L. Gordon Crovitz of The Wall Street Journal has an interesting column today on what’s wrong with our banking system and, maybe, how to fix it. You should read the whole thing (it’s not lengthy) but here’s a part that caught my eye:
We’re now more than $1 trillion in taxpayer bailouts into the credit crisis, and the one enduring certainty is uncertainty. There is uncertainty about what caused the problem, uncertainty that either Wall Street or Washington knows what to do, and uncertainty about financial models that measured risk until they didn’t. Markets thrive when information flows freely, and they seize up when uncertainty replaces understanding.
Plan B is to go back to Plan A. Regulators urge using new bailout funds to return to the original goal of discovering the true value of these securities. “A continuing barrier to private investment in financial institutions is the large quantity of troubled, hard-to-value assets that remain on institutions’ balance sheets,” Federal Reserve Chairman Ben Bernanke said in a London speech earlier this month. “The presence of these assets significantly increases uncertainty about the underlying value of these institutions and may inhibit both new private investment and new lending.”
Banks can’t resume lending because they don’t know how unsound they are. Private investors can’t know how bad bank debt is, so they hesitate to invest in banks. There are echoes from the experience in Japan, where the collapse of a real-estate bubble in the 1980s became a drag on the economy for years as regulators put off the day of reckoning of the full losses.
That’s pretty much what’s freezing our housing market: uncertainty. Agents and appraisers may know what a house is worth, today (if you can extrapolate from such a tiny pool of recent sales), but we have no better idea than Barak Obama what it will be worth next year (yes, even the Obama can’t predict the future). Sellers know what they paid for their house and are certain that it must be worth at least that much and buyers are waiting to see what the future brings. As Krovitz says, this lack of information causes hesitation.
A suggestion for resolving the banking situation is to mark down all the bad loans to zero, wipe out all shareholders and start anew. That’s too drastic a remedy for our residential market, I hope, and I’m not suggesting that we all set our prices down to zero and see what bids come in. But it might be a good idea to ignore what you paid for your house and concentrate instead on what value it still offers. There’s shelter value, there’s a Greenwich premium – I agree with Mad Monkey on this latter element; we just disagree on how much to value it – and there are those few scattered sales to provide some guidance. If your mortgage balance is high and your equity low, there’s also the pain factor to consider, but that pain will only increase during the year if prices continue to plummet. In a way, the banking mess is an easier problem to fix.