We are receiving almost daily updates on the state of the banking industry in this current economic turmoil. I don’t know about you but I have a hard time even keeping up with the banks that are being closed, merged or changing names or identities. Some of the financial institutions that have been around for a long time like American Express are even becoming banks. We do need a banking system for our modern economy to work. I recognize the need for that and for some of them to exist but sometimes I wonder if we are really getting the best bang for our buck with the various types of bailouts being thrown out on virtually a weekly basis it seems for the last couple of months. I mean Citigroup got 25 billion in mid or late October and then only a week ago it had to be saved again with greater cash infusions. All this turmoil reminds me of the situation that existed for many of our large banks in the early ’80’s. You are bound by now to be familar with the “mark to market” concept that has been in the news so much lately. That means making the banks and financial institutions mark any asset to what it is believed to be worth now in the marketplace as opposed to taking the long haul view and allowing some room to place a value that reflects value over a period of the presumed useful life of the asset and its underlying property supported by a mortgage. Using that method now requires many of the banks to write down some mortgages to zero even though they do have a value. Even in foreclosure there is value in the real estate. Like much of accounting theory it is guess work. A while back everyone thought mark to market was wonderful because it made the banks be transparent about their capital reserves. Now many wonder if it isn’t doing more harm than good because it makes the balance sheets of the banks look worse than they really are.
We faced a different set of circumstances but a similar problem with the valuation of bank assets almost thirty years ago and the method for dealing with it then was quite different than now. Beginning in the late ’70’ a number of our largest banks decided it was smarter to make fewer loans to bigger borrowers than givng numerous small loans to consumers. The biggest borrowers around were nations. The thinking was why make one million car loans and have all the cost of servicing them when you could make one loan to say Brazil for the same dollars and only had to deal with that one borrower. The paperwork was less and the administrative costs were obviously lower. The banks would increase their profits enormously was the thinking. So in fact the big banks, like Chase, Chemical, and Continental Illinois to name just a few did just that and loaned out hundreds of billions to Brazil, Indonesia, etc. Then guess what, those countries didn’t do as well as everyone thought they would. Those countries defaulted and made it clear they didn’t intend to repay the loans. Not a dime. So what did our stalwart regulators do about it? They knew if they made the banks write down the value of the loans to foreign countries that many of them would not have any capital left or not enough capital to continue in business. The solution was that they just ignored the problem. The regulators let the banks continue to carry the loans on the books at full value and thus preserve their capital structure. The publicly announced position was that those countries would maybe pay the debt someday down the road. It was a fiction of course. Those debts were worthless but the Feds decided that they would just give the banks time to work their way out of it and everyone pretended that they still had good assets on their books. There was lots of comment and controversy at the time but it slowly moved away from the front pages as the real estate collapse took its place and was forgotten. Some of those banks went under anyway, like Continental Illinois because of those loans and imprudent loans in the real estate market.
It is always interesting and sometimes even educational to recall past events that foreshadow current events. Maybe we can learn something from that experience to apply to today’s headlines. Our situation today is probably more like those of the early ’80’s than the ’30’s, even though many keep trying to use the ’30’s as the best example of what we are going through now. I wonder about that. In addition to the problems with the larger banks we had a recession to work through. The recession was the painful price of the raging inflation under Carter. What do you think? I certainly don’t think merely printing more money and handing it out hand over fist to banks or consumers will do us much good in the long run. The market can be a tough place but it always works and it always ultimately fair if the politicians stay out of the way.
A word to do without–liar. Wouldn’t it be such a better world if we didn’t even need that word? Those lies damage reputations, hurt finances and injure relationships. The truth even when it is painful inevitably causes less harm and always speeds healing and recovery. Be nice if the politicians could remember this.