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Treasury Department sees modest cutback in bank lending

A survey of 20 major banks leaves unanswered the question of how well the government bailout is working.

February 18, 2009|Ralph Vartabedian

The nation's major banks modestly reduced their overall lending in recent months, even while they were collecting nearly $200 billion in federal bailout funds, the Treasury Department said Tuesday in its first progress report on the banking rescue program.

The survey of 20 major banks left unresolved the question of how well the government banking bailout program is working, though economists and finance experts were generally reassured that lending had held up relatively well in the face of a drastic economic downturn and a near meltdown in the banking industry.

"It is roughly neutral, and that in itself is encouraging," said James VanHorne, a Stanford University finance expert. "I was concerned about a meltdown."

In October, Treasury began implementing the $700-billion Troubled Asset Relief Program, buying preferred stock and rights to purchase common stock from hundreds of banks across the nation.

The rushed program was meant to avert a wholesale collapse of the industry by pumping cash into the system with the hope that it would lead to more lending to companies and individuals. So far, about $200 billion has been paid out to banks, with commitments for about $50 billion more.

The lack of transparency in how Treasury handed out the money and the lack of restriction on how banks could use it has fueled suspicion that the program would end up costing the government billions in securities losses.

By one estimate, Treasury paid $70 billion more for the bank securities than their underlying value. But without the program, most experts say, not only would lending have dropped, but the entire banking system would have collapsed.

Even now, the threats to the system remain potent, with an estimated $1 trillion to $2 trillion in bad assets still to be written off.

"Are we out of the woods? I don't think so," VanHorne said.

In their report, Treasury officials said total mortgage and corporate loans were down by 1% each, while credit card balances were up 2%. New commitments for commercial real estate loans dropped 19%. Though the report did not include an average number for all lending, it described the industry as in a "general trend of modestly declining total loan balances."

Putting the best spin on conditions, it said, "Despite significant headwinds posed by unprecedented financial market crisis and economic turn, banks continued to originate, refinance and renew loans."

VanHorne, among others, said the report failed to answer the key question of why lending had trended down. On one hand, banks may have pulled back to protect themselves from bad loans in a weak economy, but that is only half the equation.

"We don't have good data on the amount of loan demand that exists in this very weak economy," he said. "We have anecdotal evidence that banks strengthened their credit standards. Whether they have tightened too much is difficult to say."

As the economy chugged along in the last decade, it ran on constant credit growth. Now it is unclear whether consumers have stopped buying because they can't get credit or whether credit is dropping because consumers are pulling back. Without much elaboration, the Treasury report suggested that both credit standards and loan demand were affecting the level of lending.

Stuart Gabriel, a finance professor at UCLA's Anderson School of Management, said he believed loan demand had slid as people bought fewer cars, homes and other goods.

"It is not surprising that loan originations are down," Gabriel said. "A flat outcome is a decent outcome in today's perilous economy."

The report also gave hope that lending was bouncing back in December and January after dropping in October and November, said Darrell Duffie, a finance professor at Stanford University. "There appeared to be an uptick in the last month," he said.

Duffie said the concern about bank lending and whether TARP was working missed an important part of the larger financial picture.

Banks provide only a third of the lending that occurs in the economy. The other two-thirds comes from securities markets through bonds, debt obligations and other instruments. So far, those markets are more badly impaired than banking.

Last week, Treasury Secretary Timothy F. Geithner launched a plan that includes measures to shore up secondary credit markets as well as improve transparency in the TARP program.

"Securitization has to come back," Duffie said. "It is way too important to the economy not to come back."



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