[OPE] Recipe for stagnation...

Reuters, August 17th, 2009
America's Japanese banks, by Rolfe Winkler

"(...) Emergency bailout facilities allow banks that otherwise would have
failed under the weight of bad loans to hold those loans to maturity -
pretending the bad ones will be paid off in full over time. In reality, many
loans will default and banks will bleed capital for years. Take commercial
real estate. As the Congressional Oversight Panel has reported [
http://cop.senate.gov/documents/cop-081109-report.pdf, ] few CRE loans that
were originated at the peak will qualify for refinancing when they mature.
Banks can pretend they will, carrying the loans at values far above what
will ever be paid back. (...) So what do we do? We can start by eliminating
government guarantees that allow banks to avoid dealing with the problem.
As things stand, the biggest banks have no incentive to write down loans
because the Federal Reserve, Federal Deposit Insurance Corporation and
Treasury Department have, in effect, promised them unlimited financing to
hold loans to maturity. As the Japanese can tell you, this is just a recipe
for stagnation. Thanks to a debt bubble that authorities refused to deal
with decisively, that country is now entering its third consecutive lost
decade."
http://blogs.reuters.com/rolfe-winkler/2009/08/17/americas-japanese-banks/

But the banks are dealing with the problem, at least to an important extent,
restructuring their operations - it is just that the financial consequences
of losing a large chunk of income are now stretched out over more years into
the future, with the backing of taxpayer's funds and foreign capital. Time
is everything in banking, and if the schedule of credit repayment is
stretched out in time, that prevents them from going under altogether,
thereby preventing a far larger macro-economic problem. In this sense,
credit is a highly flexible financial instrument.

Winkler mentions that Dan Alpert at Westwood Capital thinks as much as a
fifth (!) of the $4.7 trillion of the total outstanding US real estate loans
could prove uncollectable, which is circa $940 billion, or at any rate close
to a trillion dollars. If you had to absorb that loss within one or two
years ("dealing with the problem") it would shoot a gaping hole in the
economy, and cause not just stagnation but a very severe depression. But it
is certainly true, that a large chunk of credit, and the incomes generated
by it, is steadily disappearing ("debt deflation" as Steve Keen calls it)
and that's a recipe for weak output growth, low investment activity in the
sphere of production, higher unemployment and greater socio-economic
inequality in the medium term.

The theory behind "unlimited financing to hold loans to maturity" is, that
as activity in the real economy picks up, the credit problems will gradually
clear, but this is a false or at least distorted view which puts the cart
before the horse, since capital finance actually is the dominant influence
on activity in the real economy nowadays. Effectively the state is saying it
"stands behind the financiers", in a confidence booster operation, but the
point is, that the actual measures taken could effectively penalise the real
economy, because the "stimulus" does not have a very large positive effect
on the real economy, and just cushions the credit shock. Effectively, that
means the incomes of one social class are guaranteed and insured at the
expense of another.

Jurriaan

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Received on Mon Aug 17 16:58:32 2009