By Nathan Lewis at Forbes
Following a Greek government default, and possibly before then, Greek banks would likely be both insolvent and unable to make payments to creditors. What should a government do?
A bank becomes “insolvent” when the value of its assets is less than its total liabilities. In time, the bank also becomes “illiquid” – unable to borrow money, and thus make payments – because people don’t like to lend to insolvent entities. Greek banks have been getting by because they have been able to borrow from the European Central Bank, but this may come to an end soon, perhaps in a matter of days.
There are two basic ways to deal with this: one is to increase assets, possibly through a government investment. This is called a “recapitalization,” and when the government is involved, a “bail-out.” Obviously, this takes money — €48 trillion in the case of Greece’s prior government “bail-out” — and often the terms of the investment are so poor that it amounts to a gift to the bankers and their creditors. The other way is to decrease liabilities, which obviously means some pain for the bank’s creditors, including depositors. But, once this accounting adjustment is done – it amounts to a revision of ledgers, and could conceivably be accomplished in a day or two – then the bank can reopen for business, in good financial health. This process is sometimes known as a “bank holiday,” a euphemistic term which shows that, when the financial system is temporarily shut down, there isn’t much to do except spend the day at the park.
Bank insolvency and reorganization – a subset of bankruptcy – is one of those things, like sovereign default itself, which is treated as something conceivable, like a catastrophic earthquake in Los Angeles, but which never actually happens. This is wholly incorrect. The Federal Deposit Insurance Corporation, which oversees this process in the U.S., lists 513 failed banks since the start of 2008.
In the case of these U.S. banks, typically the insured depositors are made whole; uninsured depositors and other creditors take a partial or complete loss; and the assets, liabilities and operations of the banks are sold to some larger bank. The bank quickly reopens, typically under the name of the acquiring bank, but the branches are the same. People with deposits at the bank at the time of its failure then have deposits at the acquiring bank. The process typically costs the FDIC nothing, as insured deposits are well under the value of remaining assets. Ultimately, it amounts to an adjustment of ledgers. (I discussed these topics in greater detail in a series of items in 2008-2011. Also, a whole chapter is devoted to these topics in my book Gold: the Monetary Polaris.)
One of the largest banks to undergo this FDIC resolution process was Washington Mutual, which was closed by the Office of Thrift Supervision in September 2008. At the end of 2007, the bank had assets of $328 billion, deposit liabilities of $188 billion, 2,239 retail branches, and 43,198 employees. The bank was quicklysold to JP Morgan Chase; former Washington Mutual branches reopened with Chase signage, and former Washington Mutual customers became Chase customers.
As of March 2014, the entire Greek banking system had roughly €319 billion of assets among 19 Greek institutions, with 93% of this held by the top four banks. Including also branches of foreign banks, there were 2,688 branches and 45,654 employees.