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Saturday, November 26, 2022

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Stop, Sheila! Stop!

Courtesy of Econophile

By Jeff Harding

The Daily Capitalist

Most economists in the government think they have saved the world from economic collapse. Recently Larry Summers said that on the White House blog. Sadly he touted the benefits of J.M. Keynes’s economic philosophy (“The wisdom of Keynesian policies has been confirmed by the performance of the economy over the past year.”). He must be looking at different data that’s not available to me.

My premise is that government action causes depressions.

Recently I wrote on the differences between Japan’s deflation and ours. In my article I stated that by letting banks fail we would have a much quicker recovery, and that we would avoid the 19 year decline and deflation that Japan suffered. The big “if” was what the government would do or not do to thwart that process. I believe that preventing banks from failing and allowing them to stay alive with bad debt on their books will result in the “zombie” institutions that plagued Japan.

Well, here is Sheila Bair, FDIC chair, leading us into deflation:

Commercial real estate is seen widely as one of the biggest dangers facing the banking industry, as heavy losses in this area are crushing many community banks and eating into bank capital. These loans often prove more difficult for banks to work out than residential mortgages.

 

“The agencies recognize that lenders are borrowers face challenging credit conditions due to the economic downturn, and are frequently dealing with diminished cash flows and depreciating collateral values,” Ms. Bair will say. “Prudent loan workouts are often in the best interest of financial institutions and borrowers, particularly during difficult economic circumstances and constrained credit availability. This guidance reflects that reality, and supports prudent and pragmatic credit and business decision-making within the framework of financial accuracy, transparency, and timely loss recognition.”

Unless she is prepared to fund these banks with additional capital, then letting banks rewrite loans only increases the risk of bank failures. Since commercial real estate values are falling like the proverbial rock, that means banks will keep debt alive on projects that aren’t worth the amount of the loan on them.

What CRE debtors are facing is a credit crunch. Their loans put in place five years ago are coming due and they can’t refinance them because loan-to-value ratios are falling and underwriting standards have tightened. CRE debtors will have to come up with more equity or lose the properties in foreclosure. Raising money in a falling market is tough to do. The Fed says we’ll see 40% loan losses next year.

So you end up with banks with bad loans allowed to stay on the books on terms that fail any bank solvency test. Who would deal with these banks? Would you withdraw your deposits because their books were phony? Would another bank make an interbank loan?

This policy will put off the inevitable, cause more banks failures, and cause tighter credit.

Sheila, stop!

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