Liberal Conversations about 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!