Sometimes it’s tough to tell when a ‘bank’ isn’t a bank

Things are not always what they seem. Trite, but true.

If national headlines scream “Another bank fails,” when actually it was an unregulated private lender that failed, it does a disservice to Main Street, said Don Childears, president and CEO of the Colorado Bankers Association, during a Colorado Springs Executives Association meeting.

“Nine of 10 national headlines that I’ve seen with the word ‘bank’ in the last 10 months were describing nonbanks,” he said.

While many people think it was “banks who got us into this mess,” actual “banks” are highly regulated and therefore generally much more conservative than unregulated financial businesses.

In fact, real banks have been a part of the solution to the economic turmoil because they bought troubled nonbank entities such as Bear Stearns and Countrywide Financial. (Lehman Brothers, AIG, investment companies and mortgage brokers/companies also are not banks.)

Two telltale signs

Only Federal Deposit Insurance Corp.-insured, regulated banks are allowed to use the word “bank” in their name. Derivatives, such as “Bancorp” denote a financial business that is not a bank.

“Ask if the business provides FDIC insurance protection for deposits. If the answer is ‘no’ or ‘we don’t hold deposits,’ then that company is not a bank,” Childears said. “Every single bank in the U.S. provides FDIC insurance for its customers’ deposits.”

In order to be able to accept deposits and lend that money to the community, banks are subjected to more than 6,000 pages of government oversight and frequent exams, Childears said.

(I’d say that’s enough to make any institution “conservative” and “traditional.”)

For example, in Colorado, banks and their affiliates account for 58 percent of residential mortgage lending, but only 18 percent of foreclosures, whereas unregulated mortgage lenders have 42 percent of residential mortgages but hold 82 percent of the foreclosures.

During 2008, only 25 banks failed (less than 0.3 percent). At the height of the last financial industry crisis, during 1989, 535 banks failed — more than 10 per week.

Nationally, bank lending remained level last year (down only 0.4 percent). And banks chartered in Colorado actually increased lending 11.7 percent, as of Dec. 31, 2008, year-over-year.

So, why aren’t many people able to get the auto, home or business loans they want?

Several reasons.

Even though banks are still lending, they cannot fill the gap caused by the unregulated private lenders who have either gone out of business or reduced their lending operations.

During 2008, for instance, banks loaned about 30 percent of credit in the U.S. economy — and unregulated lenders loaned the rest. The unregulated lenders have severely curtailed lending, thus consumers don’t have the access to credit they are accustomed to.

Because of the financial and housing industry crises, borrowers are less creditworthy these days on two counts — lower incomes and assets (usually homes) being worth less.

“The banking industry is the last soldier standing in terms of financial services,” Childears said. “But regulatory pressures restrict the ability of banks to lend. The decades-old federal policy … that encouraged widespread home ownership, by setting up huge bureaucracies to provide cheap money for Americans to own homes, caused bad practices in the lending industry.”

The party that originated the loans didn’t own the loans — they were passed on to other agencies — so the original lenders weren’t motivated to make appropriate lending decisions.

“When coupled with instant gratification — not saving for a down payment — and the ability to get 100 to 110 percent loans on homes,” Childears said, it added to the crisis.

The “core problem” was caused by excessive leverage (businesses and consumers “borrowing to great excess”). When combined with poor values behind securitized debt; shrinking asset values in most sectors; declining income; investor/lender nervousness; consumer caution; and regulatory pressure on banks to increase capital and constrain lending, it caused a “perfect storm.”

Wall Street and Main Street comprise a “fragile, interconnected system based on trust.”

The subprime lending implosion during 2007 was a “catalyst for uncertainty and the system got nervous,” Childears said.

And no one foresaw the scope or speed with which the stock market would drop 40 percent to 70 percent, while real estate values plummeted 40 percent to 60 percent, and the federal funds rate and Treasury bills dropped to at or near zero.

Nervousness spread within the credit markets and investors refused to buy international bonds at any prices because they weren’t sure they’d get their money back, he said.

When investors quit investing, the interconnected credit system tightens. Bankers and their regulators get nervous if they’re leveraged at 12 times capital.

Perhaps an explanation is in order.

“A bank’s capital reserve is an account kept separate from lending funds to protect against inevitable loan losses,” Childears said. “The amount of money a bank can lend to the community depends on the amount of capital reserves. For every $1 in a capital account, a bank can lend roughly $7 of their customers’ deposits. You’d never see a bank at 15 times capital. But brokerage houses routinely had 30 to 35 times or even 50 times capital leverage.”

Capital is a “safety net” to protect a business.

“We think it’s just absolutely insane that Fannie Mae and Freddie Mac were operating at 60 times capital,” Childears said.

Rebecca Tonn covers banking and finance for the Colorado Springs Business Journal.