Smith Faculty Opinion Article

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

September 24, 2009 

Washington’s Neglect of Main Street Banks Threatens Recovery

The Federal Reserve has announced the recession has ended but watch out. Washington’s inclination to bail out the biggest banks while letting their Main Street brethren languish may prove the steel arrow through the heart of the economic recovery.

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.

Many regional banks are laboring under failing commercial loans. This year, the FDIC has closed and merged more than 90 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.

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 and 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 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.

In the second quarter, the FDIC insurance fund fell $2.6 billion to $10.4 billion, and losses from deals it has already made are likely to be double that. Either surviving banks pay much larger insurance fees—making credit even tighter—or the Treasury will lend the FDIC money against a doubtful promise to repay.

The Obama Administration and Fed have done just about everything possible to keep the nation’s largest banks open, 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.