2009-04-26

Calculated Risk: Bank Balance Sheet: Liquidity and Solvency, Part I

Calculated Risk: Bank Balance Sheet: Liquidity and Solvency, Part I




The link is to an awesomely simple explanation of why the banks are insolvent. In part two, CR makes an interesting distinction:

The banks are facing huge additional losses for these legacy assets, and these losses will make some banks "balance sheet" insolvent (liabilities will be great than assets). However, the bank is not insolvent in the business sense, because the bank can still pay their debts as they come due - at least for now.


Which explains why someone like me (and lots of other people) keep saying the banks are insolvent but they continue to operate.

This is why the stress tests are so important in helping identify zombie banks - and why financial institutions relying on government support should be required to make the entire test results public.

The "stress tests" can be computed by anyone with the time and energy to dig through balance sheets. The link shows Bank of America with 2.3% capital (the blue box in the graphic at the top of my post). Citibank is at 1.4%.

If you read about fractional reserve banking, you'll find that 10% is supposed to be the number that must be kept on reserve ... not a small fraction of that.

A recent Reuters report suggests TCE will be a critical metric for the bank stress tests: “U.S. regulators want the top 19 banks being stress-tested to have at least 3% tangible common equity.” In other words, regulators want banks to have a leverage ratio below 33x. (3¢ of TCE for each $1 of tangible assets = 33x leverage)
33x leverage! That's considered "good!" Good lord.

Sadly, some banks may not make even that miniscule goal; but instead of failing, we're going to be told those banks have six months to raise capital.

The more likely scenario is a Bear Stearns style attack on those banks.

For an alternative, slightly insane view, here's a site that promises good news about the economy.

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