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Banks need more capital

What lies behind the credit squeeze is the combination of reduced trust in and decimated capital at financial institutions. People and institutions don't want to deal with anyone unless they have substantial capital to back up their promises,
yet the crisis has depleted capital across the board.
The obvious solution is to put in more capital
Paul Krugman, The New York Review of Books, December 18, 2008

When Sweden experienced a financial crisis in the early 1990s, the government stepped in and provided the banks with additional capital equal to 4 percent of the country's GDP—the equivalent of about $600 billion for the United States today—in return for a partial ownership.

It seems doubtful, however, that this will be enough to turn things around, for at least three reasons.

First, even if the full $700 billion is used for recapitalization (so far only a fraction has been committed), it will still be small, relative to GDP, compared with the Japanese bank bailout—and it's arguable that the severity of the financial crisis in the United States and Europe now rivals that of Japan.

Second, it's still not clear how much of the bailout will reach the components of the shadow banking system — largely unregulated financial organizations including investment banks and hedge funds — that are at the core of the problem.

Third, it's not clear whether banks will be willing to lend out the funds, as opposed to sitting on them (a problem encountered by the New Deal seventy-five years ago).

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“Why didn’t we see this coming?”
“What do you mean ‘we,’ white man?”
Paul Krugman, årets nobelpristagare, New York Times, 27/11 2008

In a guest article, Alan Greenspan says banks will need much thicker capital cushions than they had before the bust
The Economist print edition, December 18th 2008

How much extra capital, both private and sovereign, will investors require of banks and other intermediaries to conclude that they are not at significant risk in holding financial institutions’ deposits or debt, a precondition to solving the crisis?

Government credit has in effect acted as counterparty to a large segment of the financial intermediary system. But for reasons that go beyond the scope of this note, I strongly believe that the use of government credit must be temporary. What, then, will be the source of the new private capital that allows sovereign lending to be withdrawn? Eventually, the most credible source is a partial restoration of the $30 trillion of global stockmarket value wiped out this year, which would enable banks to raise the needed equity. Markets are being suppressed by a degree of fear not experienced since the early 20th century (1907 and 1932 come to mind). Human nature being what it is, we can count on a market reversal, hopefully, within six months to a year.

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En bank får låna ut 10–20 gånger sitt egna kapital.
Förlorar banken en miljard måste den alltså kräva låntagarna på 10–20 miljarder.
Det får konsekvenser i den reala ekonomin.

Tomas Fischer, Fokus 19/12 2008