The banks are winning (and that’s not entirely a bad thing)

January 8, 2013

Two pieces of news this week, from opposite sides of the Atlantic, have one thing in common. In their battles to put the mistakes of the past behind them and to be under as few restrictions as they believe they need to do business, the major global banks are winning.

The biggest headlines in the United States were over Monday’s announcement of multibillion-dollar agreements for the big banks to resolve disputes stemming from bad lending practices during the housing boom. Bank of America will pay $10.3 billion to Fannie Mae and Freddie Mac over claims that it (or, more precisely, the Countrywide mortgage lender that Bank of America acquired in 2008), sold the mortgage firms bad loans to package. A separate, $8.5 billion settlement between 10 giant banks and regulators over shady lending practices is meant to reimburse victims.

The building in Basel, Switzerland where bank regulators meet to chart the course of global finance. (Bank for International Settlements)
International bank regulators meet here in Basel, Switzerland, to chart the course of global finance. (Bank for International Settlements)

Perhaps more significantly, over the weekend, international bank regulators meeting in Basel, Switzerland, said they will relax rules on how much liquidity the titans of global finance must maintain. That is, how much of the banks’ assets must remain planted in securities that can be sold quickly and easily to free up cash if the bank faces a sudden rash of withdrawals. Under new rules, they will be able to use more low-rated corporate bonds and even some stock investments to meet that so-called  liquidity coverage ratio, and they have until 2019 to fully comply with the rules. That was enough to drive the stock prices of European banks up sharply this week; shares of French bank Societe Generale were up 5.8 percent as of Tuesday morning, and German Deutsche Bank shares were up 4.8 percent.

There has always been tension in trying to deal with the banks and their mistakes in the run-up to the crisis. On the one hand, there is a deep-seated desire to be punitive, to extract a pound of flesh for the past and to punish bank shareholders by mandating high requirements for capital and liquidity aimed at ensuring that a crisis like this can never happen again.

That sounds attractive, but it runs head-on against another imperative: Getting the global economy back on track. Every dollar that a bank holds as part of its liquidity buffer is a dollar it is not lending out toward a longer-term, illiquid investment, such as a loan to build a factory. And as long as the Bank of Americas of the world are facing a large and uncertain legal liability tied to their past behavior in mortgage lending, they are going to hoard cash to guard against extreme negative outcomes — and hesitate to resume mortgage lending on a large scale and expose themselves to future risks. As my colleague Danielle Douglas notes, Bank of America’s share of mortgage originations was 21.6 percent in 2009 but has now fallen to 4.2 percent; this is a bank trying to get out of the mortgage business, and the lack of competition in that industry is a key reason that the U.S. Federal Reserve’s monetary easing efforts haven’t pushed mortgage rates down more.

It’s natural that those who advocate on behalf of victims of bad lending practices see the new settlements as inadequate. The $8.5 billion agreement between 10 large banks and their regulators, the Office of the Comptroller of the Currency and Federal Reserve may sound like a lot. But consumer advocates have argued that the liabilities should be uncapped and should more generously compensate people who were shoehorned into a mortgage they had no hope of repaying or were improperly forced to foreclose on their home loans. They consumer advocates may be right — but there is also a case to be made that capping that exposure is the most important step in encouraging economic growth. Now that the banks’ legal exposure is a specific number rather than some massive, open-ended liability, they can account for it and move on in their role of supporting economic activity.

On the capital and liquidity standards set in Basel, there is even less widespread debate among whether regulators are getting the balance right between helping the economy along versus ensuring a more stable financial system in the longer term. The banks themselves lobby aggressively  for looser capital and liquidity requirements, but it doesn’t stoke the fires of too many populist critics. Instead, we have to hope that the regulators, led by Bank of England governor Mervyn King, are getting the balance right.

With the five-year anniversary of the financial crisis approaching and large chunks of the world economy still in dismal shape, the banks are winning. Now we just have to hope that they use those victories to support growth.

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