Walter Bagehot and zombie banks

As part of my blueprint for saving the financial system, I have said that banks should be required to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

One of the reasons for requiring ultra transparency is so market participants could figure out which banks are solvent and which are not.

Of equal importance, market participants could also figure out which of the insolvent banks has a franchise that is capable of generating over time the earnings to return to solvency and a positive book capital balance and which do not.  The insolvent banks in the latter category are candidates for closure.

By approaching the issue of franchise capability this way, I was able to adhere to Walter Bagehot's maximum

any aid to a present bad Bank is the surest mode of preventing the establishment of a future good Bank.

Under the blueprint, the definition of a present bad bank is one that is insolvent and does not have a franchise that is capable of generating the earnings to return to solvency.

As part of the blueprint for saving the financial system, banks have a role as a safety valve between the excesses in the financial markets and the real economy.

Specifically, banks act as a circuit breaker by recognizing the losses on the excesses in the financial markets today and rebuilding their book capital by retaining future profits.

Before and after the losses are recognized, the present bad banks fit the definition of a "zombie" bank as used by NakedCapitalism and others:

[A zombie bank is] a financial institution that has an economic net worth less than zero but continues to operate because its ability to repay its debts is shored up by implicit or explicit government credit support.

The zombie banks are the banks that the market would identify as needing to be closed.