The story so far is easy to understand. Governments, central banks and banks got it wrong for five years, and allowed the western world to get too heavily into debt. Governments and individuals borrowed and borrowed at the attractive rates on offer.
Central banks then decided the party had to end and took the drinks away. Now we face the prospect that too many people will not be able to pay the interest on their borrowings and will not be able to repay them on time. Banks have too little money to lend, so house, property and vehicle prices are plunging. This means the banks are even more exposed, as they will not have enough money from the sale of an asset if and when someone hands back the keys and admits they cannot afford the interest.
It is now fashionable to say we need to “de leverage”. The main reason is to cure the inflation excess debt created. I have news for them. The future problem is deflation, not inflation. De leveraging was a good idea a couple of years ago, but today too much deleveraging will just turn a recession into a slump.
There are two ways banks can get their balance sheets into better shape. The first is to withdraw borrowing facilities from existing borrowers, and make very little or no new loans available to people and businesses that want to borrow. This is now happening on a dramatic scale, and will mean more bruising news from the rest of the economy.
The other way to do it is for the banks to raise new capital. If the main banks went out and doubled their share capital, raising new money from old and new shareholders, they would then have much stronger balance sheets and would be happier with the amount of lending they have already made.Some banks are reluctant to do this because their share prices are low. Unfortunately they have no choice. Their share prices are low because investors are worried about their lack of capital, so it is a circular argument. They also have the problem that if assets keep falling in value they can lose the money they raise, forcing them to write off more of their own assets. Again, they have no choice. They have to seek to replace the money they have lost. The shareholders have to pay up to keep their bank going.
It is now becoming popular to say that only the taxpayer can provide the capital the banks need. This is a dangerous argument. The taxpayer should not provide capital for the medium and longer term to help the private shareholders of these banks. Nor should the taxpayer nationalise them, as there is no evidence that nationalised management would be better. There are limits to what taxpayers can afford. Nationalising major banks is beyond their purses and their appettie for risk.In this downturn the governments are going to need all their credit worthiness to borrow to pay the running costs and to help the individual causualties of recession.
There is no substitute for major bank capital raising now. The sooner the better. They must just swallow hard and acept the low prices of the shares they can sell. It’s time for them to visit the Middle East and Asia, where the investment money is.