Guest commentary: The Fed's Bank-Aid subsidy

Good morning. This came via email, and I thought it worthy of its own post. Reader Mike Juha argues the Bernanke Fed is subsidizing banks, and banks aren't passing along the subsidy to consumers.

Bernanke's Bank-aid subsidy
By Mike Juha

"The rate reductions by the Fed FOMC are being made into a subsidy by and for the banks. The Fed rate reductions can not help the economy until this changes.

"Since August 2007, the Fed has reduced rates from 5.25% to 3%.  During that same time, bank mortgage loan rates have increased, rather than decreased. For example, a 1 year ARM should bear a rate roughly 1% more than the Fed rate. Today, interest on a 1 year ARM loan is 2.5% more than the Fed rate.  The Fed is lending $30 billion every few weeks through its discount window at 3% to the banks.  In turn, the banks are lending these Fed funds at 5.5% or more today, versus 5.4% 6 months ago.

"This makes the recent Fed rate reductions a subsidy program for the banks, rather than an economic stimulus. Such an outcome does not help the economy. Credit is being reduced in cost only at the interbank level.  Credit is being increased in cost by the banks at their retail level.  As a consequence, the economy is placed in a greater credit squeeze.  And, the banks are squealing with joy over gifts of low cost money from the Fed.

"The Fed is not requiring the borrowing banks to act in concert with its plan.  Such a requirement should be prerequisite to qualifying for borrowing from the Fed."

Thanks, Mike.
Thoughts? Comments? Insights? Email story tips -- and commentaries -- to peter.viles@latimes.com.
Photo Credit: Fed Chairman Ben Bernanke, by Getty Images via LATimes.com

Comments

[amir]

That's true.

However, many banks in this country are now insolvent. They owe more than they have on the books. If big banks start falling, we'll be in a great depression with millions losing everything. Bernake is trying to save the banks from their own horrible decisions. It's corporate welfare. But what else could he do? If he forces the banks to give better deals to consumers the banks could falter.

As aggravating this decision is, he really has very few choices. If you owe a hundred thousand dollars, you have a problem, if you owe a hundred million dollars, the bank has a problem, if you owe a hundred billion dollars, the government has a problem.

We will all pay for this, because the dollar will be diminished which is effectively a nationwide tax.

[MyLessThanPrimeBeef]

I think the banks have been the legal owners of the Fed since way back when it was created almost a hundred years ago.

That's not subsidy. There is another name for that. What is it? Um, uh, what is it?

Oh, yes, that's called knowing who is the boss.

[Bob]

Bankers are for profit. It's competition that keeps the rates low. There is no competition now, houses are in free fall and those who read this blog know you are nuts to buy.

Banks sell their loans to someone else. The someone else's are all taking a big hit. They want a better chance at making a profit to cover the loses that are still taking. Hence, higher rates, higher points and other loan fees. The cost of borrowing goes up on the way down.

[Tombstone Realty]

Agree -

This whole "trickle-down" philosophy only works if the banks act altruistically, and pass down the benefits to the consumer. Course, they don't do this. They are instead increasing the margin of profit for their shareholders with some funky economics in their books. Not to mention what this does to the dollar. This also benefits the banks - if your savings accounts have really low rates of interest - they don't have to pay you as much. So in addition to the fed's nearly free money, they are sitting on our CDs and using it as nearly free money too.

Not only mortgage rates not come down, neither have credit cards. Even though I kept zero balances, my credit card was raised from 9.8% to 13.6% due to "increasing cost of business" over the summer. They have yet to drop anything since.

In the end, it won't help anyway. People will walk away from their homes, default on credit cards - because they'll feel the banks are just ripping them off anyway. They've become the car salesmen of the financial world - you buy from them because you have to, but you have no guarantee that what you buy is worth the price. What's worse, is that we've burned international investors as well.

Even with my savings, no debt, and good credit, I don't think I'd trust a US bank to give me a fair mortgage.

[Dominic Smith]

Apples and Oranges isn't it? Lowered short term rates by the fed don't set the lenders up to lower long term (mortgage) rates. The way I see it, the Fed reduces the short term rate, setting us up for greater inflation down the road and the banks are taking that into account.
I'd not want to be stuck in a 30 year contract with anybody based on the cost of money at the Fed's "teaser" rates when those teaser rates will, down the road, require the Fed to tighten and raise.

[KYLE]

Yes, the fed rate cut should be reflected by corresponding cuts in ARM rates if all other parts of the equation were static.

My guess is the risk premium associated with ARMs has gone up substantially and this has more than offset the fed rate cut.

[Michael Snyder]

Sounds like Mike Juha's been reading this blog. He failed to mention the obscenities occurring in consumer interest rates or the five year tax rebate for banks incorporated into the President's "stimulus plan". For those of you who don't already know, this provision will allow businesses to write off their 2007 losses against their income for the previous five years. Do the math on that one and buy some Goldman Sachs & Meryl.

By cutting interest rates by 1.25% in eight days the Fed's capitulation to Wall St. pressure reminds me of a young mother with a willful two year old. With wages declining right along with equity all of the credit in the world won't help the consumer. You simply can't continue to break earnings records in one sector ( I'm talking Exon Mobile) without the money coming from another. This is just another example of how we have the finest government money can buy.

[Waiting to refi after more cuts]

Um, could the banks be, like, anticipating future hikes?

[Laker]

It is all true and correct. However, we need to understand the problem that the banks are facing. Banks need help and they get the help by increasing their margins. The other option was that bank increase, yes increase all interest rates across the board to that they could have larger margins and improve their cash flows. Doing this would not only freeze the housing market, but more likely kill it. That is the "deal" that the FED has agreed to with the banks. He will help them get more revenue in form of margins for the promise for them not to increase mortgage rates. This is simply done by reducing the FED rate and thus larger margins to the banks.
If the this would not be done, large banks would go under, period. Banks like WAMU 100% chance of BK, WELLS maybe 75% chance of BK, many smaller ones would see same destiny. So this is catastrophic to the economy.
Now, I'm the last person to want to help the banks, but again, banks are not defined to loose so much money while not having the capital to back it out.
In normal market with a FED that was only caring for inflation, FED rate will not decrease, but then bank would have raised the mortgage rates dramatically to cover their losses and elevated risks from declining housing market. Actually, I still see the mortgage rate going UP in later part of 2008 to 7% and 8% in 2009.

[sheila]

he's right, because the lenders only have to make half as many loans to make the same profit as they would if their rates were tied more closely to the Fed's lending rate, which means now half as many people and businesses have access to money, and to much less money at that.

just because some people abused the lending process by not conforming to solid collateral/borrower guidelines does not mean that "access to affordable money" is bad for the economy. it is required for kids to go to college, for responsible homeowners to repair/renovate their houses, for people with steep one-time medical bills, and for companies to make capital investments which lead to job creation and wage increases.

the Bitter Renter Brigade would be incredibly happy if they can borrow at 5% but i'm guessing rates will balloon right around the time the houses crash (remember the 80s, when 15% was normal?), which means, once again, banks win. what you save in house price, you make up for in interest payments. if we think WE are ever gonna beat the system, we all need to think again - the whole thing is gamed in favor of the corporatocracy that runs this country. they let a few people win (like any casino) to trick the rest of us into continuing to pump our money into their rigged system...

and exxon, which is getting an ENORMOUS "bailout" in the form of multiple billions in taxpayer subsidies in the new energy bill, posted the highest profit (again) of any publicly held corporation ever. all while artificially inflating and fixing oil prices which has really hurt us all (an "oil bubble") - where are the squawks of outrage from the "anti-bailout" crowd on that, or does it just make you mad when it's a poor individual who needs govt. action?

[JohnnyB]

Exactomundo Mike...

[anonymous]

Exactly. AND they are dumping their foreclosure inventory at the same time, so they are actually setting the pricing as well. They are seriously hurting homeowners and builders. I can't believe this is legal.

[Clay]

Mike is absolutely right. I moved from LA to Georgia in October so my wife and I could buy a house (that topic has been beaten to death already on this blog). While monitoring mortgage products from then until now, I've noticed interest rates barely moving. But at the same time, ING takes every opportunity it can to lower the rate on my Savings account. Banks are skimming the cheap fed money off the top and playing "one for you, one-two for me" games with consumers. What kind of economic stimulation is that?

[Dizzy Dean]

Some people are so naive. Anyone who thinks the Fed's priority in cutting rates was to provide economic stimulus and to help the average citizens is dreaming.

[cane]

Mike is exactly right. The Fed is throwing a lifeline to the banks, not the consumers. I assume by doing this they hope the bleeding will stop and credit will be eased up for consumers down the road. Trying to keep the recession from turning into a depression.

[Ace]

Mortgages are tied to long term bond rates, not the fed discount rate. When the fed lowers the discount rate, short term debt (like credit cards and car loans) usually goes down. Mortgages will go up because the buyers of the mortgages fear inflation.

I read a while back (I can't remember where) that the US is one of the only advanced housing markets that offers mortgages of more than 7 years. Places like Canada and England only have 5 or 7 year loans with balloon payments at the end. The person who wrote the story was predicting that if things keep going the way that they are heading in the US, no one will write loans longer than 7 years.

[tew]

We would need to see the long term historical relationship between Fed Funds and these various loans. Just looking at the spreads today vs. 6-12 months ago may be very misleading. It was the historically low credit standards and low risk premiums (spreads) of 2003-2007 that enabled this mess.

Perhaps today's spreads are more in line with historical norms. I would actually expect the spreads to be higher than historical averages, since lending institutions are faced with declining home values and the realization that the street level components of the system have become full of fraud and misrepresentation.

You're free to call it a subsidy, but comparing spreads today with those of 2007 is not the way to understanding.

If you were offered a loan at 3% (floating), what would you lend that money out for into today's housing market?

[150 multiple choice questions]

Wait a minute, you mean the fed doesn't have a magic bullet to solve all problems and make the financial and housing markets grow by 20% a year? I'm SHOCKED I tell you. SHOCKED.

The system is gamed... this is the fed bailing (or trying to bail) out their banking friends under the guise (or honest hope) of helping the economy. Problem is, the banks know how screwed they really are so aren't willing to loan money to each other or anyone else and this is really Bernanke's biggest problem: what to do when everyone realizes he can't do anything?

But thank God all the realtors are around giving economic policy help on raising Freddie and Fannie's limits. Can't think of a more inept / corrupt group (you're probably thinking I mean realtors but this time I'm actually talking about Freddie / Fannie... or both) that is less ready to deal with more debt. They can't even do their basic accounting, who thinks this is a good idea or will even help much if at all? Let's say the higher limit leads to more defaulting conforming loans... then what?

[twohoos]

Won't defend everything the Fed and the banks have done, but here are a couple thoughts.

First, you can't equate 30-year mortgage rates with the overnight Fed Funds rate. Mortgages are, and SHOULD be, closer to the Prime rate, which is 6% (i.e. the Funds rate plus 3%). This is good; it's the mortgage rates last summer that were still abnormal, due to the persistence of lax lending standards. If the Fed hadn't cut rates aggressively, mortgage rates would have skyrocketed as lending standards tightened, and the credit squeeze would be far far worse.

So, of COURSE it's a subsidy for the banks -- they are the ones in danger of going bankrupt (not the individual mortgage holders, who as we've seen can just walk away). A rash of major bank failures would in turn expose the Fed to massive FDIC payouts (not on the mortgages, but on the other deposits they hold), so the Fed is also protecting itself, along with the taxpayers who are the real source of the Fed's money.

[Cal]

I was thinking about interest rates on my drive in this morning, if interest rates on savings drop it would make people move their money to places with higher returns (stocks, bonds, muni bonds) and out of the banking system. That would hurt the banks. So I don't think its exactly a free lunch for the banks. I just think the fed is trying to balance the money flows across the distressed assets trying to make sure nothing else blows up. They are trying to prevent deflation by any means necessary.

The fed funds are short term as are the TAF funds so while I do believe the banks will profits from the fed funds reduction they need to get longer term financing in place and that comes from savings and assets.

[Robert in Palm Springs]

The pathetic thing about the "stimulus" and rate cuts is that they will ultimately have little or no impact on the unfolding global financial disaster. They only go to show just how weak the USA now is.

The greatest borrowing and spending binge of all time is over. Get used to it. Recessions are a natural part of the business cycle. Unfortunately, our recent economic "expansion" was not normal; it was all fabricated by inflating asset prices. Everyone knew that could not be sustained and it is over for real estate and is ending for stocks and commodities as well.

Ostensibly, these actions by the Fed and Congress are supposed to help the average American, but in reality, they are making politics in an election year. For the Fed, it is all about rescuing their friends at the banks and brokerages. These efforts will fail..

NO ONE is addressing the real issues: Job creation, the rebuilding of our manufacturing base, the need to save, crushing debt service in all facets of our government, the trade and current account deficit, crushing debts of consumers and businesses and, most importantly, desperately needed regulation of the financial sector (and the dismantling of the "shadow banking system").

When business was good, our companies bought back their own stock to inflate their value rather than investing in their companies. Now we are paying the price for all this bad behavior and it MUST be paid. No pain no gain.

We will have a deep recession if not a depression and America and the world will be changed forever. Hopefully, the one benefit that will come out of all this is a return of good old common sense which has been sorely lacking at all levels of American culture.

[Mark]

If major banks go under without the aid of cheap money from the Fed, all consumers will suffer and we will risk going into the Second Great Depression.

I personally don't want full-doc 30 year fixed 0 point mortgage rates to ever go below 5%. That's the only benchmark I ever use, since that's the mortgage product that serious, responsible long-term homeowners use. Once rates go below 5% it invites all the speculators and stated-income liar loan buyers back into the market, and they're the ones to blame for the current bubble. The speculators that bit more than they could chew need to pay for their bad decisions and allow the housing market to correct itself...once home prices go down 40% from their 2006 levels, we'll be close to a bottom...until then, there's no need to allow speculators back into the market with cheap consumer loans.

This argument that banks should be FORCED to pass down their cheaper money rates to borrowers is amateurish. They're a business and if you don't like what they charge you, don't buy their loan product. Let the free markets work themselves out, without causing a Second Great Depression to occur with your silly assumption that the government should force private Banks to pass down the savings to consumers. The free market will do that on it's own, as long as banks can afford it without going under.

[waitingforgodot]

Mark wrote: "This argument that banks should be FORCED to pass down their cheaper money rates to borrowers is amateurish. They're a business and if you don't like what they charge you, don't buy their loan product. Let the free markets work themselves out, without causing a Second Great Depression to occur with your silly assumption that the government should force private Banks to pass down the savings to consumers. The free market will do that on it's own, as long as banks can afford it without going under."

It's more amateurish to argue for the government to protect private banks, and simultaneously to use the phrase, "free market." The banks may need assistance, but that sure ain't no free market.

[alvin]

i think KYLE, tew and Mark are on the right track.

Yes, banks' cost of money has gone down, but the risk of default (both perceived and real) by the people they lend to is higher, resulting in higher spreads to offset the risk.

It IS (relatively) free market competition that determines what the risk premium (spread) will be - and it's always a moving target. So if the current premium is 2.5% on average, then the average rate is going to be 5.5% (the cost of money - now 3% - plus the spread - now 2.5%). If the fed hadn't cut, and instead kept rates at around 5% - then shorter term ARMs might be closer to 7.5%.

[www.johnjasonchun.com]

That's why I bought financial stocks at the bottom!

How to increase your profit margins by 200% without changing your program!

Reduce your cost of goods sold!

(:-)