I thought I'd written this post before, but when I wanted to link to it the other day, it turned out I hadn't. I have addressed the issue more or less tangentially three times, but I've never addressed it head on. So here it is.
The biggest reason for the lack of an economic recovery in the U.S. is banking regulators preventing the banks from lending as much money as they normally would.
Let me say that again.
The biggest reason for the continued economic problems is banking regulators forcing the banks to be overly conservative about making loans.
That's not the only reason - there is one other reason that is almost as big - but this one is probably the biggest.
The way this is happening is through capital ratios - the ratio of the bank's capital, or net worth, to the bank's total assets, basically loans outstanding. Banking regulators - in particular the FDIC - are requiring the banks to maintain higher capital ratios than under normal circumstances, often twice the normal amount. The argument is that a higher capital ratio makes a bank less likely to fail. That makes it less likely that the FDIC will have to step in and pay off the depositors - remember, the FDIC is the agency that insures deposits - and thus less likely that the FDIC will itself run out of money. From the FDIC's standpoint, it's self preservation.
A higher capital ratio doesn't increase the bank's capital, of course - that's still the same, at least in the short term. With the same absolute amount of capital a higher capital ratio requires a bank to cut down on its loans outstanding - for example by reducing revolving credit lines and not making new loans. Doubling the capital ratio means the bank can only lend out half as much money.
That, of course, also means that banks only need half as much money from depositors. Have you wondered why it seems like banks don't seem to want your business any more, charging you more in fees for the privilege of letting them use your money? This is why: they don't have much use for your money, so they're happy to get rid of customers. The fees, on the other hand, will increase their net worth - their capital - which actually will help them lend more money.
This is, of course, a disaster from an economic standpoint. The biggest squeeze is on credit for small to medium businesses. Since those smaller businesses are the ones that create most jobs under normal circumstances, squeezing them of course dries up job creation as well. From the parochial viewpoint of the FDIC bureaucracy, this may makes sense, but from the viewpoint of overall economic policy, it doesn't.
Here are the three times I've alluded to this before:
A recent post regarding an example of a bank trying to give up its banking charter - thus escaping FDIC regulation - just so it can continue making loans to small business:
A post on the federal reserve helping this process along by paying banks not to lend money, so there's a carrot as well as a stick to avoid making loans:
My first post discussing the effects of an emphasis on increased capital ratios - then in the form of "stress tests" - in which I incidentally predicted the result of "suddenly having lots of banking fees appear on checking and savings accounts" as well as of a longer recession, both of which have happened:
I think there are two ways to respond.
1, why aren't the banks lending money?
Search for "So, did the banks keep lending?" to skip down to the relevant section.
2, why are capitalization ratio requirements so high?
I don't have a link to too-big-to-fail banks' exposure to European debt, unfortunately, but I think that's your answer.
That says they aren't lending money, but doesn't really say why. Treasuries pay very low interest rates; banks could get higher rates - and make more money - on other loans. The reason is as I said: the regulators won't let them. Treasuries are considered "risk free"; that means they don't count in capital ratios, which are based on risk weighted assets. Loans to individuals and businesses do have risk, so they are limited.
And no, the capital requirements are not due to Europe. European banks have huge exposures to European government debt, but the big U.S. bank exposure is to U.S. government debt - the treasuries that your article points out. The capital requirements are due to the old "shutting the barn door after the horse is gone" mentality: since the financial crisis happened, and the FDIC had to pay the insured depositors of some banks, they now want the banks to be more conservative to avoid that happening again.
That, of course, ignores the fact that the whole purpose of the FDIC is to pay the insured depositors when banks fail. And with the barn door shut, the horses that are still there can't be taken out to be ridden.
The protestors would better be camping on the FDIC's doorstep, though they might get the banks to push back a bit more on the FDIC.
On November 4th, 2011 04:15 pm (UTC), (Anonymous) commented:
Look at the NFIB surveys for the last couple of decades. Independent business owners consistently put financing dead last or almost last in their list of business constraints. Even in the depths of the "credit crisis," dead last.
The notional, available supply of financing for business is effectively infinite. If borrowers don't borrow because they can't find productive uses for financing (because they can't sell any more of their goods), and lenders don't lend because they can't find promising borrowers (because the borrowers can't sell any more of their goods), can we really say that higher capital ratios or other supply constraints cause A) less borrowing or B) less growth?
Most of the last couple of decades happened before the recession, when the regulatory climate hadn't tightened yet, so of course it doesn't show the result of that tightening. For example, the latest "Problems & Priorities" publication from your source, the NFIB, is dated 2008, before or at the beginning of the crunch.
Based on a report a year later, the NFIB site said that "access to credit has become increasingly more difficult". The objective measures show increasing denial of credit as well as increasing interest rates; only 50% had most or all of their credit needs met, as compared to 89% in 2006. In about a third of the cases, the denied credit would have been used for expansion, so denial of credit meant fewer jobs; that's bad for the jobs picture even when the business owner sees other problems as even more important.
The bottom line is yes, higher capital ratios and other regulatory conservatism is indeed resulting in less borrowing and less growth.
Edited at 2011-11-05 06:20 pm (UTC)