“The United States banking system is effectively insolvent”

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Some of the large banks in the United States are like “dead men walking” and most are “insolvent”. That is the conclusion of an article by Steve Lohr in today’s International Herald Tribune.

Nouriel Roubini,  professor of economics at the New York University, has to date been both pessimistic and prescient about the crisis. In his latest report, Roubini estimates that total losses on loans by American financial firms and the fall in the market value of the assets they hold will reach $3.6 trillion, up from his earlier estimate of $2 trillion.

Of the total, he calculates that American banks face half that risk, or $1.8 trillion, with the rest borne by US non-bank financial institutions (such as insurance companies) and banks based outside the USA.

“The United States banking system is effectively insolvent,” Roubini said.

Roubini’s numbers might be the highest, but he’s certainly not alone in his dire predictions. Simon Johnson, a former chief economist at the International Monetary Fund, estimates that the United States banks have a capital shortage of $500 billion. “In a more severe recession, it will take $1 trillion or so to properly capitalize the banks,” said Johnson, an economist at the Massachusetts Institute of Technology, quoted in the IHT article.

At the end of January, the IMF raised its estimate of the potential losses from loans and other credit securities originated in the United States to $2.2 trillion, up from $1.4 trillion last October. The IMF says that US and European banks would need at least $500 billion in new capital, a figure more conservative than those of many economists.

Still, these numbers are all based on estimates of the value of complex mortgage-backed securities in a very uncertain economy. “At this moment, the liabilities they have far exceed their assets,” said Posen of the Peterson institute. “They are insolvent.”

Yet, as Posen and other economists are at pains to point out, there are crucial issues of timing and market psychology that surround the discussion of bank solvency. If one takes the somewhat optimistic view that current conditions simply reflect a temporary panic, then the value of the banks’ toxic assets could well recover over time. If not, then we can guess what will happen.

“If they had to sell these securities today, the losses would be far beyond their capital at this point,” says another expert, Raghuram Rajan, a professor of finance and an economist at the University of Chicago graduate business school “But if the prices of these assets will recover over the next year or so, if they don’t have to sell at distress prices, the banks could have a new lease on life by giving them some time.” That sort of breathing room is known as regulatory forbearance – essentially a bet by regulators that time will help heal banking wounds.

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1 thought on ““The United States banking system is effectively insolvent””

  1. , society is a reaohilnstip between top down order and bottom up growth. The most ordered society on earth is likely North Korea and the least ordered is likely Somalia. The trick is structural flexibility that enables healthy growth, which requires the feedback mechanisms Lawrence mentions, in order to mitigate some of the more corrosive aspects of growth. The very top down processes which tend to squash our individuality are the very same natural evolutionary tendencies which evolved multicellular organisms in the first place. Your own body is a function of this reaohilnstip between top down order and bottom up growth. When the order overwhelms the growth, you get old and die, but if the growth rejects the order, you get cancer and die. So the issue is how to further develop our economic and political systems to be able to survive the current problems and build a better model from the lessons learned. The fact is that there is no going back because the old model is broken. Whether they want to, or not, governments are going to find themselves in the position of nationalizing the banking systems. Many people are going to be crying foul, but the public is ultimately responsible for the health of the monetary systems on which a modern economy depends. I, of all people, am not advocating any form of totalitarianism, either of the socialist or fascist persuasion, nor am I a particular fan of anarchy. There is no happy medium either, as that’s another form of stagnation, so there will always be a swinging between varying poles and preferences. Rather than look to the past, consider the future: The banking system is broken. It will be propped up by government to whatever extent is possible. Rather then cry socialism, do you have any ideas? Should we return banking to a private profit system, or would it be to the larger interest to try it as a public function. Think in terms of other public functions, the roads, the courts, the military, legislative and executive branches, etc. How many of those would you want to see run as private enterprise? It is possible to have effective public sector functions. In fact the private sector depends on them. Consider the court system: Do you think a viable society could exist with a private legal system? How about the military? The fact is that our military has become privatized and from what I’ve read, I find it disturbing, to say the least. I could go on, but you get the idea.

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