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Banks Should Ignore Administration and Only Exercise Sound Lending

|Includes: AXP, BAC, Citigroup Inc. (C), COF, DFS, JPM, WFC

On December 14, 2009, President Obama met with the CEOs of the largest banks in the country to urge them to approve more loans, lower interest rates and curb fees.  The meeting was obviously in response to lawmakers feeling that, having bailed out the banks, the nation has a right to expect concessions from its financial institutions.  This feeling is fueled by the belief that since receiving federal funds, U.S. banks have failed to adequately return to the business of lending money.

To put this in perspective, we should remember that one of the recession’s largest contributing factors was the practice of giving out home loans to consumers whose incomes and credit histories did not justify those loans.  The assumption was, of course, that any loan was essentially a good investment given that the value of most homes was expected to appreciate astronomically.

That assumption, as we of course know now, was flawed.  The abundance of loans caused the housing market to over-inflate.  The over-inflated housing market caused home values to drop.  As home values began to drop, the loans proved unsound, and the more loans that failed, the worse the housing market became.  But what did we learn from this?  And what did the banks learn?

After all is said and done, what we all should have learned is that a bad loan is a bad loan, and pretending otherwise invites disaster.  People who cannot make their mortgage payments will be forced to foreclose.  As taxpayers, we were forced to come to the aid of large financial institutions, like Citibank (NYSE:C), Wells Fargo (NYSE:WFC) and Bank of America (NYSE:BAC), when they found that so many of the loans they had extended could not be paid back.   At the same time, we found it difficult to sell our own homes in a market glutted with competition.  The fire-sale prices that were the result of widespread foreclosure depreciated housing prices across the board.   We should have learned that we don’t want lenders to give out loans to people who can’t pay them back, and lenders themselves should have learned that they shouldn’t loan money to high-risk applicants.  Because lenders learned their lesson, banks now give out fewer loans and credit cards and are more careful about what applications they approve.

Doing business in this way is not only good for the banks, but it’s good for all of us as well.  The problem is that the federal government, having bailed out these banks with tax dollars, isn’t happy with the their newly found caution.  The government’s end goal was for banks to be able to continue “business as usual,” and now that they’re healthy enough to operate free of federal assistance, the government expects the banks to extend loans as liberally as they did during the bubble. 

Before the meeting on the 14th took place, White House Senior Advisor David Axelrod told Good Morning America, “What the president’s going to say to the bankers is, ‘you guys were part of the problem, you helped create an economic crisis here that cost 7 million Americans their jobs and now you have to be part of the solution.’”  Essentially, Obama’s meeting with banking CEOs encouraged them to throw caution to the wind, and begin making unsound loans once again.

Axelrod and the President need to realize that, by being cautious, the banks are participating in the solution:  they’re no longer approving loans with an abandon that is ultimately a threat to the American economy.  They’re basing interest rates and loan approval on real credit risk, and not on assumptions about markets or political special interests (including the urging/bullying of the President).  In short, they are acting the way banks ought to act, giving out loans only to those who deserve them.

The solution to the recession is not the creation of more housing and credit bubbles. Instead it should be based on a realistic assessment of the situation at hand.  While we can all agree with the Obama administration that a large part of the economic disaster was caused by the banks’ unsound lending practices, we should understand that the problem had nothing to do with the banks being too cautious —it was quite the opposite.  As Obama asks the nation’s leaders to begin extended more and more loans, he has to face the fact that it was precisely this lack of restraint that created the recession to begin with.  Bad lending practices cause banks to fail and should be avoided rather than given the President’s seal of approval.   We all know what happens when big banks fail, as taxpayers we get the bill.  Perhaps looking ahead to mid-term elections and even 2012, the President should keep this in mind as well. 

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