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Dennis Santiago Headshot

Fixing the Economic Mess: It's Time to Stop Crowding Out Main Street

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What's happened to the Great Society? We've got a stagnant industrial economy where the unemployment rate among our youngest and oldest members of our workforce is dangerously high coupled with a financial system whose mark to market can best be described using the Mickey Mouse term "Imagineering". Our equities markets are driven by seemingly volatile whimsy. All sure signs our dreams are an optical illusion. The weird part is that it's not like the United States doesn't have wealth. It's what we've done with all this money that's gotten us to the edge of a zombie apocalypse. We're like bad gambling addicts putting our money into ever more convoluted zero sum casino games instead of using it to build true quality of life.

Quantifying the dearth of money for Main Street

In 1989 our FDIC reporting banks listed $4.86 Trillion in assets. By March of 2011 those assets almost tripled to $13.52 Trillion. The balance sheet lending base went from $3 Trillion in '89 up to a high of $8 Trillion in mid-2008. It's dropped back down to $7.3 Trillion as of 2011. But here's the thing. On a percentage basis, lending was sixty-three percent (63% ) of banking assets in 1989; it's just fifty-three percent (53%) now. That means one tenth of the banking systems resources that were used to fuel the U.S. Main Street economy are now pointed elsewhere. Where?

Securities investments and trading for one. In '89 operating banks held $983 Billion in securities and trading instruments in their balance sheets. As of 2011, that number has grown to $3,466 Billion, three and a half times. On a percentage basis -- a measure of a bank's attention span -- it went from 20% to 25% of the asset book. That's a lot of mula to be betting at the casino. It's compounded of course because these "bets" have to be hedged because like a bipolar creature the aggressiveness of one desk needs to be counterweighted by another desk in order to sooth the risk/compliance officer's need to have everything equal zero each night -- certain proof that all of this wiggling actually accomplishes very little other than creating yet another incentives and bonuses manufacturing off track betting facility for derivatives. If you've ever taken a close look at off-balance sheet derivatives notional balances versus the estimated fair value of that book and seen the astronomical multipliers you'd know it's mostly smoke and mirrors.

Stuffing the mattress is another place the money has gone. In 1989, banks had $383.6 Billion in cash sitting around or approximately 8% of total assets. Wipe your cobwebs and remember this was back when they weren't feeling all that good about lending because it was the tail end of the Savings and Loan (S&L) crisis, something about problems lending to unworthy borrowers with inadequate documentation. They were anticipating needing the cash to absorb losses on faulty debts. Remember that "A Déjà vu means they've made a change in the Matrix" for this next part. In the heyday of our most recent sub-prime lending spree the cash balance as a percent of assets for the banking system went as low as 3.6% in mid-2007. Flash to the present day. It's back up to 8% again and the mattress is now stuffed with $1,190.4 Billion clams. Nice arrangement of deck chairs. The reason for this of course is because everyone is waiting for an iceberg called the "first loss event" where -- Déjà vu -- people are anticipating the need to absorb losses in on faulty debts. There's a YouTube out there showing what happens if you give a chimpanzee a loaded AK-47 that explains it a lot better.

All of this basically takes money out of investing in Main Street America. Back in '89 a banker's fiduciary attention was $2.25 focused on lending assets for every dollar managed in investments or cash. Today it's down to $1.56 or to put it bluntly, going to the casino is almost as important as the day job. There's been an $800 Billion decline in lending by banks to Main Street since mid-2008 and the entire planet is feeling the pain.

All isn't lost. There's no such thing as stress that cannot be measured and managed. I recently finished penning the bulk of my company's comments on Stress Testing Guidance to the Federal Reserve, Office of the Comptroller of the Currency (OCC), and Federal Deposit Insurance Corporation (FDIC). Part of stress testing is designing good scenarios that do more than just blindly run parametric cases. They need to help point out the issues so people can plan and implement real world solutions. The banking system -- big and small -- clearly has a role to play in funding the economic recovery. To do that it needs to be able to reallocate assets from non-productive uses to strategic ones. I personally have this pet notion that if the U.S. can re-import five percent (5%) of the industrial base we outsourced over the last decade and a half, the remainder of this decade will be a lot more pleasant. Even if production here costs more at first, the secondary effects on housing, services and consumption will more than overwhelm the incremental costs. And I also believe that U.S. technical ingenuity is more than capable of automating out a lot of the U.S. versus outsource labor differential over time if we put our minds to it. None of it can happen unless the financial basis for a concerted recovery can be put into place. How much might be available from the banking sector?

Well let's start with some simple policy thoughts. What if a series of steps were taken with the goal of reallocating securities and trading assets held by the banking industry as a percentage of total assets was rolled back from 25% it's at today to 20%. That creates energy for about $750 Billion to move in the direction of Main Street lending. Then what if we couple it with similar policies to get cash held by banks from 8% to say 6% of total aggregate assets? That systemically urges another $379 Billion to get off the mattress and get back to work on Main Street. That's a cool trillion or so of foundation building private capital.

Now I am aware that a lot of the cash on hand at banks is loss reserves money against the zombie fear of a potential large real estate asset value collapse. It hovers like a dark cloud over everyone and everything. I like hard hitting non-linear shocks in my stress testing because such realities drive academic models bonkers. So let's call it a 20% across the board crash of real-estate lending valuation which as of 1Q2011 works out to around $800 Billion bucks if everything goes hand basket on us. All I can say to that is that loss will very likely be real if we sit on our hands and do nothing and those securities holdings -- many of which are still closely tied to these same real estate assets -- will cave with them. But if we do what the United States does best and shift gears to meet the challenge, I think we may just stand a chance. It's certainly worth putting that question into the stress test battery in the models I work with that look at banks one by one in this country. These are higher horspower versions of the simple indicators my company still contributes to the Move Your Money campaign. Based on past analysis of stress in the system, I'm pretty sure some banks will actually prosper. But I guarantee you they won't risk it unless they are confident policy makers have their act together.

This is all rough "heuristic" thinking to be sure. But heck, the traditional intricate equations don't seem to be doing much better. Does anyone still believe it's not time to think outside the box?