Peter Boockvar had an interesting analysis of the banking industry. He pointed out that the lending capacity of the banks already exists, and that there is evidence that is in plain sight. He pointed out that the top 20 banks are paying a dividend total of $40 Billion. He then said that was $400 Billion in lending capacity. The CNBC commentator said it was only $40 Billion because no bank is going to use leverage. The commentator clearly doesn’t understand the way our banking system works. Boockvar is correct.
Our banking system is a Fractional Reserve system. Let’s consider the scenario of a bank holding on to $1000 dollars that would have gone to dividends. How does that lead to $10,000 in lending capacity? Well, the bank holds $1000 dollars in capital. It can lend that $1000 to Person A. Person A deposits the money in a bank (doesn’t matter which bank). That bank holds $100, or %10 to satisfy their reserve requirements. They can then loan out $900 to Person B. Person B deposits that money in a bank, which must hold $90 (again, 10%), and can loan out $810 to Person C. Person C spends the money immediately, giving it to Person D, who puts the money in the bank (the money ends up in a bank as long as it isn’t sitting under a mattress). That bank must hold $81 (10%), and can loan out $729 to Person E. This process repeats itself, but approaches the “Money Multiplier,” which is the inverse of the Reserve Ratio. So, 10%, or 1/10, has a “Money Multiplier” of 10. Add up those loans from only $1000 in capital, and you get $10,000 in loan capacity. From an accounting perspective, this isn’t increasing bank leverage. It is quite susceptible to a bank run, but that’s the nature of a fractional reserve system. This is why banks might hold reserves greater than their reserve requirement.
Bottom Line: There are hundreds of billions of dollars in lending capacity in the system right now. That’s just from the information that is in front of our faces (the dividends that banks are paying out), from a small subset of the market (20 banks). The lending capacity is quite possibly much higher than that. This makes the $700 Billion bailout package obviously redundant. So, how could the bailout package work if the money is already out there? Banks aren’t lending despite having the capacity to do so.
Semantics Moment
When I say the bailout won’t work, I mean that it won’t have the benefits to the overall economy that people (Bernanke, Paulson, Bush, etc.) are claiming. It will possibly allow institutions to survive that would have otherwise failed. In that sense, it will be declared a success. But the stock market, the housing market, the credit market, the job market, and your local corner market are not going to be helped by this bailout package.
The catch is that the package would have benefited Goldman Sachs and Morgan Stanley the most. They’d already written down a lot of their paper to market prices, so selling at a premium would directly benefit them. The reason I call it a catch is that there are now executive pay limits in the plan, and it might not appeal to these banks any longer.
Most banks are accounting with a mark-to-model scheme, which means that they haven’t declared a decrease in value in their assets. Their “models” assume that the assets are much higher in value than the market price. Even selling at a premium would result in a loss on their books (unless the government is paying a ridiculous premium). That means that most banks can’t play, or can only play in a limited fashion. If they take losses, they reduce their lending capacity. Interestingly, these banks won’t be negatively effected by the executive pay limits.
