A year ago, I predicted that the losses of US financial institutions would reach at least US$1 trillion and possibly go as high as US$2 trillion. At that time, the consensus among economists and policymakers was that these estimates were exaggerated, because it was believed that sub-prime mortgage losses totaled only about US$200 billion.
As I pointed out, with the US and global economy sliding into a severe recession, bank losses would extend well beyond sub-prime mortgages to include sub-prime, near-prime, and prime mortgages; commercial real estate; credit cards, auto loans, and student loans; industrial and commercial loans; corporate bonds; sovereign bonds and state and local government bonds; and losses on all of the assets that securitized such loans. Indeed, since then, the write-downs by US banks have already passed the US$1 trillion mark (my floor estimate of losses), and institutions such as the IMF and Goldman Sachs now predict losses of more than US$2 trillion.
But if you think that the US$2 trillion figure is already huge, the latest estimates by my research consultancy RGE Monitor suggest that total losses on loans made by US financial firms and the fall in the market value of the assets they hold (things like mortgage-backed securities) will peak at about US$3.6 trillion.
US banks and broker dealers are exposed to about half of this figure, or US$1.8 trillion; the rest is borne by other financial institutions in the US and abroad. The capital backing the banks’ assets was only US$1.4 trillion last fall, leaving the US banking system some US$400 billion in the hole, or close to zero even after the government and private-sector recapitalization of such banks.
Another US$1.5 trillion is needed to bring banks’ capital back to pre-crisis level, which is needed to resolve the credit crunch and restore lending to the private sector. So, the US banking system is effectively insolvent in the aggregate; most of the British banking system looks insolvent, too, as do many continental European banks.
There are four basic approaches to cleaning up a banking system that is facing a systemic crisis: recapitalization of the banks, together with a purchase of their toxic assets by a government “bad bank”; recapitalization, together with government guarantees — after a first loss by the banks — of the toxic assets; private purchase of toxic assets with a government guarantee (the current US government plan); and outright nationalization (or call it “government receivership” if you don’t like the dirty N-word) of insolvent banks and their resale to the private sector after being cleaned.
Of the four options, the first three have serious flaws. In the “bad bank” model, the government may overpay for the bad assets, whose true value is uncertain. Even in the guarantee model there can be such implicit government over-payment (or an over-guarantee that is not properly priced by the fees that the government receives).
In the “bad bank” model, the government has the additional problem of managing all the bad assets that it purchased — a task for which it lacks expertise. And the very cumbersome US Treasury proposal — which combines removing toxic assets from banks’ balance sheets while providing government guarantees — was so non-transparent and complicated that the markets dived as soon as it was announced.
Thus, paradoxically nationalization may be a more market-friendly solution: it wipes out common and preferred shareholders of clearly insolvent institutions, and possibly unsecured creditors if the insolvency is too large, while providing a fair upside to the tax-payer. It can also resolve the problem of managing banks’ bad assets by reselling most of assets and deposits — with a government guarantee — to new private shareholders after a clean-up of the bad assets (as in the resolution of the Indy Mac bank failure).
Nationalization also resolves the too-big-too-fail problem of banks that are systemically important, and that thus need to be rescued by the government at a high cost to taxpayers. Indeed, the problem has now grown larger, because the current approach has led weak banks to take over even weaker banks.
Merging zombie banks is like drunks trying to help each other stand up. JPMorgan’s takeover of Bear Stearns and WaMu; Bank of America’s takeover of Countrywide and Merrill Lynch; and Wells Fargo’s takeover of Wachovia underscore the problem.
With nationalization, the government can break up these financial monstrosities and sell them to private investors as smaller good banks.
Whereas Sweden adopted this approach successfully during its banking crisis in the early 1990s, the current US and British approach may end up producing Japanese-style zombie banks — never properly restructured and perpetuating a credit freeze.
Japan suffered a decade-long near-depression because of its failure to clean up the banks. The US, the United Kingdom, and other economies risk a similar outcome — multi-year recession and price deflation — if they fail to act appropriately.
Nouriel Roubini is a professor of economics at the Stern School of Business, New York University, and chairman of RGE Monitor.
COPYRIGHT: PROJECT SYNDICATE
Four-time NBA all-star DeMarcus Cousins arrived in Taiwan with his family early yesterday to finish his renewed contract with the Taiwan Beer Leopards in the T1 League. Cousins initially played a four-game contract with the Leopards in January. On March 18, the Taoyuan-based team announced that Cousins had renewed his contract. “Hi what’s up Leopard fans, I’m back. I’m excited to be back and can’t wait to join the team,” Cousins said in a video posted on the Leopard’s Facebook page. “Most of all, can’t wait to see you guys, the fans, next weekend. So make sure you come out and support the Beer
Revelations of positive doping tests for nearly two dozen Chinese swimmers that went unpunished sparked an intense flurry of accusations and legal threats between the World Anti-Doping Agency (WADA) and the head of the US drug-fighting organization, who has long been one of WADA’s fiercest critics. WADA on Saturday said it was turning to legal counsel to address a statement released by US Anti-Doping Agency (USADA) CEO Travis Tygart, who said WADA and anti-doping authorities in China swept positive tests “under the carpet by failing to fairly and evenly follow the global rules that apply to everyone else in the world.” The
Taiwanese judoka Yang Yung-wei on Saturday won silver in the men’s under-60kg category at the Asian Judo Championships in Hong Kong. Nicknamed the “judo heartthrob” in Taiwan, the Olympic silver-medalist missed out on his first Asian Championships gold when he lost to Japanese judoka Taiki Nakamura in the finals. Yang defeated three opponents on Saturday to reach the final after receiving a bye through the round of 32. He first topped Laotian Soukphaxay Sithisane in the round of 16 with two seoi nage (over-the-shoulder throws), then ousted Indian Vijay Kumar Yadav in the quarter-finals with his signature ude hishigi sankaku gatame (triangular armlock). He
Rafael Nadal on Wednesday said the upcoming French Open would be the moment to “give everything and die” on the court after his comeback from injury in Barcelona was curtailed by Alex de Minaur. The 22-time Grand Slam title winner, back playing this week after three months on the sidelines, battled well, but eventually crumbled 7-5, 6-1 against the world No. 11 from Australia in the second round. Nadal, 37, who missed virtually all of last season, is hoping to compete at the French Open next month where he is the record 14-time champion. The Spaniard said the clash with De Minaur was