Does Overdraft Fee Windfall Mean US Banking System Unsustainable?
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Related subjects: Economic Recovery, In the Loop, J.E. Robertson, Mortgage & Credit Crisis, Opinion, U.S. Economy, U.S. news, Webb Tisch Comments Off
August 2009 —one year after the beginning of the visible collapse of the American financial sector set off a global recession— has brought the news that the largest US banks are taking in record revenues from small-account overdraft fees. Applying fees between $25 and $39 per overdraft, the nation’s largest banks are now taking in more revenue from overdraft fees than from their primary banking operations. The reliance on such fees to drive profits also suggests major US banks may not be sustainable in their current form.
The Financial Times reports the projected record profits from overdraft fees to small account holders is $38.5 billion. FT also reports the median overdraft fee jumped from $25 to $26 during the last year, the first time that figure has increased during a recession for more than 40 years. For banks with assets in excess of $50 billion, the median overdraft fee was $33, a clear sign the nation’s largest banks are dependent on such fees to drive profits.
This news suggests the major US banks did not carry out their pledge to make their banking operations more consumer-friendly and/or more conducive to preserving and expanding individual wealth, in exchange for unprecedented amounts of public money used to prop them up during the worst banking crisis in 8 decades. The solvency of major banks has been a question of persistent speculation and significant mystery since February, when a number of large banks reacted to a program of theoretical “stress tests” by offering to give back federal dollars.
Experts have speculated since well before the summer of 2008, when the mortgage-backed securities crisis threatened to undermine the entire US financial system, that major banks had used the freewheeling logic of financial exotics and mortgage-backed split-then-bundled derivatives to claim to hold more cash in reserve than they actually do. Such a situation would, in any case, run afoul of federal banking regulations, but could also leave banks insolvent.
The atmosphere of panic that overtook the financial world and the Congress last fall is seen by some as evidence that long-term solvency was precisely the problem: that there might be no viable way to carry major banks through the worst of the fallout from the collapse of mortgage-backed securities. It would be one thing to protect them from specific “toxic assets”, quite another to find all the money they claim to hold but do not.
It was clear by spring 2009 that the nation’s biggest banks were increasingly uncomfortable with the “stress tests” the Treasury Department had ordered. The banks claimed the process gave the government too much control over their businesses, but independent observers noted the stress tests did not actually mean control, only observation: the problem wasn’t in what the government was doing, but in what it was finding.
We don’t actually know all the details of what was uncovered in that process of sifting through the complicated accounting operations the banks use to justify their claims about preservation and generation of assets. But it is very far from conspiracy theory to make the logical assumption that there are specific qualities of those accounting operations the banks did not want the federal government to observe.
Economists and regulators have been puzzled by the unusually entrenched unwillingness of banks to resume lending, even after receiving the largest bailouts in the history of American government assistance to private business, and with relatively few strings attached (financial regulatory reform has not yet even been taken up by Congress or the White House in any official legislative process). A neat explanation that solves all these mysteries: too little cash in reserve.
In the US, banking institutions with deposits and notes totaling in excess of $43.9 million must hold 10% of the total value in reserve cash. In other words, the bank must have liquidity of 10% on its total account holdings. This varies, depending on attendant regulations for various types of institutions and various forms of transactions related to that liquidity question.
What does not vary, however, is the fact that by using the wrong means of measuring cash in reserve, a bank can get into trouble claiming liquidity it cannot actually resort to if needed. That fact has led to economists speculating that during the mortgage-backed derivatives binge, fractional reserve banking morphed into a precarious and untenable system of claiming as cash reserves assets which were partly or entirely fictional or speculative.
In plain English: the banks may have lied about whether they were 10% liquid or not, setting them up for a fall far more perilous than what the bailouts have covered so far. The result would be that the banks would have to hoard that cash in order to meet their reserve requirements, the only logical way of explaining why lending, potentially the most lucrative part of their business, has not resumed at projected rates.
According to a Raw Story report from July:
Before the committee — which assembled Tuesday to hear the testimony of Neil Barofsky the Special Inspector General for TARP, along with Federal Reserve Chairman Ben Bernanke — [Rep. Dennis] Kucinich [D-OH] wondered aloud if “banks are parking a historic amount of taxpayers’ money in the Federal Reserve while the businesses and consumers across America are starved for credit,” and whether the Federal Reserve is paying banks to avoid making loans.
“Is the Fed paying banks NOT to loan money?” a Kucinich media advisory pondered.
Kucinich cited a Bloomberg report that found that in May 2009, major US banks were holding “excess reserves” with the Fed at a daily average rate of $877.1 billion, up from $2 billion one year earlier. Clearly, in May 2008, the banks were lending all they could, or close to it, and lending had slowed while banks received massive infusions of taxpayer money… but an increase of 43,855%, in one year?!
No, the banks did not take in that much in profits, and no, they did not suddenly become so wealthy as to count all that cash as excess reserves. Somewhere in between, there is the truth: somehow, the difference between the proper required cash in reserve from one year earlier and the proper required cash in reserve for May 2009 is a story that can be told within the range of unlent money referred to as “excess reserves” for the two weeks ending 20 May 2009.
- Some reporting also contributed by J.E. Robertson
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