As reported at The Hill, the requirement for banks to mark assets to market prices was delayed for another year by the FDIC. Mark to market accounting means that if one bank sells an asset for a certain price then all other banks must price similar assets at that price.
Currently, banks are not required to mark-to-market. Rather, they can price assets at full value even if they are not worth full value. This is the biggest reason that banks are delaying foreclosures. If they foreclose on a home that is worth $300,000 but has a $400,000 mortgage, the bank must take the $100,000 loss. This not only affects the bank in that they recognize a loss, but due to fractional reserve banking (think leverage) this could reduce the bank’s ability to loan another $1,200,000 (banks are leveraged about 12:1).
Industry firms were asking for the FDIC to extend mark-to-fantasy for three more years. I reckon the FDIC gave them one year to look as if they are being “tough” on the evil bankers, but I have no doubt they will get one year extensions for as long as they desire.
This is clearly a coordinated plan by the government to build the banks back up over time. The banks can falsify their books, which mark-to-fantasy truly is, and rebuild their balance sheets by borrowing from the Federal Reserve at essentially zero percent and investing in guaranteed Treasuries at 3%. With fractional reserve banking, as alluded to earlier, this can be quite profitable. Imagine a bank gets $100,000 in deposits from customers. With the magic of fractional reserve banking, this could become $900,000 (or more). The bank can invest at 3% in guaranteed Treasuries so they don’t risk any more foreclosures or write-downs while only paying a meager interest rate on the $100,000 in deposits. Pretty sweet to be a banker. The government is going to continue this operation until the banks are healthy again.
At first glance, this may seem like a wise idea. Rather than doing another TARP program, the banks can be rebuilt over time. Also, this helps stabilize housing (or provide the illusion of such) because the banks don’t foreclose, which keeps home prices from continuing to drop in price.
In fact, the government did this in the 1980s when banks made bad loans to Latin American countries. And, it did work back then. But, as you probably guessed, I don’t think it will work the same way now. Why? Well, back in the 1980s, the banks kept the debts to Latin American countries at mark-to-fantasy, but it didn’t really impact the U.S. economy because banks were increasing their lending to U.S. citizens and businesses. Our economy had the capital it needed to grow.
Today, lending is dropping, and it is dropping fast. Small businesses and consumers can’t get access to capital. Here is a chart from the St. Louis Federal Reserve showing the drop in bank lending.
You might dismiss this chart saying that it is natural for banks to be cautious in their lending during a recession. It will pick back up once the economy gets moving. However, this is the first time since the 1930s that lending dropped during a recession.
This chart shows that lending increased, or at least stayed constant, for every other recession dating back to the 1973 recession. This lack of lending means that the economy is not going to reach the levels it did before the recession began. Our economy has been fueled by debt over the past few years. In fact, our economy, as measured by Gross Domestic Product (GDP) , would have been substantially lower had it not been for homeowners taking equity out of their home for spending. Take a look at this:
You can see we would have had anemic growth without debt as far back as the year 2000. With debt limited now, the economy won’t see any real growth even with government spending. The banks are hoarding money because they know that even with the mark-to-fantasy rules that they face massive write-downs or losses.
So the government plans to recapitalize the banks over time, but it may not work this time because without lending the economy will continue its weakness, which will increase foreclosures and business failures. So we could be in a vicious loop where the banks hoard capital, but this hoarding causes more losses. And, the government thinks they have the solution because it worked in the 80s.