Bank lending still isn’t happening

Why are they still not making loans? Let me count the reasons.

| Sep 24, 2010

For the first time since 2002 the Fed said that inflation is uncomfortably below target (any time below 1%, some sectors of the economy are already in deflation), and the Fed “…is prepared to provide additional accommodation if needed.”

Credit markets took the Fed’s post-meeting announcement on Tuesday and ran a bit too far: the 10-year Treasury note stone-dropped to 2.50%, today back to 2.60%, but mortgages were little changed.

Given the deep policy division at the Fed (the do-nothings paralyzing the do-somethings), I think the Fed will need to see weaker data to resume quantitative easing. Martin Feldstein this week had the best description of the economy: “In a holding pattern.” He sits on the NBER committee that calls the beginning and end of recessions, and looked less than thrilled at its pronouncement that the Great Recession ended 15 months ago. Next Fed meeting: the day after Election Day.

One of the puzzles in this cycle has been the steady contraction in lending by banks. The Fed has packed banks with no-cost reserves since 2008, but nothing has come out the far side, bank credit shrinking as never since the 1930s.

Why? The bankers say that few people or businesses qualify for loans; and those that do, do not want to borrow. The bankers would also like you to stop asking.

Banks still fear more losses

As pinched and punishing as bankers can be, banks only make money by making loans. However, fear of loss stops ’em cold. There are two broad categories of loss fear: worry about new loans that you could make, and the rather deeper concern for loans that you have already made. But, we know the banks are now in fine shape, don’t we? Sharp Timmy Geithner and his super-duper stress test last year said so, right?

I get the sense that banks are trapped in a game of hot-potato. The spuds in question: mortgages long gone from bank balance sheets, long-since sold, or partially written off, or somebody else took the first hit. Now these rotten russets are returning to fields of original harvest. Night of The Living-Dead Tubers.

Fannie and Freddie have outstanding at least $20 billion in bank buy-back demands, the bank foot-dragging causing complaint to Congress. Analysis of defaulted loans often trails foreclosure by years, hence no way to know how many zombie Idahos will lurch home. Right now Fannie and Freddie have another 1.5 million loans headed into foreclosure, many to be dumped in the buyback truck, and a steady flow behind that.

Fannie-Freddie buybacks are straightforward. The hot-spud game is a circular affair. At the peak of stupidity in 2007, there were $2.2 trillion in mortgage Asset-Backed Securities outstanding (the worst paper, nothing to do with Fannie-Freddie), now written down by $789 billion (Fed Z-1, L.218, line 19). Many of those loans were made by the dearly-departed and gone altogether (Bear, Lehman); however, many more were made by the departed-but-absorbed (World by Wachovia then Wells, Countrywide and Merrill by BoA, WaMu by Chase), and even more by the usual-suspect survivors.

Seems that many of the buyers of ABS from these creators feel they were misled, and would like buy-back at original face value. Seems further that the creators hung on to the lucrative right to service these delayed-action explosive spuds, and the captive servicers are reluctant to tell their parent banks that they have to buy back, even though that’s the servicers’ duty. And there’s the Federal Home Loan Bank system, in court to force the original cooks of blighted hash browns to fry in their own oil.

A trillion here, a trillion there

Then, behind all of that lies the officially sanctioned commercial-loan extend and pretend, $1.4 trillion outstanding at banks, and another half-trillion ABS-securitized, real losses hidden. And the 2nd mortgages and equity lines outstanding, still 90% of the $1.1 trillion 2007 peak; banks haven’t made a lot of new 2nds, and the old ones — half of Ireland moved to Boston to keep from eating stuff like that.

As frustrated as the nation was by TARP and “bailouts,” banks need help. Not more pretense of good health, not more punishment, not more yer-on-yer-own, but help. 

Commentary by Louis S. Barnes on mortgage, credit and business trends will appear periodically in Boulder Reporter. Lou is our credit-market oracle and will offer updates Fridays, written in the voice of a bond trader overdue for his martini. No fluff, no blue-sky predictions, afflicting partisans of all affiliations, real-time right-now news. Learn more about Lou at Premier Mortgage Group.