USA Today
Two years after Lehman Bros.' collapse caused a global credit panic, financial flows in the United States have returned to normal — or at least what passes for normal amid a still-wounded economy.
Since the scary days that followed Lehman's sudden demise, major changes have swept the banking industry, with traditional investment banks disappearing like financial dinosaurs, and some of the industry's household names fading into mergers or oblivion. Merrill Lynch, home of Wall Street's iconic bull, was absorbed into Bank of America. Wells Fargo swallowed Wachovia. Citigroup found itself tethered to government life support.
Today, the nation's big banks are in much better shape than they were two years ago, but the issue of how to handle the collapse of another cross-border giant still shadows the global economy. Troubling weaknesses are visible in the smaller regional banks that attract less public attention. And plenty of additional change lies ahead for the industry as it battles regulators about implementing new domestic and global banking rules.
"They have more capital. Much better management of their liquidity. In general, they're being more cautious," says Simon Johnson, an economist at the Massachusetts Institute of Technology. "But the overall culture remains the same, and the system is largely unreformed."
Last year's government-run stress tests led to the nation's 19 largest banks raising $205 billion in capital to buttress themselves against future losses. Another sharp decline in U.S. housing prices or in commercial real estate could yet hammer bank balance sheets. Likewise, if Europe's major banks suffer significant losses on their holdings of government debt from countries such as Greece or Ireland, U.S. banks could feel the aftershocks. If the economy sinks into a double-dip recession, U.S. banks would need to raise an additional $80 billion in capital, the International Monetary Fund concluded this summer.
"Stability is tenuous. ... Bank balance sheets remain fragile, and capital buffers may still be inadequate in the face of further increases in non-performing loans," said the 51-page IMF study.
Confidence returns
Lehman's Sept. 15, 2008, bankruptcy filing marked the break between a challenging episode of financial weakness and the onset of the worst global panic since the Great Depression. The collapse of such a storied firm — Lehman had been a Wall Street fixture since before the Civil War— caused banks to regard each other with unalloyed suspicion. Unsure which institution might be the next to succumb to losses from complex mortgage-backed securities, routine bank-to-bank lending dried up.
Within a month, one measure of banks' willingness to make short-term loans to other banks registered the financial equivalent of a heart attack. The so-called TED spread, the difference between interbank loans and short-term government debt, jumped to 4.63 percentage points — almost 15 times its 2000-2007 average of 0.31. Today, the spread is just 0.16 percentage points, one reflection of the credit market's return to normalcy.
The late 2008 credit freeze sent the already wobbly economy into a nose dive. In the three months prior to Lehman's implosion, the economy lost an average of 246,000 jobs per month. In the next three months, labor market casualties averaged 652,000. By then, the last remaining major investment banks, Goldman Sachs and Morgan Stanley, had become plain-vanilla bank holding companies, submitting to Federal Reserve regulation of their activities in return for access to the Fed's financial lifeline.
Now, with memories of their near-death experiences fading, the nation's largest banks are once again booking profits as if the global financial crisis never occurred. In the second quarter, the industry posted earnings of $21.6 billion compared with a loss of $4.4 billion in the same period one year ago. It was the highest quarterly profit total since the third quarter of 2007, shortly before the recession began, according to the Federal Deposit Insurance Corp.
Some individual bank performances were eye-popping: Bank of America reported $3.1 billion in second-quarter profits, as did Wells Fargo. Citigroup earned $2.7 billion.
The image of highflying bankers recovering nicely while 14.9 million Americans remain jobless — Goldman Sachs' payroll is up 9.3% the past year — has complicated the Obama administration's efforts to resuscitate the banks. Public ire has been further fueled by often-anemic bank lending.
The volume of bank loans grew at an annual rate of 7.1% in the past decade, reaching a peak around $7.8 trillion in mid-2008. Since then, banks' total loans have steadily shrunk, though the pace of contraction has slowed in recent months, according to Capital Economics. Loan volume in August was 6.6% below that of one year earlier; in May, the decline was nearly 9%.
Still, banks continue to stockpile excess reserves at the Fed rather than lend it. Before the Lehman bankruptcy intensified the financial crisis, excess bank reserves were negligible. But as the panic spread, bank reserves soared to the current level of $1.03 trillion — up $171.7 billion in the past year.
"Banks could actually expand enormously the amount of loans they're providing," says Paul Ashworth, senior U.S. economist at Capital Economics.
Ashworth estimates that using their excess reserves, banks could make new loans worth roughly $3.5 trillion — more than four times the size of the administration's controversial stimulus program. But after a decade of ludicrously easy credit — best illustrated by so-called NINJA loans, where customers with "no income, no job and no assets" were granted mortgages — the lending pendulum has swung sharply in the other direction.
"Banks are very cautious about increasing the supply of their new loans. ... Banks will not be taking the crazy chances they were back then, and we don't want them to," said Ashworth.
The problem isn't limited to the banks. With existing factories operating far below capacity, there is little reason for many businesses to expand. Demand for new commercial and industrial loans was roughly unchanged in the most recent quarter, after having dropped during the three months that ended in April, the Fed said.
The most recent Federal Reserve survey of senior loan officers showed some signs of easier loan availability. For the second-consecutive quarterly survey, banks reported easier credit for large and midsize businesses. For the first time since 2006, banks said they were making more credit available to smaller businesses. Domestic banks also reported — for the first time since the Fed began asking in January 2009 — that they were no longer shrinking credit lines for existing business customers.
"Banks are lending again. But they're still very cautious about what they're willing to get involved in," said Russ Yates, an analyst at SNL Financial in Charlottesville, Va.
Smaller banks are a particular worry. The IMF noted a rising gap between the number of home foreclosures and "seriously delinquent loans" at regional and community banks, suggesting additional loan losses for those institutions. Larger banks hold diversified portfolios that are able to absorb some losses. But the fortunes of smaller banks in areas that have been hardest hit by the housing crash, such as Las Vegas, South Florida and parts of California, rise and fall with those local economies, Yates said.
The FDIC's list of problem banks has grown to 829 mostly smaller lending institutions, up from 775 on March 31. Even some banks that received government aid under the Treasury Department's TARP program continue to struggle. In its latest report on the program, the department said 123 banks did not make their scheduled dividend payment to the government on Aug. 16.
New rules and more overseers
Preventing a repeat of the financial crisis was the focus of the Obama administration's overhaul of financial industry regulation. Critical decisions that will determine how far-reaching the actual changes are will be made by officials in agencies such as the new Consumer Financial Protection Bureau.
"A lot depends upon how it's implemented," says Nicolas Véron of the Bruegel think tank in Brussels.
The IMF's study of the U.S. financial system endorsed the new regulatory approach, though it criticized the arrangement's hydra-headed nature. The number of agencies with responsibility for monitoring the financial sector increased under the new bill, potentially complicating existing inter-agency coordination problems.
"We asked many times why bolder action could not be taken," Chris Towe, deputy director of the IMF's Monetary and Capital Markets Department, told reporters in July.
Global banking supervisors agreed Sunday on new rules that will require banks to maintain higher levels of capital reserves. The Basel III regulations, named for the Swiss town where the regulators meet, will boost a critical bank buffer from 2% of assets to 7%. Most U.S. banks already maintain capital cushions in excess of that figure. A few, including Bank of America, Capital One and M&T, may need to raise capital, according to CreditSights, a credit research firm.
"The last crisis would likely have been significantly less harsh if capital requirements had been higher," said Douglas Elliott, a former investment banker now with the Brookings Institution.
Bankers, especially in Europe, complained that higher capital requirements would crimp already struggling economies by curbing new loan issuance, so regulators provided an eight-year grace period for the new rules to be phased in. At November's G-20 summit in Seoul, President Obama and other world leaders are expected to give the new rules final approval.
Assuming no new crisis before 2019, the Basel III rewrite could make the global financial system safer. But MIT's Johnson, co-author of 13 Bankers, worries that neither the new U.S. nor global rules will be sufficient to forestall a crisis rerun.
The largest banks still carry an implicit government guarantee, he says, and will again act recklessly once memories of the last crisis fade.
"As the world economy gets going again, we'll find out if the big banks are better managed," Johnson says.
Since the scary days that followed Lehman's sudden demise, major changes have swept the banking industry, with traditional investment banks disappearing like financial dinosaurs, and some of the industry's household names fading into mergers or oblivion. Merrill Lynch, home of Wall Street's iconic bull, was absorbed into Bank of America. Wells Fargo swallowed Wachovia. Citigroup found itself tethered to government life support.
Today, the nation's big banks are in much better shape than they were two years ago, but the issue of how to handle the collapse of another cross-border giant still shadows the global economy. Troubling weaknesses are visible in the smaller regional banks that attract less public attention. And plenty of additional change lies ahead for the industry as it battles regulators about implementing new domestic and global banking rules.
"They have more capital. Much better management of their liquidity. In general, they're being more cautious," says Simon Johnson, an economist at the Massachusetts Institute of Technology. "But the overall culture remains the same, and the system is largely unreformed."
Last year's government-run stress tests led to the nation's 19 largest banks raising $205 billion in capital to buttress themselves against future losses. Another sharp decline in U.S. housing prices or in commercial real estate could yet hammer bank balance sheets. Likewise, if Europe's major banks suffer significant losses on their holdings of government debt from countries such as Greece or Ireland, U.S. banks could feel the aftershocks. If the economy sinks into a double-dip recession, U.S. banks would need to raise an additional $80 billion in capital, the International Monetary Fund concluded this summer.
"Stability is tenuous. ... Bank balance sheets remain fragile, and capital buffers may still be inadequate in the face of further increases in non-performing loans," said the 51-page IMF study.
Confidence returns
Lehman's Sept. 15, 2008, bankruptcy filing marked the break between a challenging episode of financial weakness and the onset of the worst global panic since the Great Depression. The collapse of such a storied firm — Lehman had been a Wall Street fixture since before the Civil War— caused banks to regard each other with unalloyed suspicion. Unsure which institution might be the next to succumb to losses from complex mortgage-backed securities, routine bank-to-bank lending dried up.
Within a month, one measure of banks' willingness to make short-term loans to other banks registered the financial equivalent of a heart attack. The so-called TED spread, the difference between interbank loans and short-term government debt, jumped to 4.63 percentage points — almost 15 times its 2000-2007 average of 0.31. Today, the spread is just 0.16 percentage points, one reflection of the credit market's return to normalcy.
The late 2008 credit freeze sent the already wobbly economy into a nose dive. In the three months prior to Lehman's implosion, the economy lost an average of 246,000 jobs per month. In the next three months, labor market casualties averaged 652,000. By then, the last remaining major investment banks, Goldman Sachs and Morgan Stanley, had become plain-vanilla bank holding companies, submitting to Federal Reserve regulation of their activities in return for access to the Fed's financial lifeline.
Now, with memories of their near-death experiences fading, the nation's largest banks are once again booking profits as if the global financial crisis never occurred. In the second quarter, the industry posted earnings of $21.6 billion compared with a loss of $4.4 billion in the same period one year ago. It was the highest quarterly profit total since the third quarter of 2007, shortly before the recession began, according to the Federal Deposit Insurance Corp.
Some individual bank performances were eye-popping: Bank of America reported $3.1 billion in second-quarter profits, as did Wells Fargo. Citigroup earned $2.7 billion.
The image of highflying bankers recovering nicely while 14.9 million Americans remain jobless — Goldman Sachs' payroll is up 9.3% the past year — has complicated the Obama administration's efforts to resuscitate the banks. Public ire has been further fueled by often-anemic bank lending.
The volume of bank loans grew at an annual rate of 7.1% in the past decade, reaching a peak around $7.8 trillion in mid-2008. Since then, banks' total loans have steadily shrunk, though the pace of contraction has slowed in recent months, according to Capital Economics. Loan volume in August was 6.6% below that of one year earlier; in May, the decline was nearly 9%.
Still, banks continue to stockpile excess reserves at the Fed rather than lend it. Before the Lehman bankruptcy intensified the financial crisis, excess bank reserves were negligible. But as the panic spread, bank reserves soared to the current level of $1.03 trillion — up $171.7 billion in the past year.
"Banks could actually expand enormously the amount of loans they're providing," says Paul Ashworth, senior U.S. economist at Capital Economics.
Ashworth estimates that using their excess reserves, banks could make new loans worth roughly $3.5 trillion — more than four times the size of the administration's controversial stimulus program. But after a decade of ludicrously easy credit — best illustrated by so-called NINJA loans, where customers with "no income, no job and no assets" were granted mortgages — the lending pendulum has swung sharply in the other direction.
"Banks are very cautious about increasing the supply of their new loans. ... Banks will not be taking the crazy chances they were back then, and we don't want them to," said Ashworth.
The problem isn't limited to the banks. With existing factories operating far below capacity, there is little reason for many businesses to expand. Demand for new commercial and industrial loans was roughly unchanged in the most recent quarter, after having dropped during the three months that ended in April, the Fed said.
The most recent Federal Reserve survey of senior loan officers showed some signs of easier loan availability. For the second-consecutive quarterly survey, banks reported easier credit for large and midsize businesses. For the first time since 2006, banks said they were making more credit available to smaller businesses. Domestic banks also reported — for the first time since the Fed began asking in January 2009 — that they were no longer shrinking credit lines for existing business customers.
"Banks are lending again. But they're still very cautious about what they're willing to get involved in," said Russ Yates, an analyst at SNL Financial in Charlottesville, Va.
Smaller banks are a particular worry. The IMF noted a rising gap between the number of home foreclosures and "seriously delinquent loans" at regional and community banks, suggesting additional loan losses for those institutions. Larger banks hold diversified portfolios that are able to absorb some losses. But the fortunes of smaller banks in areas that have been hardest hit by the housing crash, such as Las Vegas, South Florida and parts of California, rise and fall with those local economies, Yates said.
The FDIC's list of problem banks has grown to 829 mostly smaller lending institutions, up from 775 on March 31. Even some banks that received government aid under the Treasury Department's TARP program continue to struggle. In its latest report on the program, the department said 123 banks did not make their scheduled dividend payment to the government on Aug. 16.
New rules and more overseers
Preventing a repeat of the financial crisis was the focus of the Obama administration's overhaul of financial industry regulation. Critical decisions that will determine how far-reaching the actual changes are will be made by officials in agencies such as the new Consumer Financial Protection Bureau.
"A lot depends upon how it's implemented," says Nicolas Véron of the Bruegel think tank in Brussels.
The IMF's study of the U.S. financial system endorsed the new regulatory approach, though it criticized the arrangement's hydra-headed nature. The number of agencies with responsibility for monitoring the financial sector increased under the new bill, potentially complicating existing inter-agency coordination problems.
"We asked many times why bolder action could not be taken," Chris Towe, deputy director of the IMF's Monetary and Capital Markets Department, told reporters in July.
Global banking supervisors agreed Sunday on new rules that will require banks to maintain higher levels of capital reserves. The Basel III regulations, named for the Swiss town where the regulators meet, will boost a critical bank buffer from 2% of assets to 7%. Most U.S. banks already maintain capital cushions in excess of that figure. A few, including Bank of America, Capital One and M&T, may need to raise capital, according to CreditSights, a credit research firm.
"The last crisis would likely have been significantly less harsh if capital requirements had been higher," said Douglas Elliott, a former investment banker now with the Brookings Institution.
Bankers, especially in Europe, complained that higher capital requirements would crimp already struggling economies by curbing new loan issuance, so regulators provided an eight-year grace period for the new rules to be phased in. At November's G-20 summit in Seoul, President Obama and other world leaders are expected to give the new rules final approval.
Assuming no new crisis before 2019, the Basel III rewrite could make the global financial system safer. But MIT's Johnson, co-author of 13 Bankers, worries that neither the new U.S. nor global rules will be sufficient to forestall a crisis rerun.
The largest banks still carry an implicit government guarantee, he says, and will again act recklessly once memories of the last crisis fade.
"As the world economy gets going again, we'll find out if the big banks are better managed," Johnson says.
