Skeptical Humorist

Here’s a dialog about the state of banking, lending, and business. Built from a Facebook post and comments.

Ed Lowry:

I was fortunate enough to purchase a copy of the Financial Times this morning. To my amazement I read about banks not lending to small business: http://bit.ly/9lofzr. If the bank does lend to SB it’s at a rate 3.5% higher than the fed fund rate.

The article continues with standard language, but I’m wondering:

We (the taxpayers) bailed out the banking industry. The Fed lowered the rate at the window so as to increase lending. Banks are using the Fed borrowings to boost balance sheets.

Given that the Fed rate is zero (or less in real terms), essentially emergency rates, and the banks aren’t lending, the bank shows more cash on hand, more liquidity, and therefore better balance sheet and higher stock price.

From my small knowledge base it would appear the banks are once again “disadvantaging” the average Joe and stifling innovation, entrepreneurship and small business, yet raking in usury rates when they do lend and receiving adventageous tax breaks.

What part of the invisible hand is invisible?

Me:

First of all:
When we bought the Honda/Kasasaki dealership in 1982, we borrowed high six-figures at 19.5% backed by 150% collateral pledged by the personal guarantees of every relative we could threaten. I would suspect that kind of deal is still available, if only one can find enough relatives to threaten.

I see several reasons the financial industry is not lending very readily:

1. If their accounting were truthful, bank reserve requirements, even under the old liberal go-go period reserve rules, are probably substantially above current available cash reserves. So the banks are trying to hoard cash before they get called out on hiding debt, like BofA did last week. That is one of the main problems the Fed has been trying to address with its cheap lending; to keep banks out of technical default.
2. Commercial property defaults continue to increase. Retail mortgage defaults are growing in the upper loan size brackets. I haven’t seen any statistics on small business defaults, strangely, but defaults must also be increasing. Turnaround predictions are only blind speculation.
3. The loan packaging industry has lost credibility and is barely functioning. Loan originators must consider holding and then collecting on their loans. They hate that.
4. There is no spark for employment growth yet, so money velocity is vastly slowed down. There is also no obvious asset-bubble replacement for our recent real estate, war, or Internet experiences. Maybe it’ll be individual weapons, like some hope.
5. Given this economic environment, what business could possibly present a business plan that would be worth the paper that it’s written on? What’s the economy going to be like one to three years from now? What wild-ass-guesses are in the business plan to make it seem to work?
6. For November election purposes, everybody seems content to stand around with their hands in their pockets, pretending to wait for a government magic policy wand-waving.

Jo Keeler

“And now for something completely different . . ”

Disclaimer – I’ve been a banker for 30+ years

1. The Fed lowered the overnight rate for 2 reasons – To incent 1)individuals/businesses to access capital to to invest in projects/buy things; 2)to steepen the yield curve so that banks can borrow short (overnight) and invest in Treasuries or the like with longer maturities (3 years or so) and earn the spread risk free. “Surfing the curve” allows the industry to earn back the capital that is charged off in the form of loan losses from bad loans. Banks can generate about 2%/year doing this and given the reequirement to hold 8-10% capital bases – well you can do that math.

Contrary to populist thought, banks do want to lend – it’s the way shareholders in banks earn a return. In this cycle there are two issues at work. (I’m referring to businesses here). First, the recovery is so tepid that businesses that have survived have no motivation to expand their operations, and therefore have no need to borrow, yet. It’s reported to be harder to get a loan. It is harder because those who want/need to borrow are more or less those who are just hanging on. So if banks lend to that population, more losses follow. Corporate america has never held as much cash on balance sheets as they do now.

Another reason it’s harder to get a loan, is that bankers generally know, as is pointed out that the commercial real estate industry is just now showing the stress that rippled through the residential markets in 08-09. And banks, especially smaller regional and community banks are full of commercial real estate. If bankers know more losses are coming, the logical thing to do is husband your capital (see my point 1 above) – take a smaller net spread and take no risk while replenishing lost capital.

Your point #2 is spot on.

Your point 3 is spot on. The implication here is that if lenders can’t sell the paper, they will be plenty more careful around who they extend credit to, if their source of return is the interest and recouping the actual principal, as opposed to packageing it and making fees by playing musical chairs. The implication is that easy credit is over. You can’t have your cake and eat it too. The easy credit days that allowed deadbeats to speculate – driving an economic boom/bubble are over. Slow, anemic growth ahead becuase job growth is the only driver to regaining general prosperity. The boom/bubble of the past 18 years (yes, since about 1992!) has masked the loss of real (non-boom related) job growth.

As distasteful as it seems to the Nancy Pelosi crowd, the tax increases looming this year are, I think, the coup de grace. The last time massive tax increases were instituted in the face of a meager recovery was 1937. How’d that work out? Not too well. It took WW II to pull out of the nose dive.

The banks have paid back the govt bailouts, for the most part. So while I personally think the weak should have been allowed to fail, the bail-out was the best investment the tax payer ever made, as far as it is measured on a cash return basis. Not so for the bail-out money to GM and Chrysler. That’s money gone forever. No return.

The (banking) industry has been pilloried, maybe justly, maybe not. But at the end of the day, it’s not that banks don’t want to lend. It’s more of the old addage that thoose who demonstrate good credit risk don’t need/want the debt (at any price), and those that do, are pretty saky risks. All general statement, but directionally correct.

So how to get the economic engine re-started without job growth?