Why banks are hoarding cash instead of lending

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why banks are hoarding cash instead of lending

Insight and Analysis of Construction Industry Trends

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Jim Haughey

RCD Chief Economist

Jan 13, 2009

Congress now controls most home mortgages in the US through Fannie Mae, Freddie Mac, the now much larger FHA and The Federal Deposit Insurance Corporation (FDIC) that inherited mortgage loans from failed banks. Add to this the ability of Congress to strong arm Citibank (10% of US mortgages) and other banks dependent on them to replace the capital lost in sub-prime mortgage defaults.

What banks are hearing from Congress now is that they should act like the government mortgage operations which are under orders to defer many foreclosures and reduce monthly mortgage payments for financially distressed homeowners. It is hard to not be compassionate about the plight of individual homeowners unable to pay their current mortgage. Some were simply naïve, never expected to be in this position and can regain financial stability with a little help.

But if we do this for too many people, mortgage capital will shrink significantly and mortgage rates will rise for everyone. Mortgage lenders have a legal responsibility to take care of the money entrusted to them by investors and depositors. So they are not making loans when they see too little home-owners equity to withstand a temporary income loss or a temporary fall in home prices. This reluctance extends to buying Freddie Mac and Fannie Mae bonds notwithstanding the new bond repayment guarantee by the Treasury. Banks do not believe that the Treasury can cover that guarantee any better than the private firms that failed to cover the much depreciated mortgage bonds they already hold. The private firms said “trust us” but did not keep enough reserves. The Treasury has reserved nothing to cover this guarantee.

Similarly, banks are reluctant to make commercial mortgages and other business loans when they can not buy bond insurance at a price that make the loan profitable. The usual sellers of bond insurance are short of capital and are nervous about the amount of assets that are being tied up, perhaps for years, in bankruptcies, reorganizations and more defaults yet to come.

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