Sunday, January 25, 2009

Banking Industry Update

There's a pretty heated debate going on around Wall Street and Washington on what we should do to fix the banking industry. In simple terms, banks lend out roughly $10-$12 for every dollar deposited (the exception were the big banks that lent $30 for every dollar deposited - RED FLAG!). When loans go bad or deposits are withdrawn the banks need increased cash (capital) to stabilize their business.

This is the basic problem facing the industry. Their assets (deposits and loans) continue to shrink, so the amount of money available to lend is contracting. To fix this problem you need to either attract more deposits, stabilize their loans or inject more money into the banks.

The current approach seems to be to stabilize the banks through capital injections. However, I remain convinced that this is a flawed strategy because the assets base of the banks will continue to deteriorate. There are two huge asset classes on the verge of collapsing - commercial real estate and consumer credit cards. As both of these asset classes join the plunging residential real estate portfolios, I think we're just chasing the end of the rainbow. As the assets fall, the banks will need more and more capital just to keep their heads above water.

Wash, rinse, repeat.....

We're burdening our children's children with unbearable amounts of debt in an effort to save some banks (and consumers) that made bad choices.

I'm not sold on the "bad bank" idea either. Under this solution, the government would create a bank to buy the bad assets in an effort to stabilize the banks. While this might work, it transfers the risk from the banks to you and I. That's counter to the entire capitalist model.

My suggestion is that the government cut the apron strings. The TARP was a colossal failure and throwing more money at the banking system is not going to do anything to fix it at this point. If government wants to stimulate borrowing again they need to become competitors to the banks. I propose that we establish a new lending institution (make it an Internet only lender) that would lend directly to consumers if they meet established thresholds (20% down even for cars, high credit score, sustainable income stream, etc) . This would

* increase the flow of capital in the US economy
* allow greater control over borrowing standards
* save the US billions

The problem with this plan is that many, many banks would go out of business. I think there is a pretty strong chance of that happening anyway, so I'd like to see us a try another option and maybe save us a few hundred billion.


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