Zombie Banks: How Broken Banks and Debtor Nations Are Crippling the Global Economy
Q&A with the Author ofZombie BanksAuthor Yalman OnaranEveryone is afraid that the world economy is about to go into a second recession. Why are we heading in that direction?That's because we haven't fixed the problems that had caused the one in 2008. Leaders in the U.S. and Europe patched up the troubled spots, printed lots of money and avoided the underlying issues. Especially the banking system, which blew up to bring the world economy down a few years ago, is still fragile, too wounded to support a recovery and filled with even more risk. That's why I call the banks zombies. They will make the next blowup more spectacular.Why are the shares of European banks falling so much? What are investors worried about?French and German banks are more exposed to the troubled economies of the region than others. During the boom times -- when Irish housing prices quadrupled, Greek civil servants were allowed to retire at the age 53 -- French and German banks fueled the boom in those countries. Now that the bubble has burst, those same banks face huge losses. There's too much debt in Greece, Ireland, Portugal, Italy and Spain. When the debt isn't paid -- and most of it can't be -- then lots of European banks will go bust.What about the stress tests? The Europeans have carried out three of those in the last three years? Why haven't those helped?The first three tests failed miserably because their assumptions were too optimistic. For example, the banks' holdings of Greek government bonds were discounted by 20 percent. But Greek debt was already trading at 40 percent of their face value. Finally, in October 2011, the EU took a step toward a more realistic test, assuming proper losses on sovereign debt holdings and asking the region’s banks to raise some 100 billion Euro in the next nine months. Even this is less than half the capital hole that exists in the banking system, but it’s better than nothing. So it will probably help the EU stave off the end for now. But once again, the zombies are being propped up –- governments will inject capital if banks cannot raise it in markets –- instead of being wound down.U.S. bank stocks have also taken a beating in the second half of 2011. Are they also exposed to Greece or other EU countries?Our banks didn't lend to Greece, Ireland or Portugal that much but they have other exposures to them -- derivatives backing their debt, loan guarantees, etc. So U.S. banks could suffer substantial losses in case of a string of EU defaults. On top of that is the added concern that the U.S. economy is sliding back into recession. We have our share of zombie banks who've managed to stay alive with temporary patches. They're too weak to survive a second downturn.Why are Bank of America shares dropping more than its peers?BofA has the largest portfolio of mortgages which are souring and faces the biggest lawsuits due to home loans packaged into tricky securities that blew up in 2008. It needs more capital to cope with mounting losses, but its leadership has been refusing to raise any. Market forces push zombie banks into a corner that's very hard to come out of. The longer BofA waits, the lower its share prices get, making a capital increase more costly and less effective.What's the solution? What do we need to do? How do we avert another crisis?Both Europe and United States need serious debt restructuring. Here mortgages need to be written down to diminished house values, in Europe sovereign bonds to levels that will allow countries to resume growth. The write-offs will cause losses on banks' books in both sides of the Atlantic. Unlike 2008, we should let the weakest fall this time, shut them down, sell off their good assets and let the surviving healthy banks pick up their market share. That way the financial sector can resume supporting economy recovery and consumers, companies return to consumption and investment.