Bank Lending Crisis Spurs Rhetoric

Congress and bailout recipients in the banking industry are oversimplifying a complicated issue in their debate over how financial companies are spending the money.
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Bankers and lawmakers are at odds over whether or not recipients of financial bailout funds are using the money to restart frozen credit markets, but both sides are oversimplifying what is a very complicated issue.

The eight major bank CEOs who endured seven hours of grilling on

Capitol Hill

on Wednesday may have deserved a lot of the flak they caught, particularly criticism of the generous bonuses they awarded many employees. The government on Oct. 28 spent $150 billion of the Troubled Asset Relief Program, or TARP, buying preferred equity stakes of the nine largest financial institutions. The appearance of taxpayers subsidizing more than $18 billion in

Wall Street bonuses

as millions of people lose their jobs is a public relations nightmare, to say the least.

But Congress also has somewhat unfairly pressed the bank CEOs to offer evidence that the government's investments are being used to make new credit available to help jump start the economy. Lawmakers' skepticism may be fueled by the banks' somewhat disingenuous assertions in their fourth-quarter earnings releases about the amount of "new credit" they extended.

Let's take each of these one by one.

House Financial Services Committee Chairman Barney Frank (D., Mass.) wants banks "to get the system of extending credit back to its fullest operation." But

JPMorgan Chase

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CEO Jamie Dimon was right when he told skeptical lawmakers at Wednesday's hearing that lending activity was holding up rather well, considering the circumstances.

On the holding company level, JPMorgan's total loans and leases declined $16.4 billion during the fourth quarter, to $744.9 billion.


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loans declined $22.4 billion, to $694.5 billion.

Bank of America's

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declined $11.2 billion, to $931.4 billion.

A $50.1 billion fourth-quarter decline in lending for the nation's three largest banks, after receiving federal money a month in, may seem like a lot. But it's not. The decline represented only 2% of the outstanding loan balances as of Sept. 30, and took place in the midst of a particularly nasty recession.

Considering that the decline included loan charge-offs, pay-downs and non-renewals of some short-term loans, the 2% decline really looks small.

Still, it is a decline. Banks have bristled at acknowledging a slowdown in lending in the face of such pressure. For example, BofA said in its earnings release that it extended $115 billion in "new credit" during the quarter. That term obscures the fact that total loan balances were slightly down. Some of the $115 billion indeed represented new lending that offset loan payoffs, paydowns and charge-offs, but some of it was renewals of loans and credit lines -- in other words, lending that technically existed before the government made its investments.

It's clearly in the banks' best interest to lend money the government has invested, since the new capital needs to be leveraged in order to cover the 5% coupon on the preferred shares sold to the government. That capital needs to be efficiently leveraged through deposit gathering (or borrowing) and investing (by making loans or buying securities). With an average net interest margin for all U.S. banks and thrifts of 3.37%, banks not sufficiently leveraging the capital, or not needing it to cover loan losses, will be better off paying the government back.

Two months was not a long enough period for the banks to leverage the new capital. There's also a bit of "cart before the horse" thinking going on. Before lending money, someone needs to apply for a loan.

BB&T Corp.

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John Allison

made that point in an interview with's

Laurie Kulikowski published on Wednesday.

"This is a tough environment to make good loans because the people you would like to lend money to unfortunately don't want to borrow it because they're scared," Allison said.

Commercial loan applications are down, according to anecdotal accounts from many bankers. Commercial developers will hesitate to begin new projects if they see little hope for tenants to occupy units when completed.

Consumers looking to refinance their homes can't do so if they are "upside down" on their mortgages, or owe more than the homes are worth, and may have difficulty refinancing or face costly private mortgage insurance requirements if they owe more than 80% of the current market value of their homes. We all know how likely it is that the home values have been greatly reduced over the past two years.

Rising unemployment also dims the prospects for increased consumer credit. Banks can and should reduce some credit card lines. This not only reduces their risk, but can save some consumers from wallowing in more debt.

The point of all of this is that it will take time for TARP recipients to deploy the capital in an intelligent, efficient way. Even if loan balances aren't increasing at the larger banks, keeping the lending activity flat in a shrinking economy is a sign of progress.

But it takes cutting through a lot of rhetoric on both sides to see that truth.

Philip W. van Doorn joined Ratings., Inc., in February 2007. He is the senior analyst responsible for assigning financial strength ratings to banks and savings and loan institutions. He also comments on industry and regulatory trends. Mr. van Doorn has fifteen years experience, having served as a loan operations officer at Riverside National Bank in Fort Pierce, Florida, and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a Bachelor of Science in business administration from Long Island University.