Federal Reserve Continues to Underwrite Big Companies and Big Banks

Economic spokesperson for the Obama administration, Ben Bernanke, and the Federal Reserve System continue to underwrite “big”…Big Companies and Big Banks.

The Federal Reserve has just released its survey of senior credit officers. The headlines, “Large United States Banks are Starting to Ease Credit Terms.”

Terrific!

“Large companies may also be finding an appetite to borrow, especially for mergers and acquisitions…The start of January was marked by a record level of M&A and 77 per cent of banks that reported an increase in loan demand said deal financing was a somewhat to very important reason for it.” (See http://www.ft.com/cms/s/0/6dbf2546-2d71-11e0-8f53-00144feab49a.html#axzz1Chh2pOYC.)

But wait…”A flood of cash by investors seeking to profit from rising interest rates is having an unintended effect in the deal world, where this money is being recycled into corporate buyouts.

Investors have been selling bonds which typically lose money when interest rates rise and putting their cash in funds that invest in bank loans that finance corporate buyouts. The loans have floating rates, so the interest they pay investors rises as rates go up.” (http://professional.wsj.com/article/SB10001424052748704254304576116542382205656.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj)

Wow! Have I got a deal here!

And, what about big banks? Well, Bloomberg has an answer for that: “Fed’s Easy Money Helps European Banks Refinance.” (See http://www.bloomberg.com/news/2011-02-01/fed-s-easy-money-helps-european-banks-refinance.html.)

Seems as if European banks are selling record amounts of dollar-denominated bonds to refinance almost $1 trillion of their debt maturing this year. “As a result of the extra dollars created (by the Fed’s quantitative easing), cross-currency basis swaps show that it’s cheaper for European banks to sell bonds in dollars and swap the proceeds back to euros than it was at the same time last year.”

European lenders “sold $43.8 billion in investment-grade bonds in the U. S. (this January), beating the previous record of $42.4 billion last January.”

So the Federal Reserve’s quantitative easing is doing good!

Yes, but what about economic recovery and the smaller banks and smaller businesses?

The Financial Times article continues: “If most of the increased loan demand is for M&A, it may be slow to feed through into higher investment in the economy.

The scope of easier credit also remains limited: Large banks say they are lending more to large companies, but life has become no easier for small companies and small banks.

There was also little sign of any improvement in lending for either commercial or residential real estate.”

It is in the smaller banks and the smaller businesses that solvency concerns still reign. It is in
commercial and residential real estate that economic conditions remain depressed and credit woes abound.

Big banks and big corporations have lots and lots of cash. The reason for this build up in my mind has been for the “Great Acquisition Binge” of the 2010s. (See my post “Where the Real Deals will be in 2011: http://seekingalpha.com/article/244709-where-the-real-deals-will-be-in-2011.) And the bank lending reported above is just adding to the acquisition cycle. The big banks are now increasing lending and, it looks as if the increased lending is going for more and more buyouts. The hedge funds and private equity funds are now stepping up their involvement in this exercise as is evidenced by the interest in floating rate loans.

And, how is this banking activity helping to get the economy growing more rapidly and reduce unemployment?

If anything, the increased merger and acquisition activity will result in a “rationalization” of business which will mean that the acquiring firms will engage in more downsizing of the acquired firms and this will mean that more workers will be laid off.

Companies will become bigger…there will just be fewer companies around.

If this is the case, why does the Federal Reserve continue to underwrite the big banks and the big corporations?

I continue to argue that the Federal Reserve is pursuing quantitative easing as aggressively as it is doing in order to keep the smaller banks going as long as possible so that the FDIC can close as many as they need to in an orderly fashion. Eleven banks have already been closed this year.

Last year the FDIC formally closed a little more than 3 banks per week throughout the year. However, the number of banks in the banking system dropped by two to three hundred (we don’t have the final numbers on this yet) when you count the mergers and acquisitions that took place in the banking industry.

My guess is that we will experience the same amount of contraction of the banking system in 2011. The monetary stance of the Federal Reserve is crucial for the banking system to continue to contract in an orderly fashion. But, this is not necessarily spurring on economic growth.

Until this contraction is over, the feast will continue for the biggest banks and the biggest corporations.