Real Estate, Especially Commercial Real Estate, is Still a Major Problem

Over the past two years or so, I have continually written about the problems that exist in commercial real estate lending, especially the problems faced by many commercial banks in the United States. 

Many commercial banks, especially the less than gigantic ones intent on growing and becoming more of a force in their local or regional areas, turned to the commercial real estate area over the past decade to “scale up” their organizations.  These larger loans allowed the “smaller” banks to increase their asset size quite rapidly and, given the means and the encouragement of the regulators, could finance this loan growth by “purchased” funds rather than rely upon “local” deposit growth. 

Of course, many of these organizations knew little or nothing about commercial real estate.  But, they could hire an “experienced” commercial real estate lender and then, with the support of their regulator, could write a policy document on their commercial real estate lending operations and forge bravely ahead to greater fame and glory.

Oh, and these “experienced” commercial real estate lenders could also begin a program of securitization of larger loans so as to create fees for the bank and sell some of the asset value off to other investors around the world. 

These commercial real estate loans still haunt the commercial banking system.  Since many of these loans, securitized or not, were “bullet” loans, the banks could continue to carry these loans at “book value” on their balance sheets and not have to deal with them until they matured…five years after they were originated…or seven years…or ten years. 

And, as has been typical of commercial bankers, the lenders could always justify carrying the loans at full value until maturity, even though the borrowers experienced problems, or, in some cases, were actually in trouble with the law.  Bank lenders are the most optimistic people in the world when it comes to explaining how a loan that doesn’t look so good…will be paid off…in full!

As many readers of this blog will attest, I have constantly argued that we still do not have a full understanding of the real value of bank assets…and one of the reasons that this is true is that commercial real estate lending has become such an important part of the balance sheets of US banks.  And, given the nature of these loans, they still remain at “book value” on the balance sheets, which in many cases, is nowhere near the “market value.”  And, in the case of “bullet” loans, will not be assessed a more realistic value until the loans reach their maturity.

I have supported this argument with two pieces of information.  First, commercial real estate lending at all commercial banks continue to decline…sometimes substantially.  Whereas there appears to be some leveling out of lending in other areas, even in the residential real estate area, commercial real estate lending continues to decline at all asset levels in the banking industry, but especially in the “smaller” banks.  Commercial banks are extremely reluctant to step up their commercial real estate lending…my argument being that there is so much trouble on balance sheets in this area that financial institutions just don’t want to introduce more complicated loans into their operations.

Second, I have argued that one of the major reasons that the Federal Reserve has pumped so many excess reserves into the banking system is to provide sufficient liquidity to the banks so that they have as much opportunity as possible to “work out” their problem loan portfolios, or, if this is impossible, to allow the FDIC to “close” banks in as orderly fashion as possible so as to avoid a disruptive, cumulative problem for the banking industry. 

So far, this latter effort has been extremely successful.  The FDIC has only been closing about one bank a week over the past year and another one-to-two banks are leaving the banking industry per week over this time due to being acquired.

The problem in the commercial real estate area is highlighted in a recent article by Floyd Norris in the New York Times, titled “Commercial Mortgages Show How Bad It Got.”  Although Norris focuses on commercial mortgage-backed securities, the problem experienced by the commercial banking industry is similar.

“Now the first of the mortgages that were securitized in 2007 have started to come due, and it is becoming clear just how bad many of the loans were.  The time when investors were most eager to buy turns out to have been the worst time to do so.

Commercial mortgages—unlike residential ones—are seldom issued for periods of longer than 10 years, and often for as little as five.  Many require no principal repayments during that period but call for the entire amount to be repaid in a balloon payment at the end of the loan.  So it can be at maturity when the bad news arrives.”

It is estimated that of the loans from 2007 due to mature in 2012, less than 30 percent will be paid off in full.  And, other loans, maturing in seven or ten years can present problems in 2014 and in 2017.

Many of the loans originated in 2007 were justified…just like in the residential area…by expected, but very optimistic, increases in rental values.  Well, rental values in commercial properties, just like in the prices of homes, had been going up for years.  Obviously, they would continue to increase!

Now, Norris reports, “more than 10 percent of loans in commercial mortgage-backed securities portfolios are delinquent.”  The worst category?  “Apartment loans with a delinquency rate of 15 percent.”

Furthermore, “Borrowers are current on their payments on less than one-third of the $3.1 billion of loans still left in the securitizations, and more than 80 percent of the properties securing those loans are thought by Wells Fargo, the trustee for the securitization, to be worth less than the amount owed.”

The bottom line is that commercial banks…and other investors…are not “out-of-the-woods” yet in terms of finding out the value of their assets.  And, the worst of the worst are those banks that went heavily into this commercial real estate lending in the “boom” years, not really knowing what they were doing. 

I believe that this fact is one of the major reasons why commercial banks are not really lending much at this time and why the regulators…the Federal Reserve and the FDIC…are acting so gently with respect to the banking system.  These regulators do not want to precipitate any more problems in the banking system than they are dealing with at the present time. 

If my analysis is correct, then I believe that it will be very difficult at this time for the Federal Reserve to stimulate a faster rate of expansion of loan growth within the banking system and, consequently, it will be very difficult for monetary policy to stimulate a faster rate of economic growth.  A healthy banking system is needed for a healthy rate of economic growth. 

And, this conclusion also holds true for Europe.  Given the state of the banking system in Europe and the problems that exist there relative to past lending in the real estate area, central bank efforts to stimulate the economies of the eurozone will have very little success.  The lowering of interest rates by the ECB and others, to me, is more for show than anything else.          

Federal Reserve Remained Quiet in April

As reported in my last review of Federal Reserve actions, all remains quiet on the monetary front. Right now, as far as monetary policy is concerned, there is not much for the Fed to do…and, to me, this is good.

Things are quiet in the banking system…except for the complaints of top bankers about new rules and regulations that are being discussed.  The FDIC closed only one bank this week, bringing the total for the year up to 23.  But, closers are going “smoothly”.

Economic growth, year-over-year, continues to be in excess of two percent, although not by much.  And, other data being reported contain some good information…and some not-so-good information.

The European crisis continues along with more stress being placed on the creation of growth rather than continuing “austerity.”  The question is how much the elections of the weekend will change the near term future for the eurozone.

And, with the presidential election in full swing, the Fed seems to be content with the above scenario.  There is little or nothing it can do between now and the election to change the trajectory of the economy before November.  It “stands by” in case there is any “fire” that needs to be put out in the meantime.  (For more on this see my post.)

Furthermore, it seems as if we have had the last of the “education” sessions put on by Professor Bernanke for a while.

Thank goodness!

In terms of the actions of the Federal Reserve over the past month, most changes that occurred on the Fed’s balance sheet seem to be “operational”.  That is, the Fed was just responding to general “operating” factors impacting the banking system. 

The largest “operating” factor that occurred in April was connected with the yearly tax collections.  Deposits at Federal Reserve banks rose in April by almost $80 billion.  This is a seasonal swing as funds are collected at tax time in “tax and loan accounts” at commercial banks.  Then, the Treasury transfers these balances to its account at the Fed, the account the Treasury writes checks on.  This movement absorbs bank reserves at the same time the Treasury writes checks, which will then go back into the banking system as the recipients of those checks deposit them.  This procedure minimizes disruptions to the amount of reserves in the banking system.  Hence, these actions are called “operational”.

Two other factors can catch our attention.  First, over the past four weeks, the Fed has increased its holdings of mortgage-backed securities by $11 billion.  This is the first increase in mortgage-backed securities for more than a year.  In total, this account declined by almost $80 billion from May 4, 2011 to May 3, 2012.  Some support for this sector of the financial markets?

The second factor is the decline in Central Bank Liquidity Swaps.  This account increased over the past year as the European sovereign debt crisis expanded into the fall of 2011.  But, these liquidity swaps began to decline since the second Greek bailout was accomplished.  Central bank liquidity swaps declined by about $19 billion over the last four-week period, and declined by over $77 billion during the last 13-week period.  As of May 3, 2012 there were slightly more than $27 billion swaps still on the Fed’s books. 

Reserve balances with Federal Reserve banks on May 3, 2012 stood at $1,481 billion ($1.5 trillion rounded off) only $8 billion more than existed on May 4, 2011.  Excess reserves in the commercial banking system, a two-week average, were $1,458 billion, just about what was in the banking system one year ago, $1,452 billion.

This relative stability on the Fed’s balance sheet was achieved despite substantial changes taking place within the banking system itself. 

Although the total reserves in the banking system only increased by a little less than 4%, required reserves in the banking system rose by about 32%.  The reason for this difference is that demand deposits at commercial banks, deposits that have the highest reserve requirements, increased by more than 41%.  Time and savings deposits at commercial banks, which have lower reserve requirements, rose by a little more than 8%.  Thus, there was a shift in the banking system from deposits with lower reserve requirements to deposits with substantially higher reserve requirements.

This shift from time and savings deposits to demand deposits has been going on for a long time.  I have been reporting on this for more than two years now.  The shift is taking place, not only because of the low interest rates being paid by banks (and thrift institutions), but because of the weak economy.  People out of work or on the edge financially transfer the wealth they have to “transaction” type of accounts so that they can live and pay their bills.  They don’t have the resources to “manage” their wealth across a spectrum of assets.  Thus, the growth in demand deposits, to me, is a sign of weakness in the economy and not a sign that monetary policy is working.

Another piece of evidence supporting this claim is the strong demand for currency outside the banking system.  Currency in circulation is increasing at a 9%, year-over-year, rate of growth.  This is an extremely high growth rate and a sign of a weak economy and not a strong one.

As a consequence of these demands, money stock growth continues to increase at a very rapid pace.  The M1 measure of the money stock remains in the high teens, growing at an 18% rate for the past year, while the M2 measure is growing at a pace slightly under 10%.

Both of these rates of growth are high, historically, but can be explained by the shift in assets toward more liquid and more transaction-based accounts.  Only recently has loan growth started to increase and this may provide some reason for the money stock to continue to increase in the future.  If loan growth does continue to increase and if this creates a reason for the money stock to grow, this would be a healthy sign for a recovering economy. 

So, not much has changed on the monetary front from last month.  I believe that this is a good situation for the monetary authorities.  It doesn’t mean that the future will be easy.  The Fed is still going to have to deal with almost $1.5 trillion in excess bank reserves when the economy begins to expand more rapidly…the threat of rising inflation is real.  Yet, the past is past and we are where we are right now…and, to me, where we are right now is hopeful.   

More News on the Troubled Banking System: The TARP Report

Reports concerning the banking system keep popping up from time-to-time that continue to cause us to pause and wonder about the financial health of the banking system. 

We do not get information directly from the Federal Reserve System or the Federal Deposit Insurance Corporation about the state of commercial banks. 

However, we see that the Federal Reserve has pumped over $1.5 trillion in excess reserves into the banking system.  The Fed tells us that the quantitative easy that has created these excess reserves is to help spur on economic growth.  Yet, there still lingers a doubt about the real financial condition of the banking system and about the possibility that the Fed is keeping the banking system excessively liquid so as to keep banks, especially the smaller ones, afloat so that the FDIC can either close the weaker ones or assist others to merge into healthier banks in a smooth and orderly fashion. 

The FDIC, at last count, still had well over 800 commercial banks on its problem bank list.  So far this year the FDIC has closed about one bank per week.  The information we don’t have is the number of banks that have been merged out of existence this year.  Last year about five banks left the banking system every week either through being closed or by being merged out of existence. 

Now, Christy Romero, special inspector general for the Troubled Asset Relief Program (TARP), has released information indicating that “351 small banks with some $15 billion in outstanding TARP loans face a ‘significant challenge’ in raising new funds to repay the government.” (http://professional.wsj.com/article/SB10001424052702303978104577364262736412398.html?mod=ITP_moneyandinvesting_0&mg=reno64-sec-wsj)

This information was released in connection with her quarterly report to Congress. 

The total of $15 billion is not a small number.  If one looks at the FDIC statistics, as of December 31, 2011, there were 5,776 commercial banks that had assets of $1.0 billion or less.  The total of 351 banks only represents about six percent of the commercial banks of this size, but the $15 billion debt to TARP is approximately 12 percent of the Total Equity Capital of these banks. 

Why did these commercial banks need so much TARP money?  Well, the TARP money was supposed to provide liquidity relief to these organizations so that they would not have to get rid of underwater assets that would threaten their solvency.  They needed the TARP money because so many commercial banks had become “liability management” banks using purchased funds to support their asset portfolios. 

The only commercial banks that used to be “liability management” banks were the larger banks that could go into the money markets and purchase funds at market rates.  The larger banks purchased monies through the market for negotiable certificates of deposit and the Eurodollar market and similar other “liquid” markets.

Over the past twenty years or so almost all commercial banks, even some very small ones became “liability managers” as they used different forms of purchased funds to allow them to bid more aggressively for riskier assets or to grow faster than their local “communities” would allow.  Government agencies, like the Federal Home Banks even encouraged this behavior by making loans available to smaller banks…and thrift banks…so that they could grow and build their asset portfolios. 

I was just amazed this past year.  Given a bank transaction I was involved in I had the opportunity to take a webinar on Asset/Liability management offered by the American Bankers Association.  Within the material presented in this webinar was substantial information on how banks…small and smaller banks…could or should use purchased funds.  Not demand deposits or savings deposits supposedly the bread-and-butter of community banks, but purchased funds from outside the “community.”

Main Street was attempting to play the game like Wall Street!

This plays right into the TARP scenario.  These “smaller” banks were using purchased funds to support assets of different flavors and assortments.  As these assets dropped “underwater” and as the purchased funds had to be rolled-over, the banks, to avoid having to take losses by selling the assets, obtained TARP funds to allow them to keep the assets on their books.

This was exactly the purpose of the government troubled asset program.

Now, here we are a couple of years later.  The assets are apparently still underwater which means that the TARP funds cannot be repaid.  And, the banks are in such bad condition that they cannot even pay the quarterly dividends that are owed to the Treasury. 

According to the Report, in the first quarter of 2012, 200 TARP banks failed to make their latest payment.  The shortfall in dividend payments is $416 million!

So, we have some more evidence that the banking system is not “out-of-the-woods” yet in terms of its solvency issues.  Given this conclusion it is understandable that the Federal Reserve and the FDIC are aiming to err on the side of too much ease and very strict oversight.  One can guess that this posture will not end soon.

Furthermore, the bigger banks are just going to become a larger and larger part of the whole banking system.    

Commercial Banks: How Safe is the Banking System?

The commercial banking system in the United States does not seem to be “out-of-the-woods” yet, in spite of the fact that 15 out of the 19 largest banks in the country recently passed the stress test administered by the Federal Reserve. 

For one, many executives of the commercial banks involved don’t seem to understand how the Fed got many of its results. 

In conference calls held after the results of the stress tests were released the banks raised major questions over how calculations of capital were made.

“Healthy institutions want to understand why there were some large gaps between their own capital estimates and the Fed’s, according to people close to those banks.  Some of the five lenders that didn’t pass the test say questions about the Fed’s scoring complicate reapplying for approval to raise dividends or buy back stock…” (http://online.wsj.com/article/SB10001424052702303812904577299611815199568.html?mod=ITP_moneyandinvesting_0)

Problems in interpretation were bound to occur, but, to my mind, the commercial banks have created their own nightmare.

The real problem:  mark-to-market accounting, or, the lack of it.

Executives in commercial banks don’t like mark-to-market accounting.  The basic reason is that they don’t like to admit that they have made mistakes or that they have taken on too much risk or that they just don’t want to deal with messy issues. 

When the value of bank assets decline, either because loans have gone sour or because interest rates have risen and the market value of securities have dropped, analysts argue that the banks should mark their assets to market so that they can get a real picture of how the bank is performing…whether or not the bank is solvent.

Bankers argue back that they shouldn’t be made to mark their assets to market “after-the-fact” because that forces them to change their balance sheets that were not expected of them before.  And, they also plan to hold their securities to maturity, when they would get their full value repaid, and they also need time to “work-out” their troubled loans as the economy improves.  They argue that analysts, by asking for them to go to mark to market accounting, are changing the “rules of the game” after the economic and financial environment has changed. 

So, the bankers can put on riskier loans, buy securitized bonds, mismatch maturities, place SIVs off-balance-sheet, and so forth, and when the economy turns south, they do not have to reveal to the public…and the regulators…what their decisions have done to the health of the bank!

They ask, “I have mismatched maturities to earn a few more basis points on my return of assets to try and keep up with the competitors, and now, since interest rates have gone up I have to mark the longer term assets to market?”

Well, you took the risk, you must own up to the consequences.  Arguing that you intend to hold the assets to maturity doesn’t “hold water” because as short-term interest rates continue to increase you will either have to sell your assets or work with a negative interest rate spread.

Also, Mr. Banker, when you made riskier loans…like subprime loans…you were stretching for yield.  You made the choice.  As the market moves, so does the value of your assets.  Own it.

  

Since the commercial banks have fought the development of an adequate mark-to-market accounting process, the Federal Reserve…and others…have tried to create a substitute for this accounting treatment of assets.  This substitute is called the “stress test.”

The “stress test” works with assumptions.  “Last November (the Fed) published test assumptions, such as a 13% unemployment rate in a U. S. recession.

But the Fed is resisting full disclosure of its methodology, hoping to retain the flexibility to make future changes and prevent the banks from gaming the numbers…”

The commercial banks “game” their own accounting numbers by not marking their assets to market.  The fear with stress tests is that the commercial banks will “game” the tests if they know what the Fed’s assumptions are.  The commercial banks want it both (all) ways.

And, how well off are the commercial banks?

Jesse Eisinger writes in the New York Times about the annual report of the Federal Reserve Bank of Dallas.  Although the article concentrates on the issue of “too big to fail”, Eisinger does print a quote from an essay in the annual report written by Harvey Rosenblum, the head of the research department at the Dallas Fed.

Rosenblum wrote: “Monetary policy cannot be effective when a major portion of the banking system is undercapitalized.  Many of the biggest banks have sputtered, their balance sheets still clogged with toxic assets accumulated in the boom years.” (http://dealbook.nytimes.com/2012/03/28/banking-regulator-calls-for-end-of-too-big-to-fail/?ref=business)

This from the head of a research department within the Federal Reserve System!

And, what about the other banks in the system?

As last reported by the FDIC there were 814 commercial banks on the list of problem banks.  There are many more on the edge of becoming problem banks.  The number of commercial banks in the United States dropped by 240 last year and only 92 of these were bank closures.  In both cases, the numbers included no banks that could be called “the biggest banks.”

You wonder why the Federal Reserve has pumped almost $1.6 trillion in excess reserves into the banking system?

I have argued for more than two years now that the Fed’s ease is not just about getting the economy going again.  In my opinion the Fed has been as generous as it has been in order to allow the FDIC to close or to approve the acquisitions of troubled banks in an orderly manor so as to allow the banking system to adjust to its “insolvency” problems as smoothly as possible.

I agree with Mr. Rosenblum, I think that there are still too many “toxic assets” on the balance sheets of commercial banks…large, medium-sized, and small.

Without some kind of adequate mark-to-market accounting process in the commercial banking system, we will continue to be “in the dark” with respect to the health of banking institutions and banks will be able to continue to “game” us.

Having an adequate mark-to-market system in place will cause bank managements to conduct their businesses in a less risky fashion.  And, only by having an adequate mark-to-market system in place will bank managements move to address the problems they face in real time, something they currently are loathe to do.  

Larger Banks Are Changing the Banking Landscape

In a recent New York Times op-ed piece, the finance blogger at Reuters, Felix Salmon, wrote about the higher fees being charged customers at larger commercial banks in the United States. 

Salmon states, “As bank fees have moved from being invisible to being visible, the inefficiency and greed of the big banks has become ever more obvious.  The result is heartening: In 2011, more than 1.3 million Americans opened a new account at a credit union.

In part that’s because smaller banks and credit unions are a better fit for the average consumer.  They don’t have the huge branch networks to support, they pay their executives mush less and they don’t generally feel the need to be enormously profitable in the first place…

So, rather than kvetch about monthly checking-account fees, let’s celebrate them.  With any luck they’ll be just the thing we need to finally get around to closing our accounts at Citibank or Wells Fargo or Bank of America or Chase, and opening a new account at a better, friendlier—and cheaper—bank.” (http://www.nytimes.com/2012/03/11/opinion/sunday/higher-bank-fees-are-a-good-sign.html?_r=1&scp=3&sq=felix%20salmon&st=cse)

This reminds me of the time I was sitting in the executive quarters of a large savings bank in Philadelphia in the late 1970s.  I was talking with several of the senior people on the retail side of the bank.  They were ecstatic about the fact that their bank had just picked up more than 5,000 new accounts over the past month or so from a commercial bank that had recently started charging depositors explicit fees on their checking accounts as well as on some other transactions related products. 

This scene was ironic to me because about a week before, I was talking with some senior executives from the commercial bank that had raised its fees and they were very, very excited about all the accounts they were losing because of the new charges.  They were excited because the accounts they were losing were generally low balance, high transactions accounts…in other words, very costly accounts…and this had been one of the objectives they had hoped to achieve with the imposition of the higher fees.

Note: the savings bank failed while the commercial bank remained healthy and was ultimately acquired by a larger, national organization that was diversifying geographically.

This story came back to me in reading the New York Times article because I see some of the fee activity of the larger banks as an effort to encourage certain bank customers to leave these larger banks and take their accounts to the smaller commercial banks or credit unions. As with the commercial bank I described above, by raising certain fees and charges, these larger banks were allowing their customers to “self select” and take their business elsewhere. 

Of course, some of these larger banks presented their new fees in such a way that they got a lot of unfavorable publicity that they didn’t really want and so they immediately backed off.  And, this news played into the “Occupy” movement and helped its cause. 

But, I would say, the larger banks got what they wanted.  According to Saxon, 1.3 million Americans opened a new account at a credit union.  And, even more opened accounts at “smaller” commercial banks.

What’s going on here?

Well, this is a part of the new, evolving financial system. 

Are the larger banks really unhappy about this movement?  I don’t think so.  The larger commercial banks are getting larger.  The share of banking assets going to the smaller banks is declining.  In February 2012, the largest 25 domestically chartered commercial banks in the United States made up just about 66 percent of the total assets of all domestically chartered banks.  In February 2008, just before the financial crisis took place, the largest 25 banks in the United States held less than 65 percent of the total assets. 

Note: total assets at all domestically chartered commercial banks were just about 13 percent larger in February 2012 than they were in February 2008.

Furthermore, at the end of the year 2011 there were 6,290 commercial banks in the banking system, almost 1,000 fewer than existed at the end of the year 2007 when there were 7,284 commercial banks in existence.  The shrinkage came in the number of “smaller” banks.

But, Salmon writes: “From a consumer’s point of view, this trend (the movement of deposits to smaller commercial banks and credit unions) will create a virtuous cycle.  As deposits leave the big banks for smaller competitors, the too-big-to-fail crew will inevitably lose political clout—and eventually, start shrinking.”

What am I missing here that Salmon sees?

I agree that things are changing, but I see them changing in a different way.  Less wealthy individuals and businesses will move to smaller banks and credit unions.  These people will prosper at not-for-profit, low overhead organizations.  These financial institutions will offer more basic banking products and services and will thrive.  And, their customer base will be very happy. (http://seekingalpha.com/article/420741-commercial-banks-can-t-get-a-break)

Wealthier customers and larger businesses will work with the newly re-structured larger banks.  We see this taking place already as JPMorgan Chase and Citigroup, Bank of America and Wells Fargo are creating new relationships, new branches, and new lounges to attract a more affluent customer.  This new target is the “mass affluent”.   These are people with assets in the “hundreds of millions.” 

This, however, is not just about “banking” but about mutual funds, stocks and retirement advice and so on and so forth.  This approach is providing the customer with complete, timely, fluid, low cost management of the “customers’” wealth.  These banks are not going after the top 1%, but they are going after the top 10%.

Not only are these accounts more lucrative, they “also face less of a pinch under new government regulations than do those of ordinary savers.” (http://www.nytimes.com/2012/03/11/business/to-increase-revenue-banks-go-after-affluent.html?scp=6&sq=nelson%20schwartz&st=cse)

And, what kinds of managers are being brought into these banks by the Board of Directors?  Not just commercial bankers, oh, no!  Commercial bankers are just “debt” guys…people that only understand advancing money if there is adequate collateral and don’t get all agitated if the borrowers credit rating is not the best.  They understand loan classifications like business loans, mortgages, consumer loans, and commercial real estate loans.     

No, the recent trend…although it is not absolute…is to bring in investment bankers at or near the top.  Investment bankers are “equity” guys…they understand ownership…and, they understand risk management.  And, they understand asset classes and portfolios of assets. (http://www.ft.com/intl/cms/s/0/0e80a8c6-6c6c-11e1-b00f-00144feab49a.html#axzz1p1BAmhf3)

So, we should celebrate, with Felix Salmon, the movement of small deposit accounts to the smaller banks and credit unions.  However, I am not sure that I am celebrating this movement for the same reason that he is.   

Bank Regulation is Going from the Ridiculous to the More Ridiculous

Bankers should be concerned about profits and making good loans and being good community citizens.

But, there is a new game in town.

Don’t grow your bank beyond $10 billion in assets.  But, if you do exceed $10 billion in assets grow your bank as fast as you can!

CEO Mitchell Feiger of MB Financial, Inc., a Chicago bank, is quoted as follows: “We are watching (deposit) accounts carefully.  We work to stay under $10 billion (in assets) until we can’t do it anymore and we’ll blow past it.  When you go past it, it doesn’t make sense to go over by $100 million.” (http://professional.wsj.com/article/SB10001424052970203918304577239172897160582.html?mod=ITP_moneyandinvesting_1&mg=reno-secaucus-wsj)

“For regional banks, expanding beyond $10 billion in assets now comes with regulatory demands that are aimed at making the financial system safer but that add complexity and costs.

As such, some banks have made the unusual decision of expanding more slowly and even turning away money to stay under the regulatory benchmark.  Some banks have lowered the interest rates they pay for customer deposits in an effort to attract less cash.  And the timing of growth initiatives also is now a factor, as some banks think it makes little sense to trip the $10 billion trigger unless they are to grow much bigger.”

Is this what we want American commercial bankers to focus on.

Almost every day the banking scene seems to get sillier…if the situation weren’t so serious.

Bankers in the United States…and all over the world as a matter of fact…are spending too much time not doing banking but doing regulatory compliance and avoidance.  Bank managements are focusing on how to stay out of regulatory trouble or regulatory attention.

This attitude is not going to change.  The changes in the regulatory environment Congress has created is going to have to play out.  Too much has been started, too many institutional changes have been initiated and organizations created, and too many people have been hired for this tidal wave to stop in the near term.  

And, regulators are still fearful of bank failures as the number of problem banks remains large and bankruptcies and foreclosures stay near record levels.  We still hear about the fact that 22 percent of the homeowners with mortgages on their houses in the United States have mortgages that are greater than the market value of their home.  We also hear that the commercial real estate market is still sufficiently in trouble that many of the loans on these properties are below loan values.  There are a lot of banks that are not out of the woods yet.      

Unfortunately, the folly will continue.  I see no way out of this swamp at the present time.

Key to Future Bank Performance: How to Get Around the Regulations

Interested in investing in a commercial bank these days?

What should be the key factor in determining whether or not to invest in a specific bank?

How about the ability of the management of the bank to get around the rules and regulations now being written up or proposed by the bank regulatory agencies?

A New York Times article this morning, “Consumer Inquiry Focuses on Bank Overdraft Fees” contains the following subtitle: “Wondering whether banks are working around new rules.” (http://www.nytimes.com/2012/02/22/business/bank-overdraft-fees-to-be-scrutinized-by-consumer-bureau.html?_r=1&ref=business)

My answer?

Yes!  The banks are working around new rules!

I began my banking career in the 1960s, a period when commercial banks began the process of financial innovation that just grew and grew through the latter part of the century.  In that decade we saw the introduction of the negotiable certificate of deposit (negotiable CDs), the formation of bank holding companies, the issuance of bank liabilities through the bank holding companies, and the creation of the Eurodollar.  Then we saw banks attempting to get around state branching laws and interstate branching laws and so on and so forth.  The rest is history!

When I was working in the Federal Reserve System in the late 1960s and early 1970s the “rule of thumb” was that the Fed was about six months behind what the commercial banks were doing.  New rules or regulations would go into effect on the banking system…the commercial banks would move to “get around” the new rules or regulations…and, it would take about six months for the Fed to catch on to what the commercial banks were doing.

Times haven’t changed…and won’t change.

Given the rapidly changing environment created by information technology, the financial institutions will just have more ways to quickly and effectively avoid any banking rules or regulations they believe it is worthwhile to avoid.

To me, what Congress and the regulators are trying to do is silly!

For one, the “powers that be” are trying to avoid 2007-2008 from happening again.

Guess what?

2007-2008 will not happen again.  We have already moved way beyond that.

Furthermore, the technology has changed to the point where it is almost impossible for regulators and legislators to understand what is going on, let alone write rules and regulations that will control what is going on. 

Look at the Dodd-Frank financial reform act.  Most of the rules and regulations included in this bill HAVE NOT BEEN WRITTEN YET!

And, President Obama signed the act into law in July 2010.  We are ready to celebrate the 2^nd anniversary of the signing of the bill and the most of the rules and regulations incorporated into the bill have not been written.

And where is this “writing” taking place?  Primarily in back rooms, with no intrusion from the public, and no review.  See the enlightening piece in the Wall Street Journal this week, “Fed Writes Sweeping Rules From Behind Closed Doors.” (http://professional.wsj.com/article/SB10001424052970204059804577225122892450312.html?mod=ITP_pageone_0&mg=reno64-wsj)

Here are some of the goodies: “the Fed has held 47 separate votes on financial regulations, and scores more are coming.  In the process it is reshaping the U. S. financial industry by directing banks on how much capital they must hold, what kind of trading they can engage in and what kind of fees they can charge retailers on debit-card transactions.”

I understand that one rule relating to when Governors of the Federal Reserve System could go to the bathroom has been removed.  The writers of the rules did not want to get into gender differences they felt were necessary and instead of raising this issue…they just dropped the whole provision.

 These rules and regulations do have effects.  The problem is that they may not always have the effects that are desired. 

In some cases they do.  For example, in the New York Times we read the headlines: “Under Volcker, the Old Dividing Line in Banks May Return.” (http://dealbook.nytimes.com/2012/02/21/under-volcker-old-dividing-line-in-banks-may-return/?ref=business)  That is, financial institutions may divide back into the distinction between commercial banks and investment banks.

This is just what Paul Volcker would like to have happen.

However, in many other cases, the rules and regulations will result in outcomes that are far from what was intended by Congress or by the regulators that wrote the regulations.  What those outcomes might be are, of course, unknown because they haven’t happened yet.

And, some of the outcomes may be totally unexpected because the outcomes will be related to the new things that information technology will allow institutions to do.  In five years, finance may be done in an entirely different way than it is now.  (See my forthcoming review of the new book “The End of Money,”)

What bank…or financial institution…should one invest in? 

Congress and the regulators have created so much uncertainty in the world of banking that it is almost impossible to say anything about bank performance in the future.  All bets on banks are nothing more than gambling, at this stage. 

I do not expect this environment to change much in the near future.  Investing in banks is not where I would want to put my money at this time because there is nothing really to base an investment decision on when it comes to the banking industry.