Hoisted from Comments: Bank Capitalization

Hoisted from Comments: Tom R asks:

Grasping Reality with Both Hands: Economist Brad DeLong's Fair, Balanced, and Reality-Based Semi-Daily Journal: There is one thing I don't understand in all this. If financial institutions are undercapitalized, i.e lack liquid assets, but are in all other regards viable, why don't owners of liquid capital (read W Buffett) buy them and hold the assets until the income stream makes them whole with nice profits to boot.. Of course I know that there are times when this does not happen, i.e. now, but what does this say about the capitalist system? Can we stipulate that capitalism in inherently flawed? Is the flaw behavioral? (We have nothing to fear but fear itself?)

The way Larry Summers puts it is roughly as follows:

At the level of each individual bank, each individual bank that finds itself overleveraged is more-or-less indifferent between whether it solves that overleverage problem by raising more capital or by shrinking the volume of loans it makes and the amount of bonds it holds. But all the rest of us would much, much rather that the banks as a whole raise capital rather than cut back on their assets.

There is a Keynesian aggregate demand externality roaming about here...

Comments

[shah8]

Is it an actual externality? On whose part?

Isn't the proper take on it the fact that one would have to wear down a lot of shoe leather to ascertain the *actual* health of a financial enterprise?

Hmmm, after thinking about it some mores...I conclude that financial entities are not indifferent either choice in sell assets or cut loans dillemma.

If a bank sells assets, proprietary information is released about its other holdings and its general strategy. Plus, there is sometimes antagonistic blowback--similar to when a someone sells a house in a hurry and takes a huge loss, then the neighbors get mad that their house values go down as well.

If a bank simply refuses to do much of anything, nobody can say nuthin'...and they can doggypaddle to maybe a safe harbor, or something.

[christofay]

Here's an answer, Buffett is too smart to buy into a black box. The banks's assets are presently un-analyzable. There is also a mistake in the banks' employment patterns, they are over-staffed with modelers, those who made the most on-paper profits in the recent past, and under-staffed by analysts, dull dry work, real analysis, not "analyst" shills from the internet bubble era. The banks are highly profitable up until the moment they go bust. But they don't go poof, they get bought out with a Federal Reserve assist.

First we should look at those who most recently gained from the banking sector, Rubin, O'Neil, Mozillo, Dime-a-dance Prince. Why don't insiders buy in if there is value? Perhaps they weren't bankers in the first place.

In the 1980s in the run-up to the S&L bust, it was said banking is the business where your cost of funds, cost of raw materials, is set by the stupidest guy in the pool. Now the Federal Reserve is setting the cost of funds, and they can print.

[howard]

jeez, christofay, give a guy a chance! i was going to say just about exactly what you wrote about buffett.

meanwhile, other than buffett, it's not clear to me that there are that may large pools of capital available that might buy banks (i.e., microsoft has a pile of cash, but it's not going to spend its cash on a bank).

[howard]

jeez, christofay, give a guy a chance! i was going to say just about exactly what you wrote about buffett.

meanwhile, other than buffett, it's not clear to me that there are that may large pools of capital available that might buy banks (i.e., microsoft has a pile of cash, but it's not going to spend its cash on a bank).

[a]

"i.e lack liquid assets"

It's not just that they lack liquid assets. They lack assets, period. They are valuing products as x on their book, when in reality (based on the income stream they can expect to get), these products are worth y, where y < x (indeed much less than x).

[anon]

"why don't owners of liquid capital (read W Buffett) buy them and hold the assets until the income stream makes them whole with nice profits to boot.. "

one word: control. At some point, significant sources of liquidity will probably want some "control", or a "seat at the table" at large fin svc organizations (vs giving liquidity to mgrs and boards without sufficient strings attached to invoke positive behavior changes from various layers of management).

http://www.iht.com/articles/1991/08/19/resi.php
5 Top Officers Leave Salomon As Buffett Takes Control of Firm
By Lawrence MalkinPublished: MONDAY, AUGUST 19, 1991

http://query.nytimes.com/gst/fullpage.html?res=9F0CE1DD173CF934A2575BC0A965958260&sec=&spon=
COMPANY NEWS; Buffett Wants More Shares Of Salomon
By FLOYD NORRIS
Published: August 17, 1993

http://www.reuters.com/article/pressRelease/idUS118195+15-Jan-2008+BW20080115
Citi Announces Key Actions to Enhance Capital Base
Tue Jan 15, 2008 6:31am EST
Excerpt:
In addition,none of the investors will have any special governance rights or any role in the management of Citi, including no right to designate a
member of the Citi Board of Directors.