Geithner Saying Be Like Buffett Can’t Make Banks Lend (Update1)

By Rich Miller

Nov. 9 (Bloomberg) -- U.S. Treasury Secretary Timothy Geithner is echoing billionaire investor Warren Buffett in telling banks “to take a chance again on the American economy.” So far, his appeal is falling flat.

While financial institutions including Citigroup Inc. and Bank of America Corp. have received more than $200 billion in capital from the government, they are limiting loans at a time of mounting unemployment, rising company bankruptcies and increasing regulatory oversight. Commercial and industrial lending has dropped 17 percent since October 2008, according to Federal Reserve data.

Economic growth will be slower and short-term interest rates will stay lower for longer than economists and investors expect because of banks’ reluctance to lend, says Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc. in New York. Bank profits may be restrained and bond prices boosted as institutions put money into safe Treasury securities rather than making riskier, more lucrative loans.

Tight credit is a “serious problem,” Hatzius says. “This could keep growth significantly weaker than the consensus view in 2010 and is likely to keep the Federal Reserve at a near zero-percent funds rate all next year.”

His forecast of 2 percent growth in 2010 is below the 2.4 percent median of 67 economists surveyed by Bloomberg News. If he’s right, traders in the federal-funds futures market who are betting there’s a more-than-even chance the central bank will raise rates by June may need to reverse their wagers. Federal funds are money that U.S. banks have on deposit at Fed banks.

‘All-In Wager’

Financial institutions including JPMorgan Chase & Co. have reduced loans even as investors such as Buffett have turned more bullish. The 79-year-old chairman of Berkshire Hathaway Inc. called his Omaha, Nebraska, company’s $26 billion purchase last week of the largest U.S. railroad, Burlington Northern Santa Fe Corp., “an all-in wager” on America’s economic future.

Loans at New York-based JPMorgan Chase fell to $653.1 billion at the end of the third quarter from $761.4 billion a year earlier. The decline reflected “some tightening of underwriting standards” on consumer loans, including credit cards, Chief Financial Officer Michael Cavanagh told analysts during an Oct. 14 call following the release of the quarter’s results. Loan demand from companies also fell, he added.

Shrinking Loans

Bank of America’s loans and mortgages shrank to $878.4 billion from $922.3 billion a year earlier. The drop was due to “lower consumer spending and a resurgence in the capital markets” that allowed corporations to issue bonds and equity to pay off debt, Kenneth Lewis, chief executive officer of the Charlotte, North Carolina-based bank, said on an Oct. 16 conference call with analysts after the third-quarter report.

“We’re actively looking for every good loan we can make,” he said. “If the economy starts to get better and there’s demand, then we will be there to supply credit.”

The bank, the largest U.S. lender by deposits, plans to curtail new credit cards and tighten standards for card and small-business customers, Brian Moynihan, the head of its consumer division said at a Nov. 5 presentation for analysts in Boston. The company expects to issue 2.5 million cards this year, down from a peak of 10 million several years ago.

‘More Selective’

“We gave out a lot of cards, but we were giving them to too many people,” he said. “Now we are being more selective.”

Former Fed governor Susan Phillips likens the situation to that of the late 1980s and early 1990s when the U.S. was confronted by a credit crunch triggered by the savings-and-loan crisis. Lending was curtailed as the number of federally insured thrift institutions dropped about 50 percent to 1,645 between 1986 and 1995, according to a study by the Federal Deposit Insurance Corporation in Washington, which insures deposits at U.S. banks and unwinds failed lenders. The cost of the crisis was $153 billion, the study estimated.

The economy and jobs growth were both slow to pick up after the 1990-91 recession, and it’s a “reasonable expectation” that will happen again, says Phillips, who was with the central bank at the time and is now dean of George Washington University’s School of Business in Washington.

The economy grew at an annualized 2 percent in the three quarters after the recession ended in March 1991 as payrolls dropped by an average 30,000 a month. Commercial and industrial loans by U.S. banks fell to $615 billion at the end of that year from $637 billion in March, according to Fed data.

Treasury Holdings

As banks have reduced their lending in the current recession, which began December 2007, they have increased their investments in Treasuries. Holdings of these securities have climbed 26 percent to $125 billion in the 12 months through June, according to Fed data.

“Banks will continue to purchase Treasuries for the next several quarters, at least until the end of 2010,” says Ira Jersey, an interest-rate strategist in New York at RBC Capital Markets, a unit of Toronto-based Royal Bank of Canada, Canada’s largest lender. The demand will help keep the 10-year yield below 4 percent through 2010, he adds; it was 3.497 on Nov. 6.

Such caution might limit banks’ profits as they hoard cash instead of lending it.

“It will take down the rates of returns these companies can generate,” says Eric Hovde, chief executive officer of Washington-based Hovde Capital Advisors LLC, a hedge fund with $1 billion of financial-industry and real-estate investments.

A pickup in lending often lags behind an economic recovery as companies initially rely on funds generated by higher profits to finance their expansion, according to Tony Crescenzi, market strategist at Newport Beach, California-based Pacific Investment Management Co., which manages the world’s largest bond.

‘Restrained’ Recovery

This time, “the recovery in lending could take longer and be more restrained than usual,” he said in a Nov. 2 e-mail to clients, as banks prepare for tougher capital standards from regulators and rethink business models that led to $1.7 trillion in writedowns and credit losses worldwide.

“There is still some tightening of credit taking place in certain parts of the country where economic conditions are deteriorating,” says James Chessen, chief economist at the American Bankers Association in Washington.

U.S. banks continued to tighten standards and terms on all major types of loans to businesses and households during the past three months, the Fed said today in reporting on the results of its latest survey of lending officers. About a net 15 percent of banks tightened standards on commercial and industrial loans, half the prior survey.

‘Fragile’ Economy

The global financial industry and economy remain “fragile,” Deutsche Bank AG Chief Executive Officer Josef Ackermann said at an Oct. 12 conference in Frankfurt. “The wave of corporate insolvencies, the impact of higher unemployment on the credit books, this all lies ahead and not behind the banks,” he added. Frankfurt-based Deutsche is Germany’s biggest bank.

The U.S. unemployment rate, which rose to a 26-year high of 10.2 percent in October, may increase to close to 11 percent by the middle of next year, according to Mark Zandi, chief economist at Moody’s Economy.com in West Chester, Pennsylvania. Bankruptcy filings by small businesses rose 44 percent in the third quarter from a year earlier, Atlanta-based Equifax Inc., a provider of consumer-credit information, reported Nov. 2.

Bankers’ reluctance to increase lending has fanned frustration among lawmakers who question the financial institutions’ strategy after they received billions in capital from the government’s Troubled Asset Relief Program.

‘Bailing Out’ Wall Street

“The original notion of the TARP was, we were going to help Main Street by bailing out Wall Street,” Senator Mark Warner, a Virginia Democrat, said in an interview. “We’ve seen Wall Street recover, but we have not seen Main Street reap the direct benefits.”

The Obama administration has only itself to blame for the failure of banks to make more loans after it chose not to nationalize them, according to Joseph Stiglitz, a Nobel Prize- winning economist and professor at Columbia University in New York.

“If we had done the right thing, we would be able to have more influence over the banks,” Stiglitz told reporters at an economic conference in Shanghai Oct 31. “They would be lending and the economy would be stronger.”

The administration decided against taking over the banks because of the “irreversibility of such actions” and “the very substantial risk” that nationalization could have frightened rather than calmed investors and the public, Lawrence Summers, Obama’s chief economic adviser, said in a July 17 speech.

New Jobs

Much of the policy makers’ focus is on credit for small businesses, which have generated 64 percent of net new jobs during the past 15 years, according to the government, and can’t tap the capital markets for finance, unlike their bigger brethren.

These companies face “the kind of financial headwinds, the classic credit-crunch risk that could slow recovery,” Geithner, 48, said Nov. 1 on NBC’s “Meet the Press” television program. The U.S. economy requires “continued policy support” to recover from a financial crisis that has pushed unemployment to its highest level since 1983, he added in a statement after a meeting Nov. 7 of finance ministers and central bankers from the Group of 20 nations.

President Barack Obama announced on Oct. 21 new measures to spur lending, including capital injections for community banks.

“There is still too little credit flowing to our small businesses,” Obama said in remarks at Metropolitan Archives, a family operated records-storage company in the Washington suburb of Landover, Maryland.

Need for Prudence

Banks have defended their practices, arguing they need to be prudent. Some small businesses that want to borrow don’t meet lending standards, JPMorgan Chief Executive Officer Jamie Dimon said in an Oct. 15 interview.

“Small-business loans are down, partially because demand is down, partially because people tightened up credit,” he said. “If we can come up with ways to rationally lend money to small business that is good lending, then we should do it. We do it all the time. We make small-business loans all of the time.”

Chase, the U.S. consumer and commercial banking unit of JPMorgan, said today it plans to increase its lending to small businesses by as much as $4 billion in 2010, boosting expected new loans to the sector to about $10 billion.

‘Mixed Messages’

Banks are receiving “mixed messages” from regulators and policy makers, says the banker association’s Chessen. “On the one hand we’re being told to be more cautious and increase capital, while on the other we’re told to lend more aggressively,” he says.

Supervisors have increased oversight, questioning loans already on the books when they come up for renewal. “It’s the worst of back-seat driving,” Chessen says.

“There is still a credit crunch out there,” says Niall Ferguson, author of “The Ascent of Money: A Financial History of the World” and a professor at Harvard University in Cambridge, Massachusetts. “We’re still in a situation that’s closer, in my view, to recession than to recovery.”

To contact the reporter on this story: Rich Miller in Washington rmiller28@bloomberg.net

Last Updated: November 9, 2009 14:59 EST

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