There’s a systemic illness infecting Main Street America. Our financial system — a vital organ in our economic being – has succumbed to a cancer called Zero Interest Rate Policy. It is a disease that has seen a flight of capital. But it has not been a flight to quality. Instead it has been a journey that has seen the wealth of the United States diverted from circulating freely in a vibrant economy to one constrained by policy and regulation that stifle America’s economic recovery dreams. There are symptoms that everyone needs to be aware of and begin to question because only by bringing these issues into the light will we stand a chance to remedy what ails us.
It’s no secret that the U.S. economy went into shock — in both economic modeling and emotional terms – beginning in 2008. The response to this shock has seen the “retrenchment of previous gains” in economic leverage that dominated the 1995 to 2007 era in finance. That era was marked by the embracement of globalization and outsourcing of the U.S. manufacturing base and financial speculation in real estate fueled by the mathematics of mortgage backed securities and its notional cousin the derivative. I’ll refer you to two articles “Economic Recovery Means Learning to Export Unemployment” and “Investors Stuff Mattresses and Wait for U.S. Economy to Find Direction,” I published in the Huffington Post for more reading. Search the popular website to find them.
Among the things chronicled in the latter article is a $2 trillion accumulation of deposits into the largest U.S. banks with assets over $100B — a.k.a. the TBTFs — beginning in the mid-2000s presumably as an artifact of globalization and accelerating with the advent of the financial crisis. This is money from corporations that lost faith in the U.S. economic engine and parked their money, effectively taking it out of use for perpetuating the capital investments cycle in durable and non-durable manufacturing. The article also chronicles that the banks in turn took this influx of liabilities and applied just over $1 trillion of it to investing on Wall Street instead of Main Street. Being flight-to-safety-minded people themselves, these bank’s “investments” were heavily geared towards government securities and that effectively turned corporate treasury money into a de facto “government” hedge fund. It’s become a source of capital that the government has protected even more by the diligent application of ZIRP that incents idle money to further entrench in that direction rather than seek return by participating in riskier Main Street lending and investing.
Done in the name of “maintaining stability,” the risk nongovernment investors are being asked to take to continue to perpetuate stability is frighteningly high. It is best seen by examining the ratio of derivatives book notional balances to the reported fair values of those derivatives in the largest banks that act as casinos for these instruments. The typical ratio is between 800 to 1,400 notional dollars to one fair value dollar, which is what happens when you take a small balance sheet number and divide it by a number close to zero. The net effect of these collective phenomena has been to create a dearth of lending available to smaller businesses and the mortgage markets. Even though deposits available to fund lending are at an all time high, the Main Street economy remains crowded out of access to the vast wealth of what is now a very idle rich nation.
Note that deposits did not accumulate in the same way at smaller banks. In fact, during the same period they experienced little deposit base growth at all. Even the “Move Your Money” consumer educational campaign that I partnered with Arianna Huffington to do in 2010 that garnered national attention and saw over 1.25 million uses of a small bank finding tool only shifted consumer deposits at banks by about 1%. The big money was always in the corporate deposits and they were trapped having to go to the big banks thanks to a “lack of choice” that was forced upon corporate America by two other members of the financial cabal, the insurance industry and the rating agencies. Corporations make large deposits far in excess of the amounts covered by FDIC insurance. Following the era of Sarbanes-Oxley and adequacy of internal controls, the amounts on those deposits above the FDIC coverage need to be insured through private deposit insurance. The insurance companies demand the bank have a rating from a recognized rating organization. And you guessed it, when all this took place only the largest banks that issued debt and derivatives had ratings. This effectively locked the smaller banks that are a major source of small business and commercial real estate funding out of the running to participate in the great deposit accumulation bonanza. We continue to live with these effects.
There is a way to disarm the trap. It’s been pointed out to me vociferously by bankers frustrated at being excluded from opportunity that companies like IRA whose ratings methods passed the crucible of accuracy validation during the financial crisis and cover the totality of the industry, including the smallest community banks, are now available and should be adopted by the insurance industry for private deposit insurance purposes. Some of these bankers particularly rail against the notion that NRSRO ratings meant for structured debt issuance even apply to measuring bank safety and soundness not just for deposit insurance but even for certifying the strength of letters of credit used to back up commercial real estate projects. I agree with them that such a move by the insurance industry would be a positive one for the country’s economic recovery. It would enable the corporate deposits base to re-deploy to banks that are more likely to lend to Main Street than the Potomac.
Dennis Santiago is the CEO of Torrance, Calif.-based Institutional Risk Analytics.