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Fail Early or Don’t Fail at All
Posted by: Lance on Sunday, August 03, 2008


On tonights podcast at QandO, I called in at McQ's request to discuss the economy. One of the things we discussed was the likelihood of our government continuing to bail out our financial institutions. For a number of reasons that will be problematic.

Of interest is how many institutions are likely to fail?

One way to look at that is to see what the market is implying. Weighted by assets, right now the market is pricing in about a 4% failure rate for just the next six months. That would be far above the S&L crisis' peak, and over its full term it amounted to failures of 17% of total assets. The assets which would need to be absorbed....575 billion. How much capital would that require to absorb them....50 to 80 billion. There is only about half that available from other institutions to take them over. Of that, nearly half is in small institutions which will be of little help. As loans continue to go bad that capital is likely insufficient to cover their own losses. This implies much more raising of capital, and who is going to give it to them? Most people who were willing have already ponied up. JP Morgan and the Fed already took on Bear Stearns. Whose balance sheet is available?

The losers in this? Taxpayers and bondholders. Having just taken on Fannie and Freddie, and guaranteed their bondholders, I assume bondholders will have to start taking hits. The lesson might be, if you are going to fail, fail early and fail spectacularly!
 
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