Saturday, February 14, 2009

Insolvency vs. Liquidity

The current consensus among the big name economists around the world is that we will see total losses from the global banking sector between $3 and $4 trillion. (Remember just one year ago, the worst case scenario from these economists was $500 billion. We have already passed $1 trillion in losses to date)

The total capital of the banking system including all assets is estimated to be around $1.5 trillion as of today. This means the entire banking system is currently insolvent. It is important to understand the difference between a liquidity problem (what you hear is the problem on the news) and a solvency problem.

With $1.5 trillion in current assets, it will take an additional $2 trillion to bring their value to zero. The problem that we keep hearing is that people cannot spend because banks are not lending. Their insolvency is why they are not lending. Even when the government prints and borrows that $2 trillion to make these zombie banks whole, the credit market will still only be a fraction of its former self.

The reason is because the buyers around the world that bought all this debt are currently getting burned today, and they are not going to just line back up to buy more once this all blows over. How long do you think it will take before a Wall Street executive can con a foreign government into purchasing mortgage backed securities? A long, long, time.

Towns, cities, states, and even countries around the world are heading toward bankruptcy because they made the mistake of lending Americans money.

Obama's new stimulus plan will be signed into effect Monday morning. The problem with the plan is that it is a spending plan, not a stimulus plan. It was not put together to maximize job growth. It was put together to maximize health care, education, and tax cuts.

Over the next few months as the administration realizes that this plan is doing nothing to help this economy, they will begin immediately putting together a plan for "stimulus two." My guess is that this plan will be released around summer time and may dwarf the size of this 800 billion dollar waste.

Everything they are doing to stimulate the economy is making it worse. As the economy gets worse they continue to make the stimulus packages bigger which in turn makes it even worse. This larger problem then calls for a larger economic stimulus package. We will follow this vicious cycle until the entire pile of debt collapses on itself.

Most people talk about the actions taken today as being a problem for our grandchildren in the future. Based on the speed and the size of the mistakes being made today, I think the bill will come sooner than most people realize.

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