You know, there is a kind of conundrum being created by the very agency who's fearless leader coined the term when talking about the artificially low interest rates (rates apparently driven lower than what we would expect in "normal" market conditions thought to have been driven by overseas demand for US Government debt by countries with very high trade surpluses) we experienced a few years ago. That agency is the Federal Reserve Bank and it's former chairman Mr. Greenspan.
The conundrum being "created" now by the Fed is allowing a plethora of new banks to enter the marketplace and compete for deposits aggressively. These aren't new local banks trying to cut a niche for themselves in a local market somewhere, these are very large, very powerful companies with millions of customers and powerful marketing arms who are very effective at pulling cash from their customers with high rate CD's through "virtual" banks, i.e.; no bricks and mortar, at a time when the traditional banking system is in very precarious and fragile financial health.
The organizations I am referring to are the likes of CIT, a multi-billion dollar commercial lending organization in business for something like a century, American Express, one of the largest international issuers of credit cards and travelers checks (virtually their own currency), GMAC, a major issuer of auto loans, mortgages through their Residential Capital subsidiary, Goldman Saks (need I say more), Morgan Stanley (ditto), Capital One Financial, one of the nations largest credit card issuers, Carpenter Fund GP LLC (?), First Trust Corporation (?), White River Capital Inc, (?), Armed Forces Benefit Association, CapGen Capital Group II LLC (?), Capital Source Inc. (?), Cummins Inc. (Is this the same as Cummins who makes engines?) and a host of other entities listed at this site.
Anyway, this past week a bank that was thought to be quite well capitalized, SunTrust Bank, suddenly announced they are seeking more of the TARP funds to shore up their balance sheet. Now, SunTrust had recently been an acquirer of smaller less healthy banks so what is up here? I suggest under no uncertain terms that the Fed by allowing all these very powerful institutions to go out and solicit deposits from an increasingly tapped out American Citizen is simply shrinking the availability of deposits to the host of currently national and regional banks who are having their own issues with holding up their capital ratios.
When Joe Public gets an offer for about 4% for a CD at a brand name company that just recently got a license to operate as a bank, he may just pull that money from his local or regional or national bank account and put it where the returns are a bit higher.
This brings me to major problem issue number two and a deeper potential conundrum, the reality that we will soon see enhanced brokered CD deposits chasing the highest rates of return by banks and companies without bank business models hungry for the cash. This event will be occurring at the same time the Fed is on a mission to bring mortgage borrowing rates to 4.5% and Fed Funds rates to .5% bringing the prime lending rates down as well.
Now I was extremely pissed off when I heard Mr. Greenspan in his testimony to Congress say something to the effect that he had never experienced anything like the mortgage meltdown in the United States. I was pissed because even a lay economics person like myself remembers vividly the meltdown in the late 1980's and early 1990's in the mortgage industry, commercial lending industry etc. which caused a precipitous decrease in values of commercial properties more severe that we have so far experienced in the residential market today and residential housing declines in the 40% area for higher priced homes in the US at the same time. Those crises brought down the S&L industry, the FSLIC and nearly the FDIC with it not to mention the creation of the Resolution Trust Corp (RTC) at a long-term cost, including interest of nearly a trillion dollars.
Yes, I could not believe he actually had the nerve to say he had not experienced anything like this before when it was only 20 years ago or 10 years before his tenure began at the Fed.
But that is beside the point. The point is the last housing and commercial property bubble and crash was caused by some similar issues. First, many mortgages issued by the S&L industry in the 1970's and earlier when interest rates were quite low were paying unflattering returns to the S&L industry who saw interest rates rise to the high teens in the early 1980's with Mr. Volker's Fed doing everything it could to crush runaway inflation at the time. The demand for higher returns on savings created a very vibrant CD brokering business and money chased all kinds of higher yielding investment options often not tied to banks or S&L's as they simply could not afford to pay the kind of returns non bank and S&L companies were offering due to their lackluster book of mortgage returns.
The creative use of Junk financing in the mid 1980's and later brought to market all kinds of bonds and debt instruments that paid higher rates of return to the point where the S&L's and banking institutions were buying this junk debt to gain the returns needed so they could compete for deposits and thus continue their traditional banking model which was failing. This vibrant market for all this junk debt further enhanced the mergers and acquisition business and gave lots of cash to banks and S&L's who were all the more aggressive in expanding their assets through reckless lending to commercial and residential developers and borrowers. Well the party ended when the buildup of leverage got to the point it ultimately came crashing down. That was a bubble bursting.
Does this sound familiar? We now had banks, pension funds, corporations, municipal savings and wealthy individuals all having chased the dramatic profits generated by massively leveraged institutions who were all buying debt instruments that paid high rates of return while magnifying the returns with high leverage strategies. What was the basis of much of these higher rates of return? Junk debt, this time substantially mortgage debt (although consumer, commercial and speculative development debt is in the mix and falling apart as I write this).
So point two is simple, the Fed is trying to drive interest rates to borrowers to artificially low levels (levels the market is simply not interested in lending) while lenders are seeing rising defaults of all types of loans and are pulling back on lending and raising interest rates to account for higher risk in the market.
This is a conundrum if there ever was one. Meanwhile the economy is faltering and money is being printed like it is going out of style. Right now, institutions are forced to pay higher rates to attract deposits. Deposits are being fought for by new banks that are being chartered almost weekly by the Fed and existing banks that are desperately trying to keep themselves solvent. Any rational lending institution knows right now, if they lend today at the artificially low rates being pushed by the Fed for any longer then a few months, they may end up eating very low rates of return on that lending if and when the money printing machine brings in a surge in inflation not seen in nearly 30 years.
It is high time the Fed take a serious break and allow some of the mess they have created to work itself out before they take any more steps that will further distort the market and create scenarios no individual is smart enough to predict at this time. Any lay economist will tell you, it takes 6-9 months for fed actions to make their mark on the broader economy and by taking drastic steps every week simply to calm the short term attention span of the markets is a very dangerous and potentially harmful strategy to partake on.
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