Friday May 31, 2013

U.S. banks reported their highest profit during any quarter on record from January through March, earning $40.3 billion in the first quarter, the Federal Deposit Insurance Corp. said Wednesday. That’s the highest figure ever for a single quarter, and it’s up 15.8 percent from the first quarter of 2012.

That’s great news, right? It means the industry that played such a big role in the Great Recession, and nearly collapsed in on itself as a result, is on the road to recovery. Some might conclude, then, that this harbingers good things to come for the rest of the struggling economy.

Not so fast. A more in-depth look at the numbers reveals some disturbing trends which indicate the banking industry is not as healthy as it may seem, and has not learned some important lessons from its near collapse of just a few years ago.

First of all, most of the profits are being driven by the nation’s largest financial institutions, while smaller banks continue to struggle. Only about half of U.S. banks reported improved earnings from a year earlier, the lowest proportion since 2009, according to an Associated Press report.

Banks with assets exceeding $10 billion make up only 1.5 percent of U.S. banks. Yet they accounted for about 83 percent of the industry earnings in the first quarter. These banks include Bank of America Corp.


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, Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. Most have recovered with help from federal bailout money and record-low borrowing rates.

In other words, taxpayers helped bail out the banks, but these same banks have done little to help spread this recovery to the rest of the economy. Bank profits from lending actually declined during the first quarter, in part because interest rates are so low. But also because many banks have adopted stricter lending standards, which means fewer people can qualify for loans.

In the long run those higher standards are not necessarily a bad thing. Reducing the number of bad loans on their books helps improve the long-term health of the banking industry. However, this had led to banks moving more money out of their reserve funds, money that is supposed to be set aside to cover loan defaults. According to the Washington Post, funds set aside to cover losses on troubled loans, or loan-loss provisions, dropped 23 percent from a year ago to $11 billion, the lowest level since the first quarter of 2007.

Regulators have cautioned banks not to drain their reserves in the midst of a fragile economic recovery. Last year, Comptroller of the Currency Thomas Curry said if they continued doing so at the same pace, lenders would not be prepared to incur more losses from home-equity loans and commercial loans taken out from 2004 to 2008, the Post reports.

It would seem the banks have already forgotten how over-exuberance and inadequate reserves led to the financial crisis in the first place. Or, perhaps they’re going on the assumption that the taxpayers will always be there to bail them out.

In fact, according to a recent report from Bloomberg, taxpayers are still bailing out the larger banks in the form of corporate welfare.

And that, says Bloomberg, is what has led to these record profits.

"Banks have a powerful incentive to get big and unwieldy," the magazine explains. "The larger they are, the more disastrous their failure would be and the more certain they can be of a government bailout in an emergency. The result is an implicit subsidy: The banks that are potentially the most dangerous can borrow at lower rates, because creditors perceive them as too big to fail."

By some estimates, the subsidy lowers big banks’ borrowing costs by about 0.8 percent. Multiplied by the total liabilities of the 10 largest U.S. banks by assets, it amounts to a taxpayer subsidy of $83 billion a year. The top five banks -- JP Morgan, Bank of America Corp. Citigroup Inc., Wells Fargo & Co. and Goldman Sachs Group Inc. -- account for $64 billion of the total subsidy, an amount roughly equal to their typical annual profits.

"In other words, the banks occupying the commanding heights of the U.S. financial industry Š would just about break even in the absence of corporate welfare. In large part, the profits they report are essentially transfers from taxpayers to their shareholders," Bloomberg notes.

Regulators can change the game by paring down the subsidy, the report continues. One option is to make banks fund their activities with more equity from shareholders, a measure that would make them less likely to need bailouts. Another idea is to shock creditors out of complacency by making some of them take losses when banks run into trouble. A third is to prevent banks from using the subsidy to finance speculative trading.

"Once shareholders fully recognize how poorly the biggest banks perform without government support, they would be motivated to demand better," according to Bloomberg. "This could entail anything from cutting pay packages to breaking down financial juggernauts into more manageable units. The market discipline might not please executives, but it would certainly be an improvement over paying banks to put us in danger."

Unfortunately, these same big banks have lots of money to spend on lobbying against any form of government regulation. They claim the free market performs better without government meddling. Well, that goes both ways. If they don’t want government regulation then they’re going to have to face the tough times and their own failures without any government, or taxpayer, support.