Banks fo­cus on cov­er­ing losses, not lend­ing

The Washington Times Weekly - - National - BY PA­TRICE HILL

Pres­i­dent Obama has been de­mand­ing that banks start lend­ing again, but the un­stated se­cret is that banks are not lend­ing much be­cause they are busy pay­ing back their gov­ern­ment aid and cov­er­ing losses of $1 tril­lion or more on de­fault­ing loans.

Banks and the ad­min­is­tra­tion all but aban­doned ef­forts to clean up their im­mense tox­i­cloan prob­lems through the bank bailout pro­gram ear­lier this year, and in­stead have been has­ten­ing to set­tle ac­counts. All of the top banks have re­paid their bailout funds to free them­selves from pub­lic scru­tiny and gov­ern­ment in­ter­fer­ence, and the Trea­sury has been trum­pet­ing the re­turn of $164 bil­lion in bailout funds by year’s end.

But that means banks now have to rely on their im­prov­ing prof­its and pri­vate fundrais­ing to try to off­set a steady stream of big write-offs for sour­ing loans on ev­ery­thing from credit cards to prime mortgages and com­mer­cial real es­tate. Es­ti­mates of to­tal bank losses on de­fault­ing loans over the next few years range up to $4 tril­lion.

An­a­lysts warn that the slow and painful process of writ­ing off this enor­mous amount of bad debt one quar­ter at a time could take years or even decades to com­plete, as it did in Ja­pan — and the econ­omy will suf­fer in the mean­time as busi­nesses and con­sumers are starved of credit that would be more forth­com­ing if the banks had healthy bal­ance sheets. Small busi­nesses are par­tic­u­larly vul­ner­a­ble be­cause they rely dis­pro­por tion­ately on banks for credit.

“We need to clean up the over­hang of toxic as­sets, which sit in zom­bielike banks,” said Rha­jeev Dhawan, di­rec­tor of the Eco­nomic Fore­cast­ing Cen­ter at Ge­or­gia State Uni­ver­sity. “De­lay­ing it is what Ja­pan did. It didn’t work. While banks are writ­ing off the bad debt, they don’t make any loans.”

Mr. Dhawan said the credit crunch is par­tic­u­larly acute for small busi­nesses, which can’t even get off the ground without bank credit. New busi­ness for­ma­tions have stalled be­cause com­mu­nity banks are weighed down with sour­ing com­mer­cial real es­tate loans. Bur­geon­ing loan losses have brought down 134 banks closed by the Fed­eral De­posit In­sur­ance Corp. this year.

The ve­neer of prof­itabil­ity at banks and the large bonuses some have been giv­ing their top per­form­ers this year have di­verted at­ten­tion from the large, fes­ter­ing loan prob­lems that con­tinue to eat away at banks, an­a­lysts say.

“The bank­ing cr isis has moved into a sec­ond stage” as banks slowly wr ite off bad loans on their books, said James Fer­gu­son, chief in­ter­na­tional strate­gist at Pali Cap­i­tal. Mr. Fer­gu­son es­ti­mates to­tal U.S. bank losses on loans of all kinds at $1.6 tril­lion, while other an­a­lysts say the losses could run as high as $3.8 tril­lion amid ris­ing un­em­ploy- ment, de­faults and fore­clo­sures.

But banks so far have re­ported only a lit­tle more than $607 bil­lion of those losses, sug­gest­ing that they have pub­licly ac­knowl­edged only the tip of the ice­berg, Mr. Fer­gu­son said.

“That would im­ply that the loss-recog­ni­tion process, which took al­most two decades to com­plete in Ja­pan, is not yet much more than one-third of the way through,” he said.

The glacial pace at which Ja­pan’s banks wrote off bad debts led to what economists have dubbed the “lost decade” in Ja­pan — fully 10 years, dur­ing which banks stopped mak­ing new loans and the econ­omy stag­nated, never post­ing sus­tained growth of more than 1 per­cent. While U.S. reg­u­la­tors are forc­ing banks to rec­og­nize their losses more quickly, an­a­lysts say it still could take years for them to fully come clean at the cur­rent pace.

Some ex­perts say banks are not ham­pered so much by a back­log of bad debt and lack of funds as they are by squeamish­ness about lend­ing to con­sumers and busi­nesses again af­ter suf­fer ing such huge losses.

“It’s pure risk aver­sion,” said Jim Spitzer, a lawyer at Hol­land & Knight, who noted that banks could eas­ily be lend­ing more with their record ex­cess re­serves of nearly $1 tril­lion and ac­cess to al­most cost-free loans from the Fed­eral Re­serve.

“They don’t want to take the risk of mak­ing loans” when the econ­omy is so weak that new loans could re­sult in fur­ther de­faults and losses, he said.

Banks also have an at­trac­tive al­ter­na­tive that en­ables them to make money without tak­ing any risks, he noted. They can in­vest their re­serves in U.S. Trea­sury bonds and make easy prof­its that way, he said.

While Mr. Obama re­cently called top bank ex­ec­u­tives into the Oval Of­fice to pub­licly ad­mon­ish them for not lend­ing, Mr. Spitzer said the gov­ern­ment also has gone to great lengths be­hind the scenes to try to make it eas­ier for banks to lend.

“The gov­ern­ment is try­ing to do ev­ery­thing it can to get the banks to make loans,” he said. “So far the banks haven’t re­sponded.”

One ex­am­ple is a re­cent move by the FDIC to not re­quire banks to write off com­mer­cial real es­tate loans if the un­der­ly­ing proper ty val­ues have dropped so far that the loans are “un­der­wa­ter,” as long as bor­row­ers con­tinue to make pay­ments on the loans and banks ex­pect the prop­erty val­ues even­tu­ally to rise again to match the loan’s value.

“The FDIC wants to pro­tect the banks,” Mr. Spitzer said. “The in­tent of the pro­gram is to avoid hav­ing the banks raise more cap­i­tal,” leav­ing them with more money to lend.

Still, even with the le­nient stance taken by reg­u­la­tors on an es­ti­mated $150 bil­lion of such un­der­wa­ter loans, banks will have to re­al­ize losses on about $700 bil­lion of com­mer­cial real es­tate loans that are so deeply un­der­wa­ter that they could never be prof­itable again, he said.

“Hope­fully, the banks have set aside enough re­serves to deal with that,” he said.

BLOOMBERG NEWS

The Bank of Amer­ica head­quar­ters build­ing in Char­lotte, North Carolina.

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