The cost of purging bad bank debts from the world financial system is rising and it looks increasingly likely taxpayers will have to foot a large portion of a bill that could run into the trillions of dollars.
The problem is two-fold: first there is the matter of either removing or limiting the losses from loans that won't be repaid; then the banks must raise more money in order to resume normal lending. Both are expensive.
The International Monetary Fund estimated last week that U.S. and European banks would need to raise $500 billion to cover losses that are expected to pile up this year and next. Don't count on private investors stepping up to fill that void because they have been badly burned by investing in banks.
The IMF now thinks losses from U.S.-originated loans may reach $2.2 trillion, well above its October estimate of $1.4 trillion.
The United States, Britain and Germany are all considering ways to clean up the banks. But as evidence mounts that the global economy is suffering the worst synchronized slump in decades, pressure is growing for swifter action.
"What's essential is to reduce the uncertainty related to the value of the assets" on banks' books, IMF Chief Economist Olivier Blanchard told Reuters last week.
"I don't think we should be dogmatic about the way to do things. The important thing is to do it."
As early as this week, U.S. President Barack Obama and his economic advisers may begin to flesh out their plans for tackling the twin problems of cleaning up debt and recapitalizing banks.
They may lay out a range of options tailored to fit the needs of different banks, including setting up a so-called "bad bank" that would buy assets from banks and offering guarantees that would cap losses at a certain threshold.
Once the bad assets are stripped, it should be easier for banks to attract private money, which would reduce the amount of public money needed to get credit flowing normally.
Economists have estimated that it could cost $4 trillion to purchase U.S. mortgage and other consumer debt. The Obama administration, mindful of the political risk in asking for a huge sum of money when taxpayers are already furious over last fall's $700 billion financial bailout, is trying to figure out how to minimize the public cost.
Douglas Elliott, a fellow at the Brookings Institution and formerly an investment banker with JPMorgan, said there was no perfect answer because each path has its pitfalls.
"Anybody who tells you they know the right answer here has either deluded themselves or is lying," he said. "The financial system is in bad shape and consequently none of the options is a good option. We are looking for the least bad solution."
RESTORING CONFIDENCE
Banking troubles are not limited to U.S. firms. Loans to euro zone companies and households fell last month for the first time since records began in 1998, a symptom of banks' credit concerns and capital strains.
Britain has already announced its own effort to cope with bad debts through a system that essentially provides an insurance policy against future losses.
Germany was considering setting up a "bad bank" to warehouse Hypo Real Estate Holding's problem loans and other assets, according to sources with knowledge of the matter.
The concern among many investors is that none of the programs launched to date — on either side of the Atlantic — goes far enough to stop the cycle of bad debts constricting lending and weakening the economy.
That will no doubt be on the minds of the Bank of England and European Central Bank when they meet on Thursday to set short-term borrowing costs.
Unlike the United States, where the Federal Reserve has already reduced its benchmark interest rate as much as it can, the ECB and BoE still have some room to maneuver, although ECB President Jean-Claude Trichet has dropped strong hints that he intends to hold rates steady in February.
Figures due this week are expected to show that the euro zone manufacturing sector remained firmly in recessionary territory in January, while retail sales fell in December.
On Friday, the closely watched report on U.S. employment is likely to say that 524,000 jobs were lost in January, equal to December's tally.
Until the banks are repaired, there is little hope for sustainable economic recovery in the United States or Europe any time soon.
