The end-goal of any bailout or government takeover
The US is a current account deficit country. Get used to it. You (and I am not an American so I can say you) have been spending more than you earn for years.
I can’t speak too rashly though because Australia and Aoeteroa (New Zealand) – the two countries to which I am closest – are also current account deficit countries.
If you run a current account deficit for long enough your financial system will be NET short deposits. There will be (say) 130 of loans for 100 of deposits. [If you are the UK it can be much more extreme – with Northern Rock having a loan to deposit ratio of a few hundred.] Individual banks will have sufficient deposits but everyone is vulnerable.
Banking can be profitable even if you are short deposits. Indeed it was silly-profitable for more than a decade before the insane lending started. The high levels of profitability meant that people would lend to banks unsecured in quantity at thin spreads.
Banks became totally dependent on their ability to roll the loans. If they can’t roll this senior unsecured funding they will fail. No ifs, no buts. That results in failure.
Most banks in current account deficit countries have such funding. In Australia it is called Bank Bills. Here it is called lots of names only because financial innovation has found lots of ways to name the same stuff.
I have calculated out the losses of banks in the US numerous times – and in no sense are the losses not able to absorbed (at some cost) by the highly productive US economy. There may be a period of austerity as America adjusts – but the economy should bounce back.
Under the presumption it can finance itself.
But it can’t finance itself unless it can assure unsecured lenders that it is a sensible place to lend.
The end of this financial crisis will occur when unsecured lenders feel safe lending to financial institutions again. If this does not happen the crisis will not end – and there will be a great-depression level event in the US. That is real – factories will be idle, and good people will be roaming looking for jobs and unable to feed their children.
So I am going to set up policy guideline here for a bailout and for all FDIC action. All policy should be geared towards making unsecured lenders feel safe. New regulation should be geared that way. The takeover of banks will be well done if it gives the appearance of respecting the rights of unsecured lenders. The WaMu deal was bad. The Wachovia one was better (only from the position of an unsecured lender but that is the only position that matters).
America has – through decades of excess spending become beholden to the whims of unsecured lenders.
Face reality. That is who you have to please.
Incidentally the Swedish/Norwegian solution did that but wiped out almost all equity and preferred shareholders. Bank stocks would go down a bundle from here with anything that looks like Scandinavia.
John Hempton
PS. I have no dog in this race. I am short a few bank stocks, long a few preferreds and have no position whatsoever in senior debt of banks.