Richard W. Fisher, President and CEO of the Federal Reserve Bank of Dallas, was discussing the current financial crisis in a speech this month, and raised a warning to creditors to resist the temptations of protectionists “to curl up in a ball and clutch their money.” Restricting capital flows, he argued “is the crack cocaine of economics. It provides a temporary high but is instantly addictive and leads to certain economic death.”
And although Federal Reserve Board chairman Ben Bernanke noted that the recession might end this year if several conditions are met, other Federal Reserve Bank presidents this month noted the negative impact that further declines in commercial property values could have on any initial recovery by further straining financial institutions and markets.
Dennis P. Lockhart, president and CEO Federal Reserve Bank of Atlanta told the Greater Miami Chamber of Commerce this month that: “Given eroding demand for commercial space, financing pressures in commercial real estate are cause for concern. Commercial real estate finance challenges could further complicate efforts to stabilize the banking system and credit markets.”
Lockhart, who has been predicting an upturn in the overall economy beginning in the second half of 2009, said this month that uncertainty in the credit remains unusually high, and the downside risks are very real because of further deterioration in real estate.
When times are tough and market conditions are deteriorating, banks “behave differently,” Eric S. Rosengren, president and CEO of the Federal Reserve Bank in Boston told the Institute of International Bankers this month in Washington, DC. As markets deteriorate, bank loan portfolios erode in value putting pressure on bank capitalization ratios.
“Undercapitalized banks shift their attention to short-run capital preservation rather than long-run profit maximization, and this change in goals has several undesirable effects,” Rosengren said. “Perhaps the most undesirable is that undercapitalized banks, finding it difficult to raise additional capital, are forced to improve their capital ratios by shrinking assets.”
“Since loans are usually the bank’s most significant asset, lending becomes more restrictive,” he said. “And, because undercapitalized banks seek to shrink without incurring additional losses, the specific form the asset shrinkage took could be perverse. For instance, some banks would support troubled borrowers in an effort to avoid loss recognition, while reducing credit to more creditworthy borrowers with whom the bank could curtail credit without incurring a loss.”
“Additionally, undercapitalized banks have an incentive to postpone reserving for problem loans, to avoid further depleting capital,” Rosengren added.
William C. Dudley, president and CEO of the New York Fed explained to the Council on Foreign Relations in New York City this month how bankers have become adverse to even lending to creditworthy lenders.
“Essentially, it has gone like this,” Dudley said, “even if I think you are a good credit, I am not going to lend to you, because others may not share the same opinion. The problem is, if no one else thinks you are good, I may not be able to get my money back if I need it. Conversely, others are not willing to lend to you, even though they think you are a good credit, because they are not convinced that I will do so.”
“The result is that no one lends, financial conditions tighten and this exacerbates the downward pressure on the economy,” Dudley said.” As economic conditions deteriorate, this undermines the financial strength of the major financial institutions, further reinforcing the downward spiral in confidence.”
