Last month, two little-known economists touched off a fire storm by presenting an extremely pessimistic view of the Bank Insurance Fund's prospects.
The authors, Roger J. Vaughan and Edward W. Hill, concluded that more than 1,000 banks would currently be insolvent under market-value accounting and that, under a worstcase scenario, rescuing weak banks could cost the BIF $95 billion, far more than other estimates.
The study, called "Banking on the Brink" and published by Washington Post Company Briefing Books, was given widespread notice in the media, with heavy emphasis on the worst scenario. Regulators and bankers harshly criticized the research, saying it was riddled with errors and misunderstandings. The authors, in turn, staunchly defended their work.
Following are excerpts from the debate. First come criticisms of the study from three parties: the American Bankers Association, the Federal Deposit Insurance Corp., and Bert Ely, a bank consultant. Then there is a response from the authors.
The conclusion of the book while creating eye-catching headlines, have no analytical basis and are out of step with the improving health of the banking industry.
Let's look at the key assumption that led to the authors' conclusions.
Writedown of Assets
In their "optimistic" scenario, Mr. Vaughan and Mr. Hill took the following sharp writedowns on every bank's delinquent and real estate loans (at December 1991):
* All foreclosed property (OREO) and all nonaccruing loans were assumed to be worth only 20 cents per dollar of book value.
* All 90-day delinquent loans and restructured real estate loans were assumed to be worth only 40 cents on the dollar.
In a "pessimistic" forecast, all construction and development loans were assumed to be worth 60 cents on the dollar, and all commercial real estate loans were assumed to be worth 80 cents on the dollar.
The authors provide no analytical or historical data supporting these assumptions, which are certainly out of line with banks' actual chargeoff experience.
For example, according to the FDIC, the 1991 loss rate on construction and development loans was only 3%, and [it was] 1.2% on commercial real estate loans -- compared with the authors' 40% and 20% rates, respectively. Even for banks in the economically troubled Northeast, the net loss rate of4.5% and 1.9%, respectively, were not in the ball park of the authors' figures.
Moreover, the loss rates used by Mr. Vaughan and Mr. Hill are well beyond even losses in liquidation for problem loans.
The writedowns rates confuse default rates with actual loss rates, ignoring the effect of recoveries in defaults. In discounting repossessed property 80% the authors overlooked the fact that these properties have already been written down to fair market value.
In the words of Karen Shaw, a well-known industry expert, this approach "clearly presumes that banks will burn down whatever may be standing on the OREO and seek to recover a little something for the scorched earth left behind."
In addition, the authors falsely assumed that banks report loan balances net of nonperforming loans. Thus, when they discounted all nonresidential real estate loans and also discounted all nonperforming loans, they were discounting the nonperforming part of the non-residential loans twice. This double discounting resulted in more than $9 billion of extra writedowns for the industry.
Forecast of Failures
Mr. Vaughan and Mr. Hall used the deep writedowns on all banks' reserves and capital to project bank failures and losses for the Bank Insurance Fund. Banks whose capital would be impaired by the writedowns were assumed to be vulnerable to failure. Again, the assumptions used to project failures and failure costs are insupportable and appear to overinflate the projections.
Take the forecast of blank failures, for example. The authors used, in part, the FDIC's forecast of bank failures for 1991 and 1992. But the actual experience for these years has been significantly less than forecast. In fact, at the current pace, failures will amount to fewer than half the 200 banks with $88 billion of assets forecast by the FDIC for this year.
Moreover, the loss rate on failed-bank assets that Mr. Vaughan and Mr. Hill have used to forecast losses were also significantly higher than the FDIC's recent experience.
Extreme and unsubstantiated assumptions lead to extreme and incorrect conclusions. In fact, the assumptions used in the study would result in predictions of large numbers of bank failures at any time in the history of banking.
Based on their exaggerated assumptions, Mr. Vaughan and Mr. Hill forecast that the FDIC will have to pay $31 billion to $96 billion for bank failures in 1992 and 1993. In comparison, the most recent forecast by the FDIC is that bank failures will cost of $17.4 billion through next year -- and the slower-than-expected pace of bank failures suggests this forecast may be too high.
Current Banking Conditions
The authors' conclusions, which rely on 1991 data, certainly do not square with the strong performance of the banking industry this year. Improving asset quality, along with increasing net interest margins, have helped banks earn record profits in each of the first two quarters of this year.
Profits for the first half of 1992 were a record $15.7 billion and will likely eclipse the previously full-year earnings record of $25 billion set in 1988, according to the FDIC. The average return on assets in the second quarter, 0.94% was the highest level since banks began reporting quarterly income in 1983.
The strong earnings have allowed banks to strengthen their capital. Equity capital, which has risen steadily since 1989, now exceeds $248 billion -- a record level. Banks added almost $17 billion to capital in the first half of this year, helping to boost the industry's capital ratio to 7.23% -- the highest level since 1966.
The improvements have been not only in the healthiest banks but also in the more troubled banks. The number of banks on the FDIC's "problem bank list" continues to fall, as does the number of undercapitalized banks. According to the FDIC, improvement in asset quality has been felt by "banks of all sizes and in all regions."
One of the study's conclusions is that the core of the problems confronting the FDIC lies in 10 bank holding companies, each with assets exceeding $10 billion at yearend 1991. While these institutions have had problems with asset quality over the last several years, statements about their impending demise are contradicted by recent market developments.
Testing the Hypothesis
Let's look, for example, at how the market has treated the stocks of the banking companies on the authors' list.
The stock price of each institution has risen -- in some cases, rather dramatically -- since the beginning of the year. On average, the companies (excluding one that has already been acquired and another that is foreign-owned) have registered a 72% increase in stock price. During the same 10 months, both the Dow Jones and Standard & Poor's indexes have essentially flat.
This study indicates that market participants do no share the authors' gloomy outlook for those institutions. In fact, the rise in stock prices for the eight institutions is clear confirmation that, in the eyes of thousands of stockholders, there is significant, positive value in the institutions and that they will continue to earn a safe and competitive return.
Equally telling is the fact that several of these institutions have merged or announced plans to merge with healthier institutions without any government assistance. Moreover, several banking organization have raised significant amounts of new capital in the market through issues of common and preferred stock, or investments made by other banking companies.
In addition, several institutions have had the rankings of their debt issues upgraded (or are under consideration for upgradings) by the rating agencies. All these institutions have also taken steps to improve their capital positions by selling assets, selling subsidiaries, and cutting costs. And one of the institutions is owned by a very large foreign corporation whose resource significantly reduce the probability of failure.
There will certainly be bank failures as the industry continues to recover from a very difficult period. But in each of the next few years, the industry will pay $6 billion to $7 billion in premiums to the FDIC to resolve bank failures. Under the more realistic assumptions of losses made by the FDIC and others, this will be more than enough to pay for losses and rebuild the Bank Insurance Fund. In fact, it is increasingly likely that the fund may never need to tap its $30 billion line of credit at the Treasury.
By virtually all measures, the actual performance of the banking industry clearly show that it is getting stronger. The true performance -- while it may not make headlines -- is in sharp contrast to the conclusions of "Banking on the Brink."
Mr. Vaughan and Mr. Hill identify institutions that are at risk by applying discounts to identified problem assets (optimistic scenario) and to commercial real estate portfolios as a whole (pessimistic scenario).
Error 1: The authors double-haircut nonperforming commercial real estate loans in the pessimistic scenario. As a result, some nonperforming commercial real estate loans are discounted by more than 100%. This error has the effect of increasing the "equity deficit" by $9.3 billion.
Error 2: In establishing discount levels for nonperforming loans and commercial real estate loans, the authors use default rates (the proportion of loans that are not fully repaid) rather than actual loss rates. This results in discounts of as much as 10 times the loss rates that banks have actually experienced on commercial real estate loans. The assumed loss rates even exceed loss rates on comparable assets in liquidations of small banks.
Inflated |Problem' Listing
To identify likely failures and their resolution costs, Mr. Vaughan and Mr. Hill use those excessive adjustments to capital to determine "problem" banks.
It should come as no surprise that they find twice as many troubled institutions as the FDIC has identified. They then apply resolution costs as high as 25% of "failed" bank assets to estimate bank failure costs.
Mr. Vaughan and Mr. Hill cite an October 1991 press release by the FDIC as the source of their 25% loss-rate assumption. The release, however, actually forecast a loss rate of 15.4% for bank failures in 1991 through 1993, based on historical loss experience.
If we use the author's assumptions, we find that their assumed cost of resolving "failing" institutions ($95.5 billion) is almost three times as much as they estimate it would cost simply to cover the banks' aggregate equity deficit and increase their capital to 8% of assets ($37.8 billion). This defies logic.
Failure to Note Fund Reserve
In gauging the amount that will be required to recapitalize the Bank Insurance Fund, Mr. Vaughan and Mr. Hill note that the General Accounting Office estimated and fund had a negative balance of $4.6 billion at the end o last year (the audited 1991 fund balance was a negative $7 billion).
The authors fail to realize that the bank fund's balance includes $16.4 billion in reserves for future failures. This amount should have been netted out of their estimated resolution costs.
In sum, Mr. Vaughan and Mr. Hill demonstrate sloppy computational methods, a lack of understanding of bank financial reports, and an unfamiliarity with such basic concepts as default and loss rates.
Their "pessimistic" scenarios are inflated by more than $25 billion in inadvertent double-counting and failure to allow for existing reserves against future liquidation losses. The excessive discounts they arbitrarily apply to bank assets lead to still greater cost inflation.
There is little evidence to suggest that their computations or assumptions were reviewed by knowledgeable parties. Their "study" illustrates that, if you apply deep enough discounts to a company's assets (never mind how you arrive at these discounts), you can cause the company to appear insolvent.
Poking holes in "Banking on the Brink" is like being a kid set free to gorge himself in a candy store -- there are so many goodies, where does one begin?
Space restricts this critique of "Banking on the Brink" to just a few of its tastier errors and blunders. Only a full-length book could do proper justice to demonstrating the totality of Vaughan-Hill's (V-H) substantial ignorance of banking.
Here are four areas where the study doesn't measure up.
Stale data: All analyses in the book are based on yearend 1991 data, though March 1992 data have been publicly available for months. Worse, V-H made no effort to adjust their analyses and conclusions for known events in 1992, such as capital raised by some weak banks and the acquisition of other weak banks by stronger banks.
Ignoring positive trends in 1992 among weaker commercial bank is perhaps why V-H raised their forecast of prospective Bank Insurance Fund losses from their yearend 1991 estimate while the FDIC, Office of Management and Budget, and Congressional Budget Office have trimmed their loss estimates.
Uniform and excessively severe asset haircuts: Although many others have made the same point, I must make it too -- V-H went to an unsubstantiated extreme in haircutting banks' problem assets.
Worse, these haircuts were applied uniformly to all banks regardless of where the bank is headquartered, where the problem asset is located, and the quality of the bank's management.
These uniform haircuts formed the basis by which V-H categorized banks. These categories then formed the basis for their range of estimates as to BIF's future losses in failed banks.
Unrealistically high projections of failed banks and losses in those banks: V-H's erroneous assumptions compound through their tables, leading them to absurd projections as to BIF's future losses in failed banks. Their handiwork reminds me of that old computer saying GIGO (garbage in, garbage out).
Their most optimistic assumption is that two and possibly three of the bank holding companies with more than $10 billion of assets eventually will fail, as will nine or 10 of the bank holding companies with assets of $1 billion to $10 billion. Their most pessimistic forecast almost doubles these failure numbers.
Again being optimistic, V-H project an asset loss rate in these larger banks off 17%, which is almost double the FDIC's loss experience in failed banks with more than $5 billion in assets.
The prompt corrective-action provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 should drive these loss percentages even lower. That would further undercut V-H's loss estimates and bring the BIF's losses in actual bank failures in line with my own projection of $15 billion to $20 billion in banks actually closed during 1992-95.
What do V-H know that the stock market doesn't? The stock market clearly does not buy the V-H assessment that many large bank holding companies will fail, and the market is betting real money.
On Oct. 30, four of the eight publicly traded bank holding companies with more than $10 billion in assets that V-H classified as "problem" companies were selling for more than book value, and all eight were selling for more than they did the day before "Banking on the Brink" was unleashed.
V-H try to explain away high stock prices for troubled banks by arguing that, for large banks, "the longstanding federal policy of arranging mergers prior to failure means that stockholders may not be completely wiped out. As a result, share prices remain positive."
Tell that to the wiped out stockholders of Bank of New England, Southeast Banking Corp., and First City Bancorporation of Texas. One would hope that V-H are put their money where their mouths are by taking large short positions in the banking companies they think will fail.
If anything good can be said about "Banking on the Brink," it is that it will become very clear in a year or two how badly V-H blew it. Wounded by losses on the bank stocks they shorted, perhaps they will then slink away to another field to endeavor in which to demonstrate their forecasting prowess.
The purpose of this brief background memorandum is to give the author's preliminary responses to the most frequent objections, to set straight a few of the mischaracterizations that have appeared in the press, and to rebut a few of the most prominent, but flawed, criticisms of the book. A fuller response will be available in two to three weeks.
This memorandum has two parts. The first discusses a variety of issues related to the way the book discounts commercial real estate values (this has been the source of particular controversy). The second deals with an assortment of more general issues that have been raised by the press and by lobbyists for the banking industry.
Discounting Real Estate
"You discount nonaccruing and past due commercial real estate loans twice."
-- The FDIC
"The assumption that the value of banks' assets will fall uniformly across the nation is mistaken."
-- Bert Ely
"The authors' methods do not take into account that some banks are better at making loans than others."
-- Bert Ely
All three comments are related; all are wrong. Nonaccruing and past due real estate are part of performing real estate in call reports. There is no double counting in the optimistic scenario; discounts are only applied to foreclosed real estate and nonaccruing and past due loans.
Because nonaccruing and past due commercial real estate loans are also included in the performing loan categories (which receive across-the-board discounts), it looks like these loans are being discounted a second time. They are not.
We did not subtract these loans from the performing category. As a result, we were able to treat banks with different track records differently. For example, if all a bank's nonfarm, nonresidential real estate loans are performing, the value of the markdown in 20% reflecting the nationwide deflation in the value of the asset category.
The larger the position of nonperforming loans in the bank's real estate portfolio, the larger the effective discount. (If most commercial real estate loans a bank makes are nonperforming, it makes sense to "hit" its performing loans hard relative to the likelihood that its performing loans will sour). So what looks like double discounting is really just a way to allow for regional and managerial variations.
An economist at the Board of Governors of the Federal Reserve System asked whether we are giving nonaccruing construction and development loans a 120% "haircut." This might seem to be the case if you looked at the model as a loan-by-loan evaluation. But that gets the model wrong.
The model is based on portfolio categories in bank call reports. Therefore, nonaccruing construction and development loans are discounted by 80%.
The baseline discount for performing construction and development loans in the pessimistic scenario is 40% (if no construction and development loans are past due or nonaccruing, the portfolio is written down by 40%).
The larger the proportion of nonperforming loans in the portfolio, the deeper the markdown on the performing loans. If 10% of the loans are in nonaccrual, and none are past due, the effective markdown on the healthy loans in 46%.
"The authors assume foreclosed property will be worth only 20 cents on the dollar, even though the bank has already marked down the property to its appraised value."
-- The ABA
Foreclosed real estate is marked down from book to appraised value when it enters the foreclosed category. The authors took additional markdowns for three reasons:
First, there is little evidence of the connection between the appraised value of foreclosed real estate and its true market value.
Given the jawboning that has taken place this year among the industry, the Treasury Department, and regulators, it is difficult to believe that appraised values have not been held above market values to preserve the capital of particularly weak banks.
Moreover, if foreclosed-property values were equal to true market values, there should be little or no difficulty in selling foreclosed properties on the open market. Yet banks have had extreme difficulty in selling such properties.
Second, recent sales of foreclosed properties have gone badly.
During the period in which we were specifying our model (from June to December 1991), there were few transactions of foreclosed commercial real estate. So we used other sources of information to estimate discounts.
These sources indicated that the market for distressed properties was trading below 50% of original (book) value.
* SNL Securities used a 60% discount in its estimate.
* Press reports indicated that sales of foreclosed real estate were taking two to three years. When they do close, they are selling at 50% of value.
* Mellon's bad bank took three years to sell about $500 million in bad real estate loans, with a 59% discount.
Markdown Trends Persist
More recent information indicates a continuation of the same trends:
* First Chicago is reported to be marking down "bad loans and foreclosed properties" by 46%.
* RTC-owned office complexes eventually sold with a 51% discount.
* In October, the FDIC signed a five-year agreement to absorb up to 80% of any loss on troubled loans taken on by two banks in a takeover of two failed banks. News accounts typified the failed banks as having "too many bad real estate loans."
* On Oct. 23, the Office of the Comptroller of the Currency released data showing that banks are receiving an average of 50 cents on the dollar on the appraised value of foreclosed property.
In addition, the FDIC protected the acquiring banks from "any unforeseen major losses on the troubled loans," according to The Wall Street Journal of Oct. 5.
The third reason for additional markdowns was that the value of troubled real estate to banks is significantly less than its eventually recovery value. So long as they hold on to troubled properties banks must continue to pay depositors and forgo interest-earning opportunities.
If it takes two years to sell troubled real estate and the asset returns 40 cents to 50 cents on the dollar, then the bank must add two years of forgone gross earnings and factor in a risk premium to determine the value of the property to the institution.
Reaching an 80%-90% Discount
In addition, the bank must factor in the costs of clearing title, maintaining the property, and closing on the sale.
Beginning with discounts of 50% of book value, and adding two or three yeas of forgone gross earnings, plus carrying and closing costs, a total discount is reached of 70% to 80% from book values.
A 10% risk premium should be added to this figure for foreclosed properties because the property may not be salable within that time frame and there could be other problems associated with these properties.
This results in a markdown of 80% to 90% of book value, which is roughly equivalent to an 80% markdown from foreclosed property value.
"The authors assume that all good real estate loans -- those that are being paid back on time by borrowers -- are worth only 60% to 80% of their value."
-- The ABA
This is not true.
The markdowns depend on the asset category. The authors mark down all loans at least 90 days past due by 60% from book value; all restructured loans are marked down by 60% from book values; and all loans in nonaccrual, by 80% from book values.
These markdowns reflect the increased default risk and decreasing recovery rates for these loans. We assume that the assets are worth 50 cents on the dollar, that there will be one year of forgone interest earnings, and that the cost of management, legal proceedings, and asset recovery is 3% of book values for past due loans.
Restructured loans have been marked down once, and this justifies using a 60% discount (instead of the 80% discount used for nonaccruing loans).
There are some performing loans in nonaccrual, with loan amounts exceeding the appraised asset value. There are also many nonperforming loans in this category. The markdown used is 80% of book value. This reflects the opportunity cost to the bank, as discussed above. The markdown is not as severe as that applied to foreclosed properties.
Performing real estate loans are marked down differentially, using a 20% markdown as a base. All construction and development loans are marked down by 40%; multifamily housing loans are marked down by 30%; and nonfarm, nonresidential (commercial real estate) loans are marked down from a base of 20%. These discounts reflect nationwide deflation in asset values.
"The authors use an average loss figure 50% higher than the FDIC's actual experience."
-- The ABA
False. The loss rates used in the study came from reports published by the FDIC, GAO, and the Congressional Budget Office up to December 1991, as well as the work of Barth, Brumbaugh, and Litan.
The rationale for the loss rates used is documented in Appendix A of "Banking on the Brink."
"The authors make judgments about banks without first having information about bank management, individual loans, and other critical factors."
-- Bert Ely
Throughout the book, the authors stress the overwhelming importance of management. That's why the appendices list the profits of banks -- as well as their capital positions -- to reflect how well they are being managed. That's also why the Bank of America looks so good, despite being listed as being "weakly capitalized."
"The projections of the health of the industry contained in the book are totally unfounded and completely out of step with the reality of the current banking industry condition."
-- The ABA
"Banking on the Brink" states that at yearend 1991 there were 1,150 "problem" banks in the United States and 262 "problem" holding companies.
The FDIC, using yearend results, had 997 banks on its problem list. (It does not publish information on holding companies).
"Banking on the Brink" does indicate that there are another 355 "vulnerable" banks and 69 "vulnerable" holding companies. These are institutions with weak capital bases that may have difficulty withstanding a prolonged recession in commercial real estate markets.
Comparing the numbers on the two "problem" lists does not indicate a large difference. The list in our book contains significantly more assets than the FDIC's list - indicating that larger banks are on the list. But we go beyond the FDIC in discussing the next tier of institutions - those that are vulnerable.
"What do the authors know that the stock market doesn't know?"
-- Bert Ely
The stocks of bad banks are being pumped by the FDIC's policy of bailing out the industry's losers before they hit bottom.
The Office of the Comptroller of the Currency, in a statement released Oct. 23, demonstrates a clear misunderstanding of our methods with regard to the pessimistic-case assumptions in "Banking on the Brink." The OCC thought we were using loss rates (this assumes that the loan will default and includes the recovery on the defaulted loan).
Yet we clearly state that these are not loss rates. Instead, we estimated the market value of the bank's assets (this is how much the bank could fetch if the asset were sold on the open market today). Our market-value estimates are consistent with the true condition of commercial real estate in today's market.
As for the complaints of the FDIC, its Oct. 23 statement demonstrates that the agency didn't even read "Banking on the Brink" carefully. For example, it charges that we cited an FDIC press release as the source for our pessimistic 25% loss-rate assumption. In fact, we cited the FDIC accurately as the source for an optimistic estimate of 17%, and the work of noted banking experts Jim Barth, Robert Litan, and Dan Brumbaugh for the 25% figure.
We also don't take the FDIC's supposed $16.4 billion reserve fund for future failures seriously because the FDIC has not reported on its contingent liabilities or on the possibility that banks acquiring failed institutions will put their bad loans back to the FDIC over the next five years.
Support at Senate Hearings
We note that, at the special Senate Banking Committee hearing held Oct. 26, the damage estimates and the threat of a taxpayer bailout raised in "Banking on the Brink" were endorsed by Professor Edward J. Kane of Boston College, economist and banking expert R. Dan Brumbaugh, and financial writer Martin Mayer.
Indeed, our estimates are not out of line with others made by truly independent banking experts.
Mr. Kane, who accurately foretold the savings and loan fiasco, predicted in his Senate testimony that a taxpayer bailout is certain to occur and the problem is far worse that federal regulators acknowledge. He questioned the probity of anyone who would argue otherwise.
Mr. Brumbaugh also projected that a taxpayer bailout is almost inevitable, saying that the believes "the BIF and taxpayers are in continuing substantial jeopardy." And Mr. Mayer drew attention to the alarming role played by the FDIC's accounting practices in deflecting attention from the true magnitude of the problem.
These are old data, from the end of 1991, and therefore don't reflect what is currently going on. After all, the industry has had two consecutive quarters of record profits, and it looks as though it is on its way to a third.
-- From press comments
"Banks earned record profits for the second consecutive quarter. . . . Ninety-four percent of all commercial banks were profitable as of mid-year 1992."
-- The ABA
These recent profits are the result of low interest rates, securities gains, and wide spreads between what depositors are paid (which are tied to short-term interest rates) and the interest earnings on securities and performing loans (which are tied to long-term interest rates).
Most of these profits are earned by healthy banks. Bad banks are still bleeding to death.
In addition, many of these favorable trends will ultimately reverse: The difference between long- and short-term interest rates will narrow due to pressures to fund the deficit as well as international differences in interest rates.
Large spreads will attract non-bank competitors into product markets, and these spreads will erode. Healthy banks will use their competitive advantages and assault the market positions of weak banks.
Meanwhile, the core of the banking problem - commercial real estate loans - will remain.
Greenspan's View on Assets
Alan Greenspan, chairman of the Federal Reserve Board, was reported in a recent issue of the Financial Times to have told a Japanese audience that the current worldwide recession is the worst since 1945 and that the principal cause is a plunge in asset prices. This is exactly our point.
Troubled banks will be stuck with their bad assets for years. These banks do not have the financial strength to write down those assets and clean up their balance sheets.
"Banking on the Brink" repeatedly stresses that the banking industry is profitable. It makes the point time and again that there are two banking industries, not one. There is reverse triage under way, led from Washington, that is bleeding America's best banks to keep the weak alive.
There are 10,000 healthy banks and 922 extremely healthy holding companies. In Chapter 4, our book documents how the list of the world's most profitable large banks is dominated by American institutions.
Talking in terms of industrywide averages and using numbers from banks rather than from holding companies hides the dimensions of the problems facing weak institutions. And more importantly, it hides the challenges facing taxpayers.
The authors' analysis says that taking from the rich and giving to the poor hurts not only healthy banks but also the economy. And it delays the inevitable development of a more balanced, efficient financial system.
"Two economists have concluded that about 2,000 U.S. banks are on the brink of collapse and that bailing them out today would cost the government $95 billion."
Again, this is not what we said.
"Banking on the Brink" states (p. 128): "Total BIF costs from all three categories of banks (insolvent, problem, and vulnerable) range from $37.5 billion to $95.5 billion (and from $31.3 billion to $80.1 billion for holding companies, allowing for cross-guarantees). The most reasonable projections range from $45.3 billion to $58.8 billion [emphasis added].
"Our |most likely' range of estimates is close to Barth and Litan's higher estimates and similar to Kane's estimates. We are somewhat higher than CBO and much higher than Ely. The Office of Management and Budget's estimates are close to our higher estimates.
"OMB's estimates is consistent with a 39% failure rate of assets in problem banks. This failure rate would be possible only if FDIC abandoned its policy of |too big to liquidate.'"
Our book summarizes our projection in the preface (p. viii): "Had Congress moved swiftly to correct the problem in 1991, the public cost to the Bank Insurance Fund and the taxpayer would have totaled more than $50 billion. As this is being written, in August 1992, it would cost more - in our judgment, perhaps $75 billion."
Some commentators have disagreed with our typifying funds in the BIF as part of the public cost because the funds come from the banking industry. BIF, however, is a public agency, and its fees are an industry-specific tax.
"Banking on the Brink" does not state that any particular bank or number of banks or holding companies will fail. It notes those institutions that are in greatest danger of failing by labeling them as "problem." Its "most likely" projection is that 23% to 25% of book assets of problem banks will fail and that 4% of the book assets of vulnerable banks will fail.
The estimates our book are on the high side of the range of most experts, and the book is quite open about the estimates provided by others. The estimates
V that are based on cross-guarantees are consistent with those of Barth and Litan and Kane, and close to those of the CBO, though a different methodology is provided.
The authors are unrealistically harsh in marking to market.
-- Several banking analysts
The authors' methods deduct 5% to 10% of the assets of the nation's most troubled banks. When the FDIC takes over failed banks, it finds that assets are worth, on average, 18% less than book value. So by this standard, the authors are conservative.
The authors say that they are not predicting the failure of individual banks, but how does that differ from calling a bank "problem" or "vulnerable."
-- From press comments
Whether an individual bank fails depends on the actions of bank management and federal regulators. It does not depend at all of our description of their capital position. Closing banks is inherently a political process -- not an economic process of a business decision