Wednesday, January 20, 2010

Why Aren’t Banks Lending?

From the Desk of Joe Rollins

The simple answer to why banks aren’t lending is because they don’t have to. Banks, like all other businesses, are required to make profits. In order to answer to their regulators and their shareholders, banks must be profitable or they cease to exist. Until banks are required to lend to make a profit, they will simply elect to do otherwise. That’s exactly what is happening today.

There are two very effective ways for the government to assist banks in becoming financially sound. One way is to directly fund them, which is what was done under the TARP. However, contrary to the public’s popular belief, the TARP wasn’t a profitable venture for the banks. Since they were required to pay 5% to the government and deal with mountains of bureaucracy, it made more sense for them to repay their TARP loans as quickly as possible. There are now no major banks that continue to have TARP money in the United States. It was much more profitable for banks to use their deposits and issue new stock than to deal with paying the 5% to the government while dealing with the insane governmental procedures.

The other effective way to help the banking industry get in a better financial position is to allow them to make more money. If money is made available to the banks at a cost of almost zero, it shouldn’t be difficult for a bank to invest at a higher rate and keep the spread as its own income. Today, banks can borrow from the Federal Reserve at close to zero. This allows banks to buy 3% tax exempt bonds, and make almost a three percentage point difference while paying no income tax on the income earned. Why would a bank ever want to loan money to a customer who might not repay them when they can make almost 3%, tax exempt?

I have recently approached several banks requesting loans for several of my clients. In prior years, banks were practically doing back flips trying to get the business of these very same clients. In almost every case, each bank told us of their impressive bank capabilities and how anxious they were to assist new customers in new and exotic loan programs. They would take up an enormous amount of my and my clients’ time, but in the end, they would always decline to extend the loan for reasons that often made no sense.

The bank’s decision never had anything to do with the particular client; rather, it had everything do with their reluctance to loan money to anyone when they were making a good rate of return without taking on the risk of potential bad debts. My forecast is that within two years, each and every one of those banks, if they are still in business, will start doing back flips once again to loan these same clients money.

Have you looked at CD rates lately? As of this writing, these are Bank of America’s current CD rates from their website:

3 Months
6 Months
1 Year
2 Years
3 Years
4 Years
5 Years

Do you find yourself wondering why interest rates are this low? It seems like banks are just telling us they don’t need our money, because they have all the money they need and they can simply borrow it from the government at such a low rate. The bank’s principal cost of operation is what they pay for the money they borrow from you (CD rates). The foregoing CD rates indicate that the government is now providing all of the capital banks need. Therefore, CD rates continue to plummet. Sadly, the CD market is one of the only ways some older people feel they can safely invest their assets. It is unfortunate that they have to bear the brunt of these low interest rates, since it adversely affects their cash flow needs in retirement.

It is not possible for someone to have a positive rate of return with a 5-year CD rate of 2.23%. If you don’t believe that the inflation rate over the next five years will average higher than 2.23%, then I’d be happy to sell you some beachfront property in Valdosta, Georgia. If inflation does as I project, every year you will lose money against the rate of inflation.

After reviewing the dismal interest rates currently being offered on CD’s, I’m baffled by the fact that people continue to invest in them. I’ve never understood the investing philosophy of investing in cash assets when rates are so low. First and most importantly, the low interest rates on CD’s are taxed at the maximum individual income tax rates. Next year, those income tax rates are likely to be as high as 50%. There are no tax incentives whatsoever to earning interest and, certainly, there are no interest incentives. However, you could own some individual stocks in virtual monopolies where dividends are many times the rate of interest. For example, you could receive the following returns on these stocks: AT&T – 6.5%, Verizon - 6.2%, Duke Energy - 5.7%, Southern Companies - 5.2%, Consolidated Edison - 5.2%. As you can tell, you can get a dividend yield at greater than 5% for these virtual monopolies with an extraordinarily favorable tax rate. How investors make the decision to invest in cash when they could buy these equities will continue to baffle me.

Here’s my solution to the entire banking problem we’re experiencing today. To make banks start lending money again, the interest rates that the banks must pay should be increased by the government. If the Federal Funds Rate was increased today, banks would immediately need to seek ways to make higher rates of return on their capital. In order to earn those higher rates of return, they would have to begin loaning money again to businesses and individuals.

Why should a bank make a mortgage to anyone in today’s environment? For any loan below $417,000, banks can turnaround and syndicate it to Freddie and Fannie for a fee of three-quarters of 1%. Basically, the bank would originate the loan, sell it to the quasi-government agencies, take a fee for its trouble and never have the risk of collecting on the debt. One other way to force the banks to start lending again is to make Freddie and Fannie quit purchasing every mortgage made in America today. Let’s get back to the banks actually loaning money to customers they know!

Have you noticed that it’s nearly impossible to obtain a jumbo loan nowadays? If you needed to borrow money above $417,000, it’s much more difficult than ever before. The reason, of course, is because the banks cannot as easily syndicate jumbo loans to third parties. As such, they typically elect not to make these loans rather than run the risk of not being repaid. If the banks couldn’t invest their money at such a valuable spread between the cost of money and the cost of their risk-free investments, they would have to loan this money in order to be profitable.

I recently blogged about how absolutely out of control Washington is these days and how out of touch they are with the American public. There seems to be some sort of agenda in Washington that defies logic. Most everyone, including me, thought that a stimulus plan was a good idea to get the economy back on its feet. However, the stimulus plan that was ultimately passed has done little, if anything, to improve the economic landscape.

Employment can’t be increased when money is being given to state governments to keep bureaucrats on the payroll that should’ve been long gone. Additionally, while extending unemployment benefits to people who’ve been laid off is an honorable cause, it does nothing to increase employment; it only costs the government billions of dollars without providing immediate results. Now, we are being told that the bulk of the stimulus money will not be spent until the end of 2010, at which point it will probably not be needed. In order to increase employment, you must stimulate small businesses and encourage banks to lend. Our government today is not doing those things.

The most recent numbers illustrate the incredibly irresponsible budget in Washington. The federal budget deficit was $91.85 billion in December alone. December is historically a positive month due to year-end tax payments by corporations, etc. However, this year it was a major negative number. For the first three months of fiscal 2010 (which began on October 1, 2009), the budget deficit was a whopping $388.51 billion.

You may recall that when the stimulus package was passed, we were told that it would help get unemployment down to 8%, yet even today it’s still above 10% one year later. The George W. Bush administration ran a deficit total of $454 billion in fiscal 2008. It seems the current administration will exceed that fiscal deficit in the first four months of the current fiscal budget year. Suffice it to say that the gross incompetence in Washington is staggering.

On Tuesday morning, a special election was held in Massachusetts for Ted Kennedy’s U.S. Senate seat, which was left vacant after his death. It’s highly likely that Scott P. Brown, the Republican challenger to the Democratic candidate, Martha Coakley, will win. I think the outcome of this election will demonstrate the taxpayers’ distrust of our elected officials. Even though Massachusetts has the reputation of being one of the most liberal states in America, the polls are showing that Mr. Brown has a good chance of winning the election. During Mr. Brown’s campaign, he promised he would vote against the proposed health care legislation, which would be enough votes against the bill to block it with a filibuster. Mr. Brown is against higher taxes and bigger government. The public is also against higher taxes. That’s why he has a chance to win in Massachusetts.

If this terrible health care bill is, in fact, stopped in its tracks, then perhaps governmental spending will finally be restrained. It’s hard to believe that our representatives are willing to pass legislation that would essentially nationalize one-sixth of the U.S. economy even though close to 60% of the U.S. population thinks it’s bad for America. In the next few weeks, I think we’ll find out how low our representatives are willing to go to pass this terrible legislation.

The economy can be improved by decreasing taxes rather than increasing them. The last thing the economy needs is a new trillion dollar tax to pay for health legislation that the vast majority of Americans think is unnecessary, wasteful and harmful to our economy.

The banks cannot be forced to lend until we increase their cost of borrowing. It would be a mistake to tax the banks, as it surely would not spur them to lend. The new bank tax proposed by President Obama is just about the worst idea to try to get them to increase lending. This tax is levied on the liabilities of the banks, encouraging banks to reduce lending, not increase lending. There just seems to be a complete disconnect in Washington when it comes to improving the economy and improving our daily lives.

Hopefully, the rest of the nation will catch on that the only way to get Washington under control is through the voting booths. Everyone should want what took place at the end of President Clinton’s first two years in office. Due to the overwhelming Republican takeover of Congress in 1994, Washington was almost evenly divided between Republicans and Democrats. The absolute best thing that could possibly happen for the economy and for the stock market was in motion – eight wonderful years of Congressional gridlock. We had the best economy in decades, and the stock market was fabulous.

In conclusion, in November, you shouldn’t vote for candidates to send to Washington – instead, vote for gridlock!

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Postscript: I wrote the above post the morning of Tuesday, January 19th. As I’m sure all of you are aware, the Republican candidate, Scott Brown, won the Senate seat in Massachusetts over Martha Coakley with 52% of the votes (Coakley had 47% of the votes). This was a landslide victory – perhaps not by percentage points, but by the historic importance of this election. Massachusetts has not elected a Republican Senator since 1972. More importantly, it now eliminates the supermajority from the U.S. Senate, and therefore, changes the legislative landscape for years to come. It will be very interesting to see if the Obama administration attempts to negotiate a favorable settlement of the health care bill or if they just bow their backs and ram it through the Congress, even over the objections of most Americans.


Jim Renzas said...

Finally - someone who "get it" - great analysis and more true today than in January

Anonymous said...

I agree with everything in your article. Except, I feel that the general public needs to speak out and start protesting against the banks. Stop using them all together. Don't put your money in them. Go to the post officne and buy a money order to pay your bills. Get a save to put your money in. Anything but use bank services. You would be surprised how fast they would change their toon. Boycotting the banks so to speak is the only way to show them that if they aren't going to lend our Tax payer money back to us, Then fine they can't use our daily deposits to gain interest. We need to be more asertive and speak out against this crime.