This is a behind-the-scenes explanation of what happened with ZOMBIE (insolvent) banks in 1982. The situation is similar today, as many banks are carrying bad loans, which only with time will they be able to write off and thus ‘heal’ their unhealthy balance sheets. This is made possible by the changing of FASB mark-to-market rules at the beginning of the crisis, and by a nearly Zero % interest rate policy from the current FED. –any ‘black swan’ event will add to their problems.
Koo worked on the syndicated loan desk at the New York FED in 1982, when the Latin American debt crisis effectively blew up the American banking sector. Here’s what happened, according to Koo…
That was about the worst possible banking crisis in modern
US history. Our conclusion was that seven out of eight
US money centre banks were actually underwater… It was so bad because everyone down from
Mexico to the southern tip of
Chile went bankrupt... Paul Volcker, the chairman of the Fed, called central banks and ministries of finance all around the world on that critical Friday in August 1982… Later a Bank of Japan official who took that telephone call from Paul Volcker told me the exact words he used.
He said: “You better give me Governor Maekawa right away. If you don’t give me Governor Maekawa, there might not be any
US banks left on Monday.”
What we at the New York Fed had to do was arrange for all the foreign banks to keep credit lines open to the American banks, knowing full well that all these American banks were actually bankrupt. And we also could not tell the outside world about the situation because if you go out and say “American banks are bankrupt” – the next day they will be bankrupt.
And so we had to come up with these stories that “Well, there are some Latin American problems, but they’re all good debt, not bad debt,” and we had to lengthen the clean-up process; it was a very difficult period for US central bankers and bank regulators in general… So by keeping this myth going, that everything is fine… we had to do that for a very long time… the whole process took about 13 years...
