Seldom has a day gone by without an article in the financial press lamenting the Federal Reserve’s dilemma regarding the faltering economy.
The story goes like this:
The economy is clearly slowing, but the central bank’s key federal funds rate already is at a quarter of a percent. Short-term interest rates are nearly zero and hardly can be cut further.
The Fed could resume its program of quantitative easing by resuming the purchase of Treasury and mortgage bonds. But that’s unlikely to have a major effect. Some believe it could even be counterproductive.
The Fed is about out of options.
This simply is not true.
The Fed could talk to its bank inspectors.
By modifying the instructions given to the central bank’s vast army of inspectors, the Fed could greatly influence the cost and availability of credit throughout the economy, and particularly the credit available to small businesses.
True, the Fed does not control all bank inspectors. But it oversees a large portion of banks and greatly influences the policies of other regulators.
Banks, rather than bank inspectors, set each institution’s lending policy. But it would be naive to think banks are not greatly influenced by the directions and even questions from bank inspectors.
Bankers’ Take
I have regular conversations with bank presidents and other bankers where I hear comments like this:
The government is constantly urging us bankers to make more loans. But every time we make a loan the least bit outside the box, we have the bank inspector on us.
At best, such loans bring unwanted attention, and if there is the least bit of a problem, we are required to set aside reserves against loans.
Believe me, we would love to boost our profits by increasing our loan balances. But there are very few borrowers who meet today’s exacting standards as dictated by the regulators. Most of our clients who want to borrow have suffered in some way from the recent economic dislocations—they have had a loss for a year or two, or the value of their assets has deteriorated, or their prospective income has been impaired.
Even if we feel they are creditworthy, we are often afraid to lend to them, based on concerns about how the bank inspectors will react.
The Fed’s policies regarding when banks must write off or write down loans greatly affect their willingness to extend credit. Write-downs are very costly to banks—they make every effort to avoid making loans that even have a small chance of requiring them.
In my industry of commercial real estate, we have a real problem with the Fed’s policy on property appraisals.
In late 2008, most Wall Street funding for commercial real estate ceased and banks greatly reduced their willingness to make loans.
The loans that banks would make were at significantly lower amounts with increasingly higher costs. This withdrawal of credit caused property sales to plummet.
Some of this decline was due to previous over exuberance and the effects of the recession. But the biggest reason for the fall was the exit of finance from the industry.
Few properties have changed hands as most owners have no interest in selling at these low prices. But appraisals are based on the latest sales at low prices.
This has caused appraised values to fall below loan amounts for many properties, even if the rental income is unchanged.
When the loans on these properties come up for renewal, often there is a big problem. Banks tell me that the Fed’s rules make it in their best interest to foreclose if a property’s appraised value falls below 90% or so of the loan amount, even if the loan payments are current and have every prospect of continuing to be current.
This is nonsensical. We have created a vicious cycle where banks’ unwillingness to loan on anything like the previous terms cause property values to fall. This causes bank loans to be classified as bad, which causes losses for the banks, which causes banks to be less willing to loan.
A good portion of the problem can be fixed with a simple Fed policy change. Banks should be encouraged and given incentives (by the Fed’s loan write-down and write-off rules) to renew on terms similar to the average of those in place during the past 10 years on loans where the payments are current and have reasonable prospects to continue to be current.
Simple, common-sense changes, like the above, will greatly help the current situation. They not only will affect current loans but also will influence banks’ willingness to make new loans.
Encouraging Lending
If banks don’t have to worry so much about the Fed’s bank inspectors criticizing or requiring write-downs of loans, they will be much more willing to extend credit, and to do so on more reasonable terms.
No one is suggesting that loan standards be thrown out. But if the Fed wants the economy to improve, we need more new and renewed loans.
Bank inspectors’ policies and attitudes greatly influence banks’ loan policies. It would amaze most nonbankers how often and in how much detail banks are inspected. A moderate lightening of this regulatory load, combined with a change in bank inspectors’ attitudes to encourage lending could do much more to help the economy than a further cut in wholesale interest rates or any quantitative easing.
Saunders is a real estate investor and owner of London Coin Galleries Inc. in Newport Beach.
