As is too well known, rating
agencies tend to be followers not leaders.
The question always is…well how far behind are the rating agencies this
time?
In this respect, the rating
agencies are in the same boat as are the regulators…they are always behind the
curve.
As far as the banking system
itself…the banking system is not doing all that well…but, we knew that…but the
U. S. banking system is doing better than the banking system in the eurozone…if
that is any consolation.
The U. S. banking system is
still holding almost $1.5 trillion in excess reserves.
To me, this means that the
banking system, in general, is still is such bad shape that it does not want to
make many loans and is perfectly content to be sitting on all the excess
reserves that the Federal Reserve has supplied it.
This situation is not unlike
the one that existed during the Great Depression. In general, commercial banks are not in good
shape.
This general condition also
existed at the time of the Great Depression.
Too much debt had been created and individuals and businesses could not
pay off the debt that they owed. Many
banks were technically insolvent.
Commercial banks continued to be closed and many of the banks that still
had their doors open were just waiting for the regulators to visit them and
pull down the shades on their windows.
As we have seen this year,
the FDIC continues to close smaller banks, more than one per week, while many
other weak banks are acquired and so go out of independent existence.
While lending in the banking
system has increased in aggregate over the past year there still are disturbing
signs. For one, cash assets at the
smaller, domestically chartered banks increased over the past year by about $33
billion while cash assets in the whole banking system declined. That is, it looks like the demand for excess
reserves in the small banks has actually increased, a sign of management
concern.
Secondly, the commercial real
estate sector continues to cause the domestically chartered banks
problems. These loans continue to
decline at the largest 25 domestically chartered banks in the United States as
well as in the rest of the domestically chartered banks over the past year.
Whereas there is some signs
that the residential real estate market may be leveling off, problems continue
to exist within the commercial real estate area. It is here that we find why many of the
smaller banks are under such stress.
During the “glory days” of
the recent expansion, many of these smaller banks strained to put commercial
real estate loans on their books to generate bank expansion. In order to support this expansion the
smaller banks became “liability managers” something small banks hardly ever did
in the past. So these managements made
two mistakes…they got into commercial real estate loans, which they did not
have the expertise to do…and they got into the purchase of funds, again
something they had never done before.
Now, these smaller banks are
paying the price for their lack of discipline.
But, it was the thing to do in another time period.
The smaller banks will
continue to face balance sheet problems for some time and the number of
commercial banks in the banking system will continue to decline.
Another
thing to watch, however, is what is happening between banks. Nearly 40 percent of the increase in bank
loans over the past year came in a category titled “Other Loans and Leases” and
this category includes Federal Funds and reverse repos with nonbanks and “All
Other Loans and Leases.” This latter
group is defined by the Federal Reserve as Including “loans
for purchasing or carrying securities, loans to finance agricultural
production, loans to foreign governments and foreign banks, obligations of
states and political subdivisions, loans to nonbank depository institutions,
loans to nonbank financial institutions, unplanned overdrafts, loans not
elsewhere classified, and lease financing receivables.”
Foreign-related
commercial banks increased loans in the first category by over $66 billion.
Large
domestically chartered banks increased loans in the second category by more
than $34 billion. In order to explain
this I would like to concentrate on the subset “loans to foreign governments
and foreign banks.” Indications are
that these large banks committed a lot of money to “foreign governments and
foreign banks” over the past year. This
is where some of it shows up.
And, what was
the biggest item to increase on bank balance sheets in the United States?
Net
deposits due to foreign related offices of foreign-related financial
institutions in the United States. The
total increase over the past year was almost $290 billion!
It looks to
me like a lot of the lending activity that took place in the United States and
particularly in the largest 25 domestically chartered banks were to “off shore”
entities. In other words, a substantial
portion of the funds the Federal Reserve injected into the United States
banking system has migrated into foreign hands.
Thus, the
Federal Reserve System is not only supporting a weak United States banking
system it is also going to help support a weak world banking system.
One final
point of the current situation in banking: fundamental Keynesian economists
have argued that the current dilemma facing the monetary authorities today is a
“liquidity trap” much as the one they claim the central bank faced during the
Great Depression.
In my mind,
these Keynesian fundamentalists are as wrong about the current situation as
they are about their interpretation of the Great Depression.
Interest
rates are low and yet the economy is not expanding because the banking system
is still so weak that the banks are not lending, not because the economy is in
a “liquidity trap.” The problem is a
supply of loans problem not a demand for money problem!
And, this
applies to Europe as well as to the United States.
A stronger
recovery in the United States will not occur until the U. S. banking system
becomes solvent once again, debt balances in the economy are reduced, and governments
realize that they are not the solution to every problem.
