Bank deleveraging has barely started
The government bail out packages unveiled across developed countries last month may have prevented the collapse of a host of banks with more toxic assets than equity.
Unfortunately for those policymakers hoping banks will now repay taxpayer support by lending to boost their national economies, a narrow escape is not the prelude to robust extension of new credit.
The patient may have been resuscitated but is still slumped on his bed in the emergency ward: he is not merrily jogging back to work.
The IMF’s global financial stability report has estimated that total writedowns from the sub-prime mortgage and structured credit disasters will reach $1.4 trillion before this is over, with banks on the hook for between $725 billion and $820 billion of that. By mid October, banks had written off $635 billion, putting maybe 80% of the problem behind them. But they had raised just $420 billion of capital.
That still leaves a gap for government capital to fill – and governments are the only source, with private equity and sovereign wealth funds nursing losses from rescue issues they began a year ago – just to deal with the old problem.
A new problem is looming: higher personal and corporate loan defaults in a global recession. The downturn in the credit cycle is only just upon us. Banks will consume even more capital in dealing with the losses yet to come.