Will the banks survive?

Fortune has a good article today that talks about the causes and potential solutions of the banking crisis.  I disagree with their conclusions, but the article does a good job of explaining the risks that the banks are facing – and getting ready to face.

How can it be that the banks are tottering after the government fortified them with hundreds of billions in bailout cash and guarantees on their troubled assets? For the past 18 months, the banks’ problems with toxic securities, especially collateralized debt obligations (CDOs) and other exotic products that packaged subprime mortgages, attracted most of the attention – and alarm. Now the storm is entering an entirely new phase that’s potentially even more dangerous: a historic meltdown in the bread-and-butter businesses of credit card, home-equity, and mortgage lending.

Unfortunately, at the very start of the article, Shawn Tully gives up.  In the paragraph just before the one I quoted above, he says Fear is spreading that if all that rescue money can’t revive these stumbling giants, only one road remains. Everyone from former Fed chief Alan Greenspan to Senate Banking Committee chairman Chris Dodd is warning that the sole solution may be the once unthinkable one: nationalization.

Why does he so quickly get to nationalization as the “sole solution”?  It’s not.  There’s another solution to the problem.  Let them go broke.  It’s how stupid people are separated from their money.

In talking about the 19 largest banks (those with assets over $100 billion) the article says:  Washington won’t let those big banks fail: It will boost their capital by purchasing preferred stock that will pay a 9% dividend. If a bank has trouble paying the hefty dividend, it can convert the preferred shares into common stock. Hence, the weakest big banks may well end up with the government as their largest shareholder.

How is that different from nationalization?  They may still be private companies on paper, but if the government is the largest shareholder, the bank has been effectively nationalized.  Government can now dictate policy to an even greater extent than they do now, sticking their noses into such things as bonuses, who gets a loan and who doesn’t, salaries, etc.  There may be a technical difference, but the end result is identical.  Bad.

FBR predicts the banks will eventually write off about 9% of their loan portfolios, with the vast bulk of losses coming in the next three years. That would hit the big four with around $300 billion – or $100 billion a year – in credit losses, more than three times the projected damage from their toxic securities.

And that’s at the four largest banks alone.  That’s Bank of America, Citigroup, J.P. Morgan Chase, and Wells Fargo.  Between them, they hold almost half of all U.S. consumer and business loans.  Double that number to $200 billion per year to get an idea of the losses still to come for the banks.

How the government proceeds from there will say a lot about the future of the banking sector. The fear is that Washington will continue to prop up Citi and other wounded banks in their current form. The best course would be to force battered banks to sell enough assets to restore their financial health – if that’s possible – or to dissolve.

I say dissolve them.  Let them go broke and bankrupt and sell off whatever assets they have at fire sales to the highest bidder.  That quickly establishes a market price for this crap, and it allows the good banks to stay in business.  No government money is needed.  And that’s the way it should be.

gk

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