Bush's credit bulimia: gorge big banks, starve customers.
Three months ago, President Bush was not interested in talking about any aspect of the credit crunch; he preferred to concern himself with peace in the Middle East and turmoil in the Soviet Union. But in October the credit question could no longer be ignored: Polls showed that 70 percent of Americans were convinced that the economy continued to languish in recession.
The President's advisers were split. On one side, those more involved in campaign fundraising, like Commerce Secretary Robert Mosbacher and Vice President Dan Quayle, as well as ideological growthmen like HUD Secretary Jack Kemp, had gotten an earful from their friends about banks so stingy that they were cutting off credit to Republican businesses. They wanted the President to do something.
On the other side, Treasury Secretary Nicholas Brady, Chaiman of the Council of Economic Advisers Michael Boskin and Chairman of the Federal Reserve Board Alan Greenspan had forecast a shallow and short recession from the moment they stopped denying its existence. They were not worried. Nor were they relying on the invisible hand of a free market. Rather, they were expressing their confidence in a particular market intervention, already in place, that aimed to end the credit crunch by making banks rich.
The chosen policy starts from the premise that banks should be rich. Fat banks can survive lean times and keep doing their job of taking deposits and making loans. The problem is that not all U.S. banks are fat; many inadvertently embarked upon crash diets in the 1980s. Today those banks are so thin that their fear of further losses in keeping them from doing their job of lending. In some cases, notably Citicorp, they do not have enough shareholders' funds to meet the minimum ratio of capital to loans that bank supervisors from industrial nations have agreed on.
The thin banks bet much of their capital on real estate--and lost. The pyramids of the greed decade are the see-through, half-empty office buildings of major American cities. What matter for the business of banking is not the aesthetics of those follies but the volume of real estate losses that they represent for the banks that made the loans to build them. Bankers find themselves having to carry not only the buildings but the builders as well--the Trumps, the Portmans, the Reichmanns and other big developers. The banks have put Trump, for instance, on a personal allowance of $375,000 per month, but their exposure in his projects is so large that they dare not drag him into the bankruptcy he has earned.
It is hard to feel sorry for banks that have lost a fair fraction of their wealth by financing buildings that no one will occupy for years. While it is true that the Empire State Building took most of the years from 1931 to 1941 to fill up, an earlier generation of bankers had the excuse that they could not foresee the Great Depression and its 25 percent unemployment. The current generation of bankers has overbuilt to the extent of 20 or 30 percent vacancy rates in many cities in the midst of what is, to date, no more than a middling bad recession and 6.8 percent unemployment. Today's empty buildings testify to a banking myopia that approaches blindness.
Unfortunately, the economy as a whole is bound up in the health of banks. Banks with shallower pockets, and especially banks that have lost substantial fractions of their capital in real estate, have tried to compensate by shunning all risk. In the process, they have slammed sound businesses against the wall and demanded that outstanding loan balances be reduced. This unseemly behavior, repeated across the nation but concentrated in the Northeast, goes by the name credit crunch, capital crunch or even credit crumble.
Long before the polls led President Bush to worry out loud about interest rates on credit cards, he and his economic advisers had settled on their answer to the credit crunch. The idea was simple. Fatten up the banks by dropping short-term interest rates and then letting the bankers do what comes naturally in such circumstances: nothing. The result is cheaper money for banks but not for their customers.
In 1989 the banks charged one another an average of 9.2 percent for overnight loans, the so-called federal funds rate. Meanwhile, the prime rate (something of a misnomer since the largest and best-rated corporations can borrow for less) ranged between 10.5 percent and 11.5 percent. The difference between what the banks were paying and what they were charging corporate borrowers was thus about two percentage points. By early 1991, the federal funds rate had been brought down to 6 percent, but the prime rate had come down to only 9 percent. The difference between the overnight bank rate and the prime rate for corporate borrowers widened from about two percentage points to three percentage points. With some $400 billion in corporate loans priced at or above the prime rate, this widening of the spread feeds about $4 billion extra into bank income.
As the weakness in the economy has persisted through 1991, the Federal Reserve has seen fit to lower the federal funds rate to 4.75 percent, and the prime rate has followed it down to 7.5 percent. Although the spread is no longer widening, banks are still trying to maintain the fat three percentage point gap.
At the same time, consumers have had to pay much more than banks for access to credit. Car-loan rates came down only from 12 percent to 11 percent between 1989 and 1991. Rates on personal loans remained stuck at 15 percent. And the busy or hapless folks who fall into debt on their credit cards are still paying 18 or 19 percent even when the banks are funding themselves at less than 6 percent.
Such spreads have done wonders for healthy banks, which are reporting record earnings. As a means of restoring the health of banks that are in bad shape, however, this forced feeding is working so slowly as to make progress invisible. So other measures to increase bank profits have been rolled out--and generally not recognized for what they are.
Alan Greenspan has supplemented the widening spreads with a lowering of reserve requirements--the non-interest-bearing billions that banks maintain with the Federal Reserve. This move may be likened to a tax cut focused on banks, a tax cut that did not have to be argued in Congress. As a result, reserves have fallen from more than $60 billioin to $50 billion. At the current federal funds rate of 4.75 percent, that's another $500 million a year for the banks, their borrowers and their customers. Under current circumstances, the banks have done their best to claim most of that tax cut for themselves.
Why don't the banks compete for credit-worthy customers by offering lower interest rates, and so drive down the difference between their cost of credit and their price for credit to something like the 2 percent spread that obtained in 1989? Part of the answer is that the weak banks can't afford to compete and the strong banks would rather maintain current profit margins than fight for increased market share. But another part of the answer is that the Administration and the Federal Reserve have joined in tacit support of enriching the banks. This is a notable application of the trickle-down theory of economic progress: As the banks become richer, they will lend more easily and the credit crunch will end.
As a solution to the credit crunch, fattening the banks has until recently had the considerable advantage of being politically painless. By November, however, it began to appear that the trickle-down was, in political terms, going too slowly. President Bush tried jawboning the banks into lowering consumer interest rates by picking on the particularly high interest rates on credit card debt. On Tuesday, November 12, he addressed a Republican fundraising luncheon as follows: "I'd frankly like to see credit card rates down. I believe that would help stimulate the consumer and get the consumer confidence moving again."
The next day Senator D'Amato introduced, and the Senate passed 7 to 19, an amendment to one of the banking bills circulating on Capitol Hill. The amendment aimed to limit the interest rate on credit cards to the "penalty rate" charged by the Internal Revenue Service to discourage citizens from falling behind in their tax payments, plus 4 percent. The penalty rate plus 4 percent amounted to 14 percent at the time of the amendment--a rate substantially lower than the 18 or 19 percent that major banks were charging their credit card customers.
On Thursday, to no one's surprise, investors and traders of credit-card-backed bonds marked down their prices sharply. These bonds exist in part because the banks cannot themselves afford to hold the loans represented by credit card debts.
On Friday the Dow Jones index of industrial stocks fell 120 points, or about 4 percent--the fifth-largest point loss ever--and it seemed to many that the Senate vote for D'Amato's amendment was the culprit. D'Amato defended his amendment by fingering the Frankenstein of "program trading," but bank lobbyists swarmed over Capitol Hill to argue that, if the amendment were enacted, in the words of The New York Times, "shaky banks might go under and millions of Americans whose credit ratings are less than ideal would have their credit cards recalled." The number that bankers threw around was 60 million credit cards, recall of which would cast the Congress in the role of the Grinch that stole Christmas.
Administration officials began to backpedal furiously from Bush's luncheon remarks. "If this legislation went through, the only people who would have credit cards are the rich people in this country," said Treasury Secretary Brady. He described the proposal as "wacky." Richard Darman, Director of the Office of Management and Budget, called the proposa.l "half-baked . . . preposterous." Dan Quayle said any such legislation would be vetoed. After The Washington Post reported that Bush's remarks had been added by John Sununu, who "decided to wing it himself," Sununu called that story a lie and blamed the mess on Bush, who supposedly just "ad-libbed" during his speech.
By Friday night Greenspan had weighed in against the amendment with the revealing argument that "the negative effect of banks' earnings will put further pressure on their ability to generate or raise capital at a time when concerns about capital positions are already contributing to restraint on bank lending." With characteristics directness, Greenspan was making a threat even more serious than that of the bankers recalling our credit cards. Consumers must pay what Republican Congressman Jim Leach called "usurious" credit rates or the banks won't be able to lend to businesses. Pay up or get laid off.
It appears that bankers are not willing to give up the credit card interest rates that provide their highest profits. They may try to act on their threats if they are pushed, in which case they will provide a ready-made issue for Democratic or populist candidates who will ask why Republican bankers should be independent businessmen when it comes to profits but wards of the taxpayer when it comes to losses.
"Commercial credit is the creation of modern times, and belongs, in its highest perfection, only to the most enlightened and best-governed nations. . . . Credit is the vital air of the system of modern commerce. It has done more, a thousand times, to enrich nations, than all the mines of all the world." Those are the words of Daniel Webster on the floor of the Senate on March 18, 1834. Awareness of the fragile and ultimately moral basis of commercial credit seems to have eroded since then, for bankers and government officials alike.
Having left Webster behind, we might turn to Stan Laurel for help in admiring the fine mess we're in. Bankers' follies in the 1980s impoverished them and left them ill-equipped to do their job when they were most needed. No banker need take the fall, however; bankers have permission from the government to make up their losses by charging uncompetitive interest rates to small businesses and families. And the banks got a special tax cut. All of which means the Federal Reserve's interest-rate cuts do less good for the economy than they might, and the deficit gets a little worse. Perhaps worst of all, the banks seem to be taking their feeding without accepting any responsibility to share their good fortune with customers.
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|Title Annotation:||President Bush's monetary policy, effect of decline in short-term interest rates on banking|
|Date:||Dec 23, 1991|
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