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Escaping the banking system

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In May of 2009, I pointed out that regulators' requirements for higher bank equity ratios could prolong the recession. At the time, I said the effect might be to keep the economy weak into the next year. Little did I know that it would still be as weak now, over two years later, as it was then.

Yesterday, the Wall Street Journal published an article about a bank that illustrates how the requirements still cause these problematic effects. The bank is a community bank that primarily makes loans to small businesses - like dentists, restaurants, and delivery truck drivers - with the loans averaging only about $100,000, less than a typical mortgage. It has a default rate lower than the national average. A year ago, it had an equity ratio of 9.5%, comfortably above the 4% minimum required by the FDIC.

Nonetheless, the FDIC served the bank with a an order requiring an increase in the equity ratio, presumably because it considers small businesses more risky than big businesses, recent evidence from, say, GM or Chrysler notwithstanding. Over the past year, the bank has been forced to shed half of its loans and half of its deposits - some of the latter evidently in the form of early redemptions of certificates of deposit, which while legal and written into the terms of the certificates, rarely happens under normal circumstances and can be upsetting to depositors.

The bank's equity ratio is now at 17.3%, a level which makes it very difficult for a bank to make any money. And of course that means only half as as much money is available for small businesses to get the loans they need, which of course has a negative effect on economic and job growth. Given that similar effects no doubt exist throughout the banking system, I strongly suspect this is a major contributor to the economy's inability to recover from the recent recession.

In this particular case, the bank is working on giving up its banking charter, getting rid of its remaining depositors, and serving its loan clients as an unregulated entity using private investment capital. If the current regulatory environment continues, perhaps all business lending will eventually move to such unregulated entities.

It would be better, though, if the regulators would start regulating for normal conditions, rather than for the worst conditions that could theoretically happen. After all, the FDIC was created to cover the depositors in such worst case scenarios, specifically so that the deposits could be safely used for growth under normal conditions. What's happening now makes it difficult to use the deposits, and thus makes it difficult for the growth to occur.

WSJ article:
http://online.wsj.com/article/SB10001424053111904480904576498442951766826.html
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On August 17th, 2011 06:43 am (UTC), psychohist commented:
Re: recession
This is sort of a general response to the thread so far.

I think peak oil is real. In the 1950s Hubbert correctly predicted peak U.S. production around 1970. Estimates for world peak oil vary from 2010 to 2030, and I believe the former estimates are closer to correct. See for example:

http://www.ccs.neu.edu/home/gene/peakoil/

I don't see production declining any faster than it rose, which means the decline will happen gradually over decades. Due to increasing demand from China and India, I do think real prices will gradually rise from here on out, with a lot of variation. This means a larger proportion of future economic growth will likely be devoted to energy efficiency improvements, like hybrids and telecommuting, leaving less for other things, but I think the technology lag is years, not decades, and will be driven more by the price trajectory than by fundamental research limitations. Because the effects of peak oil are felt over decades rather than years, I don't think it has a significant part in the current delayed recovery, which is on a shorter time scale.

I don't think the same thing is happening with other commodities as with oil. Prices of other commodities are being kept high by faster recovery in other parts of the world than in the U.S., along with a lot of excess cash pumped in by the federal reserve in "QE2", along with the factors such as I mention in my original post limiting the ability to use that cash for economic growth.


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