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The Bad Banks Are The Biggest Banks

 January 26, 2009 02:49 PM

Barry Bosworth gave what I consider to be the best take on the entire banking crisis:

  • Bosworth Says Geithner Will Be Confirmed as Treasury Secretary (PODCAST)
    Jan. 22 (Bloomberg) — Barry Bosworth, a senior fellow at the Brookings Institution, talks with Bloomberg's Ken Prewitt about Timothy Geithner's confirmation hearing as U.S. Treasury Secretary and the banking industry.

The bottom line is that cleanup of toxic assets is a relatively simple three-step procedure:

  1. Shut down and take over the bank;
  2. Remove bad assets to an asset management corporation; and,
  3. Sell off and recapitalize what remains.

The only problem, as Bosworth puts it diplomatically, is the fact that "some of the bad banks are the biggest banks." In turn, fixing the problem would be expensive, not to mention equity holders would be wiped out.

But what is expensive? The financial sector has gone from 22% to 10% of the S&P 500.On December 29, 2006, the financial sector of the S&P 500 Index was valued at 2,834,594,000,000. On January 23, 2009, the figure stood at 748,879,000,000. That is a loss of $2.08 trillion in market cap.

The good bank/bad bank solution is politically difficult unless a way can be found to do it without wiping out equity holders. The reason? Where there's life, there is hope, sort of like how shareholders of Nortel clung on for nearly nine years after the tech bubble popped. For insurance firms and pension funds, a zombie bank is better than no bank at all.

For you history buffs, the present situation closely mirrors 1992 Japan, for it was then when the keiretsu's were about to come undone:

A NIGHTMARE YEAR FOR JAPAN'S BANKERS
One acute problem for banks is the spiral of failures among finance companies, which turned copious bank credit into an astonishing $800 billion in loans during the 1980s. Many of the loans went to buy real estate, which then was used as collateral for even more credit from banks or other finance groups.

To stave off big write-downs, many lenders are now scrambling to rescue a number of these finance firms. Mitsui Trust, for instance, was the main lender to Dai-Ichi Corp. and a related property developer, which together ran up $8 billion in loans. To keep them afloat, Mitsui and other banks this spring agreed to slash some debt payments in half and cancel others altogether. The deal will cost Mitsui an estimated $55 million this year alone.

Also debilitating has been the hit on the banks' unrealized stock market gains, which they're allowed to count as capital. With the Nikkei stock average down 60% since 1989, most of these "hidden reserves" have disappeared. If the Nikkei falls below 12,000, IBCA estimates, the world's biggest lender, Dai-Ichi Kangyo, as well as No. 2 Sumitomo and No. 3 Sakura, will have no hidden reserves left at all.

We all know how that one ended…


Rich
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