The Fourteenth Banker Blog

August 31, 2010

New Banks Needed #2

Filed under: Running Commentary — thefourteenthbanker @ 8:30 AM

I posted New Banks Needed #1 on Huffington Post also, and was disputed by someone who was in denial about the status of the industry. He said, quote, “There are over 10,000 financial institutions in the United States today, the vast majority with ample capital, and a huge desire, to lend.”

Here is some analysis to put that statement to the test.

The gist of what I am saying is this and is really not controversial.

  • Banks have embedded losses on their balance sheets
  • These imbedded losses impact profitability and capital
  • Because risks in the economy are large, banks are exceedingly careful about lending.
  • On an individual bank level, this is appropriate.
  • In aggregate, this reduces growth or recovery potential
  • This is in line with the “Zombie Bank” discussions that were all over the place during the depth of the financial crisis, which predicted just what we have going on today.
  • The Fed policy of low rates and other regulators complicity in “extend and pretend” does not solve this dilemma. It simply prevents the clearing of the market for financial assets and the development of new robust financial institutions that are capable of taking on risk.
  • New banks with new capital are needed. They would not be encumbered by imbedded bad assets or dependent on a super low rate environment.

New banks would also provide the opportunity to shed the predatory financial model that imperils our future. The ability of bankers to be in denial about the state of affairs and to argue for the status quo is not a reason to believe them. That’s it.



  1. Agree with everything you—I’m actually surprised anyone thinks that what you’re saying is controversial. It isn’t. It’s simple reality.

    The problem as I see it is, in Fall ’08, the Fed and the government saved the banks—but the banks acted like they were doing THEM a favor.

    Banks were never brought to heel—indictments were never handed down—bonuses were obscenely allowed to go on.

    So it’s too late now—banks are the zombie monsters of the economy. The only way to kill ’em is a shotgun blast to the head—not all this pussy-footing around them as if they were the Queen of England.


    Comment by Gonzalo Lira — August 31, 2010 @ 11:43 AM | Reply

  2. The problem is existing banking institutions with embedded , non provided for, loan losses. Loan and lease loss provisions are, in theory, a loss accrual to cover expected losses minus expected recoveries at the Balance Sheet Date. The fudge number is the value of recoveries from liquidation of the collateral. What is entirely unknown are future losses from current receivables in full contract compliance thought fully collectable as of the Balance Sheet Date. Historically, loan and lease loss reserves provide for experience based estimates of future losses in the ensuing accounting period. Past history once provided experience on which non performing loans will be cured . Hence , total non performing loans and leases less recoverables would enter into an experience factor for determining the charge against earnings for Loan and Lease losses are accrued. It should be obvious that loans made in the period from 2001 or so through the financial crisis are sui generis in terms of basing the lossess on cumulative long term loss experience factors. The banks do not know their loss exposure which , in itself, is a vast departure from historical experience. Banks obviously understood this trend since they bought more Credit Default Protection than they sold. This interjected the really big unknown. What is the credit loss risk associated with those from whom the banks bought protection? The big example was AIG. The CDS losses from an AIG failure would have killed the big banks , since they are partially just agents for others. John Paulson bought protection from DB, DB bought protection from others like AIG. Consequently and AIG failure would not have relieved DB of making good to John Paulson. These are all five year contracts or more . Most are still in force. If the government bankrupted and recapitalized banks over the CDS issue alone, they would have had to bankrupt and recapitalize all of the big banks. This is furthermore complicated beyond reason in that subsidiaries were part of the chain of transactions.

    Is it really not possible to estimate losses for accounting purposes bank loss provisions under the foregoing circumstances?

    Comment by Jerry J — August 31, 2010 @ 4:17 PM | Reply

  3. In Hard Times, One New Bank:

    Credit is finally available, but no one wants it:

    Comment by Rover — August 31, 2010 @ 4:21 PM | Reply

  4. We should have true competetion with a system of banks run by states.

    All federal guaranteed loans should be gradually dismantled. Why should Bill Gross get risk free profits paid for by the taxpayer? This is just another tax entitlement.

    SBA should be reformed and become a direct lender. Take out the middle man who charges fees and frequently refuses to make a guaranteed SBA loan.

    Comment by ella — September 1, 2010 @ 10:27 AM | Reply

  5. I appreciate what you’re saying about needing start-ups with clean balance sheets. However, unless I’m missing something here, this still doesn’t address the issue of hundreds of billions of underwater assets on existing banks’ books. That problem is huge and no one seems to be dealing with it in any real way.

    Comment by Shoto — September 1, 2010 @ 8:54 PM | Reply

    • There is very little flexibility in dealing with underwater bank assets due to a multiplicity of countervailing contractual impediments.

      What does underwater mean in terms of legal effects on the contractual aspects of a banks claim on others it carries as an asset? An underwater asset of the bank derives from the underlying secured interest being worth less than outstanding value of the banks asset claim. Unless, the banks claim is not meeting contractual terms the bank has no recourse to call the loan unless provided for in the contract. From an accounting perspective nothing can be done to impute a reserve charge based on valuing the individual performing loan. Accounting does not speculatively value future events and still remain accounting. There must be a tranactional event that estabishes the need for a loss accrual relating to a claim on others. A claim on others, held as such, is not merchandise. A claim on others, held for sale as merchandise is, well merchandise. Banking, by nature , cannot be the business of merchandising. We have combined the two which led to the financial crisis. The most important characteristic, in my view.

      Securitization of claims on others that bannking assets by nature were artificially turned into merchandise backing a derived tier claim on others. Backed by has no connection to secured by as concepts. Backed by is the right to cash flows including post liquidation of security. Almost literally, no banking remediation is possible unless a financial institution buys up the entire securitization. This problem led the astute to buy credit default instruments . That these CDS’s had sellers of risk assumption at very low rates is proof positive that the banking system had no other way of pre-empting the risk and did not believe in pre-emption in the first place.

      At this point, the assets of the banks are what they are. Either performing or not performing and there is little, next to nothing really, that can be done at the asset level on a systemic basis.

      The only remaining out to preserve the basic banking system will be mass state induced reorganization and recapitalization forced from bank creditor’s.

      Only so much money can run to Treasuries or possibly to other nations state debt. As it is , near zero yields on Treasuries will build in future losses to holders and introduces the same accounting conundrum I discuss above. Even worse, these low yields applied to defined benefit plans introduces massive underfunding and in some cases should trigger immediate funding calls on the contractual contributors to these defined benefit plans. Just what else might defined benefit plan trustees do when they expected yields of say 6 % to meet future benefits and yields fall to 2 % ? Or less.

      I see multiple systemic collapses comming into synchronicity with each other as the next financial crisis emerges and triggers a panic.

      Accounting too will be kaput. At the least, we go back to a strict cost basis regime and leave it to the user of the statements to make their own judgements. Right now , there are so many judgements involved, all biased by nature, that financial statements are becoming close to worthless for financial institutions.

      Comment by Jerry J — September 2, 2010 @ 2:10 PM | Reply

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