see also in GloboTrends:

• Japans lost decade of the 1990s
• Crisis watch
• Commercial Banking (business model)
• history of economic crisis and currency devaluations
• credit crisis of 2007-09

 

 

Anatomy of a Banking crisis:

from blog posting at Bronte Capital blog here

 

The fixed currency model of bank collapse

 

First observation: banks intermediate the current account deficit

 

· Countries that run big current account deficits have banks with loan to deposit ratios above 130. (See Australia or New Zealand for examples.)

 

· Countries that run big current account surpluses have loan to deposit ratios of 70 or less. (See my post on 77 Bank for an example.)

 

· Another way of saying this is that banks in current account deficit countries are generally reliant on wholesale funding. [It’s the crisis in wholesale funding that is causing the problems in American banks now.]

 

Second observation: fixed exchange collapse with currency runs

 

When a country has a fixed exchange rate that is too high (evidenced by unsustainable current account deficits) they become subject to runs on the currency. This happens as follows:

 

· Some speculator (eg George Soros) shorts-sells the currency and buys whatever it is fixed to. They do this by borrowing the target currency or by withdrawing lending in the target currency.

 

· They then take the borrowed currency and give it to the central bank/currency board who swap the domestic currency for foreign reserves at the fixed exchange rates. In doing so they reduce domestic money supply causing short term interest rates to rise. If they do this enough they induce a recession (ugly). This creates pressure (political and otherwise) for a deviation.

 

 

· Alternatively the central banks sterilises the money supply change. However if they continue to do this they will run out of foreign currency reserves – and the fixed exchange rate collapses anyway.

 

Many a fixed currency has been broken this way. George Soros did it with the pound. Nameless speculators did it across Asia. The Mexican Peso and Argentine Peso both had fixed currency pegs that didn’t hold.

 

Third observation: a currency run results in the banks being de-funded.

 

· Given that most the lending in the “target currency” is to banks and the banks in current account deficit countries are generally dependent on wholesale funds – the run on the country causes funding pressure to banks.

 

· This funding pressure when it is particularly intense will cause those institutions most dependent on foreign currency to become illiquid and hence collapse. The currency crisis morphs into a run on bank wholesale funding.

 

Past currency crises have been associated with bank collapses. In Thailand (which was precisely to this model) the finance companies actually collapsed and the banks almost collapsed. In Korea both the banks and currency collapsed.

 

But you need to be really careful of countries with fixed exchange rates and huge, unsustainable current account deficits.

 

Never much fun shorting the banks in such countries

 

If you had picked the collapse of the Thai Banks you might have cleverly shorted the stocks. It would not have helped much. Suppose you shorted $100 worth of a Thai bank. It collapsed down 95% (corrections in the comments). So you had $95 in profit. The only problem is that you have the profit in the pre-crisis exchange rate. The currency also dropped almost 90%. So you were left with about $10 profit. That is fine-and-dandy but it is not much reward for effort of picking a system that is about to collapse.

 

You would of course be much better just shorting the currency – or shorting the ADRs of the target stock (the ADRs being priced in a hard currency).

The real exception is that if you find a bank in a hard currency that is totally exposed to the debacle country you can make a fortune. You can guess now that Swedbank is my bank. It is not the only one – but is very spectacular.

 

 

 

Surprisingly common 

history of Banking crisis

 

read more:  http://www.ft.com/cms/s/0/c6c5bd36-0c0c-11de-b87d-0000779fd2ac.html#

 

 

Perspective:

 

Bank Failure Facts

According to the FDIC, from 1934 through  2007, there were only two years with no bank  failures, 2005 and 2006.   The year during that period with the most

bank failures was 1989, when 534 banks  closed their doors.   During the savings‐and‐loan crisis (1986‐95),  2,377 banks failed, representing 67 percent of

the 3,559 bank failures from 1934 through  May 2008. At the peak of the crisis (1988‐ 1989), 1,004 banks failed,  a rate of one failure  every 1.38 days. 

 

 

Bank Failures by Decade

• 2000‐2007: 32   (surprisingly few!!)

• 1990‐1999: 925 
• 1980‐1989: 2,036 
• 1970‐1979: 79   
• 1960‐1969: 44   
• 1950‐1959: 28   
• 1940‐1949: 99   
•  1934‐1939: 312 

 

Source: FDIC Historical Statistics onBanking, 1934-200

Data  brought to our attention infrom the Gartman letter

 

 

Model for recovery from Banking Crisis:

 

recommendation:  follow the Swedish model for recovery

 

 

 

 

Big-market crises in the past:

“the big five” (Spain 1977, Norway 1987, Finland, 1991, Sweden, 1991, and Japan, 1992)

 

lessons:

 

Banking crises are protracted, they note, with output declining, on average, for two years. Asset market collapses are deep, with real house prices falling, again on average, by 35 per cent over six years and equity prices declining by 55 per cent over 3½ years. The rate of unemployment rises, on average, by 7 percentage points over four years, while output falls by 9 per cent.

 

Not least, the real value of government debt jumps, on average, by 86 per cent (see chart). This is only in small part because of the cost of recapitalising banks. It is far more because of collapses in tax revenues.

 

How far will the present crisis match the worst of the past? The continuing willingness of the world to finance at least the US – though not necessarily the smaller and more peripheral deficit countries, such as the UK – is a reason for optimism.

 

source:  http://www.ft.com/cms/s/0/4f5c5ba2-dc22-11dd-b07e-000077b07658.html

 

for more reading...please see:  a seminal paper by Carmen Reinhart of Maryland University and Kenneth Rogoff of Harvard

 

 

Twin Crises: 

Currency + Banking

 

 

 

 

 

 

 

Banking Crisis - history analysis

 

http://www.nber.org/papers/w14587

 

The historical frequency of banking crises is quite similar in high- and middle-to-low-income countries, with quantitative and qualitative parallels in both the run-ups and the aftermath. We establish these regularities using a unique dataset spanning from Denmark's financial panic during the Napoleonic War to the ongoing global financial crisis sparked by subprime mortgage defaults in the United States.

 

 

Banking crises dramatically weaken fiscal positions in both groups, with government revenues invariably contracting, and fiscal expenditures often expanding sharply. Three years after a financial crisis central government debt increases, on average, by about 86 percent. Thus the fiscal burden of banking crisis extends far beyond the commonly cited cost of the bailouts. Our new dataset includes housing price data for emerging markets; these allow us to show that the real estate price cycles around banking crises are similar in duration and amplitude to those in advanced economies, with the busts averaging four to six years. Corroborating earlier work, we find that systemic banking crises are typically preceded by asset price bubbles, large capital inflows and credit booms, in rich and poor countries alike.

 

 

references:

* The Aftermath of Financial Crises, December 2008; www.economics. harvard.edu/faculty/rogoff/files/ Aftermath.pdf; ** Banking Crises, December 2008, National Bureau of Economic Research Working Paper 14587, December 2008, www.nber.org; *** Prospects for the US and the World, December 2008, www.levy.org

 

note that (from these papers); " the big drivers of debt increases (after the drisis) are the inevitable collapse in tax revenues that governments suffer in the wake of deep and prolonged output contractions, as well as often ambitious countercyclical fiscal policies aimed at mitigating the downturn."

 

 

Credit Crisis 2007-09

 

 

see our discussion on credit crisis of 2007

 

How the government should be involved:

 

When private banks no longer are willing to lend money to each other, there is a credit crisis.  In response to the recent credit crisis, we witnessed a situation where investors were only willing to invest in US Treasuries.   Even the "safe" money market mutual funds came under attack as investors fled and poured money into Treasuries.  As a result of a massive "flight to safety", the yield on US treasuries has dropped to record lows. This happens when everyone wants to buy these assets, which drives up the price, and has an inverse effect of driving down the "yield to maturity".    With all this money pouring into US government bonds, there is little credit left over for banks to lend to eachother.  The US Central Bank has the responsiblity (unlike the ECB) to act as the "lender of last resort" in a situation where there is a banking freeze, and if US banks are unwiling to lend to each other.  In this function, the US Central Bank has been acting exactly as it should have by lending to banks when they wont lend to each other.  Think about it....if investors decide on a mass scale that they only want to pour money into the government, then its the governments responsibility to turn around and invest that money back into the market.  This is why I dont understand the argument put forth by congressmen (and many in the media) that they are against a government bailout of the markets.   This argument makes no sense, because the Fed and the Treasury are acting as they should.  If investors are only willing to pour money into the Treasury, then its the resonsibility of the government to turn around and offer that liquidity back to the market.  In this function, they compensate for the dysfunction and fear in the market just as they are intended to do as the "lender of last resort".

 

 

 

1. Creat a BAD BANK:

 

a bad bank, “which would purchase assets from financial institutions in exchange for cash and equity.”

 

Federal Reserve officials are focusing on the option of setting up a so-called bad bank that would acquire hundreds of billions of dollars of troubled securities now held by lenders. That may allow banks to reduce write-offs, free up capital and begin to increase lending. Paul Miller, a bank analyst at Friedman Billings Ramsey & Co. in Arlington, Virginia, estimates that financial institutions need as much as $1.2 trillion in new aid.  read more here:  http://www.marketwatch.com

 

The Swiss bank UBS set up a bad-bank last year to fight off trouble. 

 

 

2. TARP - $700 bn...

 

Buy toxic assets from banks (original Paulson idea).  Remove toxic elements...to get banks to trust lending to each other again...

 

In the U.S., the initial proposal for TARP was to buy hard- to-value assets such as subprime residential mortgage-backed securities, debt linked to commercial mortgages and collateralized debt obligations. Departing Treasury Secretary Henry Paulson abandoned it in favor of capital injections as a faster method of deploying the funds.

 

The departing Bush administration used most of the first $350 billion of the Troubled Asset Relief Program for buying stakes in banks. The declines in bank shares show that the strategy has failed to shore up the banking system’s solvency. 

 

 

 

 

 

 

 

3.  Recapitalize banks directly (British plan)

 

large injections of cash direclty into banks.  Shore up confidence.

 

4. Nationalization of banks

 

State takes direct control of banks.  A more radical alternative would be the nationalization of some banks. Sweden used that option during a crisis in the 1990s.  In addition, the government created a bad bank that bought troubled assets at a discount, while leaving financial institutions to manage their more-liquid holdings.