Banks and Economic Recovery

This is the time of year when most businesses plan for the next calendar year. We just completed a half day board retreat. I will offer you a peek inside our heads in the event it aids your thinking for 2010.


In recent weeks we are hearing a fair amount of commentary about the recovery being underway. Most of our retreat discussion centered on the external environment for 2010. We reviewed the case for a recovery in 2010 and the case for another tough year. We are going to plan for another tough year.


A number of factors do support the case for a 2010 recovery. Equity markets have recovered a lot of lost ground since March of 2009. Equity markets usually rise at the end of a recession. Ben Bernanke, Tim Geithner and President Obama are all telling us the recovery is happening. Our own Business Pulse survey of regional business leaders reflects a modestly more positive outlook on 2010. There are some signs of residential real estate bottoming out in the bubble markets.


Three general factors contributed to our conclusion to plan for 2010 to be a difficult external environment. The first is the dismal shape of the banking industry. Banks are not particularly popular during good times. While the public and political moods have turned sharply negative toward banks, here is something the public must come to terms with. We will not have a healthy economy without healthy banks. The federal government acts like the angry farmer when he discovers that half the horses have left the barn. He cannot beat the horses that fled, so he turns his wrath on the animals that he can strike. Most of all he is motivated by his desire to avoid explaining to his hungry wife and kids that he left the barn door open. He assures the family that there will be enough food as he plans to cut one leg off of each remaining horse. The family will eat and there will be no more runaway horses. There will also be no field work done.


Let’s walk through some barnyard math on bank closures. The FDIC has closed about 100 banks in the last 24 months and has suggested that there are another 400 to close. The average cost of closure has been around $500,000,000 per bank. The FDIC “reserve” is basically created by taxing surviving banks to pay for future closures. This reserve has fallen to $6 billion despite a tripling of the effective tax in 2009.  Seeing the reserve deficit, the FDIC just decided that banks will pay today what they would be expected to pay over the next three years. With a stroke of Enron-like accounting creativity, the FDIC determined that banks can pay 3 years of expense without affecting earnings or capital. The unfunded liability for closing an additional 400 banks may be around $200 billion over the next 24 months. You don’t need to feel sorry for banks, but you do need to realize that this tax overhang on the animals that did not leave the barn greatly impedes the flow of capital into all banks, even those who operate real, responsible businesses.


The regulatory tone at the top could not be more different than it is at street level. The rhetoric at the top is that “things are getting better; we just need you banks to keep your rates low, keep credit flowing and work with your borrowers who are struggling”. I recently attended a roundtable session with about 25 banks at which top regulators spoke. The message behind closed doors was “things are bad and if there is a recovery coming it is a long way off and very weak and unsustainable”. The data presented showed a severe capital shortage, rapidly rising non-performing loans and very weak earnings. This disconnect in rhetoric can be partially explained by the legitimate responsibility officials such as Secretary Geithner and Chairman Bernanke have for maintaining public confidence. There is also the desire to avoid accountability for the manifest failure of regulators to adequately supervise the industry. The Washington narrative is, “we didn’t have enough regulations and regulators”. Acknowledging the fundamental failure of the vast existing regulatory structure conflicts with this narrative.


Next week, we’ll give you a summary look inside our loan portfolio. We receive monthly financials of hundreds of businesses in our region. This gives us the most reliable real time pulse on economic activity in our area.