September 1, 2008 | posted by Michael Baxter in Banking |

The IMF forecast total losses from the Credit crunch will top $1 trillion, and now we have just passed the halfway mark. But then again, don’t be surprised if the IMF ups its forecast soon – with house prices crashing like they are, it seems many more debts will go unpaid yet.

But here is a stat to really make you sit up. According to the FT, so far Merrill Lynch’s losses have come in at $14bn, while write downs are at $52bn. To put that in perspective, since the bank was first listed in 1971 total inflation adjusted profits total just $56bn, calculates the FT. In other words, losses from the credit crunch so far amount to no less than 25 per cent of cumulative profits.

It’s really quite stunning, and presumably other US banks are suffering just as much.

It is no wonder that Kenneth Rogoff, former chief economist at the IMF, has said that one large US bank will fail in months. In fact, Mr Rogoff put it quite colourfully: “We’re going to see a whopper, we’re going to see a big one, one of the big investment banks or big banks.”

The thing is, what should the authorities do?

And come to that, what should the authorities do about crashing house prices?

Opinion seems to be split down the middle. Some say that every time a bank is rescued, inflationary pressures are being built up for the future. Then they add, how can the banks learn their lessons if they are not allowed to fail.

Then, closer to home – literally closer to home, the call is going out for the government to rescue house prices. It is strange isn’t it, how when prices were rising too fast, any government that tried to put a stop to it would have been lambasted by the property industry for interfering with the market. Now, all the industry wants is for the government to do something – even if that something involves throwing taxpayers’ money at trying to solve a problem that can only be solved by letting prices fall to a realistic level. (Can you imagine the stink if the government tried to subsidise BP and Shell if the price of oil suddenly started to fall?)

Then again, if banks do fail, and the government refused to pick up the pieces, the result could be years and years of negative growth, or to use the ‘d’ word – depression.

The argument that rescuing banks could lead to inflation, ignores the deflationary effect of doing nothing. So far, more than $500bn has been sucked out of the system. Some, but not all, has been replaced through new money. The deflationary dangers are very serious – talk that rescuing banks could lead to inflation is way wide of the mark.