We survived the Great Depression. Most people kept their jobs and most banks didn’t go under. There was great suffering, obviously, but as long as there are no Hitlers or Musolinis in the wing today, we should get through this mess.

Goldman also bought Litton Loan Sevicing, a subprime servicer of a very nasty sort, last year (won the bidding in October, deal was supposed to close before year end). That looks like a bet the bottom was nigh. Servicers are hemorrhaging cash right now, so this probably is not the best deal Goldman ever did.

Long way of saying it isn’t clear they are talking their book. .

I guess. But what is this hope based on? Isn’t it so that in the last few years aggregate debt, especially household debt, has risen dramatically compared to incomes, i.e. the ability to service that debt? Are there any signs, in this age of outsourcing and ‘labor arbitrage’, that incomes are going to catch up in any kind of reasonable time frame? I just don’t see it. So how can we possibly avoid asset deflation, e.g. home prices, where in some areas affordability, as measured by historic norms, is totally out of whack?

Looking at this graph, I’d guess prices have fallen somewhat less than half way (in real terms) to the eventual bottom.

I think we all know, anecdotally, that things have gotten far out of balance. And just as crazy as all that was, the Fed is behaving just as crazily trying to stop the inevitable correction.

Like I said before: IMO such a correction is needed to show Americans the wrongheadedness of a FIRE dominated economy.

The problem with this system is that all the banks are interlinked through derivatives. At the same time, there is little transparency.

The derivatives combined with the lack of transparency means that if any single reasonably-sized financial institution fails, then everyone will make a run on all of the other banks because of fear of the unknown (which counter-parties the failed institution would bring down because of derivatives default). So the collapse of any single component in the system causes the collapse of the entire system (and a Great Depression).

As a result, nothing in the entire system can be allowed to fail—nothing.

That is the harsh lesson we are learning about derivatives and transparency. Pandora’s Box has been opened. It is derivatives that have set the stage for potential systemic collapse.

I would try to be careful in how you instruct financially not so literate friends and colleagues to arrange their affairs, Too many people saying that banks are in trouble (to the point that there are worries about large scale failures) can be self-fulfilling. I would low key it but deliver the same substance, and stress that some banks are more prudently managed than others.

It doesn’t help that, thanks to the formal end of Glass Steagal (it was dead long before it was officially buried) the media uses the term “bank” to refer to traditional banks and what the Bank of England called “large complex financial institutions” some of which are pure broker dealers (Goldman, Lehman, Merrill), others are what the Europeans called universal banks (Citi, UBS, Barclays) with securities operations plus commercial and retail banking.

The risk and consequences of failure are a much greater in the LCFI and their slightly smaller kin (Bear) than in traditional banks, ex the ones that jumped in with both feet on the subprime bandwagon. Banks are kept on a much shorter leash.

The big broker dealers are far more important to credit intermedation than banks are. Failures there will put lending in a deep freeze (most banks on-sell a big chunk of the loans they originate). If the securitization process continues to be impaired, traditional banks have no where to go and will run into balance sheet constraints pretty quickly. So we can get a big time lending contraction without bank failure or even serious impairment of traditional banks.

But the amount of deposits is pittance compared to the scope of the problem. Looking at the logical progression, I am primarily concerned that all the junk will get marked to market at once and there will be chaos. (Or the counterparties fail which is basically the same thing.)

If someone could convince me that the long term structural problems aren’t that bad and can be resolved, then I would hesitate to take money out, but I don’t think this is like the classic bank runs that were set off on mere rumors. The big boys are definitely not sitting still (I think Krugman’s note about how the mass flight to treasuries might take away all control from the Fed is fascinating) and the government is not prepared to accommodate us if something does happen.

In general, I think the problem isn’t human nature, but that our system isn’t built in a way that accounts for feedback loops that are entirely rational. I do hope that something fundamental changes, and soon.

I also would question that moving the money to a bank that is being reasonable would really help the situation all that much because they aren’t going to start suddenly taking risks in order to try and stave off deflation.

This does not count all of the other loans that may be in doubt.

If the GSE’s are looking at 1.5% loss, I would worry about capital adequacy. At 40x leverage (we can debate about the NOL) Fannie and Freddie would look quite precarious.

Are we in the eye of the 1000 year storm or are we just feeling the outer bands?

Thanks for the reminder re the implod-o-meter, forgot to look them up. But I do wish per Anon of 8:24 that I had or could easily locate a total for the equity capital of the securities industry and banking industry.

Mikkel and Anon of 9:57 PM,

This is one of those problems where behavior that looks rational on an individual basis can produce very bad results in the aggregate.

If everyone started holding several months of cash, that could lead to deflation. Do you want to be part of the behavior that leads to a deflationary crisis and, say, a fall of GDP of 10% in one year? Those are the sort of outcomes that banks runs and deflation produce. That’s why the Fed feels justified in doing the sort of things that this blogger and many readers take issue with.

I have not done the research myself, but there have to be local/regional banks that are not too exposed to the credit mess. I might use their price performance over the last year as a first screen and dig a bit re the composition of their assets and their loss reserves versus chargeoffs. It may seem impossible to believe, but not all banks are risky or badly run.

Moreover, a straight payout from the FDIC is not the only route for getting benefit of its involvement. The FDIC also uses the purchase and assumption method, whereby a sound bank takes over some or all of the assets and liabilities of a failed or illiquid bank. It doesn’t use its assets in those brokered marriages.

Thanks for the help. I was just making a guesstimate that was higher than what the GSEs could account for. Sounds like I overshot considerably. But that means the losses to the securities industry will be even greater.