Bank Crisis

In: Business and Management

Submitted By sab7070
Words 592
Pages 3
The Wall Street Journal recently reported that a majority of banks have slowed lending at an average of 1.37% from the 3rd to 4th quarter of 2008. Although it may sound scandalous that banks would decrease lending while receiving government funds intended to be loaned out, their actions appear more appropriate when the current state of the economy is considered. The deepening recession has triggered a massive de-leveraging among households, which has dramatically reduced the demand for credit. The same effect is seen among businesses, as the incentive to invest continues declining along with the ever-worsening economic outlook.

Moreover, it’s unrealistic to assume that lending will grow from the inflated levels of the past decade, especially as banks resume tighter lending standards. The fact that overall lending is off only 1.37%, and that some banks reported increases in lending, is probably evidence that credit is beginning to flow more freely. So, rather than fretting about the lending levels of banks that received TARP funds, everyone’s attention should be focused on the major reason banks were given the funds in the first place: de facto insolvency due to insupportably low levels of capital on their balance sheets.

Like it or not, the financial sector will be unable to fully recover until a majority of the toxic assets are removed from banks’ balance sheets. These assets continue pushing banks toward insolvency, with many already technically insolvent. The insolvency stems from the large amounts of securitized assets that were financed with bank capital, which now stands at impossibly low levels. In addition to this problem, banks have had to write down these toxic assets, leaving the value of their liabilities permanently lower than the value of their assets — the classic definition of insolvency.

The most crucial problem with these illiquid assets…...

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