The Largest U.S. Banks Have Repeatedly Gone Bankrupt Due to Wild Speculation. The Fed Blessed the Speculation then Helped Cover Up the Bankruptcies



As I have previously pointed out, the New York Times wrote in February:
In the 1980s, during the height of the Latin American debt crisis, the total risk to the nine money-center banks in New York was estimated at more than three times the capital of those banks. The regulators, analysts say, did not force the banks to value those loans at the fire-sale prices of the moment, helping to avert a disaster in the banking system.

In other words, the nine biggest banks were all insolvent in the 1980s.

Richard C. Koo - former economist at the Federal Reserve Bank of New York and doctoral fellow with the Fed's Board of Governors, and now chief economist for Nomura - confirmed last year in a speech to the Center for Strategic & International Studies that most of the giant money center banks were insolvent in the 1980s.

Specifically, Koo said:
After the Latin American crisis hit in 1982, the New York Fed concluded that 7 out of 8 money center banks were actually "underwater"
All the foreign banks (especially the Japanese banks) had to keep their lending facilities open to American banks so the American banking system didn't collapse overtly and out in the open
The Fed knew that virtually all of the American banks were "bankrupt", but could not publicly discuss how bad the situation was. If went out and said the "American banks are bankrupt", the next day they will go overtly go bankrupt. So the Fed had to come up with a lot of stories like "its good debt on their books"
Then-chairman Volcker instructed the banks to keep lending to the Mexican dictator so that the Mexican economy didn't totally collapse, because - if Mexico collapsed - it would become obvious that all of the U.S. banks were underwater, and they would immediately collapse
It took 13 years to manage the crisis (at another point in the talk, Koo says 15 years).
The way that Volcker approached the problem was that he allowed U.S. banks to keep their lending rates relatively high, while the central bank brought short-term rates down. The spread between the two (the "fat spread") became revenue for the banks, and the banks used the high fat spread to gradually write off problem loans and to repair their balance sheets.
Volcker's covert rescue of the American banks using secrecy and a high fat spread didn't cost U.S. taxpayers a cent
Koo points out that you can't use the fat spread approach where there are no borrowers
Lessons for Today

So what is the take-home message from all of this? What are the lessons for today?

Well, initially, it shows that it wasn't just some S&Ls, or a Long Term Capital Management or two.

Virtually all of the largest U.S. banks gamble and speculate and then all go bankrupt. The money center banks gambled in Latin America and lost. They went bankrupt.

Have they changed their behavior?

No. They have - with the Fed's blessing - simply changed casinos, and for the last decade or so, have put all of their chips into CDOs, CDS, and other leveraged and securitized bets built like a house of cards on top of subprimes and option arms and alt-as and whatnot. Now they've lost and gone bankrupt again.

And the Fed playbook obviously includes pretending


http://www.washingtonsblog.com/2009/...anks-went.html