Monday, January 09, 2012

The weakness of US banks

Ed Harrison writes in The expansionary fiscal contraction bust Credit Writedowns 01/08/2012:

If you argue that austerity works in cutting deficits over the longer-term but the short-term pain is worth it, that’s a different argument than the one Republicans are making – and one not likely to get one elected, which is why they’re not making it. But even so, the spectre of debt deflation looms heavily as much in the US as in Europe. After all, BofA is not trading in the single digits because of irrational despondence. The banking sector in the US is still very sick – and will remain so for the foreseeable future. [my emphasis]
Debt deflation means when the value of debt held by the lender as an asset decreases. A bond purchased at a market price of $1,000 may decrease in its market value due to changes in the borrower's credit status. A decrease in assets with liabilities unchanged means a decline in the equity ratios of the lender and therefore a higher vulnerability of the lender to unfavorable business and economic events.

The best time to tackle the real problems of the banks was in 2009 when the Obama Administration first came to office and had maximum credibility among the public in undertaking to fix the problems of the financial sector. Obama's timidity and deference to the financial lobby had seriously negative consequences.

A crackup in the eurozone - a very possible and likely event - could take down some big American banks and compound US economic problems.

President Obama was being cautious in 2009 in his approach to the financial crisis. After the recklessness of the Cheney-Bush Administration, caution didn't look all bad. But sometimes caution produces sub-optimal decisions and policies.

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