Ok, let’s give every financial institution a year to sell all its assets (as opposed to a week). Who’s going to buy them?
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No idea. Question about the banking system: My understanding is that banks can loan out at 10:1 against deposits. Is that correct? Is there a reason for the particular leverage ratio (whatever it is)? How do U.S. banks get to the 10:1 (or whatever) leverage ratio? Who do they borrow from? Is it just private parties generally? I know they can borrow from the Federal Reserve, but that’s not the normal SOP, correct?
Now, if a bank goes under, then the FDIC is on the hook for a percentage of the deposits. Does the FDIC have preference over the failed bank’s creditors in that they can sell off assets until the depositors are paid back and then the banks’s creditors get what’s left?
If you can point me to a good source that explains all this, I would appreciate it. I would basically like to know what the taxpayer is on the hook for when a bank fails in the normal circumstance (i.e, absent all these bailouts). If my understanding is correct, then the taxpayer is pretty well protected in all these bank failures and the only reason for the bailouts is to prevent a theoretical massive deleveraging wave from sweeping through the system and bankrupting ‘everyone’ at the same time. However, if the taxpayer is on the hook for more than the deposits when a bank fails, then it could be argued that federal bailouts of banks benefits the taxpayer in some way and it would likely alter somewhat my perception of the bailouts.
[quote=davelj]
You think the majority will need bank financing?
Do you really think there’s enough private long-term capital to buy all of these assets (you pick the time period)?
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I guess that depends on the price. If the assets sell cheaply enough (very close to zero), I’m sure that there is enough private, long-term capital out there. So, I think your argument is really something like “Is there enough private long-term capital out there to get a fair price?” Well, who’s to say what’s fair? You argue that some of these assets are under-valued. Mr. Mortgage seems to think many of these assets are still overvalued. No one really knows what the future income streams on these assets are going to be, so no one really knows for sure if the assets are over-valued or under-valued right now. Further, according to Mr Mortgage:
This story and my input above is also exactly why ‘market participants’ have somehow forced Markit to pull the release of their new US Prime Mortgage Security Index. Markit are the creators of the well-known ABX index that did such a great job shedding light on what was really happening in the Subprime market. For a year, the pundits made Markit out to be a chop shop but in the end they were correct as were most waiving flags two years ago.
**Request…If any of you know anyone at Markit, I would love to help out in the creation of this index. I am absolutely positive that with the proper inputs from the right people, a very accurate tracking index can be made for all Prime securities, including Jumbo Prime. This index is very necessary, especially given the government is likely going to be buying this stuff on the tax payer dime and the Fed holds hundreds of billions as collateral for loans — that the tax payer will ultimately have to pay for as well.
So banks aren’t interested in even trying to value these things. What does another extremely knowledgeable blogger (Yves from Naked Capitalism) think about this:
Yves here. Repeat after me: you need recapitalization AND price discovery. The near pathological avoidance of the latter by the officialdom would seem to support widespread suspicions that marking assets to market, or even a realistic notion of longer-term value, would confirm that the industry is insolvent.
Question: If my understanding is correct that taxpayers are pretty well protected in the normal circumstance of a bank failure, then why should I, as a taxpayer, care what the bank assets sell for? So the insolvent institutions fail and someone else supposedly benefits by getting assets on the cheap. Big whup. That’s capitalism. Now, there will be massive unemployment, but the government can step in to help with that.
It seems that where I differ with you is in what step the government should step in. You seem to think the government should step in to help insolvent institutions. I think the government should let the institutions fail and then step in to help with unemployment. I believe the latter solution would force people into more productive areas as opposed to allowing them to keep earning a living by being employed by an insolvent institution.
[quote=davelj]
“Banks are insolvent because banks are insolvent”? Really? I will agree that some banks are insolvent and most of these will ultimately fail. But do you think ALL banks are insolvent? And how are you defining insolvency in the case of banks? Please be precise.
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Dictionary.com defines insolvency as being “unable to satisfy creditors or discharge liabilities, either because liabilities exceed assets or because of inability to pay debts as they mature.” My understanding is that most of the insolvent financial institutions are insolvent because they can’t pay their debts due to the fact that they borrowed short and lent long. That is a failed business model. Let the institutions who did that fail. Surely you would agree that if a bank can’t pay debts as they mature, that they are insolvent?
Do you know of any financial institutions that were shut down because the value of their liabilities exceeded the value of their assets? If not, then the only banks that have been shut down are those that can’t meet their obligations.
And no, I don’t think that all banks are insolvent. However, as I understand it, several more financial institutions (Goldman Sachs, BofA, etc) would be insolvent due to failure to pay their debts as they mature if they weren’t allowed to borrow from the Fed (i.e., taxpayer).
[quote=davelj]
Most banks actually followed the time-honored precepts of good lending, even during this bubble (it would probably surprise you to know how many folks weren’t reckless – but you won’t read about them in the paper). But certainly almost all of the bigger banks did not. So, I’ll assume, unless you tell me otherwise, that when you refer to “banks” generically, you’re really referring to the largest (and most careless) US banks. The vast majority of community banks in this country will sail through this crisis largely unscathed.
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Good. If a bank isn’t insolvent, then it shouldn’t fail.
[quote=davelj]
I think we should let the vast majority of the bad banks fail. But not all at once. And the biggest banks need to survive in some form, although I have no issue with wiping out all the common and preferred equity of these pigs. I want to let the creative destruction process work, but I don’t want to let it work in such a hurried manner that it completely undermines faith in the financial system and blasts us back to an agrarian society. Although perhaps that’s your preference.
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I’m not sure about the “not all at once” thing. Who’s to say that’s not a better solution? Maybe that allows the system to rebuild sooner and more efficiently? It does seem like allowing a massive cascade of failures all at once could cause problems. However, I’m not sure that over-paying for bank assets (i.e, paying more than the ‘market’ would) is the solution.
As for the ‘agrarian society’ thing, you are a finance guy so I guess you think that the finance industry is the be-all-end-all. Some are thinking that portions of the finance industry could disappear completely with no ill effects:
I’ve detected this “investors aren’t worth the trouble” vibe from several YC founders I’ve talked to recently. At least one startup from the most recent (summer) cycle may not even raise angel money, let alone VC. Ticketstumbler made it to profitability on Y Combinator’s $15,000 investment and they hope not to need more. This surprised even us. Although YC is based on the idea of it being cheap to start a startup, we never anticipated that founders would grow successful startups on nothing more than YC funding.
If founders decide VCs aren’t worth the trouble, that could be bad for VCs. When the economy bounces back in a few years and they’re ready to write checks again, they may find that founders have moved on.
There is a founder community just as there’s a VC community. They all know one another, and techniques spread rapidly between them. If one tries a new programming language or a new hosting provider and gets good results, 6 months later half of them are using it. And the same is true for funding. The current generation of founders want to raise money from VCs, and Sequoia specifically, because Larry and Sergey took money from VCs, and Sequoia specifically. Imagine what it would do to the VC business if the next hot company didn’t take VC at all.
