More and more real-world data and forecasts are conflicting with the “green shoots-surely things are getting better” story. One view comes from Institutional Risk Analytics’ Chris Whalen.
In his monthly Special Feature (pdf only, no online source), Whalen suggests that banks are far from out of the woods. Although he believes that damage will not be as bad as that of the 1930s, he generally concurs with the IMF’s observation, that US banks are only partway through recognizing their losses (the IMF believes US banks have taken only 60% of their total writeoffs, and European banks, a mere 40%). Whalen sees the crisis extending at least several more quarters, and possibly into 2011.
Whalen believes aggregate loan losses could hit 4%, twice the level of the savings and loan crisis, but short of the 5% level seen in the Great Depression. FDIC losses on failed bank resolutions are also running at much higher levels than in the 1980-1995 period (11% then versus nearly 25% now).
Some tidbits from this report:
To put the current crisis in perspective, consider the amount of debt incurred in the form of bonds issued to fund the savings and loan crisis of the 1980s are still being paid off. Given the far larger cost of cleaning up the current crisis, a similar amortization of debt could stretch well into the second half of the 22nd century….
Recent statements by Timothy Geithner and other finance chiefs have emphasize the need for more bank capital, expecting that his will make the financial system more viable. Yet, missing from the discussion is any meaningful acknowledgment that 1) it was the activities of banks, not their capital levels, that caused the financial crisis; 2) that larger banks as a group do not have the earnings power to support higher equity capital levels, at least capital provided by private investors; and 3) that large banks are well behind the rest of the industry, in terms of capital, especially when assets are truly market to market and off-balance sheet exposures are consolidated.
Item 2) on Whalen’s list has extremely serious implications. It means that the current approach to dealing with the financial crisis is inherently flawed. Banks are unlikely to be able to secure enough capital on private terms, or if they manage to (say by retaining earnings) their stock prices will be under pressure and bank management will be under pressure to increase returns. That will lead to a combination of getting into riskier activities and “freeing up capital” which is a fancy way of saying use even more off balance sheet vehicles.
Thus the pressures will be to institute an even more extreme version of the pre-crash paradigm. The other option, of turning banks into utilities and letting them offer simple products but also allowing them to earn a decent regulated return is simply inconceivable to the powers that be, and of course unacceptable to the industry. But that would be a far better course of action than the type of dysfunctional behavior we are likely to see to finesse the dilemma Whalen set forth.