"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Friday, January 21, 2011

Modern Monetary Theory Economist L Randall Wray: "The Banks Are Toast"

Just last week, I wrote on the phantom income gains from $1.4 trillion in defaulted loans - which is bad enough.  But after reading this article by L. Randall Wray, it's actually worse. There's more to it.  Professor L. Randall Wray, a Professor of Economics, and one of the foremost Modern Monetary Theory (MMT) thinking economists, this week wrote about the condition of the largest US Banks.  He sums up his diagnosis thusly:  "You are Toast."

Some of his commentary:
The big banks are reporting that profits are up. Citigroup is celebrating a 46% gain in share prices and net income of $1.31 billion. Wells Fargo just reported strong profits.Yet there are many reasons to doubt the good news. As I've said before, it is more likely that they are toast.  
First, the income reports result in large part from reductions to loan loss reserves. Yes, banks are partying like it is 1999—everything is hunky-dory so there is no reason to sock away reserves against possible defaults. Heck, no one is going to default in 2011. Right? Move those reserves into the profits column.  
Banks are not making any money in traditional lines of business—that is, by making loans. No one wants loans. The economy is down for the count. Other than pulling money out of loan loss reserves, banks can only make profits by revaluing assets. The write-downs of trashy mortgages need to be reversed. Banks trade trash with each other at higher prices, recording profits. They sell trash to the government at inflated prices—more on that below. And they jack up late fees on homeowners, credit card users, and other debtors. Even though none of those borrowers can actually pay the late fees, the banks book the revenue now.  
Wray continues:
But here is the much bigger problem: the banks are getting sued from here to Pluto by homeowners, soldiers and sailors, Fannie and Freddie, PIMCO, the NYFed, and just about anybody with access to a lawyer. And, increasingly, the banks are losing.  
Wray then proceeds to describe the various legal methods defaulting homeowners are employing against the big banks, with increasingly positive results. He also describes fraudulent or irresponsible activity on the part of the big banks against the GSEs Freddie Mac and Fannie Mae and even against US Military personnel!

Wray's conclusion:
And that makes the banks toast. Forget anything you read about their income, their profit rates, their recovery. They've got to take back the unbacked mortgage securities—they do not meet the “reps and warranties”. And there is no property behind them, so foreclosure is out of the question. They can pursue homeowners in court—but homeowners lost their jobs and in any case could not afford the houses the lender fraudsters put them into. Yet, they get to stay in the homes, can claim their titles, and can negotiate for better terms with banks that are failing.
The next several years will be fun. Bet on the lawyers.
For a detailed reading of the article, the link is HERE.

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