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A simplified explanation of America's banking crisis and how it might be fixed

By   Follow Me on Twitter     Message Richard Clark     Permalink
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To that, depositor Alex fumes:   But what about my money?   It's only worth half of what she paid for it, but you have to sell it, because I have to at least get some part of my deposit back!


Banker Bob's reply:   Alex, don't worry about it.   Your money is still totally safe in my bank.   Why?   Because, I know the dollhouse market is coming back.   Just keep the faith in that.   It's got to come back.   And that means that all I have to do is keep Caitlin's dollhouse on my balance sheet, listing it as more or less worth its original value, and that allows me to make a simple claim:   The market for dollhouses is "illiquid' right now;   in other words, I am not able to sell the dollhouse, into this market, so there's no way, really, to determine its market price.   So we're fine -- we just have to assume that the market is going to come back, and that I will eventually be able to sell it for a hundred bucks, a ways further down the road.   In the mean time we keep our books hidden and don't talk about what's really on them or in them.   Keep the faith Alex.  


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However, depositor Alex is wholly unsatisfied with this, and says, "But that's a crazy assumption.   We're entering maybe the worst recession in decades.   People are losing jobs and income all over the place.   Everyone says things are probably going to get worse in the short term, not better!


Banker Bob's response:   Shhhh!   Alex, I've chosen to believe that this house will be worth more one day.   And it's important that you share this faith.   If we and our government can just keep assuming that the dollhouse hasn't really gone down in its ultimate value, then everything is okay.   (Otherwise I'm going to lose my bank and all my money, and so are millions of other people.   So for the time being, it's imperative that we all pretend that everything is okay.   So don't upset the apple cart.   Don't rock the boat.)

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Depositor Alex replies, "That's funny, I talked to a professor at Columbia Business School yesterday.   He's an expert in bank crises and a former banker himself.   David Beim's his name.   And he told me you'd say exactly that."


Note:   In the real world, bankers are saying much the same thing as Banker Bob.   They too hold toxic assets, whose quoted prices are down around 20% or 30% of their face value, and the bankers say, "I'm sure these houses are eventually going to be worth much more than their currently quoted prices.   In other words, I don't want to mark their prices down to their currently-stated market value.   In short, I don't want to "mark them to market, or mark to market."


So all bankers are saying essentially the same thing:   'Please don't make me mark to market, because if you do, I'll soon have to declare bankruptcy.   If I accurately show, on my books, all those price reductions, from 100% of the original home value all the way down to 20% of the original home value, I've just wiped out my entire capital and more.   And then I'm going to have to go to the government and say, close me down, I'm broke and can't repay any of my depositors.  

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Naturally, bankers find this quite hard to do.   And furthermore, regulators don't want it to happen to all the banks at once.   Certainly not all the big banks.   For they fear that this could well lead to a financial catastrophe for the entire country and perhaps the entire world.


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Several years after receiving my M.A. in social science (interdisciplinary studies) I was an instructor at S.F. State University for a year, but then went back to designing automated machinery, and then tech writing, in Silicon Valley. I've (more...)

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