We recently learned that the U.K. financial institution, RBS, lost $41 billion. We also learned that Citigroup lost $8 billion. How are we to interpret these numbers?
Would you be surprised if it was the reverse, with Citi losing $41b and RBS $8b? Probably not. You see we have no way of assessing the current state of banks. There is very little transparency.
For example, we do know that Citigroup as $300b in assets sitting “off balance sheet”. Who knows what those assets are worth.
We also know that some of these assets are not being marked to market (fair market value) because there is supposedly no bid or extreme lack of liquidity. As a result, we are relying upon the model prices that the bank (rather than independent third party) provide.
In this video blog shot on January 22, 2009, I make two points. First, in order to rebuild confidence in our banking system we need an extraordinary degree of tranparency. Second, the government has no business blowing taxpayers’ money on bailouts of institutions where the government has no idea what the value of the firm is.
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Streaming Video from Duke University
Image courtesy of flickr/Jurek Durczak
This may explain the persistence in the recent crisis to some extent. The risk premium is still high because of the defensive behaviors of financial institutions: they are not sure about the lost of the other ones. It seems the elevated spreads will continue as long as the real damage has not been uncovered and it is known by public.
This may explain the persistence in the recent financial crisis to some extent. The risk premium is still high because of the defensive behaviours of financial institutions: they are not sure about the lost of the other ones. The elevated spreades will continue as long as the real demage has not been uncovered and as long as it is known by public
I have a previous post on the sources of volatility which is related to your comment. In economics lingo, this is considered “uncertainty”. For example, you can look at some specific risk metric for a bank — and call that the “risk”. However, you have no confidence in the numbers that go into the risk metric. This is called “uncertainty”. Investors care about uncertainty and this pushes up risk premia — just as you say. Also see my posting on the Shroud of Citigroup.