Ever wondered why “zombie banks” are a problem?

September 23, 2009

Here’s a good piece from Bill Bergman at GlobalResearch.ca (ht Arthur Kimball). It’s an interview with Ed Kane, Walker Todd and Martin Mayer….three guys with long experience in and around banks whose opinions are always worth hearing…

The most interesting part is Ed Kane’s commentary on zombie banks. He explains why they’re a problem:

Kane: Another point is that these so-called “hard-to-price assets” have much more value to “zombie banks” than to anyone else, which is why there is no liquidity in that market. The deeply insolvent institutions want what everyone else calls “toxic assets” because it gives them a chance to climb back if the economy recovers well into solvency.

Bergman: Ed, you coined the term “zombie banks” in the S&L crisis. What inspired you?

Kane: It was just an attempt to make clear to people the dangers of keeping an institution that was deeply insolvent alive, or at least walking. The notion of the zombie is that it would be put in its grave by its creditors if it weren’t for the black magic of government credit support guarantees and loans. These institutions have very distorted incentives, just as the zombies do in the horror movies. They’re looking for things that even might have negative present value but have a possibility of producing good results. It’s a long shot bet to plug a hole in their balance sheet.

The trouble with the zombies is that they ruin the market for everyone else. They’re not looking for solid investments but something that has a chance of a big payoff. They’re willing to pay more for deposits or funding generally than other institutions, so they spread “zombieness.” They make other institutions have trouble earning a living.

Todd: It is the dead feeding on the living.

A good example is GMAC Ally Bank offering market-leading rates on CDs even though they’re broke.

There is much more in the interview.

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