More on Banks....or on Not Becoming Japan (and on Avoiding a Reverse Robin-Hood)

In December 2007 I was thinking about Japan, and whether the US would or would not go through a Japan-like stagnation. This was a complex question, and much discussion has happened during the last 12 months. Gradually a consensus has emerged in recent months among many economists and bloggers that one of the key facts of Japan in the 1990s was that banks were allowed to pretend to be solvent and continue operating -- so they functioned like deadwood that nonetheless sucks up water and light, obstructing growth by robbing economic nutrients, just by being in the way.

How were Japan's bad banks in the way?

They continued to hold depositors' money and savings, but became overly conservative in lending in the 1990s because they were trying to recover from having bad loans on their books that they refused to admit made them insolvent.

The overly-conservative attitude helped drag on Japanese confidence and thus the Japanese economy.

It wasn't that Japanese banks were obstinate or wanted to support big salaries/bonuses or dividends.

In the popular modern usage, many were "zombie" banks -- walking around and taking up crucial economic space, but essentially dead.

Thus Japan did not have a normal process of lending and investing, and this contributed to the unusual Japanese stagnation which happened even while the world economy was growing.

This is the view of many economists, and the only qualifier I can think of is that once Japan's economy was in one of it's several recessions during this time, there was less need for lending of course. The time lending matters more is when a tentative recovery begins. When a recovery is starting, can banks step up with new lending in a more normal fashion?

This is the reason many believe something has to be done about American banks. So that we can avoid one drag that contributed to Japanese stagnation in the 1990s.

But....as you would guess, the story then becomes more complex.

Exactly how should we "rescue" our banking system?

I've answered several of the difficult questions a few days ago here.

But one thing I did not explain then is why the overwhelming majority of bloggers and many or most economists don't like most of the of the past ideas that Congress considered (plans spread by bank lobbyists). Now the administration is said to be considering a "bad bank" plan.

The question about any "bad bank" plan is whether it is structured so that it will essentially take money from taxpayers and effectively give to it poorly-managed banks (by relieving them of their bad loans and securities they chose to take on) in exchange for....nothing or little. Just money for free, or for a small portion of the actual value, when the money doesn't need to be given away for free in order to rescue the banks!

Many plans have been aimed to essentially create a transfer of wealth from average taxpayers to rich bank investors, disguised as a financial system rescue. It is a disguise, because it is not necessary to permanently transfer wealth in order to rescue banks.

We have excellent plans available to rescue the financial system that do not try to permanently transfer (give instead of loan or invest) wealth from taxpayers (you and I) to bank investors on average much richer than you and I are.

Will the administration's "bad bank" plan be structured differently, so that it is not just a taking from taxpayers?

We'll have to wait and see what the details of the plan are to discover this.

Be assured, several bloggers (yours truly included) have shown they can penetrate and understand the implications of various proposals in terms of these long term bottom line effects.

It's a trillion dollar question. Literally.

It's now understood overall losses of various sorts will be at least $1 trillion. So when $1T or more of our money is eventually, gradually taken, will we get a stake in return the way we should?

If you are an average tax payer, your personal stake in this question is likely at least $8000-$10,000 (over time).

We are literally and exactly talking about whether over years of time perhaps $9000 or more will be taken from your own pocket and be given to much richer investors.

Will we "rescue" banks by robbing taxpayers through future taxes and possible future inflation, and giving that money in preference to the bad gamblers at the remaining banks -- actually rewarding those gamblers (banks CEOs and officers and bank investors) more when they gambled more and made more bad decisions?

Yes, that's more money given to the least successful gamblers.

These are normal possible dangers of a "bad bank" plan (which might be avoided through a lot of modifications of the basic idea).

There's no end to the injustice and just plain wrongness of this, if it happens this way. And to the anger it would cause that will last and rebound.

This is why it's better for more bad banks to go into FDIC before a general rescue, so that stockholders and bank officers responsibly take more losses instead of only taxpayers paying 100% of the loss. In the FDIC process pieces of the bad banks are then revived and come back alive with new owners, just exactly like many recently have (Washington Mutual for instance). Pieces, whole parts, or total banks are absorbed or bought by better banks and thus get better management.

But not every bank still alive or that has made acquisitions is actually a well managed bank.

How do you know which banks are well-managed?

The ones that are in better condition are the ones that have been better managed, and better examination can determine this.

It's like a hospital ward where some are beyond saving, some are moderately sick, and some are barely sick. We need to rescue the moderately sick and not lose too much of our limited energy and resources trying to heroically revive those that are really and truly dead but still here -- the "zombies". (see Yves Smith discuss the real meaning of triage)

We let the zombies get recycled, and save the moderately sick.

This results in a much better outcome for our whole economy, because we do not have an unlimited ability to borrow against the future without regard to the amounts.

The price does matter, and keeping better managers and letting go of bad managers does matter and aids in future economic results. When bad loans aren't made, then good loans have lower interest rates.

And when we rescue banks, we want this to be an investment because you and I deserve to own the stock, ownership shares of banks, that we are putting money into.

In other words, when we save a bank, we can either give money for free to existing owners, or we can instead rescue banks by purchasing a new stake (investment) in the bank.

Both ways rescue the bank. The first way is a reverse-Robin-Hood -- a transfer of money from middle class taxpayers to stockholders and officers of those banks in exchange for....nothing, or less than enough. Essentially a sophisticated form of...well, of theft. The latter (investment and actual public ownership of stock or preferred shares or bonds) is right and just. Taxpayers actually get something in return for their money -- a stake in the recovery of the bank -- what any other investor would get.

To prevent "zombie banks", we just need to truly examine them. That's what my previous post laid out in critical detail, along with important points of how to structure the rescue.