Bashing The Regulators Won't Get Loans Flowing

Ever since "credit crunch" returned as a fashionable term in 1990, bankers and regulators have taken much of the heat for the shape of the economy. Critics blame the harsh crackdown on easy lending standards and the resulting miserly ways of the nation's bankers for pushing the economy into recession. Now, many economists blame the delayed recovery on a combination of tough regulation and continued reluctance among banks to make loans.

On Sept. 27, President Bush sounded the alarm from the pinnacle of government. Specifically, he blamed tough bank examinations for having a "chilling effect on the availability of money." The message to regulators: ease up. Despite three discount rate cuts by the Federal Reserve this year, banks remain stingy with new loans, Bush said. According to the President, that's why the recovery he claims is here is just barely discernible.

NO FLOOD. There's little question that the credit crunch made the recent recession more painful and difficult to overcome. Past recoveries have depended on the willingness of banks to lend in bad times as well as good. But the Administration is mistaken if it believes that tinkering with regulations will result in a flood of new loans.

Although bankers acknowledge that they have toughened lending standards across the board, they insist that loan demand remains weak. And with last year's sudden regulatory crackdown on real estate loans painfully fresh in their minds, bankers are leery of Washington's mixed signals. They don't want to make a loan now with Bush's blessing only to write it off during the next crackdown.

Tough regulation is not the only reason banking in the sober `90s is a lot different from in the roaring `80s. After propelling bank profits steadily higher over the past decade, debt is no longer as popular as it once was. Many successful companies are lowering their loan exposure--de-leveraging, in the buzzword of the 1990s. "We're just not seeing the demand out there," says John B. McCoy, chief executive officer of Banc One Corp. of Columbus, Ohio.

The cutback in borrowing is most apparent among consumers. "We're seeing the reversal of a decade-long trend," says Robert Dugger, chief economist for the American Bankers Assn. The charge-it mentality of the Reagan years is no longer popular. And the recession is just one more incentive for householders to reduce their debt exposure. After hitting its nadir in the early days of the gulf war, consumer confidence still hasn't mustered a strong comeback. Not coincidentally, consumers aren't willing to buy big-ticket items, such as cars and appliances. As a result, consumer credit outstanding fell at an annual rate of 1.4% in July, the most recent number available, hard on a 2.8% drop in June.

Even if potential borrowers suddenly shed their caution, the regulatory changes being discussed by the Administration and the Fed would have little immediate effect. One proposal under consideration would allow banks to increase the amount of preferred stock that could be counted as capital. Banks find it easier to sell high-yieldingpreferred shares than common stock. Another option under study would enable banks to reduce the amount of capital they must hold for certain types of real estate loans by reclassifying them as less-risky residential debt.

But there are just as many incentives to lend only reluctantly. The Fed has made it clear that only the strongest banks will underwrite stocks and bonds. Likewise, high capital ratios will determine which banks will be able to acquire other banks in the current consolidation process. To many bankers, it's time to shape up regardless of regulators. Bad loans are a growing problem (chart). And profits remain weak. Earnings at the nation's 12,150 commercial banks dropped to $4.6 billion in the second quarter, down 12% from a year ago.

LONG BETS? Just as important, bankers don't trust the Administration, especially when it isn't speaking with one voice. During Senate confirmation hearings last month, William Taylor, Bush's nominee for chairman of the Federal Deposit Insurance Corp., disagreed with the notion that tough examinations had largely discouraged bankers from making legitimate loans.

No wonder bankers are reluctant to commit themselves to new loans that could be on their books for years to come. "Banks are unwilling to make five-, six-, seven-year bets," says George J. Vojta, co-head of global corporate finance at Bankers Trust Co.

That may mean that the only policy tool that Washington has to prime the economy is interest rates. With lower rates, even frugal borrowers and tightfisted bankers will eventually emerge from their bunkers. After what they've been through, preaching and prodding won't do the trick.