Wednesday, April 15, 2009

an unwind so vast and pervasive as to dwarf even the great depression in its potential. needless to say, many western governments would not survive

TO BE NOTED: Decline and Fall of Western Civilization

"why banks cannot be nationalized

david goldman in two posts -- here and here -- on why major banks with large capital structures cannot be resolved nor even pushed into a large debt-to-equity swap.

The next sector to collapse would be the insurers: as I’ve said here again and again, the big pyramid scheme in the US financial system is that the insurers own the bottom of the capital structure of the banks. Bank preferreds, trust preferreds, hybrids, etc. were the favorite repast of yield-hungry insurance portfolio managers. ...

[W]hat [goes] if the insurers go?

The answer is, “everything,” including the most mundane transactions in trade — because everything requires insurance. ...

Of course it was a pyramid scheme: of course the insurers who allow a load of kasha to get from Minsk to Pinsk should not have owned the bottom of the banks’ capital structure, and so forth. No-one should have owned bank preferred shares but misers living in caves in the Swiss alps living exclusively on home-grown goats’ milk, so that the vaporization of these securities under nationalization would not even have gone noticed. Bank subordinated debt should have been sold exclusively to the hoards of sleeping dragons who would not hear the crash of the issuer thousands of miles away. We know that now. My recommendation is that Larry Summers and Timothy Geithner should be deputized to find sufficient dragons and Swiss misers to place the $135 billion in TARP capital injections to the banks….

…but in the meantime, the only alternative is to allow the banks a zombie existence cannibalizing the “toxic” assets left over from the structuring excesses of the boom.

the government of great britian is now being forced, in the wake of a collapse in private trade finance or supply chain insurance, to make a market where insurers no longer can. one can imagine such a step as but a taste of what could come in the aftermath of large bank resolutions. even the creeping restructuring presented on the citi example is unlikely to run very far very fast.

with the help of goldman, richard koo and others, i've changed my opinion on bank nationalizations severely since this posting in late february. critical to my changed understanding has been the exposition of a mechanism by which the united states government can rationally embark on a plan to support monetary aggregates and incomes and therefore (following a severe repricing to discounted cash flows) asset prices with the expectation of never testing a national bankruptcy -- that is, by dredging the banks for all cash flowing into them which cannot then be lent out, thanks to the collapse in loan demand as the private sector retrenches, in exchange for treasuries.

but equally important has been a deeper understanding of exactly who and what stands to be liquidated in the event of grand-scale bank debt restructuring. such a process would, so far from leaving a cleansed banking system, wreak untold havoc on the global economy -- indeed loosing what australian academic economist steve keen considers in recent comments to be an unwind so vast and pervasive as to dwarf even the great depression in its potential. needless to say, many western governments would not survive such a turn.

whereas i once said

[I]n my view these are problems that have to be remedied, if only because an FDIC-style resolution process -- probably involving a long-term RTC-style bad bank to warehouse and sell assets taken over in resolution back into the private sector -- is the only remotely practicable, safe and fair way forward. it won't be painless, but it will put losses where they belong and leave in its wake a stronger and healthier banking system.

i now see both that there is an alternative and that to "put losses where they belong" is not a reasonable course of action regardless of any perceived moral imperative. i hope to write more upon the subject of that moral imperative soon.

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permalink -- posted by gaius marius @ Wednesday, April 15, 2009 "

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