Friday, October 28, 2011

What Does The Balance Sheet Of Insolvent Banks Look Like and Options To Restore Them

Uwe Reinhardt is an economics professor at Princeton and one of our leading experts on healthcare economics. I am always impressed by his ability to clearly explain economic concepts. I also respect him for his ability to explain economics to his students at Princeton in a manner that often ruffles the feathers of their wealthy parents who cherish a more conservative description of economic concepts.

In this article he does a great job of describing a banks balance sheet and explaining the difference between a liquidity problem that exists when banks are short of cash and insolvency that exists when banks do not have adequate capital to cover their liabilities. Since the European recovery plan requires banks to write down the value of their holdings of Greek debt, many of the banks will need to increase their level of capital in order to remain solvent. The method by which the banks will recapitalize has not been defined. They may be able to raise capital from private investors or they may require a capital infusion from nation states within the union.

In any case, this article will give everyone a better understanding of a bank's balance sheet. In a subsequent article, he will present some of the options that might be used to recapitalize the banks.

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