Is Another Banking Crisis Coming?

The US banking system is in very serious trouble. In fact, as an institution, American banking is probably broke. The reason is incompetent management of foreclosures. Two things have gone wrong. First, banks have carried foreclosed properties at unrealistic valuations. Second, millions of titles have been thrown into uncertainty by flawed foreclosure procedures and illegal foreclosures.

In fact, just as the original mortgages were worthless when bundled into securities because there was no way to determine their actual value, the foreclosed properties are worthless because there is no way to determine whether or not they have clear titles. So the inflated valuations cannot simply be lowered to more realistic levels. There is no realistic level.

This means that the banks are in the position of having to write off vastly more valuation than they have capital. That is the definition of being broke. The banks do not have any capital. They only have the illusion of capital.

When the last banking crisis erupted, the Bush Administration at first hesitated to support failing banks. The result was the collapse of Lehman Brothers and the unprecedented crisis of confidence that followed. The administration was left with no choice: it began the bailout process. The Obama Administration was faced with a fait accompli. It had no choice but to continue the same mistaken policy.

I outlined what should have been done in a previous journal, but it was not done. Instead of pouring money into the banking system, the government should have guaranteed and regularized the mortgages. This would have returned value to the securities that were causing the problem, meaning that institutions likeLehman Brothers and  AIG would never have been bankrupted by needing to make good on their huge credit default swap portfolios. It should then have changed the terms of all mortgages that had been designed with balloon payments intended to be refinanced by rollovers and/or home equity loans, transforming them into a more realistic and viable form.

This combination of actions would have solved the crisis without any bailouts–which, incidentally, solved nothing, as is going to be seen shortly.

The situation now is probably worse than it was in 2008. Then, most underlying titles were intact, or appeared to be. That isn’t the case now. A property with its title in suspense is absolutely worthless.

So what needs to be done is another version of what should have been done in the first place. There needs to be legislation that, once again, does two things. First, all titles that are in limbo need to be guaranteed by a new federal authority. Second, regulators need the power to compel the banks to value foreclosed assets at realistic levels.

This will result in a wave of bank failures, to be sure, but it will not result in the collapse of the entire system, which will happen if nothing more is done than to throw more money at it. The loss of value is too vast to be restored by a bailout. It would take trillions of dollars, and that money would have to be generated by the Federal Reserve buying back its own bonds. In other words, the money would have to be printed.

Given that we are already stressing the system this way, the risk to the currency is too great. At a time like this, the last thing we need to do is to risk hyperinflation or the collapse of the dollar in world markets, which would plunge the world’s economy into a crisis greater than the one experienced in 2008.

In a previous journal, I also pointed out that the last crisis was triggered by the removal of vast amounts of liquidity from the world economy by an explosive increase in commodity and energy prices. This was triggered by two things: demand and a lack of supply. Supplies of crucial commodities like rice were compromised by bad weather–in that particular case by massive flooding across Southeast Asia and drought in the US southeast in 2007.

As was the case last summer, the disruptive weather of 2007 was caused by climate change. As I have said many times, nature isn’t interested in what we believe or don’t believe. Nature is numbers, and the numbers could not be more clear: we are consuming more of our planet’s assets than it can afford to give us without falling out of balance.

It is falling out of balance. This time, commodity prices are soaring again because of a combination of rising demand in prosperous Asia and the Middle East, and drought in grain producing areas such as Russia, the Ukraine and the central United States.

Fortunately, this time, we do not also have an increase in fuel prices, at least not at the moment. Should that happen, the liquidity drawn out of the much more fragile world econony this time will have startling consequences. We will soon be in worse shape than we were at the beginning of 2009.

We cannot do anything about commodity prices. They are going to rise. But the United States Congress needs to legislate to prevent another banking crisis, and it needs to do so immediately.

However, it will not do this and it cannot do it. From the beginning, the entire government has looked in the wrong direction for a solution. Shoring up the banks with infusions of capital was never the solution. Regularizing mortgages and guaranteeing them was the solution. But it was far cheaper and did not enable the bankers to feed at the public trough, something they dearly wanted to do.

Now that they have gotten a taste for public money, they are going to be coming back for more. A lot more. There will be talk of ‘nationalization’ of the banks, which is really just putting the full faith and credit of the United States behind their absence of faith and lack of credit. But the question must be asked: how much faith and credit does our country actually have left to give them?

Unfortunately, the voters do not have a lobby in Washington. We send representatives, certainly, but they leave their obligation to us at home. Once they arrive, they answer not to the people but to the lobbies. And I am not speaking in a partisan manner here. All policy is now lobby-driven. Most of our representatives don’t even understand the real needs of the country. They imagine that money will solve the problem.

However, the banking crisis is not a financial problem. It only looks like a financial problem because it appears to be about a lack of capital. It is that, but the underlying cause is a lack of value. Value depends on confidence, and until confidence is restored, no amount of financial manipulation will solve the problem.

To do that, titles must be cleared and properties valued at levels that will attract buyers. Nothing else will work and, at this point, anything else that is tried will almost certainly blow our precious currency up in our faces, and our lives and even our position as the leading economy of the world along with it.

If the world ever manages to disentangle itself from the dollar and get past the need for our currency–really, its addiction to our currency–watch out, because then the American economy will have no bottom.

That happened in Germany in the 1920s, and I can assure you, it can happen here, too. And I can assure you as well that there is some sleazy little demagogue in Des Moines or Los Angeles or Dallas, just as there was one in Munich in 1922, slouching toward Bethlehem to be born.