If you read this blog and listen to Planet Money, you may have had enough of this topic, but Calculated Risk pitched in with two posts on liquidity and solvency crises, complete with graphical balance sheet illustrations. He does a better job than I have of conceptually illustrating the workings of the various bank bailout plans that have been offered.
This is his assessment of the current strategy:
The Geithner approach is to keep injecting capital into the banks to cover the losses. This is known as the “Zombie” bank approach. . . .
Although the bank is balance sheet insolvent, the bank will never be business insolvent [unable to pay its debts as they come due] because the government will continue to provide money to cover losses.
If only a small percentage of financial assets are held by zombie banks, then this approach will probably work. These banks will be crippled, but the other banks can meet the financing needs of the economy.
I should note that CR does not say the entire banking system is insolvent, or that any banks in particular are insolvent.
The posts are from late April but I missed them, probably because they were on my birthday.
By James Kwak
The Baseline Scenario 
Speaking of the bailout, if it’s not redundant, I’d like to highlight this nifty NY Times web page detailing bailout dollars committed and disbursed:
A friend pointed me to your blog recently, enjoying it. I put together a brief balance sheet-oriented primer for friends and family at http://notestoself.posterous.com/yacp-yet-another-cdo-primer. It doesn’t quite reach PPIP yet, but it’s a start.
“If only a small percentage of financial assets are held by zombie banks, then this approach will probably work. These banks will be crippled, but the other banks can meet the financing needs of the economy.”
Do most consumers need more debt?
Do most businesses need to expand?
What gives? TARP has been a puzzlement since Paulson announced it last fall.
“If only a small percentage of financial assets are held by zombie banks…” – then what is the point of propping them up with a lifetime supply of federal-funded capital?
Why not let the zombies fail and let the healthy banks (where most of the financial assets are held, according to this theory) “meet the financing needs of the economy” – without federally funded capital injections?
It makes no sense to prop up a small number of zombies (if that is indeed what we are dealing with) if the majority of the financial system is sound.
So is it or isn’t it? Do we have a fundamentally sound financial system, with just a few bad apples – or have they all rotted in the barrel?
When will we stop, as the old saying goes, chasing good money with bad. We can’t afford to prop up the bad actors for a lengthy period of time without jeopardizing the good actors and everyone watching the play. Let’s let the failures go bust (takeover and workout) and move on. We’ve just created what seems to be a perminent drain on the taxpayer, just to serve the very people who put us in such a bad position. It’s just not rational OR SUSTAINABLE. I believe that the President is pragmatic, but is leaving the decisions to the wrong people (Geithner, the toady wonk, and Summers, the insider’s insider). Time to listen to the larger group beyond the administration — and by my count a very substantial majority of financial leaders and economists outside of the oligarchy’s purview, which have strongly recommended this.
Happy belated birthday
There’s a major flaw in Calculated Risk’s diagramatic depiction of bank resolution. The Geithner plan, the “Zombie Bank” plan, and the FDIC or “preprivatization” plan are presented as equivalents, as co-equal alternatives, as if there is a choice before us today. In fact, there is no choice. The FDIC or “preprivatization” plan TODAY is a dangerous fantasy. It cannot be put into action until it is clear that to seize a major financial institution would not endager our entire financial system.
To remove from bank balance sheets, as Calculated Risk does, legacy assets, capital and a vaguely defined portion of bank debt would destabilize credit markets perhaps as much as the Lehman’s dissolution did. Why? Because to remove those assets it is necessary to attribute value to them, and without any analysis of intrinsic value the value of legacy assets will be imputed to be book value of the capital seized plus bond debt is taken as well. It cannot be otherwise! Do it for one and you do it for all. Suddenly, all legacy assets on every balance sheet everywhere have specific values, and, with global output shrinking, financial systems everywhere are served with specific and perhaps horrendous solvency shortfalls.
It is positively dangerous to suggest (or even add credence to the suggestion) that “preprivatization” can be implemented TODAY without running the risk of destabilizing credit markets. The thought that it can is a sort of tunnel vision, “stove pipe” thinking, that fails to take into consideration all contingent circumstances. In theory it looks fine, a clean, quick solution that moves our economy around a Japanese eventuality, a lost decade. In reality it is riskier than hell and out of sync with unfolding developments. “Preprivatization” has its place but not as an alternative to the “Zombie Bank” plan but as another tool to be used farther down the road.
P.S. 5-19-09 and 90-day Libor is down another 5 basis points.