The Real Story of "Zombie Banks"

You've heard the phrase "zombie banks".

The guy who coined that phrase - Ed Kane, professor of finance at Boston College, past president of the American Finance Association, and co-founder of the Shadow Financial Regulatory Committee - explained in an interview in June what that term really means:

Kane: Another point is that these so-called "hard-to-price assets" have much more value to "zombie banks" than to anyone else, which is why there is no liquidity in that market. The deeply insolvent institutions want what everyone else calls "toxic assets" because it gives them a chance to climb back if the economy recovers well into solvency.

[Senior Morningstar equity analyst, and former Chicago Federal Reserve economist William] Bergman: Ed, you coined the term "zombie banks" in the S&L crisis. What inspired you?

Kane: It was just an attempt to make clear to people the dangers of keeping an institution that was deeply insolvent alive, or at least walking. The notion of the zombie is that it would be put in its grave by its creditors if it weren't for the black magic of government credit support guarantees and loans. These institutions have very distorted incentives, just as the zombies do in the horror movies. They're looking for things that even might have negative present value but have a possibility of producing good results. It's a long shot bet to plug a hole in their balance sheet.

The trouble with the zombies is that they ruin the market for everyone else. They're not looking for solid investments but something that has a chance of a big payoff. They're willing to pay more for deposits or funding generally than other institutions, so they spread "zombieness." They make other institutions have trouble earning a living.

Not only have the Bush and Obama administrations kept the zombie banks out of the grave with bailouts, guarantees and loans, letting them keep their toxic assets off their balance sheets in structured investment vehicles, and other shenanigans, but they have made actually allowed them to become bigger than ever.