Why banks (still) aren't lending

Extra4/23/2009 12:01 AM ET
Why banks (still) aren't lending
Taxpayers want bailed-out banks to make loans and goose the economy. But given the depths of the economic mess, that's the last thing the banks should do.

[Related content: banks, loans, recession, Treasury, financial crisis]
By David Weidner, MarketWatch
Banks need to stop the charade, ignore the political and public pressure and admit they're not lending.

It's not because they don't want to, but because it's bad business.

Don't think so? Take this pop quiz. Bank of America (BAC, news, msgs) posted smashing first-quarter profits and its chief executive, Ken Lewis, said the Charlotte, N.C., company is lending as if the good times never ended. So, in the bank's conference call, which of the following statements did Lewis make?

A. "Credit is bad, and we believe credit is going to get worse before it will eventually stabilize and improve."

B. "Even our internal economists are a little at odds as to the timing (of the recovery), with some seeing recovery earlier (than year's-end)."

C. "We believe unemployment won't peak until next year at somewhere in the high single digits."

D. All of the above.

E. None of the above.

For a CEO whose bank is lending as if it's 2006, you might be surprised that the Lewis who proclaims to be bullish on loans is bearish on the economy. The answer is D.

There's only one problem. No bank CEO can reconcile more lending with a deteriorating economy -- especially one in which economic conditions are the worst they've been in generations. But that's exactly the claim the bank chief is making.

Talk back: Do you see signs the economy is improving?
Lewis described a deep recession that's going to be here for months. Still, Bank of America touts that it's "helping" homeowners and small businesses with new loans. It claims to have added 45,000 customers and provided them credit. The reality, however, is less impressive: Bank of America loaned $183 billion during the quarter, up just 1.6% from the last quarter of 2008, when lending took a big dive industrywide.

This isn't to single out Bank of America. All of the major big banks, including Wells Fargo (WFC, news, msgs), JPMorgan Chase (JPM, news, msgs) and Citigroup (C, news, msgs) have been doing the credit double-talk that goes something like this: These are terrible conditions to be lending in, but we're lending in them without risk.

If those claims sound a little too good to be true, it's because they are. Almost all the big banks that have taken cash from the Troubled Asset Relief Program have curtailed lending, according to The Wall Street Journal.

One of the intentions behind TARP was for it to be a kind of stimulus program made through the banks. After plugging holes on each bank's balance sheet, the TARP cash was supposed to flow into new mortgages, auto loans, credit card lines and corporate lending. Six months later, it's fair to say TARP money has helped prop up some banks, but it hasn't flowed into the consumer credit markets the way the framers intended.

Now, critics have argued that the banks should be loaning this money to help stimulate the economy. Companies need credit to expand and hire, they say, and consumers need credit to buy products and help feed the economy.

In almost any other economy, this would be true, but not at a time when an overextension of credit created the recession we are fighting.

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Credit cycles, by definition, are periods where banks overextend credit and then pull back to correct the imbalance. If the government forces banks to lend to at-risk borrowers, we're going to aggravate an already dire credit picture and require more government intervention.

You can easily see how lending to home buyers not worthy of credit would fuel the nation's housing woes and create more housing problems, but what about the loans most people assume are helpful to the economy: small-business loans?

It turns out that existing small-business loans are defaulting at an alarming rate. More than 4.4% of small-business loans were in 30-day default, up from 3.48% a year ago. And 1.29% were delinquent 90 days, up from 1.04% a year earlier, while 0.63% were 180 days delinquent, double the rate a year ago, according to PayNet, a small-business payment network.

It doesn't matter what type of loan; lending into an economic downturn is an invitation to trouble.

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The truth about bank profits

Some of the biggest US banks posted first-quarter profits that skeptics assert are based more on accounting gimmicks than healthy operations. Are the earnings legitimate? (April 22)The steep rise in defaults and nonperforming loans suggests that the economy will make it hard for banks to simultaneously set aside reserves and lend more money out. Small businesses will lay off workers before they start missing loan payments, and the unemployed can't pay off their credit cards and car loan payments.

Taxpayers fuming about the banks' unwillingness to loan government money into the system might reconsider, given that the banks are actually being prudent with taxpayer cash. Now that banks have been backstopped by the Federal Reserve and Treasury Department, they have less incentive to scrutinize credit. The risk of bad loans has been shouldered by Washington.

Banks have made a lot of missteps in the financial crisis -- overreaching with credit, misusing taxpayer cash, imposing punitive interest costs on consumers, being insensitive -- but reining in credit is not one of them.

So, when Lewis and his counterparts at competing banks brag about how much lending they're doing, take it with a grain of salt. In most cases, this is posturing by CEOs looking to fend off criticism they're not doing enough to help the economy.

What critics fail to acknowledge is that we all benefit from banks adhering to lending standards. When that doesn't happen, we get financial collapses that compare to the darkest times in our history.

Well, I can see the banks being moire prudent in their loan policies, and that is welcomed, but what about those who still have good credit and are at minimal risk? I know of a car dealer who has 20 people wanting to buy a car from him but cant find any financing. Since the taxpayers are financing the banks recovery shouldn't the banks BE REQUIRED to loan out a certain percentage of the money we are giving them? Only to the best credit risks, mind you, and at rates that reflect the risk involved, but DO loan to those that qualify. How else are we going to get OUT of this recessionary period? Its NOT like the banks are going to be giving out FREE money - just loan it to us at reasonable rates when we need it! How many people would go to work IF they had dependable transportation? how many CANT work because their transportation isn't reliable?

Especially in the used car business, the downside risk has become minimal, as repossessing the vehicle has been automated and electronic. There are chips that can be placed in vehicles that will NOT allow them to be started when the payments fall behind. I know the guy who invented that chip and he says that business is brisk.

In addition most cars these days have a GPS unit, frequently installed by the dealer without the buyers knowledge, that allows the dealer to track the vehicle around town and pick it up quietly whenever a lack of payments makes it necessary. The dealer gives a spare key to the repo man he and just follows the car around town until its parked somewhere. The repo guy unlocks the door and hauls it away before any damage can be done. This minimizes the risk of any any malicious damage being done to the vehicle and facilitates the pickup process. The car is washed, cleaned, and processed and $300 later is back on the lot for sale.