Friday, February 19, 2010

Banks--It's a Love/Hate Thing

Banks! You can’t live with them and you can’t live without them. Everyone has their story about a bank and/or a banker who did them wrong. And, now, President Obama has chimed in as the Bank Critic-in-Chief.

I have my own stories to tell. These tales are made even more interesting by the fact that I was a bank loan officer for five years from 1980 to 1985. Together, with my college degree in economics, I have a perspective that is a blend between outraged consumer and the insider who knows the rest of the story.

Banks have a tough road to hoe. First and foremost, they are responsible for safeguarding your money and insuring that when you want or need your money it is there for you. Secondly, banks make money by loaning your money to others who are supposed to pay the money back with interest. Thirdly, the banks are generally stock-held companies and their stockholders expect a return on investment commensurate with similar investment opportunities. And fourthly, banks are highly regulated to insure that your money is safe, consumers are informed of the cost of borrowing, your privacy is protected, and nobody is treated unfairly, just to name just a few of the key rules.

Bankers and the term “Fat Cats” have become synonymous over the decades. The reasons are fairly simple. Bank buildings are usually opulent brick and mortar structures designed to instill confidence in the strength of the bank institution itself. Bankers most often wear dark suits and together with their fiscally conservative nature, they can give the appearance of being powerful and world-class snobs.

The Nazi’s in pre-World War II Germany fanned anti-bank sentiment into a racial issue to support their belief in the pernicious anti-Semitic delusion that all the bankers are Jewish. Thank goodness we have gotten past that image, but when the President of the Untied States for political reasons bashes the banking industry as being the lacky dog of Wall Street Fat Cats, one should not be surprised when social tensions increase.

The problem is a simple one. Everyone wants loose credit when they are borrowing, but tight standards when it comes to the lending of their money, or taxpayer money. When the current recession began it was largely due to the imminent failure of large banking institutions that had built large loan portfolios on flimsy standards and highly leveraged credit instruments. Many people correctly trace the beginnings of the financial crisis back to Federal regulators in the Clinton Administration who used the Community Reinvestment Act to encourage banks to substantially increase home ownership among minority populations. While a laudable goal, the only feasible way to increase home ownership among minorities was to relax credit standards for home mortgage loans. Real estate loans were made for 100% of the purchase price and sub-prime interest rates were used to qualify candidates. During the peak of the housing boom, borrowers were encouraged by overzealous lenders to overstate their income and previous bad credit was ignored. We were warned by the experts that the slightest downward trend in housing values could precipitate a crisis and it did when the house of cards began to fall in 2007.

Sensing a crisis that could spread to every sector of the economy, the Bush Administration proposed and Congress approved the Troubled Asset Relief Program (TARP) to re-capitalize banks that were forced to write-off billions of dollars of mortgages that would never be repaid. Many people criticized this program as an unnecessary bailout for fat-cat or greedy bankers. The new term “Too Big to Fail” was coined amid hues and cries of let them fail.

While I am not a fan of government bailout programs, I believe the TARP was warranted for the following reasons. There is a principle in the construction trade called the “keystone.” A keystone is usually a brick in a structure that when removed would result in the failure of the building. Banks are one of the keystones to a free enterprise economy. Failure of the credit industry means potential loss of depositor dollars, severe contraction of available money for businesses through reduced credit, and a ripple effect that reverberates throughout America from the fat cats to Main Street. More importantly—and substantially different from the follow-up Stimulus Package which I did not support—the TARP money was loaned to financial institutions and would likely be repaid with interest. Indeed, many banks have repaid their TARP money with interest already, especially when the Obama Administration decided unilaterally that TARP gave them authority to regulate private sector salaries and bonuses.

Quite naturally and I believe appropriately, banks have reverted to more common lending practices. To get a mortgage or a small business loan you should have what is called the Five Cs: Capital—your investment into the deal, Credit—your track record of paying money back on time, Collateral—a real asset to back up the loan if you do not pay, Conditions—what you intend to do with the money and the economic prospect of success, and Character—your reputation for honesty and for being a law-abiding citizen. I applaud this change and it is necessary to ensure against future credit crises. But, now, we have a President who once roundly criticized banks for building their financial house of cards and who now speaks out of the other side of his mouth to admonish banks for not being loose enough with their (your) money.

In all recessions, it is normal for credit and venture capital to get tight. And it is human nature to grouse publicly about how the greedy and stingy banker will not help someone start or expand their business. Do you think for one minute that the people who are denied credit will ever tell you that their cash flow won’t support repayment of the loan, or that they are already in hock up to their eyeballs, or that they have a pattern of not making their payments on time? No Sir, you won’t here that from the disgruntled customer and privacy laws prohibit the bankers from defending their decisions publicly.

When I was a banker in the early 1980s, the credit card companies were in the habit of mailing credit cards to everyone, including students with no visible means of support. The result was predictable. There were huge numbers of defaults on credit card debt, bankruptcy filings, and big losses for the banks that issued the cards. Quite naturally, credit cards became more difficult to get after that while banks went back to the Five Cs and practiced more conservative credit card issuance policies. We have come around full circle once again. Hardly a day goes by when I don’t get a letter from my credit card company urging me to use my card or offering me a larger line of credit. I even get solicitations offering credit cards to my unemployed college kid which I dutifully throw away knowing full well he would not know how to handle all that available debt.

The point is that everything in life is cyclical. The banks will come back around and loan money again, the economy will resurge, and the sun will come up tomorrow. It just may not be soon enough to suit President Obama’s political time frame.