1. There are up to five different ways of defining bank insolvency, and most discussions equivocate among them. While many of the banks may face"regulatory insolvency" because of failure to maintain mandated capital, they are not necessarily insolvent under GAAP (generally accepted accounting principles). The government imposition of the former is worsening the situation.
2. The capricious nature of government policy is making it more difficult for the banks to weather the crisis and is piling on losses much larger than they otherwise would suffer.
Hat Tip: Tyler Cowen
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David Pearson - 2/20/2009
Hempton argues that banks have economic value arising from lending profits. However, those lending profits are dependent on the spread between loan and deposit rates. What would that spread be in the absence of FDIC deposit insurance? Loan rates already reflect risk-based pricing, so they would not change much. Deposit rates, on the other hand, would have to spike to retain risk-adverse depositors. In other words, in a true free market, the banks would be insolvent. All of their collective "economic value" stems from a taxpayer subsidy. This is hardly consistent with "solvency".
As for government actions "piling on" losses, please remember, again, that many of these banks would have failed were it not for government intervention.
Let's be consistent. Free-market thinkers should argue for bank bankruptcy. Because this has systemic implication, the only alternative is temporary government receivership. Pretending that current shareholders own anything of value: perpetuates a fiction dependent on taxpayer generosity, and; refuses to let our capitalist system punish risk takers.
Conservatives would like to believe this is all a mark-to-market misunderstanding because it lets them off the hook. The "hook", in this case, is the need to let capitalist risk-takers fail.
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