Liberal Conversations about Banking

Blaming bankers for government mandates that ruined banking.

One of Mr. Obama's conversational standbys when he's not blaming Mr. Bush is to blame "greedy bankers" for all that ails us.  He occasionally segues over to blaming wealthy corporations who're sitting on "piles of cash" without creating jobs, but "greedy bankers" and "Wall Street financiers" have taken the brunt of his rhetorical excesses.  Presumably his Teleprompter has a hotkey for inserting the phrase.

The New York Times recently chimed in to support his theme, asking, "Mr. Banker, Can You Spare a Dime?"  Their article tries to help Mr. Obama "win the conversation" by telling stories of two credit-worthy small businesses, one of which hadn't found a bank willing to lend despite vigorous growth and another who'd finally find a small bank who would write a check.  The article ended:

Three years ago, the federal government used tens of billions in taxpayer dollars to save the banking system. Now, at this dire economic moment, the country needs the banks to return the favor. Pushing the country’s banks to act more like Sterling Savings Bank, and less like JPMorgan Chase, is something that the president might want to put on his jobs agenda.

The Times is working overtime to help Mr. Obama win his attack on banks.  USA Today chimed in:

Home buyers such as Bob and Janet Zych have fueled the U.S. housing market for decades. ...

They have excellent credit with scores that top 800 ...

But this year, "after faxing a ream of paper" about their finances, they got so fed up applying for a home loan that they simply wrote a check for their new, $85,000 vacation condo in Phoenix.

The joke used to be that to get a loan, you had to prove that you didn't need their money.  The Zynch family had the money to pay cash and they still couldn't get a loan.

Why on earth not?  The Times would have us believe that bankers have lost interest in profiting by lending money.  Has greed gone out of style?

The Times Plays the Other Side

Fortunately, the Times touches on one of the reasons banks can't lend.  In "Fair Lending and Accountability," they argue that banks need more government scrutiny:

Given the discriminatory policies used by lenders before the housing meltdown, the banks and mortgage companies deserve the scrutiny. Borrowers need more protection.

Pricing discrimination — illegally charging minority customers more for loans and other services than similarly qualified whites are charged — is a longstanding problem. It grew to outrageous proportions during the bubble years. Studies by consumer advocates found that large numbers of minority borrowers who were eligible for affordable, traditional loans were routinely steered toward ruinously priced subprime loans that they would never be able to repay.

More minority borrowers have ended up in foreclosure than non-minority.  "Consumer advocates" say racist bankers won't lend to creditworthy minorities out of bigotry and an unwillingness to accept money polluted by their dusky selves.

The long, sad history of Unity Bank, which was founded in 1968 specifically to benefit under-served creditworthy minorities suggests that advocates who said minority buyers could handle loans are flat wrong.  Unity Bank went broke over and over despite massive support from the US Government.

Bankers are predictably accusing the federal government of forcing them to lend to unqualified borrowers — which is implausible. Discrimination cases are based on evidence that qualified borrowers have been ill-treated because of race, sex or national origin.  [emphasis added]

Why is it "implausible" to argue that banks were forced to lend to unqualified borrowers?  Lots of minority borrowers ended up not paying back their loans and banks aimed at serving minorities went broke over and over.  If borrowers don't repay loans, by definition they're unqualified, or their "qualifications" are bogus.

The Times won't accept the fact that minority buyers are often less qualified than non-minorities - lower personal wealth, lower and less reliable salaries, lower credit ratings, shorter credit history, and so on.  In urging banks to make loans to people without the financial stability to pay, the Times makes it harder for banks to make normal loans - banks have to set aside extra reserves to cover their foreseeable losses on the minority loans they're forced to make.  What's "implausible" about that?

The Real Reason They Won't Lend

As senior bankers point out, "Any fool can lend money; the trick is getting it back."  Bankers won't lend to anyone when they're feeling pessimistic.

This is another aspect of our faith-based economy, and one more illustration of why successful presidents must be cheerleaders.  The Economist explained why banks are too glum to lend:

But this downturn is likely to be far more durable. The grimness of the long-term economic outlook is one reason. The fact that a complete overhaul of banking regulation is now really starting to bite is another.  [emphasis added]

There are many new regulations which make banks less able to lend.  During the bubble, banks lent as much as $30 for every dollar of reserves.  Leverage works wonderfully in padding bonuses when the economy goes up; alas, leverage wipes you out when the music stops.

This wouldn't be a problem if we'd let the banks get wiped out, but we didn't; instead, Bush's Treasury Department bailed them out using your tax dollars.  The vehement public outrage means that the government now cares about not letting it happen again.  Instead of simply deciding never, never ever to bail out bankers in the future, regulatory agencies are forcing banks to increase reserves:

Among other things, the new rules require banks to hold more capital against losses and bigger pools of liquid assets that can be quickly turned into cash if funding markets run dry. Big banks have already started to cut the size of their balance-sheets, mainly as a result of being forced to hold more capital against their trading books under the so-called Basel 2.5 rules, which come into force in 2012.

The final Basel 3 regime will have them set aside yet more.

Banks have to know what it costs them to get money to lend you.  They must charge enough more than their cost of funds to cover rent, taxes, managerial bonuses, dealing with regulations, and still make a profit.  The more money costs, the more they charge.

Suppose the new rules say a bank has to have a 10% reserve.  The bank needs $100 in capital to lend you $1,000.  The bank has to pay for a total of $1,100 - $1,000 to lend and $100 in reserve.

Their "cost of funds" includes not only the cost of the $1,000 they lend but the cost of the $100 they reserve.  That $100 doesn't earn any money but they have to pay the cost of getting it, too.

This increases the interest rate you have to pay by 10%; regardless of how low the Fed pushes official interest rates, the banks have to borrow 10% more money than under the old rules.  You and they and pay more accordingly.

No Loans At Any Price

What's worse, you may not be able to get a loan at any price.  Banks had loans outstanding when the crisis hit.  As regulations increased reserve requirements, banks had to get more money to reserve for the loans they already had.

Suppose a bank had $1 in reserve for every $30 lent.  This was OK under the old rules.  They have $100 in reserve and they've lent $3,000.

The rules change; they need 10% reserve.  They need $300 sitting idle to cover $3,000 worth of existing loans, but they only have $100.

They have to scramble for $200.  Investors know they can't lend the money, the $200 has to sit there - they either increase their reserves or go out of business.  Knowing that banks must get money, investors with cash drive hard bargains.

Warren Buffet put $5 billion into the Bank of America.  What did he get in return?  The fine print hasn't been made public, but cash is king in times like these.

Supose you come in with a wonderful business plan like the ones the New York Times criticized banks for not funding.  Can they lend you a dime?

No way - they're scrambling to get reserves the government now requires to cover the loans they've already made.  They're at, say, $200 of reserves and they need $300 to cover their $3,000 worth of old loans.

They need another $100 just to get even.  Before they can lend  to you after that, they have to raise whatever you want to borrow, plus 10% of that as reserve to cover your loan.

In the short term, it doesn't matter how profitable the bank is - they can't cover increased reserves from profits alone.  What matters is the reserve ratio set by the government.  If they're short, banks can't lend at all, even if their profits appear to be very, very high - it all goes into meeting the newly-increased reserve requirement.

Banks want to lend - that is how they make money.  Unfortunately, they are being hit with a double whammy: They're being told they have to lend to borrowers who everyone knows can't pay the money back and also that they need more reserves even for good borrowers.

On top of that, on September 2, the Federal Housing Finance Agency sued banks for misrepresenting $200 billion worth of mortgages the banks had sold to the government.

The Times asked, "Mr. Banker, can you spare a dime?"  The answer is "No!"  Not one dime can they lend until a) they get their reserve ratios up enough to cover their existing loans, b) they finish writing off their bad loans and c) they get another penny to reserve against the dime they lend you.

The longer that takes, the longer you'll wait.  Don't hold your breath!

Will Offensicht is a staff writer for and an internationally published author by a different name.  Read other articles by Will Offensicht or other articles on Economics.
Reader Comments

I guess I'm not seeing the problem. So with the new rules, if I'm reading this right, the banks need to beef up their fractional reserves back UP to a 10% level. Historically, this level was 10% for literally centuries! Who the hell let them get away with letting it drop to a frightening 1% to begin with? All of a sudden, another huge reason for the 2008 meltdown manifests itself.

Will there be some pain while banks readjust to a reality their ancestors had no problems with? No doubt. But the system will be at least marginally stronger as a result. And so will the rest of us who will have to defer some gratification for awhile. Maybe you don't REALLY need that new condo after all...or that Range Rover.

Now, next up: Let's get back to a currency that's actually backed by something...

September 21, 2011 11:50 AM

The problem is that easy money can lead to a boom. The problem is managing things so you get the growth due to easy money without the pain of the coming crash. We have never managed that.

Bumping up the reserve requirements means banks can't loan for a while. Over time, the economy will recover. Banks will want to make more money, so they will lobby for lower reserves. That will work, so they will lobby for lower reserves.

That will go on until it can't go on any longer, and we will get the next crash.

For "reserve requirements" going forward you can substitute any regulation that reduces banking profits.

September 21, 2011 5:28 PM

The Times is bleating about banks not lending. They don't discuss regulation, though. They say there's nothing Congress can do to make banks lend, forgetting completely that all the regulations came from congress.

No Extra Credit
The real problem isn't taxes or the deficit. It's the lack of lending.

What if the Obama jobs plan, the coming deliberations of the supercommittee, the debate over taxing millionaires — what if none of it is likely to make a whit of positive difference for the economy? What if the only thing that matters is something Congress and the president rarely mention, and can do nothing about?

I’ve come to believe this is the case. What is killing the economy is lack of credit. In the aftermath of an asset bubble, invariably the result of too-loose credit, banks don’t just tighten their standards; they practically shut down.

This was true during the Great Depression, and it’s been true during the Great Recession. And until normal credit standards return, economic growth will continue to be stunted. “Overreaction to the credit bubble is now the knee on the throat of the economy,” says my friend Lou Barnes, a mortgage banker at Premier Mortgage Group in Colorado.

Not long ago, Lou sent me a powerful new piece of evidence, a presentation put together by Paul Kasriel, chief economist for Northern Trust. Titled “If Some Dare Call It Treason, Was Milton Friedman a Traitor?” (the title will become clear shortly), it has the force of revelation.

The first part of the paper is spent “dispelling the nonsense” (Kasriel’s words) that factors besides credit are the root of the problem. He persuasively mocks the idea that “uncertainty” is holding back companies from borrowing. (“Uncertainty,” Kasriel told me, “is the last refuge of economists who can’t explain what is going on.”) Ditto for onerous taxes, record budget deficits and lack of demand.

He then documents “a post-WW II record” credit contraction, before moving on to a surprising solution: more quantitative easing from the Federal Reserve, which is essentially the buying of bonds from investors by the Fed, using money it prints, as Kasriel freely admits, “out of thin air.”

That this solution is controversial is not lost on Kasriel; his title is an obvious play on Rick Perry’s comment that continued quantitative easing by the Fed chairman, Ben Bernanke, would amount to borderline treason. But that’s where his reference to Friedman comes in. Kasriel is absolutely convinced that if the great conservative economist were alive today, he would be leading the charge for quantitative easing. It’s all we’ve got left.

In the 1930s, the Fed’s tight money policy compounded the lack of credit and sent the country into the Depression. Decades later, Milton Friedman was the economist who most persuasively proved that point. Bernanke, a student of the Depression, took that lesson to heart; his willingness to flood the system with liquidity during the financial crisis prevented a repeat.

It is also what led Bernanke to try the first two rounds of quantitative easing. “Banking under normal circumstances is a transmission mechanism from the Fed to the economy,” Kasriel told me. “That transmission mechanism is broken.” Quantitative easing is not nearly as efficient at expanding credit as having the banks involved, but it does work. During the decade of stagnation in Japan, Kasriel points out, Friedman urged its central bank to expand the money supply and buy bonds — exactly what Bernanke has been doing.

The main argument against the printing of money is that it raises the odds of inflation; even the esteemed Paul Volcker is worried about it, as he wrote in Monday’s Times. But Kasriel is convinced that the bigger fear right now is deflation, and that the expansion of credit by the Fed should be seen in combination with the contraction by the banks.

September 25, 2011 5:21 PM

I'm sorry but I do not believe that the problem is all that hard to solve. Some will accuse me of being naive and simplifying a difficult problem but they must be from the Ivy League. After all, it is they who put us in this mess to start with and why listen to them now.

Here is the solution and it makes the banks take responsibility for their actions:
1) No bailouts from this day forward.
2) No government interference whatsoever with regulations.
3) No FDIC for depositors, allow the free market to write its own insurance either to depositors in the case of a bank default or the bank buying it for the same reason. It would work either way as one bank could offer high CD rates and the other bank could offer other services but with fees. This would create a freer market for depositors rather than the one size fits all that we currently have.
4) Zero federal taxes on banks

This scenario would put the onus on the banks to make good loans but have to address the free market for deposits and the insurance companies that wrote the insurance on the bank's deposits would keep them in line. Government bureaucrats could pack it in with their idiotic rules and regulations. The government has no business telling any company how to run its business.

September 25, 2011 8:54 PM

In Cautious Times, Banks Flooded With Cash
With fewer attractive lending and investment options, it is harder for banks to make a healthy profit from the enormous amount in deposits.

Bankers have an odd-sounding problem these days: they are awash in cash.

Droves of consumers and businesses unnerved by the lurching markets have been taking their money out of risky investments and socking it away in bank accounts, where it does little to stimulate the economy.

Though financial institutions are not yet turning away customers at the door, they are trying to discourage some depositors from parking that cash with them. With fewer attractive lending and investment options for that money, it is harder for the banks to turn it around for a healthy profit.

In August, Bank of New York Mellon warned that it would impose a 0.13 percentage point fee on the deposits of certain clients who were moving huge piles of cash in and out of their accounts.

Others are finding more subtle ways to stem the flow. Besides paying next to nothing on consumer checking accounts and certificates of deposit, some giants — like JPMorgan Chase, U.S. Bancorp and Wells Fargo — are passing along part of the cost of federal deposit insurance to some of their small-business customers.

Even some community banks, vaunted for their little-guy orientation, no longer seem to mind if you take your money somewhere else.

“We just don’t need it anymore,” said Don Sturm, the owner of American National Bank and Premier Bank, community lenders with 43 branches in Colorado and three other states. “If you had more money than you knew what to do with, would you want more?”

Like Mr. Sturm’s banks, Hyde Park Savings Bank, a community lender in the Boston suburbs, lowered its C.D. rates this spring to encourage less-profitable customers to move on. As a result, Hyde Park shed about 1,000 of its 35,000 C.D. holders, preferring customers who also had a checking or savings account.

So far, banks have reported a modest increase in lending this year. Critics, however, fault the industry for being too tight-fisted — no matter how much bankers insist that demand is anemic, especially from the most creditworthy borrowers.

But the banks’ swelling coffers are throwing a wrench in efforts to get the economy back on track.

Ordinarily, in a more robust environment, an influx of deposits would be used to finance new businesses, expansion plans and home purchases. But in today’s fragile economy, the bulk of the new money is doing little to spur growth. Of the $41.8 billion of deposits that Wells Fargo collected in the third quarter, for example, only about $8.2 billion was earmarked to finance new loans.

Normally, banks earn healthy profits by taking in deposits and then investing them or lending them out at substantially higher interest rates than what they pay savers. But that traditional banking model has broken down.

Today, banks are paying savers almost nothing for their deposits. As it turns out, the banks are not minting money on those piles of cash. Lending levels have not bounced back from only a few years ago and the loans going out are not keeping pace with the deposits rushing in.

What’s more, the profitability of each new loan has shrunk. Because the Federal Reserve effectively sets the floor off which banks price their lending rates, its decision to lower interest rates to near zero means the banks earn less money on the deposits they lend out.

The banks are also earning less on the deposits left over to invest. They typically park that money overnight at the Fed for a pittance, or invest it in ultra-safe securities, like bonds backed by the government. But with interest rates so low, the yields on those investments have been crushed.

October 25, 2011 7:37 PM
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