The US banking and housing industries at the end of 2009
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During the recent weeks and months, there has been much discussion in the US media about banks not lending money to small businesses or working with home owners that are struggling with their mortgages or who are already being foreclosed upon. This situation prompted President Obama to call the leaders of the nation's banks to the White House on December 14. The meeting was well orchestrated and afterwards, several of the head bankers met the press and agreed with the President and that they all needed to do more lending to the people on "Main Street."
However, most academics and experts, including Peter Morici, an economist and business professor at the University of Maryland, said this is just another publicity stunt.(http://www.thetakeaway.org/stories/2009/dec/14/president-obama-hosts-bank-leaders/) Consequently, it appears the White House meeting was a good short-run public relations event for the President and for the banking industry, but will do little to increase day-to-day lending by US banks.
So, what is the real reason behind the lack of lending? There are probably many factors that have made banks reluctant to do the President's bidding, but the following are some things that should be considered.
First, banks are in business to make money. CEOs and other bank executives may listen politely to the US President, but they know they must satisfy their stockowners to keep their jobs. To satisfy investors, it is critical that banks (large and small) begin to show noteworthy profits. Therefore, bank leaders are looking at the risk versus expected return trade-off of every loan; especially immediately after the great recession. This is also very true of those institutions that used to buy mortgage backed securities and other derivative financial vehicles.
Second, bank executives have been chaffing being under the control of government officials. According to CBS News White House correspondent Mark Knoller, White House pay czar Ken Feinberg announced on December 11 the second round of rules governing executive compensation for bailed out companies. In general, this newest set of rules limits executive pay to $500,000 which is, most assuredly, not in the best interest of the affected employees. During the second week of December, Bank of America repaid $45 billion in bailout funds. As a result, it became the latest large US bank no longer subject to such federal restrictions. Given current CEO Ken Lewis's pending retirement on December 31, this freedom probably helped it considerably in its search for a new CEO. Now, most large banks and financial institutions have paid back the emergency loans they received at the height of the financial crisis. By one account, all but about $40 billion of the $400 billion of the various bank bailouts has been or soon will be repaid and this is welcome news for the US tax payer.
However, the remaining emergency loans are owed primarily by small local banks. These are the ones that traditionally loan money to small local businesses and they are relatively illiquid when compared to their large counter parts that deal with Wall Street and other national markets. In addition to many of these banks being strapped for funds to loan, there are the several very real credit issues. Many small businesses are much more risky than they would have been two or three years ago because consumer spending is now reduced due to the economic downturn. Furthermore, there are the issues surrounding the housing market.
According to John Burns Real Estate Consulting (JBREC), the current US housing industry can be characterized by the oversupplied nature of the market. Furthermore, many believe the existing meager sales volume is and has been "propped up" by government intervention – the homebuyer tax credit, high volumes of Federal Housing Administration (FHA) –ensured mortgages, the Freddie Mac and Fannie Mae bailouts, and the Federal Reserve's mortgage rate intervention. In other words, once the effects of these programs and efforts by the US government are concluded, the underlying demand for houses will be even weaker than it is now. Consequently, the value of many existing homes will fall even further. Small banks simply cannot afford to take the risk of making loans secured with collateral that has a very good chance of being worth less than the face value of the loan in the very near future. Ironically, there have been areas within the U.S. where new home starts have shown up ticks. Such slight improvements are limited to specific areas and these may reflect the American preference for a new house as opposed to an almost new, but still previously occupied house.
So, what does all of this really mean? It means natural economic forces are behind the current behavior of bank managers. Banks want to be profitable and large banks have better opportunities than making home mortgages and small business loans. Furthermore, they have used their liquidity to payback bailout loans and this has freed them of more than the normal amount of government oversight. Small banks are illiquid and, for their very survival, cannot afford the consequences of any bad loans (home mortgage or small business). The housing industry must work off the excess inventory created, in part, by the lax lending practices, permissive regulatory environment and social motivations of the five or six years prior to 2008. Finally, small businesses must wait for banks to make loans, and, how long this wait is, will depend on the time it takes for the American consumer to have enough confidence in his or her financial condition to begin spending at levels that will sustain small businesses. All of these are interrelated and, of course, all will take time to reach solution. For now, the US government has done all it can do, but cheerlead.
