Easy Money

A Future of Finance article in a December 2009 Financial Times quoted a partner at a leading London law firm: “There are huge piles of toxic debt on these [bank] balance sheets but much of it isn’t being recognized. Loans are being rolled over. There is a saying in banking circles now that ‘a rolling loan gathers no loss'” The same article also quoted Raymond Baer, chairman of Swiss private bank Julius Baer, who warned: “The world is creating the final big bubble. In five years’ time, we will pay the true price of this crisis.”

In a WSJ op-ed 10/16/09, Ann Lee, a former investment banker and hedge fund partner, writes that banks are hoping that by rolling over the loans at negotiated terms borrowers will eventually be able to make payments. She predicts that this cycle of rolling debt, reminiscent of what happened in Japan during the 1990s, could continue for a decade. With so much unrecognized bad debt, banks have little incentive to increase their lending. Instead, they borrow from the Federal Reserve at near zero interest rates and use the money to buy Treasury bonds, pocketing the difference in interest rates as profit. Since Treasury bonds are taxpayer IOUs, taxpayers are effectively subsidizing the profits of Wall Street banks. Ben Bernanke, head of the Federal Reserve and chief architect of this subsidy scheme, was recently reappointed by President Obama.

In late November, Standard & Poors released their analysis ranking of 45 leading banks in the world, using a new risk adjusted capital ratio (RAC), which will probably be adopted in 2010. This ratio gauges a bank’s leverage of assets to equity with greater attention paid to the risks of those assets than the current Tier 1 capital ratio does. According to this more rigorous metric, banks like Japan’s Mizuho and Sumitomo Mitsui, Citigroup, and Switzerland’s UBS have a particularly weak capital base. Just nine of the 45 banks rated by S&P had an adequate risk adjusted capital.

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