Everyone Wants a Piece of the Banks

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Some economists argue that even the strongest institutions should be conserving their cash, because a big decline in asset values could still leave them insolvent and in need of a taxpayer bailout. "We don't want big banks, even responsible big banks, to gamble with the taxpayers' chips," says Boston University economist Laurence J. Kotlikoff. One reason for concern: Banks could still get smacked by losses on their vast portfolios of real estate loans, says Edward Casas, head of Navigant Capital Advisors, a corporate finance adviser in Skokie, Ill. One sign that the companies haven't fully recognized their losses, says Casas, is that they're reluctant to sell assets at the going market price. He says midsize and small transactions "are still basically frozen" because banks won't cut their asking prices enough.

The cash cushion highlights another dilemma: Should banks lend more money or should they be tougher about granting loans to limit the risk of defaults? Loans on banks' books fell from $7.3 trillion in October 2008 to just under $6.7 trillion in early January 2010. Politicians have demanded that institutions step up lending to help lift the economy. Presumably banks would like to comply, since that's how they make their money. The $1 trillion they have stashed at the Federal Reserve earns just 0.25% a year.

The main reason for the decline in lending is that the recession has turned some would-be borrowers into bad risks and suppressed demand for credit from others. The National Federation of Independent Business says that in December only 8% of its small-business members reported they had credit needs that weren't satisfied, vs. about 5% who say so when credit is flush.

But some banks may have dialed back too far. In Denver entrepreneurs Frank Alfonso and Bill Cossoff had to get their local congressman's help to land a loan to open a third Big Papa's BBQ restaurant. In Los Angeles, Lourdes Sobrino says she was turned down by 15 or more banks for a $500,000 loan to relocate her Mexican-style Lulu's Dessert business, which employs 45 people. Facing a Jan. 22 deadline to vacate her current premises, she was seeking outside investors instead. Her problem: The 28-year-old company lost money in 2009. "I've had loans all my business life," says Sobrino. "I paid all of them successfully. The banks say, 'We're very conservative.' …Honestly, they don't care."

The other people grabbing for a piece of the banks' stash are the bankers themselves, who want higher salaries and bonuses. At JPMorgan, average pay at the investment bank rose 37% last year. But industry earnings may well fall in 2010, and if they do, pay could fall in tandem, says Alan Johnson, managing director of Johnson Associates, a New York-based compensation consultant.

Meanwhile, prospects for the Obama tax on banks are uncertain. The levy faces a possible constitutional challenge and accusations of unfairness. Warren Buffett opposes a tax. "This is not conducive to an investor-friendly environment," says Peter Sorrentino, who helps manage $13.8 billion at Huntington Asset Advisors in Cincinnati. A senior Obama Administration official says the White House is hoping the banks will take the money largely out of their bonus pools, but that would not be required.

In short, lots of people want to get their hands on the money of those "overcapitalized" banks. But at the moment, it looks like shareholders will be getting first dibs.

With Bradley Keoun, Elizabeth Hester, David Mildenberg, and Jane Sasseen

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