Sunday, February 8, 2009

Bank Failures Rising, the Jubilee Solution

The worst part about the debt deflation Depression that we are in is the uncertainly. It is the sheer uncertainty of things which creates irrationality and panic behavior. No one knows which banks are next to fall, because nobody knows the true value of so many financial instruments that are on the banks' asset sheets. The uncertainty leads to panic decisions, which spread and ripple through society, like runs on banks, or futher malinvestment in banks that should be allowed to die, throwing good money after bad. The mainstream media and the government are working hard to prevent true knowledge of our economic condition, to prevent just such panic behavior, while doubling down on malinvestment through government control.

Given that the uncertainties of a slow grinding collapse are the worst thing going on right now, the certain finality of a Jubilee would be just about the best thing we could accomplish. Knowing that there was no further to fall, knowing the exact amount of real assets, purging our financial system of the cancer of overleveraged and unknown-value debt, Jubilee would pretty much end all confusion and panic. There would only be one concern after a Jubilee: generate cash flow. There would be no panic related to becoming homeless or having your business liquidated because you were behind on your payments. No panicked selling would be necessary, and we would see the immediate end of the deflation.

Jubilee would provide a soft landing for our economy, the softest possible. Many economic adjustments would still have to take place, as production and price-levels would have to attain a new equilibrium. Areas of mal-investment and unsustainable activity would be revealed quickly, and the economy could quickly readjust, with a lot of breathing room for everyone involved. It would be an era of opportunity and optimism.

The banking system failure is imminent. When you get the object that a Jubilee would destroy money and the banking system, ask them how that is different that what is going on now? Only now, the end of our banking system will come with panic and uncertainty. Our banks survive on faith, but already articles in the mainstream pages are coming out about the immanent collapse of our banking system. My advice: get your money out now, before the run on the banks begins en masse.


This January, the government took over six failed banks, including three on a single day. Last year, it took over a total of 25. When it happens, the government swoops in and try to minimize disruption. Recently, it has tended to close banks on a Friday and achieve something close to business as usual by Monday morning, arranging for other banks to take on the assets. ATMs have kept working, and people have had access to their cash.

So far, most of the failed banks have been relatively small, many with assets only in the hundreds of millions of dollars. But what would happen if one of the nation's big banks, the kind that manage hundreds of billions in assets, went down?

"That would probably cause a complete meltdown of the American financial system," says Andreas Hauskrecht, an associate professor of money, banking and finance at Indiana University. After the financial crisis accelerated last fall, the government increased the limit for the amount of bank deposits it will insure for individual depositors, from $100,000 to $250,000, effective through the end of this year. And while few Americans have to worry about keeping anything bigger than that in the bank, the government could eliminate the limit altogether and insure all deposits regardless of size if a huge bank, such as Citigroup or Bank of America, were to fail, says Jim Wilcox, a professor of financial institutions at the University of California at Berkeley.

No one has ever lost money in an account insured by the Federal Deposit Insurance Corp. But no one has ever seen a bank that size go under, and news of a giant bank's downfall would probably touch off a panic in which even depositors with money in safe banks rush to get it out.

But there's a bigger economic problem: Other lenders, which hardly trust everybody these days anyway, would stop trusting anybody. Businesses, unable to borrow money day to day, would fail, with worldwide consequences. It doesn't take an economics degree to realize that would be nothing short of catastrophic for the economy. "Not to say there's not good aspects of letting someone fail," says Robert G. Hansen, senior associate dean at Dartmouth College's Tuck School of Business. "But the short-term costs of inflicting that punishment to everybody are really high, and I don't think the Obama administration has the stomach for it."

Already, the new administration is treating the Lehman failure as a lesson. Treasury Secretary Timothy Geithner suggested at his confirmation hearing before Congress that the feds would not let another big bank go down. "Lehman's failure was enormously complicated, an enormously complicated set of events," he said. "It didn't cause this financial crisis, but it absolutely made things worse."

The emergency medicine prescribed by the last administration — flooding the financial system with billions of federal bailout dollars — hasn't worked. If anything, banks are sicker.

But no single fix is seen as a magic bullet, and financial experts say the government is quickly running out of lifelines.

In theory, the government-run bad bank would buy soured debt that's gumming up the banks' books and clogging the flow of credit. That could shore up banks' base of capital, soothe investors and get banks lending again. But in practice, it's far from simple. For starters, no one — including the banks themselves — knows how much these assets are worth. The complex nature of mortgage-backed securities, credit default swaps and other contaminated products has made investors too afraid to touch them.

Goldman Sachs estimates the government would need to shell out $4 trillion or more to absorb all the banks' troubled mortgage and consumer debt. How big is $4 trillion? It's more than one-third of the economic output of the United States in a year. It's more than twice as big as the first federal bailout and the coming economic stimulus combined. Just look at all those zeroes: $4,000,000,000,000.

Nationalization isn't a sure thing either. In the S&L days, the government recouped some taxpayer money by selling the physical assets of the banks, things like real estate and cars — not the hard-to-value paper assets held by banks today. That wrinkle makes it much harder for the government to follow the RTC strategy, says Jonathan Macey, deputy dean at Yale Law School and the author of a book about a government bailout of Sweden in the 1990s. "We're not talking about valuing buildings and dirt," Macey says. "This is quite a bit different." In other words, it's uncharted territory once again.

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