What Happened

So how did we get here?

When banks take losses on a lot of loans, it cuts into their capital—the accumulated earnings that forms their surplus of loans minus deposits. If it loses enough capital, the bank may be considered undercapitalized.

If this happens, the quickest way out is for it to shrink its asset size. That’s the easiest way for the percentage of the bank’s capital to grow. This is why a lot of banks aren’t anxious to make new loans, or even to renew existing ones. Their capital has fallen so they have to shrink. Multiply this by a couple thousand banks and you have a national credit crunch.

If we don’t want the banks to shrink, we have to help them raise more capital. But if this comes with excessive penalties, I think the banks will say no thanks, we can just shrink. Our duty is to our shareholders. And you can’t fault them, even if the result is negative for the economy.

That’s why any federal capital assistance can’t afford to be vindictive. As I’ve said before, payback is not a policy.

Douglas R. Tengdin, CFA
Chief Investment Officer
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By | 2014-09-04T14:00:45+00:00 October 9th, 2008|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. –
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