March 16, 2009
Heart of Banking Crisis in a Non-Banking World
By Cindy Ivanac-Lillig
Banks’ balance sheets are in crisis. All proposed solutions point to different ways to get “toxic assets” off the balance sheets. Conventional wisdom seems to be these "toxic assets" are difficult to value or have no value. However, if we conclude we simply need to remove them from the balance sheet to have everything return to ‘normal,’ we may be disappointed.
The “toxic asset” conversation centers on mortgage-backed securities (MBS) and commercial mortgage-backed securities (CMBS). Banks hold these securities on their balance sheets as financing vehicles for their businesses. It is similar to an individual holding a mutual fund. These securities used to be fairly liquid and provide some security during ‘normal’ business in the last few years. Banks would sell them when they needed more funds to lend or pay out. And when they had excess funds, they would buy them as investment vehicles.
At the moment, MBS and CMBS don’t have much of a secondary market (buyers and sellers), which is highly abnormal. This has left banks unable to finance their activities as easily as before. In addition, in ‘normal’ times, banks could make loans and then sell them to non-bank issuers of MBS and CMBS. This option is also not available to them at the moment.
These disruptions shed some light on how banks are financed. Both the issuance of MBS and CMBs, as well as the secondary market for them, lies in a non-bank world – the world of finance – and it has seized up. To illustrate how this impacts bank behavior, let’s look at the CMBS market. These are the securities created by pooling together commercial real estate loans. The underlying commercial real estate market did not show declining numbers until the last quarter of 2008. It currently has a default rate of less than 2%. However, the January 2009 FRB Senior Loan Officer Opinion Survey says, “80% of domestic banks reported that they had tightened lending standards for commercial real estate. 95% increased their loan-rate spreads….” (The numbers for residential lending were actually more favorable than that of commercial lending.) Because banks have assets that are difficult to sell and because they have few options in terms of selling a loan they initiate, they are choosing to give fewer loans. It isn’t only about the health of the underlying market.
The non-bank channels that finance banks have seized up, and this ironically may be the heart of our current ‘banking’ crisis. Removing bad assets alone will probably not result in resumption of ‘normal’ bank lending, but addressing securitization would go a long way. Perhaps when Fed Challenge team members are asked how the Fed should measure the results of its banking interventions, the leading indicators to consider should be non-banking ones, such as new issuance of mortgage backed securities. What do you think? Check out the TALF program, which squarely addresses the securitization issue. It’s set to launch on March 19.
Posted by Cindy at March 16, 2009 6:15 PM
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Why would the public buy toxic assets? I like to say, "Beware of the naked man offering you his shirt."
Posted by: Mike Fladlien at March 19, 2009 12:57 PM
Thanks for the post I actually learned something from it. Very good content on this site Always looking forward to new post.
Posted by: Valeri Popadiuk at June 25, 2011 11:58 AM
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