America has produced great humorists and social commentators. During the Great Depression, none was more loved than Will Rogers, cowboy, movie actor and star of stage and radio. Part Indian, he claimed that his ancestors didn’t come on the Mayflower, they met the boat. He said he wouldn’t join an organized political party, so he became a Democrat. Talking about the Depression, he noted that America was the only place where people loaded their cars and drove to the poor house. Some of his radio monologues on government plans to get out of the Great Depression survive, with a hilarious description of discussions between Big Business and President Roosevelt who demands that Business recover and reform itself, yet Business replies that it can only recover if it isn’t reformed, but promises to do that later, once it has recovered. Perhaps humor is the best way to view the current crisis, so here goes.
A Cajun’s neighbor, desperately needing cash, offers to sell his mule for $200. The deal is struck and the Cajun asks the farmer to bring the mule next morning. The farmer shows up and tells the Cajun that the mule has died and the money spent, but that he will repay him as soon as he can. The Cajun says “Bring the mule anyway.” Later, the farmer asks the Cajun how things are going. The Cajun: “I made $798.” He gets a quizzical stare in return. The Cajun: “I sold four hundred raffle tickets for the mule at $2 but the guy who won was so mad when he found out the mule was dead that I had to give him his two dollars back”.
There are many metaphorical links to the current banking/Wall Street situation. I don’t intend insult to Cajuns, who enjoy life in general and music and food specifically, even if their cooking tends to be incendiary. They avoid Wall Street’s need to define self-worth via $50 million aircraft and office remodels. So how do the banks value their dead mules? Assets can be declared several ways, e.g. put the mule on the books at acquisition cost ($200) or current value, sometimes called ‘mark to market,’ which for the defunct burro is zero. Unfortunately, under deregulation and lax enforcement of the rules that were left, assets were marked to complex financial models, or ‘mark to make believe.’ Rather like the Cajun running his raffle scheme.
This ‘mark-to-make-believe’ value can be estimated but start at the bottom of the trust-in- banking ladder, rounded to the nearest few $ trillion (T). Long ago, the value of money was tied to gold: you could redeem your dollar for gold, no trust required. In modern banking with sensible reserves, the banking system holds ~$40T. It didn’t require a leap of faith to trust in that. But the complex financial ‘products’ (collateralized debt obligations, including sub-prime mortgages and other Wall Street creations), many traded in shadow markets rather than the usual stock and commodities exchanges, expanded that to ~$100T. It’s hard to trust, let alone set market value for those assets.
The easy credit inflated assets like housing, commodities and financial instruments to ~$300T. For perspective, total world annual Gross Domestic Product is ~$50T. What we are seeing is the collapse of faith in the value of those $300 trillion assets, hopefully not back to gold-standard levels but at least to a rational number representing a rational economy. Market forces are doing this all too well, with world-wide exchanges having dropped ~80% and housing prices ~20% and falling, emphasizing that pumping a lousy couple of trillion into bailing out the banking system won’t restore trust in the burst $300T balloon of over-inflated assets. Even if anyone would buy those debts (we’re all in the same international financial-system boat) you can’t print money fast enough so that the public can buy raffle tickets for all those dead mules.
Last fall, I wrote about the Scandinavians handling of their 1990 banking crisis. For those in Washington supposed to protect us from dead-mule raffles, here’s a specific example. In Norway, the Government Bank Investment Fund (GBIF) was formed to handle the crisis by examining bank’s books and providing capital to insure liquidity. Private investors were given first chance to provide capital reserves after the dead mules were accounted for; if they didn’t, the price of receiving government funds was to wipe out shareholder equity, and fire the directors and top management. At two major banks, all shareholder equity was wiped out; in a third, (Den Norske Bank) shareholder equity was cut by 90% and all public funds were placed in preferential positions. The government profited from selling its bank shares after their economy recovered.
Washington thinks that naming something is more important than enforcing what the name implies—campaign reform, ethical standards, sound science, fiscal responsibility….take your pick. The way to create a good bank using a ‘bad bank’ (a term Washington is bandying about) is not to repeat the name endlessly but to follow the Scandinavian model: let an independent entity determine the value of assets (not what the banks would like the public to pay for them) and true solvency and, if insolvent, fire both boards and management, write down the assets to a realistic value and deal with them in a form of resolution trust like a’bad bank’. And we can’t leave the current bunch of banking bonus thieves in charge. As Will Rogers might well put it, “Can’t let a bunch of dead mule Madoffs run between Wall Street and Washington, trying for one last deal. Let ‘em get away with it, and the public is sure to lose their asses.”
The figures on the banking system come from the Manchester Guardian’s interactive presentation on the debt pyramid, which can be found at: http://www.guardian.co.uk/business/dan-roberts-on-business-blog/interactive/2009/jan/29/financial-pyramid
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