Banks Are Expecting Loan Trouble

We talked yesterday about ways in which banks are pretending that 2020 isn’t happening. For instance, banks have made loans to companies, and those loans have covenants requiring those companies to have at least a certain amount of income each quarter, and for the next few quarters of 2020 banks are saying things like “ehh don’t worry about having that much income” or “we’ll just use your 2019 income and pretend 2020 is the same.” The basic theory is that 2020 is terrible, but maybe things will get better, and the best way to handle it is to just pretend things are fine and hope that eventually they are. Taking reality into account all at once could cause further disasters: If you insist that every borrower have a lot of income in 2020, they will not, and you will foreclose on all of their loans and cause a cascading series of defaults, and you’ll lose a lot of money. If instead you pretend that everything is fine, a lot of those borrowers might actually recover and repay their loans on time, and you will avoid disaster just by ignoring it.

This is not a crazy theory, though that doesn’t mean it will definitely work.