy’s capacity to recover and will lead to multiple Japanese style “lost decades” around the globe.

The whole boom of the last 25 years was predicated on financial deregulation, massive fraud, and a huge build up of private debt as a consequence of inadequate fiscal policy to generate full employment and rising incomes. Growth was based on household borrowing and the continuation of negative saving trends (that is, household deficit spending). A good place to start recovery efforts, therefore, would be to change this method of economic growth by promoting employment, rather than capitulating to the siren songs of the bankers whose recklessness got us into this mess.

In a much saner world, we would be in the midst of a government-led investment push, much like the Space Race or the Manhattan Project, to drive new energy technologies forward by scaling up production and innovation, both apt to lower unit cost points. There would also be a concerted effort to establish the new infrastructure required. (After all, highways were constructed in part for national defense purposes, and railroads and canals had their share of public subsidization.) But with the ease of capture so visible, no such effort led by the government could be trusted enough to be supported, especially by a citizenry that has become one of fragmented (and anxious) consumers. Deficit austerians in government fail to understand that a budget deficit is essential for stable economic growth if the contribution of net exports (the difference between exports and imports) is not strong enough to sustain domestic demand while the private domestic sector is trying to save.

We need to put an end to these ridiculous policy responses. We not only require substantially increased supervision and regulation of the financial sector, but must also put a stop to the practices that brought on the crisis in the first place. If left alone to deal with the current problems, market mechanisms will push management and owners of insolvent institutions to ramp up losses and engage in yet more fraudulent accounting, leading to an even bigger crash down the road.

7 Comments
  1. Randall Joseph Shake says

    Funny accounting tricks that keep toxic assets off the balance sheet are dishonest and not realistic. It is pandering to Wall Street and not helping a real recovery. Nobody is buying this nonsense.

  2. Randall Joseph Shake says

    A few years ago I attended a bi lateral trade conference. Where I met a High net worth Latin American Investor. Who drove to Texas in his bullet proof S Class Benz. He said Investors for Latin America were not investing in the US. They did not trust the information.

  3. DavidLazarusUK says

    I foresee a massive banking crisis within a decade. It could happen within a few years as result of soveriegn defaults within the eurozone. As several hundred billion of euro loans are simply defaulted on. The terms of the bailouts are unsustainable.

    In the UK specifically the banks have only survived because of super secret deals which we will never even know about not even under the 30 year rule or even the 100 year rule. That makes me question the solvency of all the big banks. One of the rescued UK banks has £46 billion in loans to Ireland. This sum is at risk of total loss, because the irish property market has collapsed substantially, and the losses have not really been taken at the banks. I personally feel that the UK property market is still overvalued by at least 40%, more if the coalition undertakes substantial austerity measures.

    In the US where nearly 25% of all mortgages are underwater, if the US undertakes austerity then expect a tsunami of foreclosures to sweep across the country, crystalising losses at the banks that will probably put the numbers of problem banks up substantially. The real problem is that as governments carry on with their current policies the only winners will be the bankers who walk away with billions in bonus pay even while the property markets, banks, the economy and everything else collapses.

  4. Anonymous says

    I foresee a massive banking crisis within a decade. It could happen within a few years as result of soveriegn defaults within the eurozone. As several hundred billion of euro loans are simply defaulted on. The terms of the bailouts are unsustainable.

    In the UK specifically the banks have only survived because of super secret deals which we will never even know about not even under the 30 year rule or even the 100 year rule. That makes me question the solvency of all the big banks. One of the rescued UK banks has £46 billion in loans to Ireland. This sum is at risk of total loss, because the irish property market has collapsed substantially, and the losses have not really been taken at the banks. I personally feel that the UK property market is still overvalued by at least 40%, more if the coalition undertakes substantial austerity measures.

    In the US where nearly 25% of all mortgages are underwater, if the US undertakes austerity then expect a tsunami of foreclosures to sweep across the country, crystalising losses at the banks that will probably put the numbers of problem banks up substantially. The real problem is that as governments carry on with their current policies the only winners will be the bankers who walk away with billions in bonus pay even while the property markets, banks, the economy and everything else collapses.

  5. Panayotis Economopoulos says

    Public debt sustainability limits or private debt leverage burden? This is the question! The first relates to voluntary (political/ideological) and involuntary(market) revenue constraints imposed upon fiscal policy and the second relates to private portfolio valuation from income flow shortfall!

  6. Yoshihiro Inoda says

    I hope this kind of blog give many support to consider financial market and make it better. ^ ^”

  7. Yoshihiro Inoda says

    I hope this kind of blog give many support to consider financial market and make it better. ^ ^”

  8. Roger Glyndwr Lewis says

    My view on the uk property market has moved to one based upon the discounted current replacement cost method of valuation. The present situation is that there is really no real market in play and sales are taking place at below the economic replacement cost where there is no Demand or a falsely low level of demand due to a severe lack of available mortgage finance this has to be addressed as Banks who foreclose do so based on their own liquidity ratios and their decisions are wildly at odds with the interests of the vast majority of borrowers interests who may well have bought or re-mortgaged with substantial equity. 
    I do think that the Market has collapsed pretty much fundamentally in the UK and by how much it is overvalued should have the notion of the economic replacement cost in view there are problems with the underlying Land value assumptions but these are not insurmountable issues to prescribe values to. 
    It is a measure of quite how bad things are though that the market value of properties is now in many cases below their economic replacement cost and there is a housing shortage of quite daunting proportions in the southern half of the UK. This is a very worrying state of affairs and places a huge number of solid Mortgage borrowers at great risk.
    I do suspect that the Banks are bluffing about their health and should be placed on a very short leash the value of real properties and real producers of real products must somehow be isolated from the Mickey mouse market money Little Johnny the hedge fund superstar of the future isn’t really going to want to give the chance of playing with that train set up without a fight though. Un told damage to the real economy what is called Main street in the states by the Mickey mouse money men of Wall Street ( The City ) our franchised parliament and politicians have stood by and watch it all happen.
    Here is my proposed suggestion at forcing a proper examination of the issue.

    My suggestion is to suggest a simple but effective direct action we can all take to force the hand of Government where we can vote with the economic power we do still have.All private Business owners and Individuals should Close bank accounts and transfer all deposits out of the Banks in private hands and open accounts with the sate owned Banks RBS and Lloyds and so forthTHose banks should then be kept in Public ownership and there should be a return to a credit based Honest Money system If any of the other Private Banks survive without Public Assistance then good for them but more regulation and very strict regulation regarding the usefulness of the funny money merry go round needs to follow.By forcing the issue this way the actions of politicians would be very accountable how would they be able to repeat the current change in Narrative. 

    1. DavidLazarusUK says

      The discount replacement replacement cost method will show most properties as substantially overvalued. The bulk of the value is probably still the land. Yes the mortgage market here in the UK is dysfunctional. My opinion is that the UK property market is overvalued by around 45%. They are now applying sensible criteria for loans. High deposits and lower loans to value. All very sensible, shame they did not apply such rules for the last ten years. These new rules should be mandatory and permanent. Ban all mortgages that do not have repayment of capital included. That does not help first time buyers as they would need 50% deposits to enter now if I am right, and without becoming at risk of foreclosure. 

      I also think that the banks are weaker than they claim. Though since breaking up the banks is not even being considered we need better regulation of them, even tougher than Basel III. Risk assessment was clearly not a strong point of the banks as they were wiped out by AAA rated bonds. The banks will not be paying taxes for decades because of their huge bailouts. These tax losses should be eliminated as a condition of state support. My solution is ban banks from residential mortgage lending, only allow the building societies to lend for homes. Also keep building societies away from the interbank market. This eliminates the influence of cheap foriegn money, forcing building societies to raise funds from depositors will mean that interest rates that they offer will mean that savers can get a decent return. It also insulates the property market from banks speculations to a much greater extent. Simple rules on lending limits in proportion to income will help alot. This will not eliminate bubbles but  mitigate about them destroying the economy. Longer term break up the banks. The state owned banks should be broken up now to create substantial competion and cap all banks access to the interbank market. Northern Rock failed because it relied almost solely on the interbank market. Banks will then have to have branch networks and depositors to fund their loans. Also penalise banks that are too big from access to the lender of last resort status and deposit protection. That will cause runs on those banks, which will force them to break up. 

  9. Roger Glyndwr Lewis says

    My view on the uk property market has moved to one based upon the discounted current replacement cost method of valuation. The present situation is that there is really no real market in play and sales are taking place at below the economic replacement cost where there is no Demand or a falsely low level of demand due to a severe lack of available mortgage finance this has to be addressed as Banks who foreclose do so based on their own liquidity ratios and their decisions are wildly at odds with the interests of the vast majority of borrowers interests who may well have bought or re-mortgaged with substantial equity. 
    I do think that the Market has collapsed pretty much fundamentally in the UK and by how much it is overvalued should have the notion of the economic replacement cost in view there are problems with the underlying Land value assumptions but these are not insurmountable issues to prescribe values to. 
    It is a measure of quite how bad things are though that the market value of properties is now in many cases below their economic replacement cost and there is a housing shortage of quite daunting proportions in the southern half of the UK. This is a very worrying state of affairs and places a huge number of solid Mortgage borrowers at great risk.
    I do suspect that the Banks are bluffing about their health and should be placed on a very short leash the value of real properties and real producers of real products must somehow be isolated from the Mickey mouse market money Little Johnny the hedge fund superstar of the future isn’t really going to want to give the chance of playing with that train set up without a fight though. Un told damage to the real economy what is called Main street in the states by the Mickey mouse money men of Wall Street ( The City ) our franchised parliament and politicians have stood by and watch it all happen.
    Here is my proposed suggestion at forcing a proper examination of the issue.

    My suggestion is to suggest a simple but effective direct action we can all take to force the hand of Government where we can vote with the economic power we do still have.All private Business owners and Individuals should Close bank accounts and transfer all deposits out of the Banks in private hands and open accounts with the sate owned Banks RBS and Lloyds and so forthTHose banks should then be kept in Public ownership and there should be a return to a credit based Honest Money system If any of the other Private Banks survive without Public Assistance then good for them but more regulation and very strict regulation regarding the usefulness of the funny money merry go round needs to follow.By forcing the issue this way the actions of politicians would be very accountable how would they be able to repeat the current change in Narrative. 

    1. Anonymous says

      The discount replacement replacement cost method will show most properties as substantially overvalued. The bulk of the value is probably still the land. Yes the mortgage market here in the UK is dysfunctional. My opinion is that the UK property market is overvalued by around 45%. They are now applying sensible criteria for loans. High deposits and lower loans to value. All very sensible, shame they did not apply such rules for the last ten years. These new rules should be mandatory and permanent. Ban all mortgages that do not have repayment of capital included. That does not help first time buyers as they would need 50% deposits to enter now if I am right, and without becoming at risk of foreclosure. 

      I also think that the banks are weaker than they claim. Though since breaking up the banks is not even being considered we need better regulation of them, even tougher than Basel III. Risk assessment was clearly not a strong point of the banks as they were wiped out by AAA rated bonds. The banks will not be paying taxes for decades because of their huge bailouts. These tax losses should be eliminated as a condition of state support. My solution is ban banks from residential mortgage lending, only allow the building societies to lend for homes. Also keep building societies away from the interbank market. This eliminates the influence of cheap foriegn money, forcing building societies to raise funds from depositors will mean that interest rates that they offer will mean that savers can get a decent return. It also insulates the property market from banks speculations to a much greater extent. Simple rules on lending limits in proportion to income will help alot. This will not eliminate bubbles but  mitigate about them destroying the economy. Longer term break up the banks. The state owned banks should be broken up now to create substantial competion and cap all banks access to the interbank market. Northern Rock failed because it relied almost solely on the interbank market. Banks will then have to have branch networks and depositors to fund their loans. Also penalise banks that are too big from access to the lender of last resort status and deposit protection. That will cause runs on those banks, which will force them to break up. 

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