Businessweek Archives

A Break For Banks That Won't Help Consumers One Bit


Top of the News

A BREAK FOR BANKS THAT WON'T HELP CONSUMERS ONE BIT

For Representative John W. Cox Jr., a first-term Democrat from Galena, Ill., it was a chance to take Economics 101 with Professor Greenspan. "So when banks lend more, that increases the money supply, and that boosts the economy?" Cox asked the Federal Reserve chairman at a Feb. 19 hearing. Alan Greenspan gently corrected him: "It isn't the money supply that stimulates the economy--it's the lending." Cox: "And you're trying to encourage more lending?" Eureka! "That's it exactly," Greenspan replied.

The performance earned the congressman an A as he struggled to figure out what's behind the Fed's latest change in monetary policy. On Feb. 18, the Fed cut reserve requirements--the amount of money banks must keep on deposit with the Fed--for the second time in 14 months. When the reduction takes effect in April, it will free nearly $9 billion that banks can use to buy securities or make loans.

`TON OF MONEY.' Bankers cheered the change--but they're not talking about a quick boost in lending. "We've got a ton of money to lend," says a spokesman for Banc One Corp. of Columbus, Ohio. "It's finding creditworthy customers to lend to that's the problem."

Other bankers agreed. And that means the initial consequence of the Fed's move will be a boost in bankprofits by about 2.5%, as they trade freed-up cash for securities, but noreal letup in the credit crunch. Fed officials argue that the change is designed more to modernize the banking system than to stimulate the economy, anyway.

Central banks consider required reserves a necessary evil: The reserves control commercial banks' ability to create money. Today's 12% reserve requirement lets banks lend roughly $8 for every $1 of reserves. The new 10% rule will boost that leverage to 10-to-1. The change won't affect banks' loan-loss reserves, the funds set aside on an institution's balance sheet to cover expected losses on bad loans.

For decades, the Fed has been trying to win the right from Congress to pay interest on banks' reserve accounts. "Reserves are a deadweight loss and a drag on banks' ability to compete" with other lenders, says a top Fed official. But paying such interest would cost the Fed $1 billion a year, increasing the federal deficit. So while banks find innovative ways to create new accounts that aren't subject to reserve requirements, the Fed is acting on its own to lighten their burden.

SAFEST MOVE. The Fed has been considering the move since it made the last reserve cut--in late 1990. This one was timed to coincide with February's seasonal low in banks' reserve accounts. "This is not a short-term policy move" to boost the economy, insists a top official. But Wall Street wasn't buying: Short-term interest rates fell in anticipation of banks' using their extra cash to buy Treasury securities, while rates on the Treasury's 30-year bond shot up to a three-month high near 8%. The rise in long rates is worrisome: Bearish bond traders could pull mortgage rates back above 9% and stifle the housing rise (page 23 13 ).

The change in reserve requirements was probably the safest policy move the Fed could make in the face of a confusing economic outlook. Greenspan describes himself as "somewhat more confident than I have been recently" of a second-quarter upswing in economic activity, led by homebuilding, retail sales, and a bounceback from January's sharp drop in factory production. Economic optimists argue that long-term rates are rising on fears that the Fed will ease too much just as the recovery picks up, stimulating inflation.

But other Fed officials wonder whether the spring upturn will take hold this time--or vanish as it did last year. With commercial construction and state and local spending "sitting out the recovery," one policymaker argues that the economy "only has two engines, housing and exports. Rising long rates shoots down one, and the stronger dollar shoots down the other." If those trends worsen, pessimists argue, the Fed will have to ease short-term interest rates again, to offset rising market rates.

If another cut is needed, Fed officials know it will have to be sizable. After the Fed's big move in December, nobody will be impressed by a return to what some insiders call "the quarter-point treadmill" of small steps through 1990 and 1991. Those expectations only raise the ante in what was already a high-stakes game.Mike McNamee in Washington, with Zachary Schiller in Cleveland


Toyota's Hydrogen Man
LIMITED-TIME OFFER SUBSCRIBE NOW
 
blog comments powered by Disqus