Thursday, 9 July 2009

Another beautiful chart

This financial crisis has produced some wonderful charts. Recent numbers either dive to the depths or reach for the sky.

I particularly like this one. It illustrates loan loss reserves of US banks. The reserves are expressed in terms of total loans.

The chart tells us two things. During the boom years, banks ran down the spare cash they put away to cover bad loans. Just before the crisis they were putting away barely one percent of their total loans.

Then, along comes the crisis and banks suddenly realise that they don't have enough reserves. Everything goes into reverse, and banks start accumulating reserves like crazy.

I reckon this number can only go higher. Soon, it will exceed the previous highs in the late 1980s, and hit an all time high.


mike said...

The chart is interesting but would be more useful if you could also draw another line showing the actual percentage of loans that actually went bad. This time around I bet it's a lot worse.

Mike Dimmick said...

In the US, banks are required to retain a certain percentage of deposits of particular classes. From memory, they must reserve 10% of regular instant-access savings deposits, but not of Certificates of Deposit or notification deposits, which have no reserve requirement beyond covering the supposed risk (see below). This could simply reflect movement by customers away from riskier no-reserve deposits and 'investments' and into safer regular savings.

In the UK banks are not required to retain any fixed ratio, only to keep enough assets to cover the estimated risk. The problem they've had is that the risk calculations were bollocks. You may also hear 'mark to market' mentioned - here the asset value supposedly covering the risk was rated at the market price of the asset. The market crash of CDOs forced the book value of the assets down, causing even the optimistic risk calculation to indicate that the bank was overexposed. Result, they had to stop lending and call in some outstanding loans.

In the US, they have now been allowed to suspend mark-to-market for 'troubled' assets, which allows them to claim that they are worth more and thereby within the risk assessment. However, that's nonsense: the value of the asset is what they can get for it if they need to sell it off quickly, or the loan amount they can secure with it, and the only correct answer to that is the market price.