Smith Faculty Opinion Article

By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

September 2, 2009 

Main Street Banks May Crush the Recovery

Like a boxer staggering to its feet, the U.S. economy is recovering.

Since May, real consumer spending has been gradually rising. Technology spending is looking up, as computers age and Asian growth pulls demand for sophisticated components. New home construction is showing new life.

These will permit 2 percent GDP growth in the second half of 2009, but a second credit squeeze could knock down the economy again.

Regional banks are in a sorry state, laboring under failing commercial loans. Through August 2008, the FDIC closed or merged 83 banks into stronger institutions and 400 more banks are on the critical list.

Many forgot how to be bankers. With one eye on quarterly profits and the other on the Country Club BBQ, many loaned to retailers and commercial real estate ventures with dubious business prospects.

Even a casual trip through suburbia from 2005 to 2007 revealed too many stores selling the same stuff, and bankers were best positioned to know consumers were overextended.

Main Street scions of finance tried to diversify risk by selling loans to Wall Street, which packaged those loans into Commercial Mortgage Backed Securities (CMBS) and then sold the securities back to the banks. This round tripped debt is collapsing, destroying bank balance sheets.

The Obama Administration’s financial sector rehabilitation plan originally proposed public-private partnerships to purchase and work out residential and commercial debt.

Instead, the FDIC, with limited resources, is merging insolvent banks into somewhat stronger banks by agreeing to absorb huge losses.

Retailers, commercial property leases and CMBS failed later in the recession than the housing market, and the full impact on regional bank lending and credit markets is just coming into focus.

Moderate-sized businesses—those supposed to build President Obama’s green economy—can’t get credit. Wall Street bankers are not much interested in collateralizing business debt through regional banks—New York has had enough of the lending acumen of Main Street bankers.

Finally, big firms are paying smaller suppliers slower but demanding payments from them sooner, imposing a cash flow squeeze on the moderate-sized business whose bankers are turning them away.

Cash flow, credit and collapse could be the bywords of 2010 as smaller businesses and banks continue to fail and the recession takes a second dip.

The FDIC insurance fund stood at $10.4 billion in June and total losses are likely to double that. Either surviving banks will pay much larger insurance fees—making credit even tighter—or the Treasury will lend the FDIC money against fees that may be collected in better times.

The Obama Administration and Fed have done just about everything possible to keep doors open at the nation’s largest banks, lending money so cheaply that even an economics professor could make one profitable.

It’s high time for systemic relief for smaller banks—a Bad Bank to work out their loans and a wholesale revamping of how community bankers run their cottage investment houses.

Endlessly, pundits and analysts pronounce that small businesses are the innovators and job creators and critical to recovery.

They can’t do that job without meaningful rehabilitation of regional banks. 

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.