“The United States banking system is effectively insolvent”

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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