Easier jawboning banks than leery borrowers
(James Saft is a Reuters columnist. The opinions expressed are his own)
Jawbone all you like, but we are in a private sector de-leveraging, and bank lending and demand will remain weak, making interest rates unlikely to rise any time soon.
Monday’s two big economic news events dovetailed neatly, if not entirely happily; Citigroup announced plans to repay $20 billion to the government and President Obama called banks together to inform them of their obligation to support the recovery.
“My main message in today’s meeting was very simple: America’s banks received extraordinary assistance from American taxpayers to rebuild their industry,” Obama said after the meeting. “Now that they’re back on their feet, we expect an extraordinary commitment from them to help rebuild our economy.”
I just don’t think that is how it is going to work, or really how the capital intermediation process has ever worked. Banks will make loans when they have sufficient capital, when there are good opportunities, meaning demand for loans from good risks willing to pay good rates, and when there aren’t better opportunities elsewhere.
Taking one for the team is not how shareholder capitalism works, even if you lavish upon it public money.
Citigroup and the other 50-odd institutions which have repaid TARP funds have good reason to want to pay back the money — it makes them look weak to clients and investors and ties their hands when it comes to compensation. It is also quite unnecessary to have direct government money because there is so much of the indirect kind. Washington let it be known in the spring that the largest banks wouldn’t be allowed to fail, effectively underwriting their financing via that guarantee.
Further very low interest rates and a steeply sloping yield curve make for a slow but extremely sure means of recapitalization. If the average cost of funds for banks is in the 1 to 1.5 percent range and 10-year government bonds yield 3.5 percent the decision to turn down a loan application from a dry cleaning business, gym or auto parts store is not too hard.
This is not even really a story of bank heartlessness; demand is weak and households and small businesses are showing a preference for trimming their sails. The Federal Reserve Senior Loan officer survey released last month showed that demand for credit from small firms is flagging, with about six times as many banks saying demand was “moderately weaker” than those seeing it as “moderately stronger.”
KEEPING THE PUBLIC MARKETS OPEN
The flow of funds data released by the Fed last week painted a similar picture; credit to the private sector continues to contract even as it continues to expand to the public sector, though at a slower rate than before. Even more striking was the gap between capital spending and internally generated funds for businesses.
All through the 1950s and 60’s this was barely positive, meaning that most capital expenditure was largely financed internally through profitability. Debt financing picked up a bit in the 70’s and 80’s and accelerated hugely in the 1990’s. In the third quarter retained earnings were actually $189 billion larger than capital expenditure, showing I suppose that capital expenditure was restrained and that businesses saw the advantage of keeping their powder dry and their balance sheets trim.
The data also showed that banks continue to rebuild capital. This is totally unsurprising; what would be shocking is if they were to begin to go hell for leather again.
The fact that public capital markets remain open, at least for big companies with good credit, is a balm considering the understandable reluctance of banks to put on more risk just about now. Public markets are funded not generally by people with balance sheets but by people with targets and clients.
Even with a lot of cash still sitting idle, zero percent interest rates are doing their part to keep this sector of the credit markets functioning.
Therefore interest rates have to stay low, both to support and facilitate the rebuilding of bank capital and also to keep alive the public markets which are now doing the heavy lifting. Asset values need to be supported to make existing debt lighter and anyone with some money to lend or invest needs to be punished for keeping it liquid.
Banks will continue to rebuild capital, at least in part by lending back to the government and pocketing the difference above their funding costs. Balance sheet repair outside of banking is happening, but it is going to be a slow process and requires a real estate recovery that may be very slow in coming.
If buyers of government debt and dollars play along, interest rates will probably remain extremely low for a more extended period than many now imagine.