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Pity the Poor Bankers

Irwin M. Stelzer

There ariseth a little cloud out of Minneapolis, smaller than the hand of a central banker, but worrying nevertheless. Neel Kashkari, newly appointed president of the Federal Reserve Bank of Minneapolis, wants to break up the big banks. Kashkari has taken to introducing himself with an attention-grabbing, “I’m the guy who bailed out the banks,” More precisely, he graduated from Goldman Sachs to the Treasury Department thanks to an appointment by then-President George W. Bush. His job, working with another Goldman alum, Treasury Secretary Hank Paulson: to administer the Troubled Asset Relief Program (TARP) and bail out large financial institutions that were on the brink of bringing down the international financial system. Like Frank Sinatra, regrets he has a few, most important among them that he did not succeed in eliminating the threat posed by banks deemed too big to fail.

This Goldman Sachs alumnus agrees with Socialist presidential wannabee Bernie Sanders, the new hero of the privileged youths who populate our pricier campuses, that the biggest banks must be broken up. Sanders said last week that when (no “if“s allowed to presidential candidates) he is president he will order the Treasury Secretary to give the biggest banks one year in which to break themselves up and restructure the bits of their businesses. Kashkari presumably would have the Federal Reserve Board use the procedures available to it – a bit more cumbersome than the one Sanders prefers – to accomplish the same objective. The twain have indeed met: The banker from Wall Street who met his wife in posh Lake Tahoe, and the Socialist from Vermont who honeymooned in the Soviet Union are as one on bank policy.

Sanders will have to take his plan with him back to the Senate when Hillary Clinton wins her party’s nomination, assuming she has not been indicted, or even if she has. Kashkari plans a series of seminars around the country, to culminate at the end of the year in a plan he will present to congress. In ordinary times, that would prove a one-day media wonder on a slow news day. But these are not ordinary times. Banks, never loved, are loathed. Jeb Bush, Ben Carson, Carly Fiorina and Marco Rubio, the Republican candidates who called for less, not more regulation of the banking industry, were eliminated by voters from the race, although not only for their policy positions on banks. Ted Cruz says he would let the big banks fail, presumably even if the walls of the world’s financial house came tumbling down with them, a situation he refused to confront in response to repeated questions. When confronted with tough questions he floats like a butterfly and stings like a bee. And Donald Trump’s bank policy consists of calling Cruz a prisoner of Goldman Sachs, presumably because Mrs. Cruz is employed by Goldman and the bank has loaned Cruz considerable sums, hardly a risky venture since the senator will be in a position to repay once the financial demands of his campaign cease and he is back in the senate or ensconced in the White House. On the Democratic side, Sanders’s rival, Hillary Clinton, long a beneficiary of financial support from Wall Street, would give regulators more discretion to break up the big banks should her various schemes for more regulation prove inadequate to eliminate the too-big-to-fail threat.

My guess is that fears of derailing the tepid recovery will combine with the lobbying clout of Wall Street to head off any crippling legislation driven by Main Street’s hatred of such as the bailee-CEOs of Goldman and JPMorgan Chase, who are continuing their race to see which one will be the first to break out of the $20 million annual compensation class and into the $30 million bracket.

Unfortunately for the big banks, dissipation of the cloud smaller than Mr. Kashkari’s hand will not prevent rain from pouring down from two cumulonimbus clouds, one threatening a downpour of regulation, the other, higher loan losses. Commercial banking involves borrowing money from depositors who can demand its return at any time, and lending it to businesses and consumers for relatively long periods of time. Borrowing short and lending long, as it is known in the trade, is profitable because banks pay depositors a lower rate of interest than they charge those to whom they lend the money. But faced with massive withdrawals of what are aptly called demand deposits – a run as it is known – the banks have to rely on their own capital to meet depositors’ demand.

Regulators know that reduction of the risk of a systemic meltdown requires increasing the amount of capital the too-big-to-fail banks must hold. U.S. banks have already substantially increased their capital, but regulators will use stiffened stress tests to raise requirements further, and add a system of insurance premiums that rise with the riskiness of a bank’s portfolio. Europe’s regulators, facing banks that are dragging their feet, last month ordered them to stop dithering and increase capital levels, and proposed adoption of this week’s proposal by the Basel Committee on Banking Supervision limiting the discretion banks now have to measure how much risk they can take. In short, both here and in Europe, higher costs, lower returns from risk-taking, and lower profits. One ray of sunshine: At some point the profit-drain created by fines extorted from the litigation-shy banks, and used to fund various poverty and other programmes near and dear to progressives in the administration, should diminish.

The second storm-in-waiting is an increase in loan losses. The law firm Haynes & Boone says 81 North American oil and gas producers and oil-field service companies with total debt of $22.5 billion filed for bankruptcy last year, and Wolfe Research predicts that as many as one-third of U.S. oil and gas companies could go that route by mid-2017. Banks are steadily increasing reserves held against possible future losses on unpaid loans. Unless oil prices rise sharply, increasing the value of the collateral behind producers’ loans – at $30 per barrel North American oil and gas producers lose about $2 billion every week according to consultants AlixPartners – there is even stormier weather ahead.

Then there are loans to finance purchases of cars. The delinquency rate of subprime car loans that have been packaged into bonds – rather like subprime mortgages were in the bad old days – is now at its highest level in nearly 20 years. With more to come as 80-month financings leave more and more vehicles “under water”, i.e., with outstanding debt far in excess of the value of the vehicles.

There are other sources of the rain falling on the banks’ parade to higher profits, most notably lower trading revenues, down 16 percent from last year’s first quarter, making it the worst in the past seven years. It all adds up to more layoffs and lower bonuses, the latter unlikely to cause a wave of sympathy from American voters. Meanwhile, the members of the Fed Board of Governors might be regretting the choice of the headhunting firm that found Mr. Kashkari for them when tasked with the job of filling the regional banker slot in Minneapolis.

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