You might think that with all the billions of dollars in bail out money that the banks were given, they would be lending money. After all, the reason the government gave the money to the banks was to lend it to the public, and help get the economy going again.
However that hasn’t been the case, so why are they still not lending? The answer may surprise you, or maybe even upset you.
One of life’s lessons is that we can take lemons and make lemonade. Many look at our economic situation as bad news, and in many ways it is. But if we understand what is really going on in the economy, we can take the right steps to turn this bad situation into a good one. This is why it is so important to understand why the banks are not lending very much these days.
Here are a few key reasons:
1) Bail out money has been used by the banks to rebuild their (investments turned bad) portfolios, instead of lending it to the public.
If you recall, there have been two TARP bailouts given to the banks.
In the first, the government positioned themselves as the good guys by humiliating the bank CEO’s for paying huge bonuses to top executives.
Then the government made the huge mistake of trying to control how the banks were allowed to spend their TARP money. This resulted in the banks repaying the loans to the government early, leaving nothing for consumer lending.
The government then gave the banks a second round of TARP money; this time with less government interference. Again instead of lending this money to the public, the banks used this money to further rebuild their portfolios.
You see when the economy was booming, banks invested in highly leveraged stocks, bonds, and, derivatives that had leverage ratios as high as a 40 to 1. You heard right, 40 to 1!
This means for every $1,000 the bank would invest, it controlled $40,000. Wow, that’s leverage! But the problem with this is when these investments failed, the banks didn’t lose the $1,000 they invested, they lost the $40,000 that was leveraged!
Look at it like buying a $40,000 car with $1,000 down payment and getting into an accident without insurance. You still owe the full amount for the car and have lost more than just your down payment.
Do you now see why they took the bail out money and used it on themselves? They had to pay off the full amount of their obligations. This made the banks healthier; however, it did nothing to help the people facing foreclosure. The main purpose of the TARP bailout money, to get the banks lending again, was never realized. There just wasn’t much left after they satisfied their own debts. In actuality, the TARP money given to banks for the sole purpose of helping the public went to pay other large investment firms.
2) The banks are lending money to the US Treasury.
Why the US Treasury, and not the public; because it’s a safe and guaranteed investment. They are borrowing money from the Federal Reserve Bank at 0%, and then making risk free loans to the US Treasury at 3%. It’s like getting 3% from thin air. This is how the banks are rebuilding their thin capital base. I have to say it may not seem fair, but it is logical.
3) The great recession.
Why would the banks want to lend to private citizens in a bad economy? If a person loses their job and cannot make payments, the bank loses the loan performance and must foreclose on the home. This results in lost interest and additional expenses. Plus in a poor economy, it takes much longer to sell a property.
Add to the above the reduced asset value, the cost of getting the property in shape for sale, and attorney fees. Experts say the total foreclosure process costs an average of $50,000 to the bank. So, banks are understandably cautious about lending for these reasons.
4) Declining home prices.
Suppose someone buys a home for $400,000 during a good economy and two years later the economy goes bad and the home value plummets to $275,000. Then homeowner goes into default.
The bank will lose $125,000 in asset value, plus the repossession costs, and the costs to get it fixed and sold, which could cost the bank another $50,000. So now in this scenario of a bad economy, the bank lost $175,000. Now you can clearly see that with home values declining, lending money for home purchases is a risky investment.
Despite all these reasons, banks are still making loans, but only to very qualified buyers. Qualifications are much stricter now: higher credit scores, larger down payments, and more capital reserves than before. This significantly reduces the pool of people with whom the banks are willing to loan.
With fewer loans being made, it means fewer buyers, which in turn means more inventory on the market further driving down home prices.
Many people are extremely worried, not just about their homes, but also their jobs, their savings, and their future. How long will the economy stay down? Are the days of the American dream of home ownership over? Does anyone still have a chance for success in America today?
I say yes.
If you are prepared, this is also one of the greatest opportunities to help people, banks, and the economy, and make some money in the process.
Did you know that during the great depression of the 1930’s, more millionaires were created than during any other time in history? It’s true, and most of them made their money primarily through real estate. With the economy on unstable ground, it opens up real estate opportunities like never before. If you know where to look, there are many good deals waiting to be worked; opportunities to buy cheaply and sell for profits.
As the saying goes one man’s junk is another man’s gold. One man’s failure is another man’s opportunity. When you learn how banking and the money systems work, you will know how to avoid the pitfalls, and strategically time when to get into an investment.
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