Jeremy Warner: Time to stop talking down banking assets

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Outlook: If every house on your street was put up for sale all at the same time and it was announced that they must all be sold within the week, you wouldn't expect to get much for your property. OK, so you might get lucky and a property developer with cash (not that common these days) comes along to buy the lot. But even then, he would expect a bargain and you would only get a fraction of your house's long-term value.

Nobody in their right mind would think of participating in such a firesale unless they absolutely had to, yet this is the sort of nonsense approach to valuation which is now routinely applied by analysts, accountants, regulators and financial commentators to bank and insurance balance sheets.

In nearly all serious recessions, most banks become technically insolvent, in the sense that, were you to try to liquidate their assets or otherwise refinance them, there would be very little chance that the proceeds would be enough to cover liabilities. Yet in previous recessions, these uncomfortable truths have tended to be brushed under the carpet or otherwise covered up. In time, the economy recovers and the assets regain their value.

One of the problems with this particular banking crisis is that securitisation has made the process of debt destruction much more transparent than in previous downturns. Many forms of debt can now be traded, and in markets such as these, this tends to give a very unflattering view of their underlying value.

You'd get virtually nothing for most collateralised debt obligations right now, even though once disentangled and held to maturity they might be worth a reasonable amount. The same with bad-debt recognition on commercial lending. Some of this lending will eventually turn out to be fine, even though it is being written down right now to reflect the higher risks of default.

The crisis in banking and the economy is being made very much worse by ever more alarmist predictions of what all these assets, or loans, might be worth. According to one report yesterday, the City expects more than half the £325bn of loans being insured by Royal Bank of Scotland under the asset protection scheme eventually to be fully written off, making the taxpayer potentially liable for around £130bn of losses.

Even assuming RBS is insuring only its most toxic credit risks, this strikes me as deeply unlikely. Accept, of course, that the more people there are who believe it, the more likely it becomes. Hedge and vulture funds that prey on distress debt can hardly believe their luck that they have a financial press so hell-bent on driving us all into the next Great Depression.

Here's another instance of the same sort of thing. According to someone I was talking to in the City the other day, were HSBC to adopt a "realistic" approach to its remaining exposure to US sub-prime mortgages, it would need to write off tens of billions of dollars more than it already has. Oh goodie. That would mean that even HSBC, thought of as one of the more solvent banks around, would be in serious trouble, and the taxpayer would have to bail them out too along with everyone else.

The negativity you get at the bottom of a bear market is the mirror image of the irrational exuberance seen at the top of a bull market, only a good sight more dangerous because it is people's jobs and savings that the doom-mongers of the press, TV and hedge funds are playing with. Bank-trashing is all the rage.

If everyone could calm down and adopt a more measured view of the likely long-term damage to bank balance sheets, much of the crisis would be over. The more we worry about the state of the banks, the worse the situation becomes. A mass fire-sale of assets, which eventually becomes inevitable if everyone keeps on talking down values in this way, is just what we don't need and what the Government's insurance scheme is designed to prevent. Let's hope it works.

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