Banks, Micturiton and Failure

The Big Lebowski: I just want to understand this, sir. Every time a rug is micturated upon in this fair city, I have to compensate the owner?
     — The Big Lebowski (1998)

Good new Floyd Norris column at the NYT pointing out that most of the banks that are failing in the U.S. aren’t doing so because they were over-exposed to debt exotica like CDOs, SIVs, or CDO-squareds. Instead, they are failing because they made bad loans, which new regulations won’t change, of course.

The severity of the current string of bank failures shows that many of the proposed remedies batted about since the financial crisis erupted would have done nothing to stem this wave of closures. These banks did not get in over their heads with derivatives or hide their bad assets in off-balance sheet vehicles. Nor did their traders make bad bets; they generally had no traders. They did not make loans that they expected to quickly sell, so they had plenty of reason to care that the loans would be repaid.

What they did do is see loans go bad, in some cases with stunning rapidity, in volumes that they never thought possible.

The takeaway is that stability breeds instability, as Minsky wrote, and Norris reminds us. Fair comment, and true, as far as it goes.

But the reason why all these banks had the opportunity to so quickly make so many bad loans, and why so many banks and loans failed so fast, is because of the systemic problems in banking, many of which were tied to loan exotica. In other words, it didn’t matter that the failing banks didn’t pee in the pool, other banks did. And in banking, like life, the notion of a peeing and a non-peeing section in a swimming pool is meaningless.