So why might most of the banks come out of this okay, without having the government nationalize them? One reason is that since most of these banks have slashed their dividends to pennies, every dollar they earn essentially goes to recapitalization, instead of going out the door to shareholders. And with the government looking over their shoulders, it's also likely that the banks are going to be running tighter ships, so their expenses may be down as well. That's why Buffett said on Tuesday: "I mean, the right prescription with most of the banks is just let them pay very little in the way of dividends and build up capital for awhile, and they will build up a lot of capital."
The interesting thing about this prescription is that, in some ways, it's precisely how the U.S. got out of its last big banking crisis, which happened during the recession of 1990-1991. While it hasn't been talked about very much, during that recession most of the big moneycenter banks were, by today's standards, insolvent -- arguably more insolvent, in fact, than the big banks are today. They were not nationalized or put into receivership. Instead, after the Fed slashed interest rates, the banks hunkered down, cut back on risky loans, and allowed the wider spreads to work their magic, and over time earned their way out of insolvency. Today's crisis is different in some important respects (in the earlier crisis, banks were able to make easy profits by investing in government debt, while today the profits on such an investment would be quite small). And there are some banks today which may be carrying so many bad loans that even their increased earnings power won't save them. At the very least, though, history suggests that Buffett has not gone around the bend, and that it's a mistake to think that nationalization is the only plausible solution to our current banking crisis.
Posted by Steve S at 7:20 PM
The New Yorker seems a bit amazed: