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03/03/2009

Bad Banks

If you haven't already please, please listen to last Saturday's This American Life. Alex Blumberg and Adam Davidson, who a few months back deftly explained the mortgage crises, again present the most objective explanation I've encountered on our current situation.

If you don't have an hour to sit down and listen I'll hit some highlights:

They first explain a bank Balance sheet:

2060200472_e588a006a8

On the left side you have a banks assets, composed of loans and other financial tools that the bank makes money from. On the right side you have the bank's ownership capital, what the bank started with plus the profit they've maybe made from the left side. You also have the bank's liabilities, what it owes the people who have deposited with it and to whom the bank pays interest (hopefully less interest than the bank collects with it's assets). Ideally the sides would balance, hence the name.

Of course, thanks to the mortgage crises those assets on the left side became troubled or toxic. People who had overestimated their worth (or simply lied about it) couldn't pay their mortgages, the banks therefore kicked them and took ownership of the houses only to find that, were they to sell the houses at the current market value, they would lose too much money. In some cases the banks would become insolvent, meaning they had not ownership capital and could no longer pay interest to their depositors. (I know I am simplifying things, really listen to the podcast, I'm just trying to whet your appetite).

With the original TARP (Troubled Asset Relief Program) the government, using taxpayer money, bought up the toxic assets so that the banks wouldn't lose money and could begin lending money again. But this hasn't happened.

Listening to some of the things on the podcast I can't exactly blame them. Check out this graph which plots the average household debt against national GDP:

Household



That peak on the right shows that in 2007 household debt matched the nation's Gross Domestic Product. Let that sink in for a second. Now look at the peak of the left, the last time household debt constituted 100% of the GDP. Yep, it's 1929. Let that sink in.

We, the taxpayers who have been begrudging the government throwing our money everywhere, have been living beyond our means and really shouldn't throw stones. We should put all the blame on criminal CEOs (note: I'm not trying to defend what I consider irresponsible practices and action committed knowingly by entitled businessmen)

So, since the banks won't (in many cases can't) lend, the government has been pouring more and more money into the bank while whispers of nationalization have echoed around the media broadcasts. Listening to the podcast you get the sense that this wouldn't be such a bad thing. The government, which has sufficient capital (thanks to the taxpayer), could briefly take over the banks, attract depositors and restart lending practices and then step right back out of the picture.

The IMF does it all the time (like with Argentina in 2002) and let's be honest, take the name "The United States" off the header of the country's balance sheet and most people would be calling for brief nationalization.

Of course the balance sheet does read The United States of America and not only do we jump and hide at the mere mention of anything that would be socialist, we are probably too big and our financial system too complicated for government to jump in an fix anything quickly.

And I'm not sure I trust a government, who apparently drags it's feet on legislation unless it's to pass some useless monkey law, to fix the situation.

Okay going to stop before I digress. Listen to the podcast.

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Austin Diaz

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