The Obama administration has been preaching the importance of fixing the small banks and getting them lending again. Here is the critical issue at play followed by a proposed solution.
First, the answer:
Yes, it is that simple. This simple, easy to implement 'fix' will immediately work to restore small bank lending from the bottom up by removing unnecessary costs imposed by current government policy.
The current problem with small banks is that their cost of funds is too high. Currently the true marginal cost of funds for small banks is probably at least 2% over the fed funds rate that large 'too big to fail' banks are paying for their funding. This is keeping the minimum lending rates of small banks at least that much higher, which also works to exclude borrowers because of the cost.
The primary reason for the high cost of funds is the requirement for funding to be a percentage of the 'retail deposits'. This causes all the banks to compete for these types of deposits. While, operationally, loans create deposits and there are always exactly enough deposits to fund all loans, there are some leakages. These leakages include cash in circulation, the fact that some banks, particularly large money center banks, have excess retail deposits, and a few other 'operating factors.' This causes small banks to bid up the price of retail deposits in the broker CD markets and raise the cost of funds for all of them, with any bank considered even remotely 'weak' paying even higher rates, even though its deposits are fully FDIC insured.
Additionally, small banks are driven to open expensive branches that can add over 1% to a bank's true marginal cost of funds, to attempt to attract retail deposits. So by driving small banks to compete for a relatively difficult to access source of funding, the regulators have effectively raised their cost of funds.
It should be clear to all the aforementioned solutions would immediately lower the cost of funds for all small banks. There will be the usual host of objections to these proposals. To understand why the usual host of objections are not significant, it is important to frame these objections with the two fundamentals that one must keep in mind when contemplating banking with today's 'non convertible' currency and floating exchange rate policy
Making banks compete for deposits has been tried repeatedly and always necessarily fails. First, it's fundamentally impractical to the point of ridiculous to expect anyone looking to open a checking account or savings account, for example, to be responsible for analyzing the finances of competing banks for solvency, when even Wall Street analysts can't reliably do this. The US learned this the hard way when the banking system was closed in 1934 and reopened with Federal deposit insurance for bank deposits for the sole purpose of removing this responsibility from the market place. Regulation and supervision of bank lending and investing then became the imperative. And while we have seen periodic failures due to lax regulation and supervision of the US banking system, it is a work in progress and far superior to the alternative of using the liability side of banking for market discipline which exposes the real economy to far more disruptions and far more destructive systemic risk.
Those who understand reserve accounting and monetary operations, including those directly involved in monetary operations at the world's central banks, have known for decades that in banking, causation runs from loans to deposits, with reserve requirements, if any, being merely a 'residual overdraft' at the central bank and not a control variable. This includes Professor Charles Goodhart at the Bank of England, who has written extensively on this subject for roughly half a century, endlessly debating the 'monetarist' academic economists who spew gold standard and fixed exchange rate rhetoric, and who are unaware of how monetary operations are altered when there is no legal convertibility of a currency.
Recall the '500 billion euro day' back in 2008 when the ECB added that many euro in reserves to its banking system, and a week later the monetarists pouring over the data 'couldn't find it.' The fact that they even looked was evidence enough that they had no actual knowledge of reserve accounting and monetary operations. And, more recently, the notion that 'quantitative easing' makes any difference at all apart from changes in interest rates (it's always about price and not quantity) reinforces the point that there is very little understanding of monetary operations and reserve accounting.
While Professor Goodhart did declare quantitative easing in the UK a 'success' he did so on the basis of how it restored 'confidence,' making it clear that there was no actual monetary channel of causation from excess reserves to lending. Banks do not 'lend out' reserves. Loans create their own deposits. Total reserves are not diminished by lending. This is operational and accounting fact, and not theory or philosophy.
What this means is that these proposals for unlimited lending to the banks by the Fed at its target interest rate will not alter anything of consequence apart from the resulting term structure of interests per se. (Also, and not that it matters in any event, total lending by the Fed won't exceed funds 'hoarded' by some banks along with the usual operating factors that routinely 'drain' reserves.) In other words, the notion that this policy will somehow result in some inflationary monetarist type 'money printing' expansion is entirely inapplicable.
The other common concern of unsecured Fed lending to its banks is the risk of losing 'tax payer money.' However, there is none, if you look at government as a whole. All bank assets (loans and other investments) are already intensely regulated and supervised, and the banks are continually subjected to strict solvency tests. This means that the government has already deemed to the banks 'safe to lend to.'
Furthermore, banks can already fund themselves in unlimited size with FDIC insured deposits, which means the government, for all practical purposes, already lends to banks in unlimited quantities as well as protecting itself by regulating and supervising all bank loans, investments, capital requirements, etc. Therefore, the Fed asking for collateral from its member banks is entirely redundant, as well as disruptive and a cause of increased rates to borrowers.
To restore the competitiveness of small banks to be able to service small businesses, the Obama Administration should immediately move to implement the above proposals.
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More importantly, the graph showing the decline in bank lending looks like a swan dive (Acapulco style). As Dave stated "Bank lending to households and businesses has contracted more than 7% from a year ago, an unheard-of rate of decline unless you want to go back to Japan in the 90s or the U.S.A. in the 30s." This is why the above proposals to stimulate small bank lending should be given serious consideration.
The Rosenberg charts can be viewed at http://www.businessinsider.com/rosenberg-the-economy-still-sucks-credit-is-tight-and-banks-are-hoarding-cash-2010-1
Wouldn't the restoration of Glass Steagall also spur lending?
Wouldn't a restoration of Glass Steagall, in fact, be the single most powerful step that Congress could take in order to spur our nation's economic recovery. Restoring Glass Steagall would immediately allow real banks to get back to the business of lending to small business instead of hoarding capital that is presently being diverted to speculation on Wall Street. Further, it would also immediately prevent financial services corporations from gambling in derivatives and other forms of speculation with leveraged FDIC deposits that they shouldn't have ever had access to in the first place. The money in commercial banks should be devoted to deposits and helping to support the " Main Street" economy of America, not Wall Street.
Shouldn't we learn from the distant, as well as the recent past, and restore the firewall of Glass-Steagall.
ThomastonPaine.com
An excellent Huff Post from Representative Maurice Hinchey on his and other's laudable efforts to restore Glass-Steagall:
http://www.huffingtonpost.com/rep-maurice-hinchey/bring-back-the-glass-stea_b_394988.html
…. I support that and more, as a matter of public purpose. See my "Proposals for the Banking System, Treasury, Fed, and FDIC" at: http://www.moslereconomics.com/?p=8968
Restoration of Glass Steagall, be the most powerful stepto spur recovery?
….. No, I would support what's called 'narrow banking'; banking for a public purpose.
Restoring Glass Steagall allow real banks to get back to the business of lending to small business instead of hoarding?
…. I don't see 'hoarding capital' as an issue. Capital is available in unlimited quantities at a price. In our capitalist economy, return on investment is the incentive that drives economic activity. So when lending to small business becomes profitable on a risk adjusted basis, it will happen.
…. Please note that while I addressed the administration's desire to 'fix the small banks' with the fact that their cost of funds is their main problem, and not capital per se (which is always available at a price based on profitability), I did not go so far as to agree that fixing the small banks will immediately fix the economy.
It would prevent financial services corporations from gambling in derivatives and other forms of speculation with leveraged FDIC deposits ?
…. Agreed. My proposals limit banks to lending that Congress specifically deems support public purpose which could include home loans, business loans, etc. with NO secondary market transactions allowed of any kind.
If the Obama Administration gave a, excuse me, cared about, the middle-class and small business, they would have already acted to do something about this.
Since they haven't done anything, except to benefit big banks and big companies, their priorities are clear. Obama, Emanuel and Axelrod will go through the motions of trying to pass a too small, ineffective even if passed bill. Congress will water it all down even more. Time will pass, people will accept that Obama and Congress are ineffective. And, nothing much will happen.
Rather like the Credit Card Reform Bill. Or, the stimulus bill.
But, then we'll find out that some really big companies in the industry are suddenly making much more profit because of the changes. While the middle-class and small business get the bill.
That's the story of the Obama Administration and Democrats in power. It's becoming boring. Obama is more corrupt than Bush.
It deserves immediate support by the White House and Congress.
For a few incentives to help restore small business, the backbone of the economy, see a Human Investment Tax Credit Program.
Downloaded it without charge at: http://www.aesopinstitute.org
Rather, the solution is the adjustment that is now taking place: the public understands more clearly than the pundits that buying things means you must have the cash on hand to buy things. To hell with the banks and their predatory usury.....Those days are happily over.
Hope he posts here more..if nothing else there will be an exchange of ideas beyond those of the current administration and the debate on economic solutions will be enriched.
1. If the FED would treat the local banks pari passu with the moneycenter banks there should be no competetive distortion.
2. Who says that local banks have to buy their retail deposits with "brokered funds" and cannot fund themselves with internal (deposit) growth?
3. Why should a branch for a local bank be more expensive than the cost of a money center branch in the same geographic area?
4. It is a know fact that retail deposits provide a more stable funding basis than institutional deposits. Point in case: LEH and BSC. It was the uninsured institutional money deposits that left the failed institutions within days. There would have been no reason for FDIC insured deposits to leave.
5. The local banker provides a) better service vs. cookie cutter money center branches that have their policies directed from the top b) The local banker knows his credit and can act much more flexible to clients' request.
6. Spreading the risk to multiple institutions will greatly reduce overall systemic risk.
So where is the beef?
.... They can do that by building branches, etc. but those expenses add a lot to the cost of funds as indicated in the article
3. Why should a branch for a local bank be more expensive than the cost of a money center branch in the same geographic area?
...... Money center banks have been attracting the larger deposits under the too big to fail umbrella. jpm has more deposits than it knows what to do with, for example
4. It is a know fact that retail deposits provide a more stable funding basis than institutional deposits. Point in case: LEH and BSC. It was the uninsured institutional money deposits that left the failed institutions within days. There would have been no reason for FDIC insured deposits to leave.
...... True, and if the fed was standing by to lend as in my proposal the point is moot, as it should be.
5. The local banker provides a) better service vs. cookie cutter money center branches that have their policies directed from the top b) The local banker knows his credit and can act much more flexible to clients' request.
..... agreed. unfortunately he's not too big to fail.