'Real Water' May Be a Drop in the Bucket

During the earlier phases of the Japanese financial crisis in the 1990s, numerous supplemental budgets were issued. A concept arose called "real water" to identify what was real new spending and what wasn't. I find this concept helpful now.

To get a rough sense of how much the banking crisis will cost, we used a study by a couple of IMF economists. Acknowledging great variance, they found that the average banking crisis cost about 16% of GDP. 16% of the combined GDP of the U.S., U.K. and eurozone is about $4.5 trillion, which is roughly the size of Japan's economy, the world's second largest. This exercise is meant to be a thought experiment and not necessarily the full cost by any means. The fact that house prices are still falling in the U.S. and U.K., for example, means that the extent of the bad assets in the mortgage-backed securities space is still not fully known.

In any event, how much real water have the U.S., U.K. and eurozone announced? In the U.S., we would count the $150 billion stimulus plan of earlier this year, and about $250 billion to $300 billion of TARP money that has been injected into the banks directly. Most of the Fed's operations seem largely to be asset swaps, but there may be some monies, like the AIG program and the assets acquired from Bear Stearns, that also should be counted as real water. In the U.K., the $23 billion of tax cuts are real water, and the $116 billion of bank recap counts.

The real water from the eurozone is a bit more difficult to assess. The Benelux countries -- Belgium, the Netherlands and Luxembourg -- have injected money into six troubled banks. France has spent about $13 billion recapitalizing banks. Spain has announced a $48 billion stimulus package and $63 billion fund to buy banks' bad assets. Germany has announced $25 billion in tax breaks for new spending on autos, capital equipment and infrastructure, and $101 billion for new capital for banks.

All told, this is around $1 trillion. We did not count asset swaps or guarantee. There were some countries in the eurozone for which we could not readily find figures. There is also the fact that the Fed's balance sheet has more than doubled, and some of this should count toward the real water as well.

If these estimates are a bit conservative for the real water, considering this to be just an average banking crisis may also understate the nature of the problem. The bottom line is that policymakers generally may still be underestimating the magnitude of the problem and the cost to fix it.

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Marc Chandler has been covering the global capital markets in one fashion or another for nearly 20 years, working at economic consulting firms and global investment banks. Currently, he is the chief foreign exchange strategist at Brown Brothers Harriman. Recently, Chandler was the chief currency strategist for HSBC Bank USA. He is a prolific writer and speaker and appears regularly on CNBC. In addition to being quoted in the financial press, Chandler is often a guest writer for the Financial Times. He also teaches at New York University, where he is an associate professor in the School of Continuing and Professional Studies. While Chandler cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.