Banking Failure: When You're Already Dead, You Have Nothing to Lose

December 19, 2007 (LPAC) – The staggering size of the $500 billion intervention by the European Central Bank is a clear sign of the panic gripping the global banking system as the banks struggle to balance their books at year's end. Aside from the fact that it exposes the bankers as the biggest pack of fools on the planet, there are two aspects of the plan worth mentioning. The first, the emergency cash injections into what are clearly bankrupt institutions, is obvious. Not as obvious, but equally important, is the type of collateral the central banks will accept in exchange for these loans.

The only thing standing between the banks and admitted insolvency is the way in which trillions of dollars of paper assets are being carried at artificially high values on the books of the banks and their clients, so maintaining these fictitious valuations is of crucial importance. This mass of "illiquid" mortgage-backed securities, CDOs and related paper ("illiquid" being a polite euphemism for "worthless") cannot be sold at anywhere near the book price. However, selling it for pennies or nickels on the dollar--assuming you can find a buyer at all--would result in setting a market price much lower than the book value, and thus trigger a wave of writedowns. To try to break this vicious cycle, the central banks are both flooding the banking system with liquidity to reduce the need for such sales, and also taking in big chunks of the illiquid paper as collateral, to pull it out of the market.

This is not a "credit crunch" which can be solved with cash. The problem is that the banks count as assets trillions of dollars of securities and bets which are essentially worthless, which means that the banks are hopelessly insolvent. Compared to the trillion-dollar holes in their balance sheets, a $500-billion handout is but a drop in the bucket. Since the financial system blew out this summer, the central banks and regulators have tried one trick after another to halt the collapse, and all have failed. This one will also fail. Rather than throwing more money down the rathole of a dead system, it is time to admit that the system has failed and adopt LaRouche's Homeowners and Bank Protection Act, as the first step toward genuine recovery.