Banking Woes

The banking system has experienced some of the greatest difficulties in the current recession. This is primarily due to lax lending standards that have created a so-called perfect storm of credit and securities risk. After reading about some of the loan losses and industry problems on the website of the Federal government at this web address, http://www2.fdic.gov/qbp/2009mar/qbpall.html, I have no recourse but to analyze the data for any kind of clues as to what is going on. In 2004, many banks were in the process of creating massive amounts of goodwill for their companies. Goodwill, for those of you who are unaware is any intangible asset that creates value to the firm, such as location, product superiority, or managerial effectiveness. Now, as I remember it, 2004 was the year where home prices in the Grand Valley really started to accelerate. It was a great time for everyone. Oil & gas was booming, people were buying houses and everyone was happy. Cut to 2009, the oil & gas industry has backed off, leaving many people with homes to sell and jobs to replace. Unfortunately this has created the effect of leaving many other people not directly associated with the oil & gas industry with homes to sell and jobs to replace. One of the beautiful parts of capitalism is how quickly capital can be applied to solve problems. On the other hand, one of the trade-offs of this is that capital can move too quickly to certain problems and can in fact be wasted as a result of not putting long-term interests on par with short-term interests. And that is where our current predicament leaves us. The problem with the Grand Valley, and the rest of the country in general, is that capital has been so liquid and transferable that certain interests have been left holding the bag as it were when the debt collector comes.

This brings up an interesting discussion of what is the appropriate level of liquidity for the current system that we have in place. In general, I would say that the amount of liquidity that we had from 2002-2005 was not preferable, but neither is the current state in 2009. With capital frozen as a result of many loans being unable to be made because of tightened lending standards, it is incredibly difficult and will remain to be so for the American economy until such time as those who have money feel comfortable lending it out again. It is not necessarily a fear of loss that is gripping the banking system like a bad case of lockjaw, but a fear of the unknown that is truly the bigger issue. Without knowing how big and how deep the recession is going to be, bankers are unable or unwilling to risk more precious capital chasing after too few opportunities that have a chance of success. For those with few liabilities right now, you should be commended for your foresight in seeing that capital would soon be hard to come by. In the current environment, having a great balance sheet consists in having few liabilities and enough capital to continue making moves in your business. I would liken the current economic environment to a person who's just had a cardiac arrest and is recovering from being brought back to life. Getting blood flowing again is critical to getting better and it is a slow process until the blockages are removed and the heart starts pumping again.

So one may be wondering, how did we get into this mess. The simple answer is enough people borrowed for things that did not pan out that we dug ourselves a really big hole and now we have to dig our way out. A great chart for how we got into this mess can be found at http://data.newyorkfed.org/creditconditions but I digress. Debt is like that. It is really easy to get into it and very hard to get out. From a national perspective, our debt has always been something of a mystery. Prior to the removal of the gold standard during the Nixon administration in this country our money was guaranteed to be good by the reserves of gold that we had accumulated. Now our currency is a “floating” currency. That means the currency operates on the same market principles that any other commodity operates under, with the main exception being there is only one legal producer of this commodity and that is the Federal Reserve Bank. So since we have a floating currency and a ballooning national deficit, how does that impact Mesa County? Well, in a macroeconomic sense, we will be paying back those dollars that we borrow as a nation with our future earnings and because we have a floating currency it is imperative that we collectively solve the problem of exploding deficits in the household and the government. In Mesa County, it could mean that income taxes may rise or government services may decline. It could mean programs are eliminated in other places that the Federal Government has more of a grip. It could mean nothing. One thing is for certain. Spending, whether it is by the government or by households, is something that will continue. This is a good thing for several reasons, but mostly because spending is spending, whether it is by households or the government. As long as the dollars are chasing projects that better society in some way, we will continue on our path to progress and prosperity.

Unless the law has changed since it was put in place, Mesa County would benefit from an increased savings rate because banking institutions are required or at least the were required the last time I checked to make loans within the community out of which those deposits are based. Here we get into the finer points of Keynesian and Classical economics, but I think that savings generally benefit a community because they increase the amount of loanable funds from a bank. The lack of a saving strategy may be great for the week that you get paid, but if anyone is going to have enough capital to start a new business or fund the building of a new home and on and on, then somebody is going to have to save or somebody is going to have to lend or both. And as long as laws are in place that link a banking institution to the communities they serve, a positive savings rate will always benefit the community. Therefore, if Mesa County as a community can increase its savings rate, banking institutions here will have more money to lend, credit will begin flowing again, and business will continue.