Banks can’t expect the government to save them from every crisis
The writer, president and CEO of the Federal Reserve Bank of Minneapolis, oversaw the distressed asset relief program in 2008-09
At the start of the pandemic, I called on the big American banks to raise $ 200 billion in equity as a preventive measure to ensure that they would have the financial means to withstand a serious slowdown induced by Covid.
Small businesses across America that had been forced to lay off workers were telling their landlords they wouldn’t pay rent until the crisis was over. These homeowners, in turn, told their banks that they would not make mortgage payments.
At this point in the Covid crisis, we didn’t know how the cumulative costs would affect the banking industry. Much would depend on the progression and mutation of the virus and the response of health systems.
The banks ignored my advice. Over a year later, what really happened? The Covid crisis has been worse than I feared, with 600,000 deaths in the United States alone and the deepest economic downturn in recorded history.
Yet the losses in the banking sector were much lower than my analysis and, in fact, what the banks’ own loan loss modeling predicted. Today, banks say they have been a force during the crisis and once again renew their perennial calls for regulatory relaxation. Does their performance during the Covid crisis indicate that the big banks are strong enough? No.
Losses in the banking sector have been much lower than expected because governments have been so aggressive in providing tax support to families and businesses affected by the crisis. In the United States, Congress has allocated nearly $ 6 billion to Covid-related support programs that have kept many businesses solvent and families paying rent, mortgages, car loans and cards. credit, which ultimately all bolstered bank balance sheets.
The tax authorities were right to be so energetic and proactive in supporting the economy during the Covid crisis. But it was also a bank bailout. Without these budgetary interventions, the losses of the banking sector would have been much greater. How much bigger?
It’s hard to know for sure, but comparing this slowdown to the losses suffered by banks in previous recessions, staff at the Federal Reserve Bank of Minneapolis estimate it between $ 100 billion and $ 300 billion. These estimates are likely low because, without aggressive government support, the economy is unlikely to recover as quickly as it currently is, and banks could still face losses.
To bring more transparency on these issues, the Minneapolis Fed has created a tool which allows the public to enter their own assumptions and estimate bank losses according to their own scenarios, with and without budget support.
We are now faced with fundamental political questions. What economic shocks should banks be able to manage on their own? And for which shocks is it appropriate to depend on taxpayer support?
Most people intuitively understand that the Covid crisis was different from the global financial crisis. The pandemic was essentially a natural disaster hitting the global economy. And the banks were no more at fault than the airlines or hoteliers.
In contrast, the banks had helped create the conditions that led to the 2008 crisis by granting millions of bad mortgages. In neither case would the banking sector, in the absence of government support, have been able to bear the losses on its own and continue to provide credit to the economy.
In 2008, many major banks faced impending bankruptcy, forcing tax authorities to intervene at the last moment to prevent a bank collapse that could have turned a deep recession into another depression. In the case of the pandemic, the tax authorities acted aggressively at first to support the economy and in doing so also saved the banking sector.
You never know in advance where the next crisis will come from, or who will be at fault when it does. The only tool we have to ensure the resilience of banks is to ensure that they have sufficient capital at all times.
Minneapolis Fed Analysis and many outside experts say banks need around 20% of equity, down from around 13% today, to protect against deep economic downturns, such as another real estate crisis or pandemic.
Banks are fighting against such proposals because higher levels of capital hurt their stock prices. The public must decide: Should banks be resilient on their own or always dependent on the generosity of taxpayers?