Banks Scapegoat Regulations for More Costly Loans Post Crisis

Banks and their allies have been using every opportunity possible to blame regulations for changes in their business models after the crisis, particular if they can make it sound like the broader public, as opposed to their bottom lines, is what is suffering. Normally this messaging effort stays at the background noise level, but sometimes the lobbyists succeed in getting their message treated as a story in its own right.

A recent example is a Financial Times story early this week: “Dodd-Frank has made banks safer but slowed economy, data show.” An alert reader could easily use this story as a “Where’s Waldo” test for finding how many bogus arguments are packed in a single piece.

Let me give you a few.

1. The story line comes from a single source, the faux objective “Goldman Sachs Global Markets Institute, a public policy research unit.”

2. The article, and therefore presumably the Goldman paper, does not out the claim that regulations hurt the economy. It contends that mortgages and other investments are more costly than before the crisis. The unstated argument is that people would borrow more if credit were cheaper. But as Richard Koo has pointed out, in a balance sheet recession, consumers and businesses prioritize paying down debt. And the weak job market is enough to make anyone think twice about borrowing much. Similarly, small business loan demand has been weak due to (*gasp*) not so hot conditions in a lot of markets.

3. Let’s get to the big howler. What’s the basis for comparison for credit pricing to consumers and small businesses? 2007, the peak of the credit bubble, when the world was awash in liquidity. An average of years over the pre-crisis period would have been a more convincing basis for any analysis.

4. Why does the FT assume, following Goldman, that these pricing increases are the result of evil regulation, as opposed to lenders being in a period where they are actually making sensible loans most of the time?

5. Why does the story assume that the cost side (driven by those evil regulations!) is the reason for the increased pricing? How about, “This is what the market will bear”? Remember, one of the effects of the crisis was to increase concentration in banking even further. For instance, American Express used to have far more credit products to small businesses than it does now. Similarly, one of the major credit card issuers to small businesses, Advanta, went bust. Less competition generally means more pricing power.

6. Big banks are also lousy at making small business loans. As we have discussed from time to time in the comments section, they have abandoned the practice of training credit officers, some of whom would wind up as branch managers and were expected to use their judgment and knowledge of local economy in making lending decisions. Now big bank branches are retail stores and small business loans (to the extent banks really make any) are score-based decisions (oh, and the biggest sources of funding to small businesses have long been savings, friends and family, and credit cards). In a happy bit of synchronicity, Lambert pointed out a new VoxEU post that underscores this issue, that banks that engage in “relationship lending” (as in they actually bothered getting to know the owners and the business of the business) are less likely to cut off the credit supply to business in bad times. And mirabile dictu, that increases their survival rate:

Data from 21 countries in central and eastern Europe show that ‘relationship lending’ alleviates credit constraints during a cyclical downturn but not during a boom period. The positive impact of relationship lending in an economic downturn is strongest for smaller and more opaque firms and in regions where the downturn is more severe….

While there is no relationship between firms’ access to bank finance and the dominance of relationship or transaction lenders in 2005 (during the height of the credit boom in many of the sample countries), firms’ access to credit suffered less in 2008/9 in localities dominated by relationship lenders. The economic effect is also large — moving from a locality with 20% relationship lenders to one with 80% relationship lenders reduces the probability of being credit constrained in 2008/9 by 31 percentage points…

All the results are confirmed when we control for possible selection bias by explicitly controlling for the lower credit demand in 2008/9.

Now this also means if you have any savvy as a borrower, you will try to go with a bank that is relationship oriented, rather than the local branch of a TBTF. That might indeed mean a more costly loan to you, but that’s the price of having a lender less likely to cut you off because he has to meet some sort of headquarters panicked imperative in a bad time.

7. Even banking stalwart Gene Ludwig distanced himself from the Goldman thesis rather than backing it:

Gene Ludwig, chief executive of financial advisory firm Promontory and former Comptroller of the Currency, said the full extent of the costs of regulations on consumers will not be known for several years because not all of the rules have gone into effect.

“There is some trade off between the costs it takes to achieve safety and stability and the cost of products,” Mr Ludwig said. “To some degree, banks may well be passing on some of the cost of increased capital and regulation to their customers.

But you can see how effective this relentless barrage of “meanie regulations” is, particularly since many readers only look at the headlines or skim the opening paragraphs. Even so, the majority of comments on this piece (and remember, the Financial Times presumably has a reasonably bank-friendly readership) wasn’t buying what the Goldman analysis was selling. So the people who were interested enough to read the story in many cases weren’t persuaded by the con. But whether enough people are really paying attention to these intellectual shell games remains to be seen.

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  1. diptherio

    Banks and their allies have been using every opportunity possible to blame regulations for changes in their business models after the crisis…

    “Changes in their business model”? Don’t I wish. What changes? You mean like switching from packaging sub-prime mortgages to packaging sub-prime car loans? And do the bank apologists think we’ve forgotten that it was their business model that caused the crisis in the first place? yowza….

    1. bh2

      Whatever the alleged “cost” impact may be, this “regulated” industry is carrying on with business as usual. As long as the FED is there to bail them out, TBTF institutions will perpetually reap unearned reward from one-way bets in the risk-free casino built and maintained for them by government policy.

      But as Richard Koo has pointed out, in a balance sheet recession, consumers and businesses prioritize paying down debt. And the weak job market is enough to make anyone think twice about borrowing much. Similarly, small business loan demand has been weak due to (*gasp*) not so hot conditions in a lot of markets.

      Nevertheless, the FED will continue to push on that string, pretending it’s part of the solution rather than part of the problem.

  2. griffen

    Ya just know, if we can rewind the time machine back to 1999 maybe they can repeat their land grab to get whatever they wanted to pass Congress and the white house. $100 say they all (mostly all since some actually attempted to manage risk) manage to screw it all up one more time. If you say Citi I say yep.

    Meanwhile, a collection of tiny violins play on.

  3. flora

    per your post:
    “Now this also means if you have any savvy as a borrower, you will try to go with a bank that is relationship oriented, rather than the local branch of a TBTF. That might indeed mean a more costly loan to you, but that’s the price of having a lender less likely to cut you off because he has to meet some sort of headquarters panicked imperative in a bad time. ”


  4. blurtman

    It is more than bizarre that once (and still) insolvent institutions can borrow at such low rates. And in addition to insolvency, should not criminality also raise an institution’s risk profile, and therefore, the price of credit?

  5. Chris Herbert

    Always the regulations. As for Wall Street, we should have prohibited derivatives a long time ago. They’ve blown up all the banks at least once. Two Nobel prize winners blew up Long Term Capital Management, and then each went on to do it all over again later. They didn’t know what they were doing. Every Wall Street CEO was clueless about the risk their companies were in. The Fed Chair, Greenspan, admits he made a ‘mistake.’ Mistake? It was an effing disaster. If a drug company came up with a new drug, do we let them go straight to production? No, we test the drug to determine whether it hides more danger (risk) than the small benefits that are visible. We’ve experienced trillions of dollars in downside from these ‘financial innovations,’ and whatever benefits there are pale in comparison. Why are they still legal? Safer business by subtraction.

    1. RepubAnon

      One of the big talking points for folks worried about regulations is “cost-benefit” analysis: whether the benefits of the regulation outweigh the costs. We need to apply this to deregulation as well: do the costs of weakening or eliminating a regulation outweigh the benefits?

      The anti-regulation folks seem to be saying: “Yes, I had to take a 40% haircut on all my holdings over $100K because my financial institution went under… but at least I saved $5/year on lending costs!” This seems less like responsible cost-benefit analysis and more a pitch to problem gamblers from a casino. Here, the problem gamblers are the investors and the house are the high-frequency traders, hedge fund managers, and others whose incomes are based on churning portfolios rather than growing them.

      We tried deregulating the savings and loan industry during the Reagan years – the result was a financial disaster. We tried deregulating the banking industry – the result was a larger financial disaster. The “Asian Tiger Economies” rose and fell due to a lack of effective regulations. The “Celtic Tiger” and Iceland’s banks pre-crash also benefited from a deregulated market, and also ended in a financial disaster. Can we see a trend here?

      So, the higher borrowing costs (if any) resulting from re-regulation can be seen as a form of insurance premium against still another financial crisis. Given the massive downside threat of deregulation, and the minor costs imposed by regulation, keeping the existing regulations, and expanding them, seems like the cost-effective solution for rational, long-term investors in the market. I realize the folks hoping to play seagull have a different view. (Seagulls fly in, eat up whatever’s available, and fly away – leaving others to clean up the resulting guano. It’s great for the seagulls – not so much for the folks left to scrub the stains away.)

  6. A Real Black Person

    In return, you, Yves, based on the views you’ve expressed here, it seems like you’re scapegoating unscrupulous capitalists for our problems while not really fundamentally disagreeing with them. Both of you seem to think that money can and should be created from thin air, something both capitalists and socialists believe in. Both camps are committed to a monetary system that only works with a high amount of centralization of power. Yves, it seems like you believe that the U.S. can and should continue to inflate its debt away by continuing to debase its currency and that the government spending more money will solve economic and social problems….why? Because it worked 70 years ago.

    I see things a little differently. Maybe we’re reaching a point where civilization as we know it is reaching diminishing returns and the whole thing needs to go. If the banks aren’t lending, it’s because they are seeing diminishing prospects for profit, that is independent of government regulation–but they many not want to admit that because that would that encourage nationalization of what people would correctly identify as finite resources and that would tear the debt-based economic system and the college system ( that is insecure enough that it needs to periodically remind the masses that ‘college pays off’) More money printing, more government spending, more college graduates, more unregulated lending…This stuff all sounds the same to me…more stuff from people who have alienated themselves from the natural world and , increasingly, unbiased, empirical data.

    1. Yves Smith Post author

      This is straw manning of my views.

      You are ascribing value judgements to how our current money system works. I don’t know how many times the MMT folks and Alan Greenspan and the Bank of England have said it: money is created from thin air. This is how a fiat currency system works. Saying you don’t like it is like yelling into the wind.

      And hard currency systems, like the previous gold-based regime, were WORSE for ordinary people, which may seem hard for you to believe give where ordinary people are in the US. Financial crises were more frequent and more severe. Did you ever hear of the William Jennings Bryan “Cross of Gold” speech? The gold standard in the late 1800s produced the Long Depression and deflation, which left many farmers and small businessmen bankrupt. Bryan depicted them as crucified on a cross of gold. So much for your idea of “empiricism”.

      Money is merely a unit of accounting. It has nothing to do with real resources. You are confusing the two, which is your issue, not mine.

      So go rail against fiat currencies all you want. It has problems but the alternatives are worse.

      1. A Real Black Person

        I’m ascribing value judgments by saying …by suggesting that fiat currencies as a tool don’t work very well… that the banks see a lack of profitable investments…By stating that civilization is reaching diminishing returns and because of that…what worked in the past won’t work now? How are any of those things “value judgments” when they can be observable and measured?

        Yves, from my perspective, it seems like you pretend that you have a problem with the system but when push comes to shove, you reveal that you are wedded to the fiat currencies, the service economy and perpetual economic growth, and industrial society. Your suggestions are nothing more than simple reforms. Band-Aids that won’t fix a any problem.

        FYI: I read a detailed account of the Roman Empire’s collapse, and while debt played a non-issue, the government did attempt to cover up financial/resource problems by reducing what each unit of money could buy. This is no different than what fiat currencies do today.

        I have yet to see a situation of how a currency backed by the gold directly caused depressions in the past. It’s a silly thing to bring up since currencies backed by something physical weren’t designed to PREVENT economic depressions but prevent currency debasement. Correlation is not causation. What I think happened is that trust broke down and various ‘actors’ pulled their money out of the market for an extended period of time and that caused economic contraction. If one thing fiat currencies do well, is that they make it harder for various ‘actors’ to take their money out of the market, if not impossible. Fiat currencies reflect political and economic centralization–all of which can work for a while, until they don’t, anymore.

        1. Yves Smith Post author

          This fixation on “currencies” and “currency debasement” is bank talk, not real economy talk.

          The Roman Empire fell not because of “currency debasement”. It’s because its economic model depended on conquest of new territories. When that stopped, the Empire stopped working. If you read books like Tainter’s book on collapse, there is NO mention of currencies in ANY of the civilizations that underwent collapse. It’s all about excessive complexity and the rising energy costs of managing complexity. Jared Diamond’s Collapse has a different collapse model (it’s more ecological) but again, currencies play no role.

          “Fiat currencies backed by gold” is an oxymoron, BTW.

          The fact that you’ve haven’t seen anything on the deflationary impact of gold backed currencies says you are unwilling to do any homework. The literature on this is large. But you’ll come and tell me I’m wrong and am not “empirical” when there is a substantial empirical record that disproves your view.

          The gold backed regime helps bankers and hurts ordinary people. The fact that you refuse to get that is astonishing.

          So you want to go all Manichean and see everything fall apart? I’m trying to prevent that. You apparently don’t like that. Please read another site rather than thought policing me or engaging in ad hominem attacks. The fact that you have to resort to trying to denigrate my motives is proof you can’t muster an argument on its merits.

    2. zapster

      “If the banks aren’t lending, it’s because they are seeing diminishing prospects for profit”

      With the finance sector soaking up in the realm of 30% of gdp, that’s no surprise at all. And much of that monstrous debt burden is from control fraud. No society, no monetary system, can allow that much of it’s product to be monopolized by a single (and unproductive) sector and survive. It’s like an engine where only one piston gets any oil–*all* the parts have to be able to move or the whole thing seizes up.

      1. A Real Black Person

        The financial sector might be claiming more of the national income because

        1. The primary and secondary economies have stopped growing
        or are growing slower than accrued interest on loans.

        2. That we have systemically devalued real work and instead reward management and administrative work…otherwise known as “symbolic work” or “knowledge work”. Management and administrative work within finance is the most lucrative type of “symbolic work” and “knowledge work” interest accrues than much faster than increases in output from the primary and secondary sectors.

  7. Chauncey Gardiner

    I suspect the real target audience of articles such as the FT article mentioned are legislators and their staffers, PR officials within the administration, senior managers at regulatory agencies, and the decision-makers at the lobbyists’ clients (demonstrates a capability to seed stories… and justifies high fees).

    The media is the message for those parties, and the public is an afterthought.

  8. Troege

    “they have abandoned the practice of training credit officers”: I would be really interested in digging a bit deeper into this. Are there any number on this? Why did banks stop training credit officiers? Was it because of hirarchy/organizational issues or because credit officers became non profitable? Do smaller banks employ more trained credit officers? Is there a realtionship with competition?
    In any case it is clear that banks not producing information about investment projects any more, which after all is one of their fundamental economic functions.

    1. Yves Smith Post author

      I don’t know when they stopped, but in the early 1980s, all the major banks had two year credit officer training programs. I think they decided to cut this investment in skills, since 1. the best trainees got MBAs and went to Wall Street and 2. they figured they could replace them with credit scoring systems.

    2. griffen

      Smaller banks are the flip side of the coin. In most instances, you find out the smaller institutions (less than $10 billion, let’s say) do have senior staff that have the training and experience for credit lending. And in some circumstances, the offshoots from Wells, JPMC or others land in those places (senior people maybe tire of the upheaval, the lack of continuity from upper managers).

      The greatest benefit to the Wells or JPMC is SCALE. Smaller institutions don’t always have the amount of resources. Which, ultimately, is an unfortunate reality. And naturally, the national media all focus on the biggest of the big institutions.

      1. Troege

        Thanks for the informative comments. It could be indeed related to inceasing job turnover. This implies that the gains from training credit managers mostly go to the credit manager (who joins for example Wall Street after having received the training) not the bank.

  9. Blurtman

    Banks as utilities seems to be the best solution. And investment banks as non-FDIC backed investment institutions, who also cannot print money.

    1. Chauncey Gardiner

      Agree. In the pre-bailout days when the Glass-Steagall Act was the law of the land, there was a creative tension, a balance, between lending money that was created through loan originations and income from interest on their loans, and the bank’s risk of losing money on those loans when borrowers were unable to repay the loans and the loan collateral was insufficient to cover loan losses. Loan losses flowed through increased loan loss accruals that reduced the banks’ accrued earnings and their capital (shareholders’ equity). In my opinion that was the primary reason why even the largest banks invested significant resources in developing their lending capabilities.

      Shortly after da Wall Street Boyz succeeded in getting the Glass-Steagall Act tossed and regulatory barriers to speculation in derivatives overturned, their fangs were bared. Debt, financial markets and derivatives began to be used for “trading gains” and as tools to loot, extort money from government (think TARP and QE-ZIRP), and for political and economic control.

      There is an old saying, though, that I believe has been attributed to one of our nation’s Founding Fathers (I think Madison, but I c/b wrong): “The bankers will ultimately force you to choose between your wealth or your freedom.” So be careful what you wish for.

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