Wednesday, January 21, 2009

Bank euthanasia?

Is there any remedy for the plight of the banks swimming in sewage of their own making other than forcing them into bankruptcy? Karl Denninger believes nothing less will work.
There is exactly one way to resolve this problem - the banks must be "crammed down" through forcible reorganization, and we must stop bailing them out and handing them money.

We cannot recapitalize them through taxpayer donations, for through that path we only delay the inevitable. We do not have the ability to "manufacture" or "borrow" the three to five trillion dollars it would take to cover those losses - a full fifty percent increase in our federal debt, on which we would pay hundreds of billions of dollars a year - forever - being a permanent drag on GDP. Such a path will only lead to more insolvency as the crimp on GDP will inevitably lead to more job losses, more credit losses and more malaise, ultimately resulting in the very collapse that the proponents of this path claim to be trying to avoid.

The math demands that we take bold action. We must force a cramdown of debt to equity, which will wipe out all of the existing shareholders, including those holding preferreds while converting the bondholders into new equity holders, pushing down the capital structure however far is necessary in order to return the firm to solvency.

To the objection that it's unfair to the shareholders to have their investment wiped out because of mismanagement by the institutions and the government, Denninger says that (a) these companies literally are bankrupt, on a life-support system that must pump unthinkable amounts of public money into them just to keep them comatose; and (b) when you buy stock in a company, you are making a bet — a bet you can lose. That's the nature of the market.

His prescription is unorthodox, pretty radical. Well, the chap who's just climbed to the top of the greasy pole, in Disraeli's phrase, promised us change and it can hardly be denied we need some, however much we may disagree about exactly what. Unfortunately, it looks like President Obama's economic team can scarcely visualize whirled peas, much less back off and rethink the situation. Their new idea is to take the old idea of pouring money into a broken vessel and raise it to new heights.

Incidentally, Denninger quotes an article in The Telegraph headlined "Gordon Brown brings Britain to the edge of bankruptcy." (The British banking system may be even closer to complete collapse or nationalization than ours.) A choice snippet:

They don't know what they're doing, do they? With every step taken by the Government as it tries frantically to prop up the British banking system, this central truth becomes ever more obvious.

Yesterday marked a new low for all involved, even by the standards of this crisis. Britons woke to news of the enormity of the fresh horrors in store. Despite all the sophistry and outdated boom-era terminology from experts, I think a far greater number of people than is imagined grasp at root what is happening here. The country stands on the precipice. We are at risk of utter humiliation, of London becoming a Reykjavik on Thames and Britain going under.

Politics has a role in this, of course — The Telegraph being a Tory-supporting paper and opponent of the Labour government. Still, for all the British press's decadent obsession with fashions and celebrities, you have to admire the traces — like this — of old-fashioned bracing journalistic invective. Can you imagine any of the empty-calorie American dailies publishing such a crushing rebuke to one of our politicians?


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