In reviewing the banking data put out by the Federal Reserve System last month, I titled my post “Grasping at Straws” because there was some indication of an increase in lending at the smaller banks. (See http://seekingalpha.com/article/215058-grasping-at-straws-in-the-banking-data.) In that post I made the following statement: “An interesting pattern is showing up in the data, however, and gives us something to look for going forward. The smaller, domestically chartered banks in the United States increased their loan balances a little bit over the four-week period ending in the week of July 7, 2010.”
In these releases the “smaller banks” are defined as all domestically chartered commercial banks in the United States with assets less than the largest 25 domestically chartered commercial banks in the United States. The largest 25 domestically chartered commercial banks in the United States hold roughly 67% of the banking assets in the United State while the other roughly 8,000 banks in the United States make up approximately 33% of the banking assets.
Focus is placed upon the smaller banks because this is where the vast majority of “troubled” banks in the United States reside and the concern about these troubled banks is significant enough that Elizabeth Warren has stated in Congressional testimony that there are serious problems which still persist in the smaller banks in the country and the Federal Reserve continues to keep its target interest rate low in order to help the process of bank consolidation flow smoothly. (See http://seekingalpha.com/article/215958-elizabeth-warren-on-the-troubled-smaller-banks.)
The increase in bank lending at the smaller banks seems to have continued through July according to the latest data released by the Federal Reserve. Loans at small domestically chartered commercial banks in the United States rose in the four weeks ending August 4, 2010, by about $16 billion or roughly 0.7%. Loans at these banks are still down, year-over-year, by about 3%, but we are looking for “green shoots” and this represents the second consecutive four-week period in which we have seen an increase in small bank lending.
The gains are concentrated in the consumer area as residential loans rose by over $13 billion in the last four-week period, consumer loans added about $10 billion over the same period, and home equity loans increased by a little more than $1 billion during the time.
Business lending continued to fall as commercial and industrial loans dropped by about $8 billion and commercial real estate loans fell by $3 billion. Furthermore, these latter loans are down by more than $16 billion over the last 13-week period. It is in the area of commercial real estate that Elizabeth Warren and others believe continued problems will plague the smaller banks in the United States.
One can draw the tentative conclusion from these data that some of the smaller banks are beginning to lend, but primarily to consumers and mainly in areas where real estate can serve as collateral. But, this is good news.
Still, in the aggregate, the smaller commercial banks are managing their balance sheets in a very conservative manner. Cash assets at these institutions rose by more than $23 billion or by about 8.5% over the past four weeks, and by almost $30 billion over the past 13 weeks. Total assets at these institutions increased by $46 billion and $70 billion, respectively, over the same time periods.
Overall, however, commercial banking shows very little life in the lending area. Year-over-year, the total assets of all commercial banks in the United States rose by less than one percent and total loans at these institutions fell by a little more than one percent. Commercial and industrial loans were the hardest hit category, falling by almost 15%, followed by commercial real estate loans, which dropped by more than 8%. Shorter periods of time do not present a much different picture.
In my post “No Banks, No Recovery” (http://seekingalpha.com/article/218027-no-banks-no-recovery) I presented the following argument: “It is very difficult to see the United States economic recovery accelerating if the banking system is sitting on the sidelines. The part of the banking system to worry about is the 8,000 banks that do not make the list of the 25 largest domestically chartered banks in the country.”
This is why I am giving so much attention at this time to the smaller banks. We have looked for “Green Shoots” before in this economic recovery and have been disappointed. We continue to look for positive signs that are not just of a passing nature. Hopefully, the data on the commercial banking system contain some positive signs that will continue to show indications that the economic recovery is, in fact, progressing.
Monday, August 16, 2010
Thursday, August 12, 2010
"We don't know what we are doing"--the Fed
The Federal Reserve has two basic problems right now. First, those running the Fed don’t know what they are doing. Second, they are doing a terrible job explaining this to the world.
Never have I seen such confusion in such an important institution. Never have I seen such inadequate leadership.
We have experienced the end of the Fed’s exit strategy, the effort undertaken by the Fed to reduce the size of the Fed’s balance sheet. The exit strategy was designed to reduce the massive amounts of reserves pumped into the financial system by the Fed so that a period of hyper-inflation would not result. That exit strategy saw the Fed’s balance sheet grow by $331 billion over the twelve-month period the “exit” strategy was in place. Excess reserves held by the banking system rose by 38% during the same time period.
(http://seekingalpha.com/article/219717-federal-reserve-exit-watch-part-13)
One can only imagine what the end to the "exit strategy” will mean for bank reserves.
So, the Fed is now not going to let its balance sheet decline. As securities mature it will replace those securities with newly purchased securities. Impact is “net zero” on the balance sheet. If the economic recovery does not pick up steam or if it stalls or even declines, the Fed will purchase even more securities resulting in a further increase in bank reserves.
The reason for this change in focus? Well, the Fed has observed that the economy is moving more slowly than previously thought.
This is the Fed and the Fed leadership that continued to fight inflation as the housing market tanked and financial institutions balanced on the edge of collapse. The Fed seems to have totally missed the August 2007 meltdown of hedge funds failing to act until September 2008. Then, in the fall of 2008, Bernanke panicked and we got the infamous TARP legislation and an inconsistent mish-mash of bailouts that “saved the financial system.” (http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic)
The Fed continues to frame its statements in terms of the weakness of the economy. However, in the statement released after the last meeting of the Open Market Committee the Fed admits that “Bank lending has continued to contract.”
This is all the attention the Fed gives to the banking system; the industry which the Fed supposedly knows intimately? And, this banking system has over $1.0 in excess reserves and is not lending? This banking system that has 775 banks on the FDIC’s list of problem banks? This banking system that Elizabeth Warren claims has 3,000 banks facing severe solvency problems? This banking system that has one out of every 2 banks in it in trouble?
The statements of the Fed just don’t coincide with what people and the financial markets see out in the real world.
There seems to be a significant disconnect between what is going on in the Federal Reserve and what is going on in the world. Damn those econometric models!!!
We got where we are because the Fed didn’t understand what was happening and then threw everything it could against the wall to see what would stick. I fear that we are experiencing déjà vu all over again!
Never have I seen such confusion in such an important institution. Never have I seen such inadequate leadership.
We have experienced the end of the Fed’s exit strategy, the effort undertaken by the Fed to reduce the size of the Fed’s balance sheet. The exit strategy was designed to reduce the massive amounts of reserves pumped into the financial system by the Fed so that a period of hyper-inflation would not result. That exit strategy saw the Fed’s balance sheet grow by $331 billion over the twelve-month period the “exit” strategy was in place. Excess reserves held by the banking system rose by 38% during the same time period.
(http://seekingalpha.com/article/219717-federal-reserve-exit-watch-part-13)
One can only imagine what the end to the "exit strategy” will mean for bank reserves.
So, the Fed is now not going to let its balance sheet decline. As securities mature it will replace those securities with newly purchased securities. Impact is “net zero” on the balance sheet. If the economic recovery does not pick up steam or if it stalls or even declines, the Fed will purchase even more securities resulting in a further increase in bank reserves.
The reason for this change in focus? Well, the Fed has observed that the economy is moving more slowly than previously thought.
This is the Fed and the Fed leadership that continued to fight inflation as the housing market tanked and financial institutions balanced on the edge of collapse. The Fed seems to have totally missed the August 2007 meltdown of hedge funds failing to act until September 2008. Then, in the fall of 2008, Bernanke panicked and we got the infamous TARP legislation and an inconsistent mish-mash of bailouts that “saved the financial system.” (http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic)
The Fed continues to frame its statements in terms of the weakness of the economy. However, in the statement released after the last meeting of the Open Market Committee the Fed admits that “Bank lending has continued to contract.”
This is all the attention the Fed gives to the banking system; the industry which the Fed supposedly knows intimately? And, this banking system has over $1.0 in excess reserves and is not lending? This banking system that has 775 banks on the FDIC’s list of problem banks? This banking system that Elizabeth Warren claims has 3,000 banks facing severe solvency problems? This banking system that has one out of every 2 banks in it in trouble?
The statements of the Fed just don’t coincide with what people and the financial markets see out in the real world.
There seems to be a significant disconnect between what is going on in the Federal Reserve and what is going on in the world. Damn those econometric models!!!
We got where we are because the Fed didn’t understand what was happening and then threw everything it could against the wall to see what would stick. I fear that we are experiencing déjà vu all over again!
Tuesday, August 10, 2010
Those Greedy B*****ds in Washington
I have not heard one elected official or government bureaucrat in Washington, D. C. apologize to the American public for all the problems they have caused the American people over the past fifty years. All I have heard from this august bunch is “Get the Greedy Bastards from Wall Street”!
Yet, it is the “Greedy Bastards” from Washington, D. C. that put into place the incentives that everyone else in the country had to respond to and that created the environment that resulted in the mess the country has been going through over the last four years. These “Greedy Bastards from Washington” were greedy for power and for the benefits and rewards of being elected and re-elected over and over again. So they developed the incentives for the rest of the country that would allow them to get re-elected over and over again.
I could go into a long list of “incentives” that the White House and Congress created over the past fifty years, but I thought that today I would work from my list of personal experiences that, to me, show how Washington can impact the private sector and put in place “incentives” that end up causing more trouble for people than they do benefits, even though the programs are put into place to “make things better for people”…and to get elected people re-elected.
In the public sector I was a spectator to the build-up of the securitized mortgage. All this “stuff” we are hearing so much about really began in the late 1960s. Fannie Mae (FNMA) was split in two in 1968, the new wing became Ginnie Mae (GNMA), the Government National Mortgage Association. In 1968, GNMA guaranteed the first mortgage pass-through security. In 1970 FNMA was authorized to purchase private mortgages. Also in 1970, Freddie Mac was created to do the same thing as FNMA. I was able to see the early years of the operation of these institutions as a liaison between the Secretary of HUD and these agencies. I also experienced the effort to create more viable mortgage backed securities so that longer term funds from insurance companies and pension funds could flow into the housing market and provide more money to help “American citizens” own their own home. (By the time Michael Lewis wrote “Liar’s Poker” in the late 1980s, the market for mortgage backed securities was the largest part of the capital markets in the world! This is up from almost zero in the 1960s.)
From where I sat there was only one reason why so much effort was put into these “financial innovations” and that was to help the people in the White House and in Congress get re-elected. The stated goal of these programs was to put Americans their own homes. Okay!
The housing sector was “bankrolled” by the United States government, to get government officials re-elected. Both parties took advantage of this effort and both parties added to the incentives available to all those participating in the “give-away.” And, today we face the reality that over half the residential mortgages in this country are held by either Fannie Mae or Freddie Mac and that each of these institutions is losing so much money that it will eventually cost the taxpayer an estimated $350 billion. Little is being done about this, and, no one in Congress or the White House is apologizing for this loss. Shame on them!
Back in the private sector I joined the Senior Management of a mutual savings bank in late 1983 with assets of about $1.0 billion. In January 1984 I became the Chief Financial Officer of the organization. There were some pretty severe restrictions on the balance sheet of a savings bank at that time. Sixty percent of the assets of the bank, and no more, could be placed in residential mortgages. The other forty percent could be placed in a limited list of marketable securities, primarily Treasury securities. The organization I joined had about 60% of its assets in residential mortgages, 30% in longer-term U. S. Treasury securities, and 10% in very liquid assets.
The bank was in trouble! Not from the mortgages. The residential mortgages were performing well. The problem was in the portfolio of longer-term U. S. Treasury securities. They were deeply “underwater” and this threatened the life of the institution which had been in existence since the 1830s.
United States Treasury issues with a maturity of 10 years traded around 7.5% in 1975. In the 1983-1984 period these securities traded in the 11.5% to 12.5% range. Needless to say, the 30% of the assets the institution held was not in good shape.
Notice, however, this bank was not in trouble because of “bad” assets. The quality of the assets on the books of the bank was of the highest level. This was an institution that was very prudently managed.
The problem came from the inflationary expectations that were built into longer term interest rates, an inflation that came about due to the inflationary policies of the United States government in the 1960s and 1970s. Remember, a small amount of inflation was good at that time because it put people back to work and that was good for the politicians. The tradeoff between inflation and unemployment was called the “Phillips Curve.” Too bad about the highly restricted thrift industry!
Let me just mention two responses that were made to this situation. The first was to convert the mutual institution into a stock institution. This was done successfully and $42 million in new capital was injected into the bank. But, the nature of the bank had changed forever. We were in a new era where “maximizing shareholder returns” became the dominant goal of the organization.
Second, we examined a new financial innovation, a “risk controlled” interest rate arbitrage of $100 million, one-tenth in size of the whole organization, to “off-set” the low interest rates that were being earned on the Treasury portfolio. The justification for the arbitrage transaction was pages and pages of computer printouts that showed how the transaction would perform in dozens of interest rate environments similar to the ones that had existed in history…the last twenty years. Ah, the benefits of computer-based quantitative simulations. Financial innovation was grand!
What happened to the bank? Well, interest rates fell back into the 7.0% to 7.5% range in 1986 (thank you Paul Volcker) and the Treasuries were sold and the olvency problem was resolved. The bank is still in existence today.
The second turn-around I was involved in was a sleepy old savings and loan association that was run by the same old man and old board of directors that had been around for years. The portfolio was solid residential real estate mortgages. This institution did not have to convert and go public, but the environment was such that in 1986 they went public and raised $18 million dollars for an institution that had less than $300 million in assets. They didn’t know what to do with the money but now they had to maximize shareholder value. So they started up a commercial real estate development subsidiary and began to explore getting into more and more commercial activities and also acquisitions. This S&L was run by a “pillar” of the community who had done nothing more than make residential mortgages and manage a large number of women tellers for forty years or so. With the “new” money, the bank grew to about $1.0 billion with many problem areas because the “old guy” just didn’t get it! I was with this institution from 1987 through 1991.
The CEO was finally forced out of his position in 1991 along with many board members. This came about because the financial community substantially discounted the stock because of the “old guy” and the regulators finally forced some board members into doing something. The bank was finally sold to what is now one of the twenty-five largest banks in the country. A board member of the acquiring institution who I knew well told me later that this acquisition was so cheap it was the only acquisition he was familiar with that was accretive in the first year after the acquisition. The regulators did not know what to do with all the problem banks they had on their hands during this time period and so forced many “good” institutions into situations they were totally unprepared for.
I then moved into a commercial bank turnaround. This bank had been one of dozens of “startup” banks which took place in the late 1980s and early 1990s. When I was brought into the bank I was amazed that the bank had policies and procedures that were well suited for a multi-billion dollar bank, but not for a startup institution that never got above $100 million in assets. The management of the bank had grandiose ideas about what they could do and a board of directors that knew almost nothing about banking. But, Washington wanted more and more banks to keep money flowing into the community. The bank had severe problems but we succeeded to the extent that we were the only “boutique” bank in Philadelphia that was not either closed or forced to merge with another institution. So much for providing funds to the local community.
I have worked in both the public sector and the private sector in my career. I have seen how the incentives set up by government have distorted markets as the incentives played to the “greed” of many in the private sector. In the short run, these “incentives” seemed to work for the good of the society. In the longer run as people found out how to “play” the system, the greed of the private sector came to dominate the news angering the people from “Main Street” and making it easy for politicians to point their fingers at the “Greedy Bastards on Wall Street” and walk away as if they had nothing to do with all the problems that they had created. Those “Greedy Bastards from Washington”! Beware of what these “Greedy Bastards” do because they only have one incentive…to get re-elected.
Yet, it is the “Greedy Bastards” from Washington, D. C. that put into place the incentives that everyone else in the country had to respond to and that created the environment that resulted in the mess the country has been going through over the last four years. These “Greedy Bastards from Washington” were greedy for power and for the benefits and rewards of being elected and re-elected over and over again. So they developed the incentives for the rest of the country that would allow them to get re-elected over and over again.
I could go into a long list of “incentives” that the White House and Congress created over the past fifty years, but I thought that today I would work from my list of personal experiences that, to me, show how Washington can impact the private sector and put in place “incentives” that end up causing more trouble for people than they do benefits, even though the programs are put into place to “make things better for people”…and to get elected people re-elected.
In the public sector I was a spectator to the build-up of the securitized mortgage. All this “stuff” we are hearing so much about really began in the late 1960s. Fannie Mae (FNMA) was split in two in 1968, the new wing became Ginnie Mae (GNMA), the Government National Mortgage Association. In 1968, GNMA guaranteed the first mortgage pass-through security. In 1970 FNMA was authorized to purchase private mortgages. Also in 1970, Freddie Mac was created to do the same thing as FNMA. I was able to see the early years of the operation of these institutions as a liaison between the Secretary of HUD and these agencies. I also experienced the effort to create more viable mortgage backed securities so that longer term funds from insurance companies and pension funds could flow into the housing market and provide more money to help “American citizens” own their own home. (By the time Michael Lewis wrote “Liar’s Poker” in the late 1980s, the market for mortgage backed securities was the largest part of the capital markets in the world! This is up from almost zero in the 1960s.)
From where I sat there was only one reason why so much effort was put into these “financial innovations” and that was to help the people in the White House and in Congress get re-elected. The stated goal of these programs was to put Americans their own homes. Okay!
The housing sector was “bankrolled” by the United States government, to get government officials re-elected. Both parties took advantage of this effort and both parties added to the incentives available to all those participating in the “give-away.” And, today we face the reality that over half the residential mortgages in this country are held by either Fannie Mae or Freddie Mac and that each of these institutions is losing so much money that it will eventually cost the taxpayer an estimated $350 billion. Little is being done about this, and, no one in Congress or the White House is apologizing for this loss. Shame on them!
Back in the private sector I joined the Senior Management of a mutual savings bank in late 1983 with assets of about $1.0 billion. In January 1984 I became the Chief Financial Officer of the organization. There were some pretty severe restrictions on the balance sheet of a savings bank at that time. Sixty percent of the assets of the bank, and no more, could be placed in residential mortgages. The other forty percent could be placed in a limited list of marketable securities, primarily Treasury securities. The organization I joined had about 60% of its assets in residential mortgages, 30% in longer-term U. S. Treasury securities, and 10% in very liquid assets.
The bank was in trouble! Not from the mortgages. The residential mortgages were performing well. The problem was in the portfolio of longer-term U. S. Treasury securities. They were deeply “underwater” and this threatened the life of the institution which had been in existence since the 1830s.
United States Treasury issues with a maturity of 10 years traded around 7.5% in 1975. In the 1983-1984 period these securities traded in the 11.5% to 12.5% range. Needless to say, the 30% of the assets the institution held was not in good shape.
Notice, however, this bank was not in trouble because of “bad” assets. The quality of the assets on the books of the bank was of the highest level. This was an institution that was very prudently managed.
The problem came from the inflationary expectations that were built into longer term interest rates, an inflation that came about due to the inflationary policies of the United States government in the 1960s and 1970s. Remember, a small amount of inflation was good at that time because it put people back to work and that was good for the politicians. The tradeoff between inflation and unemployment was called the “Phillips Curve.” Too bad about the highly restricted thrift industry!
Let me just mention two responses that were made to this situation. The first was to convert the mutual institution into a stock institution. This was done successfully and $42 million in new capital was injected into the bank. But, the nature of the bank had changed forever. We were in a new era where “maximizing shareholder returns” became the dominant goal of the organization.
Second, we examined a new financial innovation, a “risk controlled” interest rate arbitrage of $100 million, one-tenth in size of the whole organization, to “off-set” the low interest rates that were being earned on the Treasury portfolio. The justification for the arbitrage transaction was pages and pages of computer printouts that showed how the transaction would perform in dozens of interest rate environments similar to the ones that had existed in history…the last twenty years. Ah, the benefits of computer-based quantitative simulations. Financial innovation was grand!
What happened to the bank? Well, interest rates fell back into the 7.0% to 7.5% range in 1986 (thank you Paul Volcker) and the Treasuries were sold and the olvency problem was resolved. The bank is still in existence today.
The second turn-around I was involved in was a sleepy old savings and loan association that was run by the same old man and old board of directors that had been around for years. The portfolio was solid residential real estate mortgages. This institution did not have to convert and go public, but the environment was such that in 1986 they went public and raised $18 million dollars for an institution that had less than $300 million in assets. They didn’t know what to do with the money but now they had to maximize shareholder value. So they started up a commercial real estate development subsidiary and began to explore getting into more and more commercial activities and also acquisitions. This S&L was run by a “pillar” of the community who had done nothing more than make residential mortgages and manage a large number of women tellers for forty years or so. With the “new” money, the bank grew to about $1.0 billion with many problem areas because the “old guy” just didn’t get it! I was with this institution from 1987 through 1991.
The CEO was finally forced out of his position in 1991 along with many board members. This came about because the financial community substantially discounted the stock because of the “old guy” and the regulators finally forced some board members into doing something. The bank was finally sold to what is now one of the twenty-five largest banks in the country. A board member of the acquiring institution who I knew well told me later that this acquisition was so cheap it was the only acquisition he was familiar with that was accretive in the first year after the acquisition. The regulators did not know what to do with all the problem banks they had on their hands during this time period and so forced many “good” institutions into situations they were totally unprepared for.
I then moved into a commercial bank turnaround. This bank had been one of dozens of “startup” banks which took place in the late 1980s and early 1990s. When I was brought into the bank I was amazed that the bank had policies and procedures that were well suited for a multi-billion dollar bank, but not for a startup institution that never got above $100 million in assets. The management of the bank had grandiose ideas about what they could do and a board of directors that knew almost nothing about banking. But, Washington wanted more and more banks to keep money flowing into the community. The bank had severe problems but we succeeded to the extent that we were the only “boutique” bank in Philadelphia that was not either closed or forced to merge with another institution. So much for providing funds to the local community.
I have worked in both the public sector and the private sector in my career. I have seen how the incentives set up by government have distorted markets as the incentives played to the “greed” of many in the private sector. In the short run, these “incentives” seemed to work for the good of the society. In the longer run as people found out how to “play” the system, the greed of the private sector came to dominate the news angering the people from “Main Street” and making it easy for politicians to point their fingers at the “Greedy Bastards on Wall Street” and walk away as if they had nothing to do with all the problems that they had created. Those “Greedy Bastards from Washington”! Beware of what these “Greedy Bastards” do because they only have one incentive…to get re-elected.
Monday, August 9, 2010
Federal Reserve Exit Watch: Part 13
In the summer of 2009, a great deal of concern was expressed about the Federal Reserve and the excessive amounts of Reserve Bank credit that had been pumped into the banking system. The Federal Reserve stated that it had an “exit” plan to withdraw these reserves from the banking system so as not to create an inflationary or hyper-inflationary environment once the economic recovery began to pick up speed.
Here we are 13 months into the “exit watch” and there has been “no exit” of reserves from the banking system. In fact, Reserve Bank credit is now $331 billion GREATER than it was one year ago; it has grown over the past 365 days by 16.7%, as of August 4, 2010.
The stated reason for this “no exit” performance: the economy has remained stagnant and as long as the economy stays very weak the Federal Reserve will keep its low target interest rates which means that the target Federal Funds rate will remain close to zero for an “extended period”.
As I have reported in my blog posts, my belief is that the Federal Reserve is excessively concerned about the solvency difficulties being experienced by the small banks in this county, a concern that I have recently summarized in my post of August 2, titled “No Banks, No Recovery,” http://seekingalpha.com/article/218027-no-banks-no-recovery. There are many small banks experiencing extreme problems and the Federal Reserve is not going to begin withdrawing reserves from the banking system until there is some indication that this solvency problem is over.
Commercial bank Reserve Balances with Federal Reserve Banks has risen by $334 billion over the past year, an increase of 46.6% since August 5, 2009. Note that Excess Reserves at depository institutions rose from a monthly average of $750 billion in June 2009 to $1,035 billion in June 2010, an increase of 38%.
This is a strange “exit.”
And, as the Federal Reserve has pumped these additional reserves into the banking system, the total assets of the commercial banks in the United States fell by 1.7% from almost $12.0 trillion to about $11.8 trillion from June 2009 through June 2010. Loans and leases at these commercial banks declined by 2.6%. Banks got out of a substantial amount of business loans during this time period, as commercial and industrial loans fell by 16.7%, June-over-June, and commercial real estate loans declined by 7.8%, year-over-year.
The reserves the Fed is pumping into the banking system are not going into “pumping up” the economy. The reserves the Fed is pumping into the banking system are just going into excess reserves!
Looking at a shorter period of time, over the past 13 weeks, the last quarter, Reserve balances with Federal Reserve banks rose by $8.0 billion. The primary swings in the Fed’s balance sheet over this time period were operational in nature. There was a $26 billion decrease in the General Account of the U. S. Treasury, a seasonal increase in currency in circulation of about $9 billion and a $7 billion rise in Foreign Reverse Repos. The offsetting transactions of the Fed to neutralize these changes was an increase in Securities Held Outright by the Fed of about $12 billion, the primary increase coming in the Fed’s purchase of Mortgage-backed securities.
In the past 4 weeks, the U. S. Treasury balance reversed itself, increasing by almost $28 billion and there were modest declines in currency in circulation and Foreign Reverse Repos. The Fed offset a portion of these by letting it holdings of Federal Agencies decline by a little more than $5 billion. The net effect of these operating transactions was a $19 billion decline in Reserve balances held at Federal Reserve banks.
Thus, over the past 4 weeks and over the past 13 weeks, Reserve Bank Credit barely changed. Both periods were dominated by operating transactions within the banking system offset by Federal Reserve balancing transactions.
As a consequence, excess reserves in the banking system stayed relatively constant over the last quarter of the year.
Loans and leases at commercial banks continued to decline over the last 4-week and 13 week periods as did commercial and industrial loans and commercial real estate loans.
In summary, the Exit Watch in the thirteenth month of its existence can report little or no action on the exit front over the past month or the past three months. “Exit” is still on hold until either the general condition of the small banks improves or the economic recovery really becomes an economic recovery…or both.
Here we are 13 months into the “exit watch” and there has been “no exit” of reserves from the banking system. In fact, Reserve Bank credit is now $331 billion GREATER than it was one year ago; it has grown over the past 365 days by 16.7%, as of August 4, 2010.
The stated reason for this “no exit” performance: the economy has remained stagnant and as long as the economy stays very weak the Federal Reserve will keep its low target interest rates which means that the target Federal Funds rate will remain close to zero for an “extended period”.
As I have reported in my blog posts, my belief is that the Federal Reserve is excessively concerned about the solvency difficulties being experienced by the small banks in this county, a concern that I have recently summarized in my post of August 2, titled “No Banks, No Recovery,” http://seekingalpha.com/article/218027-no-banks-no-recovery. There are many small banks experiencing extreme problems and the Federal Reserve is not going to begin withdrawing reserves from the banking system until there is some indication that this solvency problem is over.
Commercial bank Reserve Balances with Federal Reserve Banks has risen by $334 billion over the past year, an increase of 46.6% since August 5, 2009. Note that Excess Reserves at depository institutions rose from a monthly average of $750 billion in June 2009 to $1,035 billion in June 2010, an increase of 38%.
This is a strange “exit.”
And, as the Federal Reserve has pumped these additional reserves into the banking system, the total assets of the commercial banks in the United States fell by 1.7% from almost $12.0 trillion to about $11.8 trillion from June 2009 through June 2010. Loans and leases at these commercial banks declined by 2.6%. Banks got out of a substantial amount of business loans during this time period, as commercial and industrial loans fell by 16.7%, June-over-June, and commercial real estate loans declined by 7.8%, year-over-year.
The reserves the Fed is pumping into the banking system are not going into “pumping up” the economy. The reserves the Fed is pumping into the banking system are just going into excess reserves!
Looking at a shorter period of time, over the past 13 weeks, the last quarter, Reserve balances with Federal Reserve banks rose by $8.0 billion. The primary swings in the Fed’s balance sheet over this time period were operational in nature. There was a $26 billion decrease in the General Account of the U. S. Treasury, a seasonal increase in currency in circulation of about $9 billion and a $7 billion rise in Foreign Reverse Repos. The offsetting transactions of the Fed to neutralize these changes was an increase in Securities Held Outright by the Fed of about $12 billion, the primary increase coming in the Fed’s purchase of Mortgage-backed securities.
In the past 4 weeks, the U. S. Treasury balance reversed itself, increasing by almost $28 billion and there were modest declines in currency in circulation and Foreign Reverse Repos. The Fed offset a portion of these by letting it holdings of Federal Agencies decline by a little more than $5 billion. The net effect of these operating transactions was a $19 billion decline in Reserve balances held at Federal Reserve banks.
Thus, over the past 4 weeks and over the past 13 weeks, Reserve Bank Credit barely changed. Both periods were dominated by operating transactions within the banking system offset by Federal Reserve balancing transactions.
As a consequence, excess reserves in the banking system stayed relatively constant over the last quarter of the year.
Loans and leases at commercial banks continued to decline over the last 4-week and 13 week periods as did commercial and industrial loans and commercial real estate loans.
In summary, the Exit Watch in the thirteenth month of its existence can report little or no action on the exit front over the past month or the past three months. “Exit” is still on hold until either the general condition of the small banks improves or the economic recovery really becomes an economic recovery…or both.
Wednesday, August 4, 2010
Interpreting the Recent Behavior of the Monetary Aggregates
All research seems to indicate that, over time and everywhere, inflation is a monetary phenomenon. If this is true then we need to take some account of monetary aggregates in the short run so as to better understand what is taking place and what the current situation implies for the future. Also, it seems as if interest in the monetary aggregates might be surfacing once again. (See my post, http://seekingalpha.com/article/217598-monetary-targets-a-fresh-take.)
the recession, but rose to over 10% by early 2009. However, this did not signal that monetary policy was working even though the end of the recession has been dated as July 2009. In fact, in looking at all the other monetary measures one could discern some troubling behavior that might indicate a deeper recession and a very slow recovery.
Let’s look at the current situation beginning with the quarter that followed the start of the Great Recession, the first quarter of 2008. If one looks at the year-over-year growth rate of the M2 measure of the money stock, things look relatively benign. Growth remained modestly above 6% through the first nine months of
the recession, but rose to over 10% by early 2009. However, this did not signal that monetary policy was working even though the end of the recession has been dated as July 2009. In fact, in looking at all the other monetary measures one could discern some troubling behavior that might indicate a deeper recession and a very slow recovery.For example, the behavior of this measure certainly did not track the performance of bank reserves or the monetary base. Through the first nine months of 2008, total reserves in the banking system averaged a little under 5%, year-over-year. In the second quarter of 2009, the rate of increase was over 1,800%! The monetary base performed in a similar fashion. For the first nine months of 2008, the monetary base grew around 2.5% year-over-year. This increased to more than 100% in the beginning of 2009.
Of course, we know the reason why these reserve aggregates grew so rapidly while the money stock measure picked up only modestly. Excess reserves in the banking system went from less than $2 billion in the second quarter of 2008 to over $800 billion in the first quarter of 2009. The Federal Reserve was supplying funds to the banking system. However, the banking system was just holding onto them!
There was another movement within the monetary aggregates that was also of interest during this time period. The growth of required reserves, the reserves the banks had to hold behind their deposits, rose throughout 2008 but not nearly at the pace of total reserves or the monetary base. Note, however, that the growth rate of the non-M1 component of M2 remained relatively constant throughout 2008 and 2009 which indicated that a lot must be happening within the M1 measure of the money stock.
Here we see that through the first six months of 2008, the M1 money stock hardly grew at all. However, starting in September 2008 which marked the beginning of the financial crisis, this measure took off and was growing by almost 17% in early 2009. Growth was mainly in the demand deposit component of M1.
Two things were happening here. First, interest rates fell dramatically in 2009; keeping money in interest bearing accounts at banks and thrift institutions did not make much sense. Second, as people lost jobs and the economic environment became more and more uncertain, people and businesses moved assets from less liquid vehicles to transaction balances (demand deposits and other checkable deposits) so as to be able to buy necessities and to pay bills.
It is very important to identify this behavior because it explains a lot about how people were using their wealth at this time and what kinds of pressures they were feeling. This information helps us understand why the economy is performing the way it is and what implications this kind of behavior has for the future.
Taking this analysis into 2010 we see that the growth rate of M2 drops off drastically to less than 2%, yet M1 continued to incease at rates in excess of 5%. This is because people continued to transfer funds from interest-bearing accounts into transaction accounts. This is supported by the information on the growth rate in required reserves which was still above 10%. Note, that because of this the Federal Reserve has needed to continue to supply more reserves into the banking system to handle this increase in required reserves yet maintain the extraordinarly high levels of excess reserves in the banking system, reaching more than $1.0 trillion in the fourth quarter of 2009.
What this indicates to me is that the behavior of people and of the business community has not changed much over the past two and one-half years. People are still scared. Because of the tepid economy, high unemployment, and the uncertainty about the future, economic units still prefer to put their funds into transaction accounts so that they can facilitate their needed expenditures. This kind of information does not give one much confidence.
Furthermore, this kind of behavior is not what is seen before economic recoveries pick up steam. And, with the M2 measure of the money stock growing below 2%, year-over-year, one can only conclude that money is not entering the economy in a way that will stimulate future business expansion. Only when bank loans begin to increase and, consequently, M2 begins to expand more rapidly, then, maybe, confidence in the recovery will grow.
To me, monetary information is very valuable in trying to understand what is happening in the economy and where the economy might be going. However, the analysis of monetary aggregates must not be the kind of “cookie-cutter” analysis done in the 1970s and 1980s. Good analysis of the monetary aggregates is very complex and must include some historical analysis with it.
Tuesday, August 3, 2010
High Taxes and Tax Avoidance
The most profound comment in the news yesterday was, in my mind, this quote:
“The highest tax bracket income earners, when compared with those people in lower tax brackets, are far more capable of changing their taxable income by hiring lawyers, accountants, deferred income specialists and the like. They can change the location, timing, composition and volume of income to avoid taxation.”
This comes from the keyboard of Arthur Laffer of Supply-side economics fame. (See, http://professional.wsj.com/article/SB10001424052748703977004575393882112674598.html.) Laffer then gives several examples of such avoidance behavior: Senator John Kerry of Massachusetts, former Senator Howard Metzenbaum, and former Chairman of the House Ways and Means Chairman Charles Rangel.
I totally agree with Laffer on his major point.
This avoidance behavior also exists in the presence of an “inflation” tax. Whereas inflation has been touted as benefitting the “less well-to-do”, this is just a short-run help. Over the longer run, the “less well-to-do” cannot protect themselves very well against rising prices and so end up with lower real wages, real wealth, and fewer job opportunities.
As in the case of government assessed taxes, those individuals in the highest tax brackets or who have accumulated the greatest amounts of wealth are more capable of protecting their real income and real assets from an inflationary depreciation “by hiring lawyers, accountants, deferred income specialists and the like.” They can find many ways to avoid inflation that are not available to the “less well-to-do.”
There are three points that I would like to make relative to the above comments. First, many policies that attempt to help one class of people in a democratic society at the expense of another class of people may succeed in the short run. However, in the longer run, these policies tend to rebound on the former class of people, making them worse off, while achieving little or nothing in terms of the latter class.
In some cases these efforts produce a “negative-sum game” result in which everyone loses something. And, this leads me to the second point. By facing off “one class” of society versus “another class” of society, antagonisms are created, suspicions are raised, and society tends to be worse off. This is not what is supposed to happen in a liberal, democratic nation.
A liberal society works where people cooperate with one another and build community. To quote Ludwig von Mises on a liberal society: “It is important to remember that everything that is done, everything that man has done, everything that society does, is the result of such voluntary cooperation and agreements.”
I am not arguing in this post for or against renewing the “Bush tax cuts”. What I am arguing for
is a change in the rhetoric surrounding discussions about the federal budget, the rhetoric surrounding discussion about the financial reform bill, and the rhetoric surrounding many other issues in front of the American public these days.
Yes, arguing for one class against another may seem like good politics, but in America this really doesn’t win elections. Arguing for one class against another is a form of populism and the very politically astute Bill and Hilary Clinton have stated that elections cannot be won on a populist platform. (One reference on this point to Hilary Clinton can be found in Robert Rubin’s book “In An Uncertain World”.) I still remember watching Al Gore, in the 2000 election campaign, speaking in Mark Twain’s home town on the Mississippi River, Hannibal, Missouri, re-framing his campaign in populist terms. My immediate reaction was…Gore has just lost the election! And, he was well ahead of dubya in the polls at the time.
My third point is that very often people (and especially politicians) get caught up in the consequences of actions, which are current, and fail to see the causes of the these outcomes. This is a big problem in economics: many economic causes occur long before the consequences of the cause are recorded. For example, rent controls on apartments may lower housing costs for renters in the short run. However, if the owners of the apartments fail to maintain the units over time because of the reduced cash flows from the lower rental revenues, many will blame the “owner” and not the rent controls, for the now shoddy apartments .
An important example of this is the government caused inflation over the past fifty years or so. The gross federal debt increased by a compound rate of more than 7% per year from 1961 through 2008. A lot of this debt was monetized so that inflation increased at a compound rate of more than 4% per year during this time period accompanied by numerous asset bubbles which resulted from the excessive creation of credit. Financial innovation prospered in such an environment leading to greater and greater use of financial leverage, the taking on of greater amounts of risk, and the growth of “creative” accounting practices. Ponzi schemes also thrived in such an environment.
Why did businesses succumb to the taking on of excessive risk? The answer: in an inflationary environment, that is where the incentives are. If a company is out-performing its competitor by ten basis points then the competitor may assume more risk or take on greater financial leverage to pump up returns to match the competitor. The environment is cumulative in that more risk begets even more: or, as Chuck Prince, the CEO of Citigroup stated, “If the music keeps on playing, you have to keep on dancing.”
And who gets blamed? The greedy bankers…and not the government that created the inflationary environment. This point was made by the economist Irving Fisher in 1933: “If it is inflation and the one who profits is the business man, the workman calls the profiter a ‘profiteer.’ The underdog reasons as follows: ‘How did I get poor while you got rich? You did it, you dirty thief. I don’t know just how you did it; your ways are too subtle, sinister, dark and underground for simple me; but you did it all the same’
But, none of us—neither the farmer, nor the workman, nor the bondholder, nor the stockholder—thinks of blaming the dollar. So the real culprit stands on the curbstone watching us poor mortals as we beat out each other’s brains, and has the last laugh.”
Working together can result in a “positive-sum game”. The wealthy and those earning high incomes, at least most of them, believe that they should pay taxes. Maybe a new approach needs to be tried rather than attacking them and then trying to penalize them by enacting highly restrictive rules or excessive tax structures which they will spend great amounts of money to avoid.
The old methods don’t seem to work. Maybe we need to work to balance the tax laws so as to maximize tax revenues rather than punish one group of people over another. Maybe we need to think about creating a more open and transparent financial system that allows the economic process to work rather than saddle the economy with rules that dictate “outcomes”.
However, the old methods are built into the political system and will not change before this November. Guess we will just keep on shooting ourselves in the foot!
“The highest tax bracket income earners, when compared with those people in lower tax brackets, are far more capable of changing their taxable income by hiring lawyers, accountants, deferred income specialists and the like. They can change the location, timing, composition and volume of income to avoid taxation.”
This comes from the keyboard of Arthur Laffer of Supply-side economics fame. (See, http://professional.wsj.com/article/SB10001424052748703977004575393882112674598.html.) Laffer then gives several examples of such avoidance behavior: Senator John Kerry of Massachusetts, former Senator Howard Metzenbaum, and former Chairman of the House Ways and Means Chairman Charles Rangel.
I totally agree with Laffer on his major point.
This avoidance behavior also exists in the presence of an “inflation” tax. Whereas inflation has been touted as benefitting the “less well-to-do”, this is just a short-run help. Over the longer run, the “less well-to-do” cannot protect themselves very well against rising prices and so end up with lower real wages, real wealth, and fewer job opportunities.
As in the case of government assessed taxes, those individuals in the highest tax brackets or who have accumulated the greatest amounts of wealth are more capable of protecting their real income and real assets from an inflationary depreciation “by hiring lawyers, accountants, deferred income specialists and the like.” They can find many ways to avoid inflation that are not available to the “less well-to-do.”
There are three points that I would like to make relative to the above comments. First, many policies that attempt to help one class of people in a democratic society at the expense of another class of people may succeed in the short run. However, in the longer run, these policies tend to rebound on the former class of people, making them worse off, while achieving little or nothing in terms of the latter class.
In some cases these efforts produce a “negative-sum game” result in which everyone loses something. And, this leads me to the second point. By facing off “one class” of society versus “another class” of society, antagonisms are created, suspicions are raised, and society tends to be worse off. This is not what is supposed to happen in a liberal, democratic nation.
A liberal society works where people cooperate with one another and build community. To quote Ludwig von Mises on a liberal society: “It is important to remember that everything that is done, everything that man has done, everything that society does, is the result of such voluntary cooperation and agreements.”
I am not arguing in this post for or against renewing the “Bush tax cuts”. What I am arguing for
is a change in the rhetoric surrounding discussions about the federal budget, the rhetoric surrounding discussion about the financial reform bill, and the rhetoric surrounding many other issues in front of the American public these days.
Yes, arguing for one class against another may seem like good politics, but in America this really doesn’t win elections. Arguing for one class against another is a form of populism and the very politically astute Bill and Hilary Clinton have stated that elections cannot be won on a populist platform. (One reference on this point to Hilary Clinton can be found in Robert Rubin’s book “In An Uncertain World”.) I still remember watching Al Gore, in the 2000 election campaign, speaking in Mark Twain’s home town on the Mississippi River, Hannibal, Missouri, re-framing his campaign in populist terms. My immediate reaction was…Gore has just lost the election! And, he was well ahead of dubya in the polls at the time.
My third point is that very often people (and especially politicians) get caught up in the consequences of actions, which are current, and fail to see the causes of the these outcomes. This is a big problem in economics: many economic causes occur long before the consequences of the cause are recorded. For example, rent controls on apartments may lower housing costs for renters in the short run. However, if the owners of the apartments fail to maintain the units over time because of the reduced cash flows from the lower rental revenues, many will blame the “owner” and not the rent controls, for the now shoddy apartments .
An important example of this is the government caused inflation over the past fifty years or so. The gross federal debt increased by a compound rate of more than 7% per year from 1961 through 2008. A lot of this debt was monetized so that inflation increased at a compound rate of more than 4% per year during this time period accompanied by numerous asset bubbles which resulted from the excessive creation of credit. Financial innovation prospered in such an environment leading to greater and greater use of financial leverage, the taking on of greater amounts of risk, and the growth of “creative” accounting practices. Ponzi schemes also thrived in such an environment.
Why did businesses succumb to the taking on of excessive risk? The answer: in an inflationary environment, that is where the incentives are. If a company is out-performing its competitor by ten basis points then the competitor may assume more risk or take on greater financial leverage to pump up returns to match the competitor. The environment is cumulative in that more risk begets even more: or, as Chuck Prince, the CEO of Citigroup stated, “If the music keeps on playing, you have to keep on dancing.”
And who gets blamed? The greedy bankers…and not the government that created the inflationary environment. This point was made by the economist Irving Fisher in 1933: “If it is inflation and the one who profits is the business man, the workman calls the profiter a ‘profiteer.’ The underdog reasons as follows: ‘How did I get poor while you got rich? You did it, you dirty thief. I don’t know just how you did it; your ways are too subtle, sinister, dark and underground for simple me; but you did it all the same’
But, none of us—neither the farmer, nor the workman, nor the bondholder, nor the stockholder—thinks of blaming the dollar. So the real culprit stands on the curbstone watching us poor mortals as we beat out each other’s brains, and has the last laugh.”
Working together can result in a “positive-sum game”. The wealthy and those earning high incomes, at least most of them, believe that they should pay taxes. Maybe a new approach needs to be tried rather than attacking them and then trying to penalize them by enacting highly restrictive rules or excessive tax structures which they will spend great amounts of money to avoid.
The old methods don’t seem to work. Maybe we need to work to balance the tax laws so as to maximize tax revenues rather than punish one group of people over another. Maybe we need to think about creating a more open and transparent financial system that allows the economic process to work rather than saddle the economy with rules that dictate “outcomes”.
However, the old methods are built into the political system and will not change before this November. Guess we will just keep on shooting ourselves in the foot!
Monday, August 2, 2010
No Banks, No Recovery
More and more information is coming out about the problems that exist in the banking sector. About ten days ago, Elizabeth Warren, the Chair of the Congressional Oversight Panel, in testimony given to the U. S. Senate Committee on Finance, revealed more than anyone else in Washington, D. C. had done up to the time about the serious problems that existed in the banking sector. (See my post “Elizabeth Warren on the Troubled Smaller Banks”, http://seekingalpha.com/article/215958-elizabeth-warren-on-the-troubled-smaller-banks.)
Now, it seems as if almost every day we learn more about the difficulties still facing the banks.
The problem that goes along with the problems in the banking industry is that there will be little or no real economic recovery in the United States if the banking industry is not present in making business loans. Without any financial support, the economy will just not be able to grow.
My initial concern for the banking industry came from the behavior of the Federal Reserve System. For at least ten months, I have been arguing that the Fed was keeping its target interest rate low because of the problems that existed in the commercial banking system, especially among the smaller banks. Although the Fed stated that the reason for keeping its target rate so low was the fact that the economy was not picking up steam in terms of recovering from the Great Recession, I felt that their policy stance was caused by something deeper within the banking system. I believed that the asset values being carried on the balance sheets of a large number of banks were so inflated relative to market values that there was a major solvency issue within the banking industry, especially amongst the smaller banks.
FDIC data gave us confirming information on this: as of March 31, 2010, the FDIC placed 775 banks on its problem list. With the five banks closed last Friday, 106 banks have been closed this year, a rate of 3.5 banks per week. Expectations are for this rate of closure to continue for at least 12 more months.
Warren stated in her written testimony that quite a few small banks had received TARP funds and, “Notwithstanding the fact that those small banks that received TARP funds were required to prove their financial health, fewer than 10 percent have managed to repay their TARP obligations, and 15 percent have failed to pay at least one of their outstanding dividends.”
Furthermore, in her oral testimony, she admitted that “3,000 small banks faced serious problems in the future related to the residential housing market and the wave of commercial real estate loan resets forthcoming in the future.” One could therefore argue that, given this estimate and the FDIC problem list banks, about 1 out of every 2 banks in the banking system faces “serious problems.”
And Congress is working on a new program that would send $30 billion to “struggling” community banks. (See “Community Bank Bailout: Program Risks $30 Billion to Save Weak Banks”, http://www.huffingtonpost.com/2010/08/01/community-bank-bailout-pr_n_666776.html.) Saturday, President Obama described this new bailout program a “common-sense” plan to help spur on bank lending to small business owners.
This, of course, is the “new” Washington line to justify the help. Give the money to the small banks and they will lend to small businesses.
What about the $1.0 trillion in excess reserves that are currently held by the banking system?
What a weak cover, Mr. President!!!
Further information is coming from the banking system, information on the loan sales that commercial banks have recently made. Peter Eavis has a very insightful piece in the Wall Street Journal this morning concerning some specific loan sales and how these sales have impacted bank balance sheets. (See Eavis’ article: http://professional.wsj.com/article/SB10001424052748703314904575399592715122512.html?mod=ITP_moneyandinvesting_8&mg=reno-wsj.)
The bottom line: a lot of the assets that commercial banks carry on their balance sheets are seriously over-valued. When these assets are finally sold, large write downs take place which are absorbed by a reduction in bank earnings. Eavis concludes his article with this comment:
“More loan sales would be welcome. Not only because they relieve banks of burdensome assets, but also because they might inject more reality into the balance sheets seen by investors.”
What does this say about the state of the banking industry? What does this say about the Federal Reserve’s efforts to keep its target interest rate close to zero? Maybe the Fed doesn’t want commercial banks to sale the over-valued assets from off of their balance sheets?
Furthermore, all this is before the “wave of commercial real estate loan resets” forthcoming in the future that Elizabeth Warren talks about. It is also before another 500,000 foreclosures Realty Trac Inc. expects to occur before the end of the year 2010. And, how many foreclosures will take place in 2011? Historically there have only been about 100,000 foreclosures every year in the United States.
It is very difficult to see the United States economic recovery accelerating if the banking system is sitting on the sidelines. The part of the banking system to worry about is the 8,000 banks that do not make the list of the 25 largest domestically chartered banks in the country. These make up approximately one-third of the banking assets in the United States. About 1 in 8 of these banks are on the FDIC’s list of problem banks, and at least 3 in 8 of these banks are on Elizabeth Warren’s list of banks that face “serious problems.”
And, as we know the 25 largest banks have a lot of cash on hand but are not lending it out. Many of the largest non-financial companies in the United States have a lot of cash on hand but are not currently doing anything with it. It would seem that these organizations are looking to use this cash for something other than economic expansion. Could it be that they see the coming period as one in which there will be major consolidation of industry and a restructuring of the economy. (See my post “The Source of Economic Success”, http://seekingalpha.com/article/216450-the-source-of-economic-success.) This will certainly not result in much economic growth or a reduction in the unemployment rate.
Now, it seems as if almost every day we learn more about the difficulties still facing the banks.
The problem that goes along with the problems in the banking industry is that there will be little or no real economic recovery in the United States if the banking industry is not present in making business loans. Without any financial support, the economy will just not be able to grow.
My initial concern for the banking industry came from the behavior of the Federal Reserve System. For at least ten months, I have been arguing that the Fed was keeping its target interest rate low because of the problems that existed in the commercial banking system, especially among the smaller banks. Although the Fed stated that the reason for keeping its target rate so low was the fact that the economy was not picking up steam in terms of recovering from the Great Recession, I felt that their policy stance was caused by something deeper within the banking system. I believed that the asset values being carried on the balance sheets of a large number of banks were so inflated relative to market values that there was a major solvency issue within the banking industry, especially amongst the smaller banks.
FDIC data gave us confirming information on this: as of March 31, 2010, the FDIC placed 775 banks on its problem list. With the five banks closed last Friday, 106 banks have been closed this year, a rate of 3.5 banks per week. Expectations are for this rate of closure to continue for at least 12 more months.
Warren stated in her written testimony that quite a few small banks had received TARP funds and, “Notwithstanding the fact that those small banks that received TARP funds were required to prove their financial health, fewer than 10 percent have managed to repay their TARP obligations, and 15 percent have failed to pay at least one of their outstanding dividends.”
Furthermore, in her oral testimony, she admitted that “3,000 small banks faced serious problems in the future related to the residential housing market and the wave of commercial real estate loan resets forthcoming in the future.” One could therefore argue that, given this estimate and the FDIC problem list banks, about 1 out of every 2 banks in the banking system faces “serious problems.”
And Congress is working on a new program that would send $30 billion to “struggling” community banks. (See “Community Bank Bailout: Program Risks $30 Billion to Save Weak Banks”, http://www.huffingtonpost.com/2010/08/01/community-bank-bailout-pr_n_666776.html.) Saturday, President Obama described this new bailout program a “common-sense” plan to help spur on bank lending to small business owners.
This, of course, is the “new” Washington line to justify the help. Give the money to the small banks and they will lend to small businesses.
What about the $1.0 trillion in excess reserves that are currently held by the banking system?
What a weak cover, Mr. President!!!
Further information is coming from the banking system, information on the loan sales that commercial banks have recently made. Peter Eavis has a very insightful piece in the Wall Street Journal this morning concerning some specific loan sales and how these sales have impacted bank balance sheets. (See Eavis’ article: http://professional.wsj.com/article/SB10001424052748703314904575399592715122512.html?mod=ITP_moneyandinvesting_8&mg=reno-wsj.)
The bottom line: a lot of the assets that commercial banks carry on their balance sheets are seriously over-valued. When these assets are finally sold, large write downs take place which are absorbed by a reduction in bank earnings. Eavis concludes his article with this comment:
“More loan sales would be welcome. Not only because they relieve banks of burdensome assets, but also because they might inject more reality into the balance sheets seen by investors.”
What does this say about the state of the banking industry? What does this say about the Federal Reserve’s efforts to keep its target interest rate close to zero? Maybe the Fed doesn’t want commercial banks to sale the over-valued assets from off of their balance sheets?
Furthermore, all this is before the “wave of commercial real estate loan resets” forthcoming in the future that Elizabeth Warren talks about. It is also before another 500,000 foreclosures Realty Trac Inc. expects to occur before the end of the year 2010. And, how many foreclosures will take place in 2011? Historically there have only been about 100,000 foreclosures every year in the United States.
It is very difficult to see the United States economic recovery accelerating if the banking system is sitting on the sidelines. The part of the banking system to worry about is the 8,000 banks that do not make the list of the 25 largest domestically chartered banks in the country. These make up approximately one-third of the banking assets in the United States. About 1 in 8 of these banks are on the FDIC’s list of problem banks, and at least 3 in 8 of these banks are on Elizabeth Warren’s list of banks that face “serious problems.”
And, as we know the 25 largest banks have a lot of cash on hand but are not lending it out. Many of the largest non-financial companies in the United States have a lot of cash on hand but are not currently doing anything with it. It would seem that these organizations are looking to use this cash for something other than economic expansion. Could it be that they see the coming period as one in which there will be major consolidation of industry and a restructuring of the economy. (See my post “The Source of Economic Success”, http://seekingalpha.com/article/216450-the-source-of-economic-success.) This will certainly not result in much economic growth or a reduction in the unemployment rate.
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