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Banks “Loading Up” on Mortgages…Sort of

The Fed and Treasury propped up the banking sector fearing that a collapse would choke the life out of the economy.  Credit had to keep flowing, or the economy would grind to a halt, and this was particularly true in the housing market.

Today, the banks are indeed making mortgage loans again, but not quite the way the government intended.  As the Wall Street Journal reports, “Banks Load Up on Mortgages, in New Way.”

Rather than use TARP funds to make mortgage loans, the newly risk-averse banks are instead using the funds to buy government-guaranteed Ginnie Mae bonds.  And they’ve been buying them by the truckload.  As the Journal writes,

As of June 30, the roughly 8,500 federally insured banks and thrifts were holding $113.5 billion of Ginnie securities, compared with just $41 billion a year earlier, according to a Wall Street Journal analysis of bank financial disclosures. It is the largest amount that banks have reported holding since at least 1994.

Banks, sometimes with the blessing of federal regulators, have been loading up on Ginnie securities for one main reason: They make their balance sheets look healthier. Since the securities are guaranteed by the government, federal banking regulators have deemed them risk-free, meaning that adding them to a bank’s investment portfolio, or replacing assets deemed riskier, lowers the overall risk of the portfolio in the eyes of regulators.

Well, that’s risk aversion for you.  Lord Keynes once called aggressive monetary policy during a period of depressed final demand “pushing on a string,” and we think that the metaphor is apt here as well.  You can give the banks dump trucks full of money, but that doesn’t mean that they will lend it when their balance sheets are already impaired and they fear that they won’t get the money back.  This is why, despite the massive increase in the money supply, there has been no inflation.  The velocity of money has fallen off a cliff because banks aren’t lending.

For this economic recovery to be real and sustainable, we must see an uptick in risk taking by banks.  Until then, you have to maintain a healthy amount of skepticism.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy