ZYWICKI: Why aren't banks lending?

Washington Times:

ZYWICKI: Why aren't banks lending?

Despite constant urging by Washington for banks to increase their lending, credit conditions remain tight. Small-business lending continues to lag, and credit card issuers have slashed credit lines and canceled thousands of accounts. Just before Memorial Day, the Obama administration unveiled its latest effort to jump-start lending, a new Small Business Lending Fund (SBLF), which will make available $30 billion to community banks to promote small-business lending. The proposal already has cleared the House Financial Services Committee.

But is there any reason to believe that this modest investment will do what the hundreds of billions of Troubled Asset Relief Program (TARP) dollars failed to do - namely, encourage banks to start lending? Not likely. As with previous efforts, the new fund fails to address the most important reason banks aren't lending: Washington bureaucrats and politicians are making it impossible for them do so.

Every loan bears some risk that it will not be repaid. In making a loan, a lender has two considerations: First, it must be able to price the risk of the loan accurately or, second, it must reduce its risk exposure by reducing the number of loans it makes, the amount it lends or the risk profile of those to whom it lends. Regulations that interfere with the ability to price risk accurately thus inevitably produce efforts to reduce risk exposure by curtailing lending.

Since President Obama was inaugurated, Congress has launched one of the most ambitious legislative agendas in American history - proposals that would fundamentally transform the economy: from remaking the health care system, to a far-reaching set of taxes and regulations to combat climate change and remake the energy system, to a comprehensive financial overhaul bill that would fundamentally reshape the banking system.

Could it be that with 0% lending from the Fed the banks have a certain gain from investing in Treasuries with 2-4% gain? And if they lose, they know that they will be bailed out by Bernanke? Why would they want to provide loans to those whose only collateral is a house which is dropping in price? Greenspan and Bernanke are the ones who control the money supply and provide all the money the banks need. Indirectly they also control where the money goes. Why doesn't Bernanke lend the money directly to those who need it? Maybe he's got too many toxic assets he purchased from the banks to make good first?

If anything put blame on all the Senators who voted to keep Bernanke in power, Democrats and Republicans alike. At least audit the Fed to see where the money they're printing is going. We know about half a trillion dollars is sitting somewhere in Europe. I think Americans need to know why it's sitting over there and not lent to small businesses in America. Also the Volcker Rule needs to be imposed.

Two reasons:

  1. They are under a lot of pressure (rightly, to a degree) by the regulators to not take risks. The feds have forced them to "write down" a lot of loans that really aren't bad loans. That reduces their capital reserves and curbs their growth.

  2. Small businesses just aren't borrowing. You can ask any community banker about that. Sure, there are always the "nut job" applicants who want to borrow a million dollars to make ginseng-flavored donut holes or something. But the businesses that are tried and true are busily paying down debt instead of borrowing for expansion. The reasons are that small businesses don't know how the health insurance bill will affect their costs, but are pretty certain it won't be good for them. Also, they don't know what "cap and trade" is going to do to their energy and transportation costs. Further, they know their ability to pay down principal on debt is going to be diminished by taxes. Also, they aren't sure "card check" isn''t going to be made law. Just about every week this government comes up with some new, strange, plan to do something or other, and they know for sure the burden is going to be on them to pay for it. But the biggest fear is the future high interest rates all this government spending is likely to produce. So most business borrowing is short-term now.

Most banks don't make any money on home mortgages. That's just something they do because they have to. Their bread and butter is business lending. For some, it's also farm lending. When businesses and farmers don't have any faith in the government, they don't borrow.

Seriously, any community bank will tell you that. They just don't have the demand. The "too big to fails" that are into other kinds of finance are different, of course.

You can ask small business people about it, and they will tell you the same thing. Expansion, buying, investing and hiring are deemed too risky right now, because most small business people think this government is nuts and/or determined to crush them with taxes and regulatory obligations.

Borrowing from the fed to buy treasuries is not a good banking strategy; first because the spread is too narrow and secondly because if interest rates go up (which they surely will) they could get locked into an unfavorable arbitrage. Having said that, some huge banks are in the market buying treasuries, which they then "retail" out to individuals and institutions. But that's a different game altogether.

Ridge, you make some good points.

We are living in a very dangerous, low-interest rate environment, which probably will stay that way. Contrast that with the 70-80's period where the FED also dropped interest rates and printed money (after Nixon removed the gold standard as we found ourselves not having enough gold to pay our debts), only to find ourselves with runaway wages and prices (Nixon tried to freeze pay and prices but to no avail). Then Carter finally appointed Paul Volcker who lent you all the money you wanted but charged you plenty of interest for it. But there's an upside to this. When you borrowed, say at 12%, to buy property or expand your business, you and your lender were in a not-so-bad position. Because when it became apparent Volcker would be dropping the rates, home (and stock) prices would appreciate and you could always refinance. A beautiful recovery occurred when borrowers lent and lenders borrowed. People saved and people spent. We don't have that luxury today. The Fed have put themselves in a bind. They overreacted first to 9/11 and then later to Cramer's notorious Armeggedon charges (among other things) when the stock market was still at 14000 and home prices corrected somewhat in 2007. Then suddenly a lot of things about lending practices were exposed (they generally are when prices drop) and the situation exacerbated.

But knowing all this isn't going to help much at this point. We have an incompetent group of economists and a corrupt system of banking and no one knows how to circulate money anymore. So much money sitting in Treasuries doesn't do the economy much good.

[quote="ProVobis, post:4, topic:201385"]
Ridge, you make some good points.

We are living in a very dangerous, low-interest rate environment, which probably will stay that way. Contrast that with the 70-80's period where the FED also dropped interest rates and printed money (after Nixon removed the gold standard as we found ourselves not having enough gold to pay our debts), only to find ourselves with runaway wages and prices (Nixon tried to freeze pay and prices but to no avail). Then Carter finally appointed Paul Volcker who lent you all the money you wanted but charged you plenty of interest for it. But there's an upside to this. When you borrowed, say at 12%, to buy property or expand your business, you and your lender were in a not-so-bad position. Because when it became apparent Volcker would be dropping the rates, home (and stock) prices would appreciate and you could always refinance. A beautiful recovery occurred when borrowers lent and lenders borrowed. People saved and people spent. We don't have that luxury today. The Fed have put themselves in a bind. They overreacted first to 9/11 and then later to Cramer's notorious Armeggedon charges (among other things) when the stock market was still at 14000 and home prices corrected somewhat in 2007. Then suddenly a lot of things about lending practices were exposed (they generally are when prices drop) and the situation exacerbated.

But knowing all this isn't going to help much at this point. We have an incompetent group of economists and a corrupt system of banking and no one knows how to circulate money anymore. So much money sitting in Treasuries doesn't do the economy much good.

[/quote]

Unfortunately, there aren't enough people to buy the treasuries, so we sell to China and Saudi Arabia, etc.

I will maintain that it all predated 911. Greenspan became convinced that we were facing deflation (probably, actually, a stabilization/lowering of prices due to enormous imports). So he lowered rates and pumped up the money supply. Upon taking office, Bernanke tried to deflate the "bubble", but it was too big, and it popped. So now we're in "Obamanomics" (spend) and the Fed has no choice but to crank the printing press.

[quote="Ridgerunner, post:3, topic:201385"]
Two reasons:

  1. They are under a lot of pressure (rightly, to a degree) by the regulators to not take risks. The feds have forced them to "write down" a lot of loans that really aren't bad loans. That reduces their capital reserves and curbs their growth.

  2. Small businesses just aren't borrowing. You can ask any community banker about that. Sure, there are always the "nut job" applicants who want to borrow a million dollars to make ginseng-flavored donut holes or something. But the businesses that are tried and true are busily paying down debt instead of borrowing for expansion. The reasons are that small businesses don't know how the health insurance bill will affect their costs, but are pretty certain it won't be good for them. Also, they don't know what "cap and trade" is going to do to their energy and transportation costs. Further, they know their ability to pay down principal on debt is going to be diminished by taxes. Also, they aren't sure "card check" isn''t going to be made law. Just about every week this government comes up with some new, strange, plan to do something or other, and they know for sure the burden is going to be on them to pay for it. But the biggest fear is the future high interest rates all this government spending is likely to produce. So most business borrowing is short-term now.

Most banks don't make any money on home mortgages. That's just something they do because they have to. Their bread and butter is business lending. For some, it's also farm lending. When businesses and farmers don't have any faith in the government, they don't borrow.

Seriously, any community bank will tell you that. They just don't have the demand. The "too big to fails" that are into other kinds of finance are different, of course.

You can ask small business people about it, and they will tell you the same thing. Expansion, buying, investing and hiring are deemed too risky right now, because most small business people think this government is nuts and/or determined to crush them with taxes and regulatory obligations.

Borrowing from the fed to buy treasuries is not a good banking strategy; first because the spread is too narrow and secondly because if interest rates go up (which they surely will) they could get locked into an unfavorable arbitrage. Having said that, some huge banks are in the market buying treasuries, which they then "retail" out to individuals and institutions. But that's a different game altogether.

[/quote]

Darn it! I was thinking of getting money from the fed to open a million dollar ginseng-flavored donut hole shop. :) :) There goes that dream, thanks a lot. :)

[quote="Ridgerunner, post:5, topic:201385"]
Unfortunately, there aren't enough people to buy the treasuries, so we sell to China and Saudi Arabia, etc.

I will maintain that it all predated 911. Greenspan became convinced that we were facing deflation (probably, actually, a stabilization/lowering of prices due to enormous imports). So he lowered rates and pumped up the money supply. Upon taking office, Bernanke tried to deflate the "bubble", but it was too big, and it popped. So now we're in "Obamanomics" (spend) and the Fed has no choice but to crank the printing press.

[/quote]

You're right about foreign money buying the Treasuries. Until China bought a ton in the last couple of years, Japan was our prime lender. Currently they're all holding $4 trillion in UST and we're paying them interest for it.

treas.gov/tic/mfh.txt

The bubbling and debubbling is a result of too much leveraging. The more the leverage, the more the risk of margin calls (or foreclosures). Interest rates don't need to go up for the bubble to pop. It's simple speculation and fear. And when the interest rates and margins stay low, they simply find themselves into some other venue or commodity or service. And then that bubble pops.

Home prices were always overleveraged but especially so during Greenspan's tenure. Where 20-30% became the paradigm of margins (down payment), it served its purpose well. You had a healthy job growth during the 80's and 90's, home prices were appreciating slowly and affordably, then came the big bubble because of the increased leveraging (0% margin) and then the big pop. Did the same thing with oil and other commodities. Basically they're all working with the paper (futures, options, etc.), not the actual delivered product.

But then government can't resist the low interest rate environment either. Bush couldn't do it and Obama can't do it. No matter what they say, it's too tempting to spend and borrow without having the political backlash of raising taxes. They'll find some way of justifying the spending and both parties are behind it. War, Medicaid Part D, various stimulus (tax cuts, tax credits, public works), TARP, etc. Wouldn't be as tempting had Bernanke simply left rates stay at 5% or so. Sure, we would have had a recession but it probably just would have been short-lived and we might have been out of it by now. But that's my opinion only. I could write a lot more about it but I want to ask you something. What would you have done had you been elected in Nov 2004? In Nov 2008?

Most business have been stressed and their collateral and equity have fallen. That is what the banks lend against.

In addition most banks will not lend to small businesses without a Small Business Administration guarantee. The SBA has its own lending guidelines based on the assets of companies.

Here is the bottom line - banks look for the safety the SBA provides them - a 85-90% guarantee.

[quote="buffalo, post:8, topic:201385"]
Most business have been stressed and their collateral and equity have fallen. That is what the banks lend against.

In addition most banks will not lend to small businesses without a Small Business Administration guarantee. The SBA has its own lending guidelines based on the assets of companies.

Here is the bottom line - banks look for the safety the SBA provides them - a 85-90% guarantee.

[/quote]

A very good and concise assessment of the situation.

The bubbles popped too hard and for too long.

[quote="ProVobis, post:7, topic:201385"]

I could write a lot more about it but I want to ask you something. What would you have done had you been elected in Nov 2004? In Nov 2008?

[/quote]

Knowing the limits of my competence, I would have immediately resigned.:)

[quote="buffalo, post:8, topic:201385"]
Most business have been stressed and their collateral and equity have fallen. That is what the banks lend against.

In addition most banks will not lend to small businesses without a Small Business Administration guarantee. The SBA has its own lending guidelines based on the assets of companies.

Here is the bottom line - banks look for the safety the SBA provides them - a 85-90% guarantee.

[/quote]

I would disagree with this in part. Most bank loans to small businesses are not SBA loans. Most bankers don't like them particularly, because they're relatively inflexible and a paperwork hassle. Most SBA loans I see are the ones bankers push their worst customers into when it looks like a hit is coming.

I would also maintain that there are plenty of viable businesses out there, with good collateral. What is not there is the willingness of most small businesses to borrow. Most banks I know are crying for business loans, which is the bread and butter, but the demand is pretty slack. I'm a small businessman myself, and I wouldn't borrow a nickel, though there are projects I would like to undertake. There are several reasons, in detail, but they all boil down to a distrust of the current government. I don't know what they are going to do next. I don't even know how what they have already done is going to be interpreted, or what regulations they are going to enact. So I can't "pencil out" business decisions because of it. I'm reducing debt as fast as I can while I still can and before higher interest rates hit. Every small business person I know is like that, and for the same reason.

I get calls from bankers all the time, encouraging me to borrow to do this or that. I get a lot of free lunches from them because of that. But I'm just not going to put the fate of my business (my livelihood) into the hands of Pelosi/Reid/Obama/Soros any more than I have to.

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