Ask the Banker: Are we headed for a colossal meltdown?

posted by Omar Afra
This whole economic mess has me as confused as a dog lost in a hubcap factory. Fortunately, one of my few childhood friends that is not incarcerated, Peyton Jones, is now Senior Vice President of Earth conscious Green Bank. I had a chance to pick his brain with a few questions recently and he has tried to explain the current economic meltdown in digestible terms for us primates.

1. 700 Billion dollar bailout: Yes or no?
Yes. The idea of the government using $700 billion of our tax dollars to bail out bad decisions by lending institutions is not easy to swallow, but it is necessary. The bailout plan will prevent a massive meltdown of the banking system, and thus preserve the market’s faith in the U.S. banking system. If things continue without a bailout plan, you could potentially see several large banking institutions fail. Washington Mutual, the nation’s largest savings and loan bank, failed today, coincidentally making them also the largest failed bank in our country’s history. If the plan does not go in place to help take rancid mortgage loans off bank’s hands, then you could see an even greater number of bank failures. Keep in mind that Washington Mutual employed over 60,000 people and was not even in the Top 30 banks in the U.S. in terms of size. Continued failures of banks of this size would continue to raise unemployment, slow consumer spending, and create a panic amongst the U.S. consumer that their deposits are suddenly at risk despite the recognizable name on the vault.
2. If yes, what is the likelihood it will succeed?
If you assume there are roughly $14 trillion in outstanding mortgages in the U.S., $700 billion would cover 5% of that total. Historically for banks a 5% loan loss on troubled assets is normal, so I think the $700 billion figure has a lot to do with historical trends. “Success” will be a tough title to give this bailout though. I think you will still see a lot of bank failures across the country, and I think you will still see a lot of banks lose big money. In addition, the U.S. tax payer will foot the bill for the bailout, and a moral hazard will inevitably be created by bailing out these large institutions. If these banks can take on excessive risk, and then have the U.S. government bail them out when those decisions go sour, then what does that teach them? I’m sure in another 10-15 years we might be talking about how this bailout led to continued risk taking.

3. In a few words, please explain the nature of this crisis in stoner lingo.
Banks have made mortgages in parts of the country where values of homes increased sharply over the previous 7 years. As homes continued to appreciate, banks got more aggressive with their lending to a point where any decline in home values could create a crisis. Over the previous 12 months, home values in these same areas began sharply declining and suddenly Borrowers were not able to sell their homes for enough money to pay back their loans. There are about 4 or 5 other semi-complicated reasons why the decline in home values has also contributed to the problem, but the biggest scare is not knowing how deep the hole might be – meaning how can you really tell when someone is getting close to not being able to make their house payment? Do we have 1 million Borrowers reaching that point, or do we have 100 million? Dude.

4. Give me worst case scenario.
Worst case scenario is having this crisis take down most of the large banks in America and having depositors domestically and internationally suddenly afraid to leave their deposits at a U.S. bank (termed a “deposit run”). If U.S. banks do not have deposits, then they cannot make loans. Without loans, businesses cannot grow and expand and the entire economy (and life as we know it) comes to a grinding halt.

5. There are some of those that say "Let market forces solve this". Let's try polemics: Are these folks brilliant or total douchebags?
D-bags. Market forces could lead to the worst case scenario outlined previously. With that being said, I do understand their ideals of letting the culprits suffer the consequences of excessive risk taking.
6. Master capitalist: Ronald Reagan or Lil Wayne? Choose wisely.
Lil Wayne spent more on his grill than I spent on gasoline in the last decade, so I think I’ll go with President Reagan.