On the Zombie Bank Problem

Christopher Whalen of Institutional Risk Analytics has written a very helpful piece over at Reuters which fleshes out the problem we have with zombie banks sucking capital out of the US economy. Unfortunately, it’s not well edited so it’s not as smooth a read as it should be, but the information is there. Taking some time to give it a careful read will be rewarding.

Most of what the Fed and Treasury have done since the onset of the financial crisis has been done for the purpose of saving the “systemically important” institutions from failure. Well, except for Lehmann, which was too far gone to save. It has not been to rescue underwater homeowners, reduce unemployment, or any other immediate concern of the average Jane and Joe. The thinking here is that things will get better on main street once the banks are back to good health.

I have said before that we need a healthy banking system to have a healthy economy. I have also said before that we are turning Japanese, in the sense that we are forcing the taxpayer and the bondholder to prop up essentially insolvent but “too big [read: influential] to fail” institutions. The second point does not necessarily follow from the first; we could have, and probably should have, done something quite different. This is the sort of thing that isn’t making it into the pre-election policy debates. Both sides, for the most part, are ignoring it. Whether this is out of actual ignorance, or something darker, I can’t say.

At least a number of the Republicans are beating up Fannie and Freddie, which is a good start. It’s hard to argue credibly that we don’t have a serious problem there. Meanwhile the financial industry lobby are finding success in creating opposition to the Dodd-Frank reform, which actually doesn’t do much to fix the problem, but it makes you wonder whether there is any realistic chance to address the issues Whalen raises.

Coming back to the investing outlook, which is our focus here, a failure to get this right could very well mean “the new normal” will govern our portfolio strategies: a longer term outlook for sub-par growth with higher market volatility. That would be an environment that continues to favor active re-allocation over the buy and hold approach.

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