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The Lost Profession of Banking

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Banking used to be a profession, not just a business. That profession is vital to the real economy, and essential at a time of profound economic system transition. It's about time we rebuild the banking profession, using public-private hybrid models when necessary, to promote banking's critical public purpose such as rebuilding our energy infrastructure for the post-carbon era.

All this was brought home to me while listening to the presentation for a large-scale rooftop solar project at the Business-Climate conference hosted by PriceWaterhouseCoopers last week.

The solar power initiative is impressive and important. A consortium comprised of Prologis (providing the industrial-scale rooftops and equity investment), NRG (the solar power developer), Bank of America Merrill Lynch (providing the "financial engineering" and underwriting -- more on this below), and the Department of Energy (providing a loan guarantee on 80 percent of the project) has come together to launch a $2.6 billion project to install rooftop solar at scale. The press release says the project will create "thousands of jobs in 28 states." So far so good. It then says, the project is "being financed entirely by the private sector." Really?

Listening to the Bank of America executive and another panelist, who was introduced as a "mortgage-backed securities expert" (remember those?), describe the complexity of the financing scheme was an out of body experience. The plan is to securitize the debt financing on this "innovative structure that had never been done before," the resulting complexity supposedly necessary to enable the project to secure low-cost, fixed-rate debt to lower the cost of capital and make the project "competitive."

This project provides a striking example of the delusional, reductionist, self-serving mindset that has become banking in America.

Back in the olden days when I was in the business, i.e., ten years ago, things were quite different (although in decline). Back then, securitization was generally for standardized cash flows with years of track record and statistically significant historical data to study. Back then, bank lending was the solution of choice for complex project finance, although project finance was no longer considered an attractive business because it "tied up" bank balance sheets.

Today, "tying up" a bank balance sheet with a project loan such as this, even with 80 percent of the risk guaranteed by Uncle Sam, is a non-starter at any of our three $2 trillion Godzilla banks (Bank of America, JPM, Citi). This is because it's less profitable for banks to hold assets like project loans on their balance sheets than it is to structure (into highly complex tranches), underwrite, and distribute such assets. Ring any bells?

More important, the bankers and their bosses only get paid bonuses out of the underwriting fees generated on such deals, not (for good reason) from the net interest earnings on loans sitting on balance sheets, so there is an agency problem here. Yes, this is deja vu all over again, and we're still staggering under the debacle caused by these same bankers and the agency conflicts they claim to "manage."

But there is business logic to it, and banking in our society is accepted as simply a "business" with no public purpose or responsibility to provide credit to the real economy or to support national security priorities like advancing non-fossil-fuel-based energy. We accept that banking's purpose is simply to optimize return on capital, and we expect the magic of the free market to take care of the rest. Then the bankers threaten to shut down the economy if we prudently raise capital requirements? The irony here would be funny if it were not tragic.

Bank of America of course is America's largest bank with a staggering $2.3 trillion balance sheet. (As a point of reference, JPMorgan's balance sheet was well under $300 billion when it "merged" with Chase a decade ago. We had previously concluded, after an exhaustive review, that we were "plenty big to serve all of our clients' potential needs.")

BofA was at the center of the financial debacle most notably because of its absorption of both Merrill Lynch and Countrywide -- and all the liabilities that came with them in the form of bad assets and lawsuits, now including the Federal Housing Finance Agency's stunning $30 billion claim to recover losses on fraudulent mortgages sold to Fannie Mae and Freddie Mac for which FHFA acts as conservator. Bank of America responded with an announcement of job cuts for 30,000 productively-employed Americans, an outrage imposed by what Yves Smith describes as "headcount-cutting profiteers" and what banking expert Chris Whalen called "criminal."

Shockingly, the $2.3 trillion BofA is trading at is only 30 percent of its book value. As with all of our mega banks, the market is saying the book equity of our too-big-to-fail banks is vastly overstated, while the shameless leaders of these banks and their regulators point to Europe and tell us how much better shape US banks are in. Oh good. The point is that BofA receives multi-billion dollar "too big to fail" subsidies from US taxpayers just to keep the lights on and a colossal $2 trillion balance sheet funded every day, the same balance sheet that has no room to hold some project finance loans 80 percent guaranteed by, you guessed it, the taxpayers. Project lending (remember bank lending?) would get the project financed prudently, the risk certainly could be priced, but it would not create the possibility for big bonuses. So forget it.

Now we have recently learned -- no surprise -- that government loan guarantees are no panacea, and like all things political, lending decisions can be corrupted. And errors in judgment also happen. But, upon observing the culture and behavior of our banking sector that misappropriates the public subsidy it receives by placing unreachable and unnecessary profit goals on top of obscene compensation requirements, it is abundantly clear that we need an alternative.

The time has come for an intelligent, independently-governed, public infrastructure bank, ideally partnering with real banks that see their public purpose as a profession, focused on productive lending in the real economy. The example of the State Bank of North Dakota is instructive in this regard, which has given rise to tremendous new interest in Public Banking models, with banking bills working through the process in over a dozen states, as a partial response to the failure of banking in America.

Rather than subsidize Bank of America in the form of deposit insurance -- and reduced cost of debt and preferred equity since the government could never let it fail -- and, guaranteeing 80 percent of the credit risk on the rooftop solar deal, for my tax dollars, I'd like to see Uncle Sam make the loan directly via a well-managed, independent infrastructure bank that would benefit from Uncle Sam's near zero cost of funding, earn the spread for the risk it's taking, and keep the value of the subsidy out of some banker's bonus check, which is where it goes now. Ideally, real banks that understand lending as a profession and the mundane but acceptable returns it entails would be required to participate and share the risk. And the securitization "experts" could focus on cleaning up the mortgage mess they created.