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Deja Vu All Over Again
Banks are simple businesses.
A "bank" consists of a small contribution of capital from stockholders, today about 8% of the total size of the bank; and the other 92% of the money is borrowed from depositors. "Banking" involves lending and investing the capital and deposits to earn enough money to pay interest to the depositors and a profit to the stockholders.
There are only a couple of ways to screw up: make bad loans and investments, or make long term loans with short term deposits.
A bank on the road to ruin loses capital dollar-for-dollar as it writes off bad loans. If it writes off too many, and chews too deeply into its 8%, it will have to raise new capital, or merge with a stronger bank. If a bank's losses exceed its capital, and it cannot find investors or a merger partner, then it must close ("fail"), and the depositors will not get all their money back.
Depositors take such a dim view of not getting their money back that all modern nations have some form of deposit guarantee. If a bank, or a few banks, or even several banks ruin themselves, there will be enough money in some "insurance" or reserve fund to pay off the depositors.
Banks are simple to run, simple to ruin, and simple to fix.
Except in large numbers.
Banks are herd animals, and tend to make the same sorts of loans and investments. Any large-scale combination of bad economy or bad luck will ruin enough similarly-invested banks to exhaust any nation's guarantee fund. Of course, as soon as bank regulators and government officials detect the imminent exhaustion of a guarantee fund, they do the right thing.
Nothing.
They know that the first person to whisper the magic words -- "public money" -- will become an instant pariah, cast from office. And, no matter how oblique, contingent, or far in the future the bailout may be, chaos will preclude policy.
The public never gets the idea, anywhere: the people being bailed out are the public -- the depositors -- and nobody except the public has enough money to do the job. The stockholders are wiped out, the bankers are unemployed, careers finished; and the recipients of the bad loans are in the worst shape of all. But facts do not matter: a bailout is demagogue heaven.
"The public should not have to pay for the mistakes of others!" "No taxpayer bailout!" Pardon, but... who else did you have in mind?
Japan is taking a daily pounding for failing to come to grips with its bank troubles. American officials are giving advice bordering on threats, and that border will likely be crossed before the year is out.
As you listen, remember our little problem a dozen years ago, and consider compassion.
In 1986, I commuted weekly to Texas as one of a few S&L "consultants" whose real job was to figure out (fast) how big the losses were, and report to Texas-based Federal regulators. I never had more fun, sorting through comic opera characters and their preposterous predicaments. The bad loans and losses weren't mine, except the portion I would later fork over as a taxpayer. The fun was limited, however, by a lifetime lesson in politics.
In 1986, Congress and Washington-level regulators insisted that S&L losses nationwide were absolutely, positively less than $15 billion. Those of us on the scene were delivering detailed reports to Texas-level Feds, telling them they couldn't get out of Dallas for less than $15 billion, and Houston for that much again.
Why, we hadn't even gotten to Arkansas.
These accurate estimates of loss disappeared somewhere in Washington. Our Senator at the time, Tim Wirth, sitting on the Finance Committee, took great pains to avoid repeated warnings of the true magnitude of the losses. Neither he nor the rest of Washington could take official notice because they had no idea what to do.
As early as 1981, every serious, senior person in the S&L industry knew that most of the 7,000 thrifts were already broke. Yet, despite our "transparent financial system", recognition of total losses and money for the bailout were not forthcoming until 1990. In a $6.5 trillion economy (then) we had to pay off about $125 billion in depositors' money.
In Japan's $4.5 trillion economy, depositor losses are at least $650 billion. The deposits still show on monthly statements, but the money is gone. No wonder it's taking Japan a while to come up with a solution. Rich and savers they may be; bureaucratic, stiff-necked, politically and financially opaque... but when somebody suggests bad motive in their immobility, cut 'em some slack. It's going to require more public money than Americans can imagine.
I don't mean to shout "Japan!" in a crowded stock market, but it may require more public money than Japan can raise.
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