What If Banks Are in Deeper Trouble Than Anyone Realizes?
Defaults are rising on every form of debt, which should come as no surprise to anyone. Those who thought that the issue was subprime mortgages need to wake up and realize that no form of debt exists separate from any other. People strapping themselves with mortgages they cannot afford are clearly going to be financially strained elsewhere. But then, people taking out lines of credit against homes, using multiple credit cards, and leasing fancy autos that they wouldn't be able to afford to purchase are also going to be hard-put to manage any untoward financial situation. That will likely add up to a lot of money:
Indeed, Goldman Sachs Group estimates that troubled assets could exceed $5 trillion, if defined as assets that could show a loss rate close to, or above, 10%. To put that in context, $5 trillion is just over 40% of the $12.3 trillion in total assets of U.S. commercial banks.Why take for granted that the losses will be a lot less? This is exactly the type of willful blindness that has led banks to where they are today.
Granted, actual losses will be much smaller than $5 trillion, and banks won't have to sell every bad asset. Most still can reserve for a good share of their losses. Moreover, the government already is on the hook for losses at Citigroup and Bank of America, with $3.8 trillion of assets between them.
The talk today is of creating a government-owned so-called bad bank, which would buy the bad assets and then liquidate them. The strategy is at least twenty years old and was in use during the 1980s, when many more banks were failing than are failing now.
The problem is that everyone is making things up as they go along. No institution to my knowledge has done risk management planning for such an extreme situation as that much potential default. Not even the U.S. government can take on this level of debt with impugnity. How many years -- how many decades -- will it take to pay off this volume of money?
I don't think anyone in government or the financial community is being straight, either with the public or with themselves. They are likely concerned about inducing panic, but maybe that is exactly what the public needs. Already we're seeing lowered spending and more attention to debt levels, at least by individuals. They are right to react strongly, because they see they are living with choices made over the years. But how long will it be until those who are in charge do the same?