Will we repeat the banking crises of the 1930s?
Yesterday the International Monetary Fund raised its estimate of the total cost of the global financial crisis from mid-2007 to 2010 to $4 trillion in bank write downs. Are we therefore going to see a repeat of the banking crises that caused the Great Depression of the 1930s?
It is easy enough to assume that government bank bailouts and re-capitalizations have been timely and sufficient to work. But even the central bankers implementing these programs admit they have no idea how they will work in practice, as what is being attempted is unprecedented.
1930s banking crises
In the 1930s there were two banking crises: from September 10th 1930 to December 16th; and then a second leg from February 24th 1931 to October 5th; and stock markets only finally bottomed after a gold drain and currency crisis from March 8th to July 8th 1932.
It is not true that the Federal Reserve did nothing in 1930. The Fed reduced the discount rate quickly. But crucially it did not then pump money into the banking system and took no further meaningful action until the summer of 1931.
From August 1931 to January 1932 1,860 banks with deposits of $1.5 billion suspended operations. It is this systemic banking crisis that the modern Fed and Treasury Department are working to avoid at all costs.
However, the IMF now puts losses to the global banking system at $4 trillion, of which $2.7 trillion is on US originated assets, $1.2 trillion from Europe and $149 billion from Japan. How this is spread between global banks we are left to guess.
Now while strong efforts by the central banks of the world in coordinated stimulus and bailout programs are certainly going to offset a part of this hole in global bank balance sheets, it is still clear that there must be a day of reckoning.
Keeping all the banks afloat will surely not work. There has to be an orderly contraction and consolidation and elimination of bad loans. This is how smaller national or regional banking crises have ended, and a global problem is the same only larger.
Historical precedent
So it would seem some kind of banking crisis, or possibly two of them followed by a currency crisis looks almost inevitable, and to that extent the pattern of the 1930s will be repeated. It is the only historical precedent that we have to guide us, and the pattern of the stock market bust and rally has been almost identical to the 1929-30 pattern thus far.
This is terrible news for stock prices. The first banking crisis of the 1930s took stocks to a 59 per cent discount on the 1929 peak; the second banking crisis left stocks down 77 per cent; and after the final currency crisis stocks bottomed down 89 per cent.
Also BreakingViews.com had this to say:
So yes, all in all the economy isn’t shrinking as rapidly as it was. But so what? It’s still shrinking. On that yardstick, therefore, the worst isn’t yet over.
Now look at another measure of “worst”: unemployment. Even when growth does return, recovery is likely to be anaemic. It will take time to absorb the excesses built up during the credit boom, from houses in the US to too many Chinese factories making cheap goods.
What’s more, it’s not as if all that private-sector debt has gone away.
The rise in savings rates in the US and elsewhere isn’t going to be a one-quarter wonder. This means that the peak in unemployment could easily be two years away.
And will that then be the end of the pain? Probably not. The crisis will leave government balance sheets shot to pieces. The best case scenario is that the authorities manage to suck all their fiscal and monetary stimulus out of the economy safely once economic growth has bottomed out. Then all that the world will suffer is high taxes and slow growth.
But there is a risk that this outcome proves too unpopular and that the authorities instead take the current fad for “quantitative easing” to the extreme – and just print money to finance their deficits. The outcome would then be inflation.
An inflationary outburst might even lead to another sort of financial crisis – a loss of confidence in key currencies. That could be worse than anything seen up to now.
Peter Cooper
April 25, 2009 at 10:11 am
From The Daily Telegraph commenting on the IMF report:
The simple truth is laid out in page 33 of the Global Financial Stability Report, published today in Washington: “if banks were to bring forward to today loss provisions for the next two years, before expected earnings, US and European banks in aggregate would have tangible equity close to zero.”
In other words, the entire global banking system would be bankrupt – kaput – if its institutions immediately wrote off all the toxic assets still sitting in their vaults without any government assistance. And bear in mind this already takes into account the money we have already thrown at the banks. So even after all this has been spent the financial system remains, effectively, insolvent, bearing in mind the amount of cash the banks have lost as a result of the bubble of the 2000s.
But, you might well respond, what about all the cash that has been thrown at the banks – almost $800bn across the world, including $110bn in the UK (just over £70bn)? Well, the problem is that according to the IMF this hasn’t been enough to get the banks back to health again. In fact, it calculates that a further $125bn will need to be poured into Britain’s banks if they are to start lending again at anything like a normal rate. If they are to bring their balance sheets back to a state as healthy as in the mid 1990s, it will take a further $125bn on top of this again.
In other words, if you thought the immense amounts of taxpayer cash funnelled into the system over the past couple of years was enough to bring us back to good health, think again. It is an extremely worrying verdict, particularly coming at a time when many had been assuming that green shoots were starting to sprout and the recession was coming to an end. But it underlines one simple but undeniable truth: that this recession is different.
Peter Cooper
April 22, 2009 at 2:46 pm