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.")

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% 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.") 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 here.)

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.”) This will certainly not result in much economic growth or a reduction in the unemployment rate.