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January 21, 2009

The World is Overbanked

We have too many financial institutions and too many people working in the financial trades. "Saving" banks is an even worse idea than saving car manufacturers. "Dusting ourselves off" means taking our losses and moving on; even the losses we incurred in the most recent round of bank bailouts. Sure, we need credit and capital; we just don't need so many people and institutions slicing, dicing, securitizing and providing it.

The goals of bank bailouts have become surrealistic. Check the logic this paragraph from a New York Times story about the UK's plan for an expanded bank bailout:

"Speaking at the prime minister's 10 Downing Street residence in London, Mr. Brown placed the blame for the financial crisis on 'irresponsible lending' by the banks and said institutions that took advantage of the new measures would have to sign a legally binding agreement with the government to provide more credit to consumers and businesses."

In the same sentence the British Prime Minister accuses banks of making too many loans and promises to force them to make more. And he used to Finance Minister.

A few days earlier both Citigroup and Bank of America got more TARP funds. Citigroup got the money so it could sell off its brokerage operation; Bank of America got the money to help it survive its deal to buy brokerage firm Merrill Lynch. Huh?

When we were being sold the enormous bill of goods called TARP, we were told that bank lending would collapse without it and that all business would grind to a halt. Turns out bank lending collapsed even with TARP and the economy staggered but didn't fall. Now the proposed solution is more bailout for those same banks who both lent too much and are lending too little.

In fact the USA economy is massively deleveraging itself. This is a good thing; it's facing reality; it's dealing with the consequences of past over indulgence. It's doing us all the things President Obama told us (correctly) we are going to have to do. But, since we are deleveraging, we don't need as much credit as we had before. We are making bigger down payments on cheaper houses; the price of filling oil storage tanks and the credit needed to finance that has plummeted; our lower credit card balances soak up less credit while our higher savings rate makes more money available. New economy companies like Google run on cash balances, not on credit.

The fact that we are saving more – helped certainly by Federal Deposit Insurance – supplies fuel to banks to make loans. But Federal Deposit Insurance makes us oblivious to whether we put our money into good or bad banks. We shouldn't repeal Federal Deposit Insurance since it may well have saved us from a far worse crisis. We should end all other subsidies to banks. The ones that are too big to fail turned out to be too big to save – it's time to dismantle them responsibly with managed bankruptcy and a quick sale of the their assets.

When the badly run banks are gone, the survivors will be much stronger. They'll get all of our deposits. They'll need to put this money to work. They'll be able to pick among worthy credits (if the government isn't doing all lending) and take a prudent amount of risk.

Further bank bailouts will simply damage the creditworthiness of the whole country. The pound plunged against the dollar and the euro when the latest round of British bailouts was announced. Interest on US Treasury bonds and notes rose from very low levels with the approval of the second round of TARP funds here. Ironically, higher treasury yields compete with bank interest rates and make it harder for banks to gather deposits and investments.

The sooner the financial sector right-sizes, the better. Because we are all now investors in AIG and the zombie banks, we are all going to have to take losses in the downsizing. The alternative is throwing good money after bad AND making it harder for well run banks to succeed and to resume offering credit to well run businesses.

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