Myth No. 3: Banks Don’t Lend Money

Michael McTague |

A widespread myth holds that banks are not lending. A polemic about why banks not lending prevents the economy from jump starting usually follows. Like all business myths, it sounds credible. And now for some analysis.

Five arguments poke holes in this bizarre myth. First, loans and mortgages form the main assets of a bank, which should stymie the myth purveyors. But, let’s go beyond. In the recent housing bubble, home prices ran up to double the base. A housing price chart shows an enormous balloon in the mid- to late-2000s. This twenty-first century explosion of home prices followed by a steep collapse tops previous bubbles in a number of ways. The price roller coaster forms a platform for the recent skittishness of borrowers and lenders.

The sub prime lending tempest and the voracious mortgage buying market dissolved with the giddy real estate prices. In today’s after-the-fall environment, bankers remember their roots: risk aversion has returned with a vengeance. Or, as many have bemoaned for years, whatever happened to Modigliani and Miller (return and risk)?

Not surprisingly in an era of high unemployment, consumer confidence takes a nose dive. Surveys of how consumer feel about spending verify this second argument. In August, 2011, the level slipped to 45 (rounded off); in late 2002, the number stood at 120. Unlike the housing bubble, there is no up and down, only down.

As far as the myth is concerned, consumers fear debt. They lack the savings, credit and general good feeling of earlier years. Pretty much the same is true of businesses. Why borrow in such a down time?

Why borrow indeed? As the economy sagged, large corporations tanked up on cash. This third argument finds stockpiles of corporate cash neatly stashed in the bank to protect profits at a bad time. Apple (AAPL) and Microsoft (MSFT) hold a lot of cash; they enjoy large profits and low cost of production. The more telling evidence lies in heavy manufacturing. For example, Ford Motor Company (F) held $22 billion in cash on its balance sheet for 2008 and $35 billion the year before. Total revenue for 2008 was $146 billion; net income was ($15 billion). Thus, they held more than enough cash to cover one year’s losses and cash stood at 15% of revenue. By the end of 2010, the total dwindled to $15 billion.

For the literal minded who still believe banks are reluctant to lend, companies with cash on the balance sheet do not need to borrow money.

The fourth argument rests on very low interest rates, thanks in part to the Federal Reserve dropping its rates to near zero in a long-term stair-step as the recession unfolded. This is a good time to borrow. The emphasis should be less on banks not lending – after all, they can dip into the trough of cheap federal money – and more on borrowers (corporations and individuals) lacking the will to take on debt.

The fifth argument is that a fair amount of lending is taking place. For the fourth quarter of 2010, Wells Fargo (WFC) originated $130 billion in residential mortgage loans, topping the $74 billion of the third quarter. For 2010, Bank of America (BAC) increased its loan volume in asset-based lending over 2009.

Considering these five arguments, one may wonder how this myth has gained so much traction. Stay tuned – another myth will be “busted” next month. Please comment on this myth and let us know which myths need exposure.

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Michael McTague, Ph.D. is Senior Vice President at Able Global Partners, a financial consulting firm in New York City.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
AFAI Alternative Fuels Americas Inc. n/a n/a n/a 0
AAPL Apple Inc. 109.57 0.08 0.07 16,384,732
BAC Bank of America Corporation 21.11 -0.39 -1.81 84,320,315
F Ford Motor Company 12.22 -0.21 -1.69 24,775,280
WFC Wells Fargo & Company 53.40 -0.94 -1.73 12,621,529
MSFT Microsoft Corporation 59.15 -0.05 -0.08 13,702,203

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