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Now that's what I call a banking crisis, Part 124

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Paul Mason | 10:18 UK time, Friday, 26 September 2008

One of the great things about investment banking is that even while a bank like Merrill Lynch goes down the tubes and gets taken over, its economics team steadily churns out research about the process as if it were happening to somebody else. It's a bit like when the BBC had to report on its own self-destruction after the Hutton Report. It can be done, and a paper from Merrill's economics team today makes fascinating reading. It's a summary of a much bigger IMF document on banking crisis, which surveys 124 historic banking crises. It's so good I am simply going to quote from it so that, if anybody in the White House cabinet room happens to be reading this, they too can quote bits of it as they get on bended knee to each other to plead for signatures on the TARP Act....

"An inconvenient truth: Net fiscal costs from banking crises are substantial, averaging 13.3% of GDP. The government is highly unlikely to make a profit on any program; the average recovery rate is just 18% of gross fiscal costs. Real GDP losses average 20% relative to trend during the first four years of the crisis. There is a negative correlation between output losses and fiscal costs: the higher the fiscal costs, the smaller the loss of output."

Translation: Dear Mr Obama, forget your plans for healthcare. Dear Mr McCain, who is gonna pay for more surges? Dear Mr & Mrs Joe Public of America - expect 4 years where you feel 80% as wealthy as you do now...

"The risk of a financing crisis: With foreigners significant holders and continued buyers of US financial assets, primarily fixed income, and primarily foreign official institutions, we remain concerned of the risk of a US current account deficit financing crisis. Nearly half of outstanding Treasurys are held by foreigners and 90% of foreign inflows into
agency debt has been from foreign official institutions."

Translation: Dear Messrs Obama & McCain, please contact a Mr Hu Jin Tao as soon as possible.

Quoting its own Chief Asia Economist, TJ Bond, Merrill's team writes: "Last, but not least, TJ suggests that the recapitalisation process is best served by also drawing capital from surplus nations abroad; this would require, however, that the US allows to some degree loss of management control. This has been the case with private capital inflows, but would be best extended to sovereign wealth funds."

Translation: America's banking sector has to be owned either by the state, or by somebody else's state: Dubai, China take your pick. This is true whatever comes out of the $700bn deal.

And finally:

"So far the US and the UK have not suffered from a sudden stop of capital inflows which has been the feature of many episodes in the past. We continue to remain concerned of the risk of a current account financing crisis. Note overnight an article in the South China Morning Post suggested that China's regulators had told mainland banks to stop lending to US financial institutions. The article was later vehemently denied by the regulators."

Translation: The fate of the US economy lies in the hands of the Chinese government. It's a good job we've been so nice to them up to now.

The whole Merrill document can be found at this URL.


  • Comment number 1.

    wow. that is a real eye-opener.

    the dependence on asian / mideast governments should not be a surprise (although i think there is a real risk that china may need those reserves to help bail out its own banking sector in the coming months).

    the ex-communist central european countries all went through similar banking crises in the 90s, which is why 80% of their banks are owned by foreigners now.

    the excerpt that really got me was:

    "the average recovery rate is just 18% of gross fiscal costs"

    up till now i was genuinely buying paulson's line that the taxpayer could break even on this bailout. now i am really not sure. if that is true, a dollar collapse is even more likely.

    unfortunately, the optimal solution - part or full nationalisation (and recapitalisation) of the banks - is so contrary to ingrained american ideology that it will not happen until the crisis gets a lot worse. and as for giving china a say over the process? well, let's just hope obama wins.

  • Comment number 2.

    Wow !! And I thought that this wouldn't have much 'fiscal' effect, that it was a 'business sector' problem which might have monetary impact through the effect on the dollar rate of interest and so on...

    I notice nobody is saying, 'Well we have to choose between the 'War On Terror' and the 'Bailout'. I guess only little things like foreign aid and healthcare have to send round the begging bowl..

  • Comment number 3.

  • Comment number 4.

    Nice graph you had on last night ...bit of a hockey stick ...any synchronicity here between it and that other hockey stick.

    Seems your all scooting around trying to explain it all , how much longer are you going to avoid that dreaded "M" word...Marx....shhhhh.

    Whilst all you guys are struggling to get your heads round it ,Ive been watching this coming for a very long time ....its just a matter of understanding the "essence " rather than the "form" of things .

    Its been hilarious watching the many over paid economists prattle on saying ... we never saw this coming .....its just a correction in the market....its like in the 80,s.......oops no its like in the 20's.

    What they call explanation is largely just description

    Just wish I had a 10 th of their dosh .Cheap at the price

  • Comment number 5.

    Isn't there any irony here if you compare the current situation with the UK after WWII. The UK was finally busted by WWII and it marked its end as a world power. The US funded the UK's war effort and by the end of the war, it was so indebted to the US that it had to do what is was told by the US. Is there an anology here with the US, the war on terror and China? Can the US only fund the war on terror with what amounts to financial support from China or Middle east sovereign wealth funds? Is this rather basic analysis correct? If so, what a strange, strange world. Will China demand leases from the US Govt of naval basis in the US!

  • Comment number 6.

    this is a better link:

    this graph seems to include all credit (incl us lenders to us borrowers), and i also wonder if there isn't a lot of double counting (e.g. spv-intermediated lending being counted twice: spv as borrower + spv as onlender).

    all the same, i am beginning to get a knot in the pit of my stomach the more i read about this. i found myself biting my fist as i got to the end of the piece.

    does anyone have graphs showing cumulative net external debt to gdp of the usa (and the uk) over the past few years? i.e. just how much money they owe to china et al.

    a dollar collapse must surely be certain now.

  • Comment number 7.


    How much is a billion

    100 million, 1000 million, a million million

    And how much is a trillion

    And can you think of a way of explaining it that we understand - beyond - it is a lot.

    Thank you

  • Comment number 8.

    looking forward top economists in the city agree that the uk will need its own fannie and freddie to take over the bulk of the uk housing market.

    the govt may also need to lend directly to non financials.

    given the depth of the crisis has been known if not since last july then this march that there is still no regulations on cds.

    people blame funds but it was the politicians who gave them a room with no rules and said 'as long as you make money we won't ask questions'.

    there is no evident urgency to change that attitude which is why [all] derivatives increased 22% in the last 6 months.

  • Comment number 9.


    billion = 1000 x million
    trillion = 1000 x billion
    quadrillion = 1000 x trillion

    (learnt that dealing with turkish lira 7 years ago)

    when dealing with macro numbers, try calculating what it equates to per capita or as % of gdp. this helps you get a much better feel for the significance.

    in usa population is 300 million, and gdp is about usd 45,000 per capita.

    uk is 60 million and about gbp 20,000 / cap.

    go do the maths.

  • Comment number 10.

    Tell me... does " diminishing rate of return " fit in here in explain it .

    What about " the insoluble contradiction within capitalism"......any takers ???

    Naaaaa . sounds too much like Marxism ........and we dont "DO" that.

    Heaven forbid !...we'll start thinking the earth is round next !

  • Comment number 11.

    I was not around in the thirties but I thought that one of the results of the Crash was the public safety hazard of walking down Wall Street without being hit by falling investment bankers. Of course, I don't know whether suicide rates have risen in New York in the past few weeks but either the big losers have found more environmentally friendly ways of disposing of themselves or there are not many big losers.

    A case of 'I'm alright, Jack'?

  • Comment number 12.

    Great post. And I love the title. Can we now look forward to "[Lack of] Homebuying is Killing Mutual Confidence in the Banking Sector"?

  • Comment number 13.

    Just wanted to say thanks for the blogs over the last few weeks Paul! As an economics graduate your blogs together with those of Paul Krugman, Nouriel Roubini and calculated risk have meant far too little time spent doing anything I should be like job applications.

    I would echo the earlier comment regarding the parallels of the present situation of America's reliance on foreign creditors (specifically China) and the end of Britain's world power status following world war II (begun in debts from WWI). If there was still any strength to the arguement that we were living in an era of one global hyperpower after the Iraq debacle, that strength has to be ebbing away now.

    Whether it likes it or not, the US is now very much beholden to its Asian foreign creditors. The fact that the Chinese could massively devalue the dollar should they want to must have those living in Washington very worried. The scale of their dependence will be quite an eye openner for many I think.

  • Comment number 14.

    the battle over the plan now is looking idealogical rather than economic.

    to the free market fundamentalists it is an offence to the 'purity' of their beliefs that there is any bail out. A crash is 'purer'.

    the split is between academic purists and those who actually trade the markets who know there is no such thing as 'purity'.

    for the purists to 'concede' to a bailout means they must concede what they believe in is 'wrong' which also means conceding to regulations.

    this is a faith based or faith driven crisis. A 'last round last man in the bunker' mindset. If they can get past that the economic solution is the simple bit.

  • Comment number 15.

    IN PRAISE OF CLARITY (#7 Takethree)

    Here here. A lot of in-talk, letter-codes and specialist terms. I try only to be obscure when I have no idea what I am talking about.

    I seem to remember our billion used to be a million million didn't it? Then, as in so much, we took up the American (devalued) one.

  • Comment number 16.

    15. At 5:19pm on 26 Sep 2008, barriesingleton wrote: IN PRAISE OF CLARITY


    It is to be hoped that when our economic genius and his chaps, and the US economic geniuses he's gone to advise, all 'solve' this crisis, they have the definition of a billion agreed first.

    I seem to recall what happened to some rocket or other not so long ago when such basics were forgotten.

    'Up in smoke' may not be the best headline when applied to the world economy.

  • Comment number 17.


    Ah yes - a Mars lander wasn't it Junk? Probably 'down in flames' but the result's the same.

    Anyway, I gather J. Gordon '10p' Brown is advising in soundbites, so doom is alive and well.

    PS Did he take Miliband D along to keep an eye on him and avoid a coup?

  • Comment number 18.

    looks like the package will be approved. thank god for that. now i can sell all my shares on the relief bounce.

  • Comment number 19.


    here are a few interesting stylised facts:

    - the us current account deficit hit another all time high in 1q08, and is now equivalent to about 5% of gdp

    - the deficit with china + deficit on oil + deficit on auto industry together account for the entire country's deficit

    - us gross external debt is the equivalent of about 50% of us gdp

    have a look at this link:

    what i find interesting about the financing of this deficit is (i) it is dominated by china and other government actors that are making a fundamentally political decision about supporting the us economy, (ii) it is predominately financed by foreigners buying usd-denominated government debt (including f mae and f mac).

    here's why i think it is a ponzi scheme: asian and middle eastern governments want to support the us economy and keep the dollar strong as the us is their biggest buyer of manufactures / oil. however, because they finance this deficit by lending in usd to the us government, it means these foreign governments have built up an enormous exposure to weakening of the usd. so it gives an added incentive to keep supplying the usa with more and more credit and avoid a collapse in the usd that could destroy the value of these governments' reserves (which could in turn lead to crises in their own banking sectors).

    china et al can continue to finance this dollar pyramid so long as they continue to receive net usd receipts from their trade surplus with the us. unfortunately (i) the usa is about to go into a recession, and (ii) oil prices are coming back down a lot, which to my mind means that the capacity of these governments to continue inflating the dollar is about to take a serious blow.

    what happens when we reach the moment of truth - i.e. one or more of these governments realises that the dollar's position is no longer tenable? well, i doubt very much these governments will coordinate to ensure an orderly devaluation of the dollar. much more likely one of them will run for the door and the rest will follow.


  • Comment number 20.


    This 'crisis' is being used to further the neolib liberalising agenda. It is just slipping through, wihtout being identiied, with all the focus on the nationalising of debts.

    You are in a position to float other ideas for the profitable parts of a bank, other than liberalising it by selling it off cheap to foreign ownership.

    How about a savings lending co-op that UK people can get into?

    People know they are getting done over, by politicians they dont trust in bed with fianancial services business but there are no alternatives being articulated.

    This is the time for alternatives to be popularly proposed.

    If not now, when?

  • Comment number 21.

    Ask why the profitable parts cant also be nationalised along with the losses.

    Because it would undermine the ethos of the private?

    Lets have the reasons out in the open

  • Comment number 22.

    @ 21

    government needs the money

  • Comment number 23.

    What is the difference between the US dollar and the Zimbabwean dollar?

    With 700 billion Zimbabwean dollars you can buy a meal in a decent restaurant. 700 billion US dollars will only buy a pile of junk.

  • Comment number 24.


    In all the talk over the past few months no commentator, economist, banker or politician has actually explained where the billions now being replaced by governments have actually gone. Money just circulates around, doesn’t it? So how come billions seem to have disappeared into thin air?

    The answer is that it isn’t there because most of it never actually existed in the first place. People have forgotten that money is a measure of wealth created by human effort, not just abstract numbers in computer files. Bankers have made billions out of nothing. Here’s how.

    I take £1000 of my hard-earned cash to the bank and put it in my savings account. The bank lends it to someone to buy a house. The £1000 is passed three or four times from buyer to seller in the house chain until the last seller, who is not buying (perhaps they inherited the house from their parents who have died), takes the money and puts it in his savings account with the bank.

    The bank lends the same £1000 again to somebody else and the cycle repeats. The same £1000 repeatedly cycles through the economy without – and this is the crucial point – without anybody lifting a finger to create any wealth to enable it to legitimately enter its next cycle. In its second and subsequent cycles the money is not hard-earned; it is merely a number in a computer file and nothing more.

    So the £1000 has been lent repeatedly and if the system wobbles, such as one of the borrowers losing his job, my original £1000, which may have been lent ten times or maybe a hundred times, cannot possibly be repaid. In fact it is impossible to say where it is (but see below) because, of the total amount lent, only a fraction has ever actually existed. A wobble could also be caused by a general slowing of the economy or a decline in the savings rate in which people save less and want their money out of the bank.

    It should at least be obvious by this stage that the orphan and I cannot both get our £1000 back since there isn’t £2000 there.

    Each time the £1000 cycles round the bankers take a percentage even though no wealth has been created. If it goes round often enough they get it all, hence their billions of dollars in bonuses and my £1000 disappears into thin air. (It must be thin air since the Large Hadron Collider has not yet created any black holes.)

    Furthermore, each time the £1000 has been lent the borrower has promised to repay it from his earnings over the next twenty years. The money to repay cannot possibly be found now because the borrowers cannot suddenly put in 20 years of work instantly to create the wealth to earn the money to repay the loans.

    Contrast this with spending the money in the supermarket. Again the money repeatedly cycles round the economy but there is a difference. In this case the £1 you spend on a loaf of bread, for example, goes to pay the wages of the farmer, the baker, the driver who takes the bread to the supermarket, the oil worker who makes the diesel for the van and the checkout girl who puts it through the scanner. All these people have done useful work to the value of their wages and between them created £1’s worth of wealth to justify the £1 entering its next cycle through the economy.

    This example is simple, yet it explains why all the money seems to have disappeared into a black hole – sorry, thin air. Fancy “financial instruments” and practices like CDOs, leveraged this and that, hedge funds and short selling, which I don’t begin to understand, are doubtless clever devices which manage to turn money over even faster without creating a penny of wealth.

    It should have been obvious to the politicians that there was something wrong when bankers could pay themselves hundreds of billions – yes hundreds of billions – of dollars over the last decade in salaries and bonuses without doing anything more than moving numbers from one computer file to another. Why they didn’t realise or why they didn’t do anything about it is for them to explain. Over to you.

  • Comment number 25.

    It has been reported that US Treasury Secretary Henry Paulson is worth about £700 million. Perhaps somebody should ask him how he managed to do $700 million worth of work in just 50 or 60 years.

    Presumably most of his money came fro his job at Goldman Sachs. He should ask 1000 of his friends to bail out the banks instead of the taxpayer having to do it.

  • Comment number 26.

    24. At 6:57pm on 28 Sep 2008, ebenezer-bean wrote:

    "It should have been obvious to the politicians that there was something wrong when bankers could pay themselves hundreds of billions ? yes hundreds of billions ? of dollars over the last decade in salaries and bonuses without doing anything more than moving numbers from one computer file to another. Why they didn?t realise or why they didn?t do anything about it is for them to explain. Over to you."

    Simple answer to this one in my opinion...

    Stamp Duty receipts; and

    Corporation Tax, Income Tax and CGT on profits and earnings.

    We have had however many consecutive quarters of economic growth but in reality, as we are starting to see, all Gordon has done is allowed Mr and Mrs UK public to do is spend twenty years' earnings in ten years.

    I'm currently thinking of running a book on the basic rate of income tax in five years. With a Conservative Gov. it could easily be 28-30%.


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