Asset Based Lending
Chief Investment Officer
Commercial Loan Automation
BirdsEye Viewlet sanity prevail
Holman W. Jenkins published a brilliant article in the WSJ the other day. I feel compelled to paraphrase it and share it with you.
The article focused on the root cause of the financial crisis and Obama’s attack on the banks. The central question which Jenkins poses, which too few people ask, is: “Were the banks insolvent or were they victims of a liquidity panic?” In fact, as we all know, some banks were indeed insolvent, but others faced liquidity panics often induced by legislator (remember Schumer?) and regulator overreaction and vilification of all banks.
Jenkins points out something we all know: nearly all TARP advances, including warrants, have been returned to the taxpayers with a meaningful profit. What this means is simply that bankers are now being punished for losses that were actually incurred by Fannie and Freddie, some insurance companies and auto manufacturers which maintain union jobs at economically unsustainable levels.
Jenkins further reiterates the reason for the presence of a lender of last resort in financial systems, which is what the Fed is. The purpose of such a lender is to make sure that lenders with good collateral won’t go under when a liquidity panic occurs. “Just as an apartment building can become unsellable even though its tenants continue to pay on time, so can a triple-A rated CDO held by a bank become unmarketable even though the underlying borrowers continue to pay”.
Banks indeed made many mistakes during the period preceding the crisis. Concentrations in both commercial real estate and single large borrowers ran rampant. Stress testing wasn’t nearly as robust as it needed to be to fully capture the risk on many banks’ balance sheets. At the same time, is it appropriate for banks to lose the entire value of assets that, had they been held to maturity, would have retained their value? And isn’t it the role of the lender of last resort to facilitate that process by averting a liquidity panic to avoid economic meltdown?
Jenkins also says that moral hazard is not an aberration and can’t be eliminated. Governments should write a liquidity insurance policy for their financial systems in times of panic. These are part and parcel of sound financial systems. There is no substitute for an indiscriminate safety net in times of panic, he says. “Quite the contrary: if it threatened bank creditors with real losses (as it properly should), invoking resolution authority would only feed the panic.”
Fannie and Freddie facilitated for decades the funneling of credit to speculators and, in recent years, millions of non-credit worthy borrowers seeking to buy their first home in frothy markets. At the time, lender behavior was rational, using quasi-government entities to absorb the risk of lending during such bubbly times. In other words, Jenkins says, it’s bad public policy that was at the root of the crisis, and the Fed’s behavior as a safety net is appropriate. This situation was aggravated by the sentiment that everyone should own a home. While a noble goal, it is not financially achievable or prudent for 100% of the population.
I’d like to add my two cents’ worth to these comments. Not only do I agree with Jenkins, but, based upon this conclusion and recent history, the so called “bailout” money could have been better deployed for a more positive impact. One important benefit of TARP – restoring stability to the financial markets – could have been achieved by the Fed’s liquidity injections into the financial system, and by Treasury using the money to stabilize the housing and commercial real estate markets. Spending TARP to create stability achieved that purpose, but it also prolonged the life of “dead banks walking” and unnecessarily contributed to the on-going uncertainty of real estate markets which still seek the bottom. The Resolution Trust Corporation of twenty years ago did a solid job of stabilizing markets. Perhaps a similar structure would have been effective today as well.
Further, as panic spread and capital markets shut down or evaporated altogether, capital in the banking system was reduced dramatically through passing “paper” losses on loans, securities, collateral and goodwill, rather actual losses. Appraisals shifted from optimistic to a “mark-to-no-market” mode, and did not reflect intrinsic values, not to mention long-term values.
Losses were thus further magnified, creating a death spiral for many banks.
Treasury would have been better served by investing TARP funds in making markets in toxic real estate as originally planned, thus stabilizing the asset values on banks’ balance sheets, preventing fatal value write-downs for both loans and bank-originated securities (trust preferreds) and siphoning huge amounts of capital out of our system.
TARP did not help stimulate our economy, nor did it facilitate additional lending, as loan demand has been depressed in reflection of the economic slump. Instead, the free market has been seeking its own equilibrium, as it always does. Prices have plummeted in some markets and not so much in others. Buyers are returning to markets that have been priced to what they believe is the bottom. At this point, our economic problems are unemployment-driven, not real-estate value driven.
I am no economist, and I acknowledge this is a very complex situation. At the same time, we have always seen banks fueling the economy and leading its recovery. Beating us up is not going to help the US economic recovery. It will delay it instead.