Ignoring Reality

ignoring reality

By all accounts, the US banking crisis is over and done with. There may be a few or more than a few smaller banks that have to be shuttered but it’s mostly just mopping up at this point in time. At least that seems to be the conventional wisdom.

Guy Debelle an assistant governor with the Reserve Bank of Australia has a bit different take which the WSJ Real Time Economics Blog featured today:

“We are still yet to see the full impact of the weakness in the North Atlantic economies on the loans on the books of financial institutions. The bulk of the losses to date by these institutions have been write-downs in the value of securities held on their books. While these write-downs have been absorbed, albeit with some difficulty and with substantial capital raisings, given the size of the output contraction, one would expect that we are not all that far advanced in the adverse credit cycle that normally accompanies recessions. For the North Atlantic economies, this was a big recession which, combined with large falls in both commercial and housing property prices, should result in large loan losses.”

He sees the problem largely as one that will impact the regional and local banks:

“This lower tier, which is a sizeable share of the US financial sector, has loan portfolios which are very regionally concentrated with a sizeable weighting to commercial property. The experience of previous cycles indicates that the commercial property cycle takes a long time to unfold, and we may have some way yet to travel. These problems in the banking system will almost certainly hinder credit provision in the US, particularly to the [small and medium sized enterprises] sector, which doesn’t have the direct access to capital markets that larger corporates have.”

When the history of this entire episode is written, it will probably observe that the economy would have been better served taking its medicine early on as opposed to waiting for real estate markets to rebound. That’s certainly the lesson one can draw from similar real estate crashes. But we humans, at least those of our species that we choose to represent us, seem to have a propensity to believe that things will always turn out differently then they did before, unless we want them to turn out the same.

That’s the illogic of current policy. We want to believe that the real estate markets will rebound and no clearing at drastically lower prices will be required. And, we want to believe that having defied gravity in that case, the market will once more proceed on an appreciating slope. Reality will probably impose its unruly self on this dream.

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