Explaining the banking crisis

At the beginning of last week’s This American Life, Ira Glass suggests that many of us are resigned to not really understanding what’s going on with the financial sector. Then the NPR boys go straight into explaining it, starting in the simplest terms and working up to the global collapse scale. Required. One of the more interesting people in the show is Simon Johnson (a former International Monetary Fund bigshot who’s worked with many other countries fixing exactly this situation), who Terry Gross had an interview that is also very interesting. That should prepare you for the Baseline Scenario post from Johnson’s blog, and all the other jargon-heavy reports you’ll to be encountering.

Update: Spoilers (don’t read on if you’re going to listen to the programs): The amount of debt Americans hold, as a percentage of GDP, typically oscillates between 20 and 50%; at two points in the last century it’s hit 100%: in 1929 and in 2007. So all these people yelling about how banks should lend out the money the US government is giving them are exactly wrong — arguably it was our level of debt that, as much as anything, caused the current crisis.

Johnson believes that the solution is fairly obvious: nationalize the banks. You nationalize, clean up the mess, and re-privatize them. Apparently that’s what the IMF, with the USA’s blessing, has been helping/forcing governments with similar problems do for decades, and it works reasonably well. Also, the US government does it all the time, just on a smaller scale than would be presently required. But were it not for the “obvious” political problems, the IMF would advise us to do exactly that. There’s also the suggestion that — maybe — that’s exactly what the Obama administration quietly is preparing to do.

6 thoughts on “Explaining the banking crisis

  1. Of the three phenomenal T.A.L. podcast specials on the economy, this one was by far my least favorite.

    I felt like the conclusion to nationalize was reached way too early in the program, or at least without as much explanation as I’ve come to expect from these guys.

    Why exactly does the government taking an ownership stake in your bank automatically correct the bank’s balance sheet? What can the government do differently to the toxic assets with no buyers (especially in the scenario where the guy says they would own the banks for a few hours)?

    Does the government just absorb the debt and then sell of their stake in the bank’s post debt future and make money right away?

    I’m not against the nationalization idea, I just want a little more explanation then the “we need it right now, seriously you have no idea how badly we need it” tone of this one episode.

    If anyone who’s been paying more attention to specific talks on nationalization knows more than I do on the subject, please explain. 


  2. Yeah, that’s sort of true. Johnson is really the one behind the nationalization idea (he calls it an “FDIC intervention”), and discusses it at greater length in the Fresh Air interview.

    Under my understanding, the government does three things:

    1) Figure out how much the bank’s assets are really worth to figure out where the bank really stands

    2) Fire people, in particular the board

    3) Possibly break the bank up into several smaller banks. You were too big to fail? Well, now you’re not.

    BTW, I’ve been reading that Baseline Scenario, and it’s pretty rockin. But it’s also much more pessimistic then lots of other things I’m hearing, which points to the fact that Johnson’s viewpoint does not in any way reflect a consensus.

  3. Well, Salon had an enlightening article about this very subject not long ago. From what I remember, the government can do several things that private banking industry can’t or won’t be willing to do:

    – It can be appointed as receiver for failed banks much more easily than any other financial institution, because its liquidity is much greater.

    – It can strip all negative factors: bad contracts, bad management, credit card programs (let the insurers deal with that), dumb investments the banks may have going, etc. Because it’s not interested in making money but in making the bank an attractive purchase.

    – It restores the public confidence in the bank, preventing a run on the deposits which often are the only good asset the bank has.

    – It prevents a run on the other assets by insurers, investors, etc. Tying those assets in court would mean huge distractions and legal bills.

    – Yes, it absorbs much of the bad debt. BUT, it can use money from the federal insurance fund that all banks contribute to, not taxpayer money. (The fund has been depleted recently, so the Fed just hiked the bank contributions).

    – And, it has a line of credit with the Treasury of $100 billion. Interest is paid from the same fund.

    The ultimate goal is not nationalization but making the banks attractive for sale. Case in point, Wamu.

    The Fed may be messy on financial policy, but the banking rescue system is well organized and has worked for decades. Banks like it too. Of course it has never dealt with a massive implosion of big banks, Wamu has been the biggest.

    BTW, when the percentage of debt vs. GDP is computed, are they making a differentiation between secured and unsecured debt (i.e credit cards) or between individual lending and commercial credit? That would be important. Lending to consumers no, commercial credit yes.

  4. I think Blumberg and Davidson did a great job at summarizing their findings considering their time restrictions. I’ll agree that the other specials might have been more satisfying but I think that’s due to the complexity of this particular issue. I mean, aren’t we still debating whether this is either liquidity or insolvency issue? And that’s just the problem, nevermind the solution. You’d be better served listening to their bi/tri-weekly planet money podcasts, which are basically the TAL podcast broken down and more detailed. And easier to digest.

    The explanation to why the gov would just hold a bank for a few hours as Alex said, boils down to making it more attractive for sale. I suppose if the bank’s structure is simple enough (i.e. neither CITI nor BofA) you can run through your objectives toward resale quite quickly.

    btw, Alex, apparently the FDIC hasn’t been able to collect premiums for the insurance fund from about 95% of the banks from 1996 to 2006.


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