How
Should Banks be Tested?
What do tests really test? This may seem a silly
philosophical question, but educators and government agencies are keen to
figure this out.
My concern here isn’t with education, but with banking.
Usually the banks do the testing: Are you credit-worthy? What’s your score?
Any one of us who ever took out a car loan, house
mortgage, or business loan knows what obstacles we had to overcome to be found
“worthy” of a loan, passing a test.
We should recall that if banks borrow money from federal
sources at around 0.25% and just charge twice as much, 0.5%, then their gross
profit is 100%! Charging 2.5% (and paying only 0.25%) provides 1,000% gross
profit margin. Wouldn’t you want to own a bank?
But banks must pass tests, too: according to a government
“stress test,” 31 of the largest US banks somehow passed: in case of a
financial crisis, they seem to have enough cash reserves to manage their leveraged
portfolios.
Given that Forbes claims
that just five banks control more than half of the $15 trillion of the
financial industry, the test of 31 banks ranges close to 80% of financial
assets. More tests will be coming, so there may be some unexpected surprises in
the next few weeks.
We have heard since the Great Recession by Republicans
and Democrats alike that without a healthy banking system our economy would
collapse, so this should be good news to all Americans, no?
What would you say if I told you that all my students
always pass my courses? Wouldn’t you suspect grade-inflation, low standards, or
simply academic incompetence?
Passing is passing, and if all students or banks deserve to
pass the test, why quibble? Isn’t the Millennia Generation big on giving
trophies in athletic contests even to losers for just showing up?
Well, if everyone on Wall Street seems delighted with
banks, it’s because self-congratulation is part of game, making sure that the
banking welfare system (with government subsidies and bailouts) shields bankers
from Main Street and pesky regulators.
But, the cozy and perhaps too intimate bond financial
institutions enjoy with their regulators—and the politicians who enjoy their
campaign largesse—isn’t shared by everyone.
Most surprisingly, the naysayers don’t only include the
Occupy Wall Street members of yesteryear or the Tea Party when its members
objected to the banking bailout; instead, it’s the Oracle of Omaha, Warren
Buffett, who has had some nasty comments about the financial industry, despite (or
because of) his intimate knowledge of its leaders and their practices.
Reuters
reports
that in his latest letter to his shareholders, he said: “Periodically,
financial markets will become divorced from reality—you can count on that . . .
never forget that 2+2 will always equal 4. And when someone tells you how
old-fashioned that math is—zip up your wallet, take a vacation and come back in
a few years to buy stocks at cheap prices." Instead of reflecting reality,
Wall Street is mired in fantasy.
As The New York Times reported only days
ago, Buffett mockingly calls the “the Street’s denizens” “money-shufflers” who
“don’t come cheap” and who have “expensive tastes.” Does he really mean it?
When
your personal fortune is $72 billion and your tastes remain relatively
upper-middle-class, you can say whatever you want. Are these just cheap shots?
Or is there an argument here? And if there is one, is it an economic or moral
one?
When Buffett
laces his Letter with a description of Wall Street bankers as those who “are
always ready to suspend disbelief when dubious maneuvers are used to
manufacture rising per-share earnings, particularly if these acrobatics produce
mergers that generate huge fees for investment bankers,” then it’s clear that
economics is at the heart of his critique.
At one point,
Buffett argues that “Investment bankers, being paid as they are for action,
constantly urge acquirers to pay 20 percent to 50 percent premiums over market
price for publicly held businesses. The bankers tell the buyer that the premium
is justified for ‘control value’ and for the wonderful things that are going to
happen once the acquirer’s C.E.O. takes charge.” But, this isn’t true; they mislead.
So, if you are
confused about why new mortgages aren’t spurring the housing market even though
mortgage rates are at historical low levels, or if you are puzzled why business
loans aren’t as easily obtained as expected, just remember: if a bank borrows
at 0.25% and invests in US Treasury bonds that yield (February 28, 2015)
4.79%--why bother with risky lending to the public it’s supposed to serve?
Have the banks
passed your financial, not to mention moral test?
Raphael
Sassower is professor of philosophy at UCCS. He can be reached at rsassower@gmail.com See
previous articles at sassower.blogspot.com
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