If you read this blog and listen to Planet Money, you may have had enough of this topic, but Calculated Risk pitched in with two posts on liquidity and solvency crises, complete with graphical balance sheet illustrations. He does a better job than I have of conceptually illustrating the workings of the various bank bailout plans that have been offered.
This is his assessment of the current strategy:
The Geithner approach is to keep injecting capital into the banks to cover the losses. This is known as the “Zombie” bank approach. . . .
Although the bank is balance sheet insolvent, the bank will never be business insolvent [unable to pay its debts as they come due] because the government will continue to provide money to cover losses.
If only a small percentage of financial assets are held by zombie banks, then this approach will probably work. These banks will be crippled, but the other banks can meet the financing needs of the economy.
I should note that CR does not say the entire banking system is insolvent, or that any banks in particular are insolvent.
The posts are from late April but I missed them, probably because they were on my birthday.
Originally published at Baseline Scenario and reproduced here with the author’s permission.
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