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Time - Man of the Year
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1993-04-08
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THE ECONOMY, Page 50Why Banks Won't Lend
Interest rates are low, but many businesses can't get loans.
Why? Banks blame regulation, but another reason is that they
have found an easier way to make profits.
By BERNARD BAUMOHL -- With reporting by William McWhirter/Detroit
and James Willwerth/Los Angeles
Gregory O'Daniel was ready to play a role in getting the
economy back on the road to recovery. The Pennsylvania
businessman wanted to lease new machinery and hire a dozen more
employees so that his two-year-old firm, Tempco USA, could boost
its production of cosmetic cotton pads and facial tissues. But
O'Daniel needed financing to do that, so he went to his local
bank for a $300,000 line of credit. His company has an
unblemcredit history and has been ringing up $600,000 in monthly
sales to such customers as Wal-Mart and K Mart. Yet the bank
turned him down on the grounds that Tempco's track record wasn't
long enough. O'Daniel now has to scale back his plans and lay
off four employees.
Susan Karlin suffered a similar fate. The graphic
designer, who has managed a profitable studio in Manhattan for
seven years, needed more computers and a larger staff to
accommodate her growing clientele. When she applied for a
$100,000 loan at a large bank, she even agreed to put up
$200,000 worth of personal property as collateral. She had no
previous history of credit problems. A week later, a lending
officer called her with the bad news: "We don't feel comfortable
with it." Karlin was upset. "I gave them all the documentation
they asked for," she said. "Still they wouldn't give me an
explanation for why I was rejected."
Frustrating experiences such as these help explain why the
U.S. is having trouble pulling out of its doldrums. Small and
medium-size businesses across the country are ready to hire more
workers, buy new equipment and lease additional office space.
But the financial fuel needed to generate this activity is
locked up tight. America's commercial-banking industry, on whom
these companies rely for financing, is shying away from its
traditional role of taking on new risks. Business loans held by
banks have plunged a record 8% since the beginning of 1991, to
$594.2 billion. "What will create new jobs and new businesses?
It certainly hasn't been lower interest rates," says Jay
Goldinger, co-founder of Capital Insight, a securities firm in
Beverly Hills, California. "Only one action can jump-start the
economy. Banks must start lending again."
The persistent credit crunch has its roots in the go-go
lending years of the 1980s, when banks and savings and loan
associations issued an extravaganza of careless loans to
real-estate sharks and corporate raiders, oil drillers and
developing countries. "All you had to do to get a loan in the
1980s was have a pulse," says Jon Goodman, vice chairman of
California United Bank. The resulting avalanche of bad loans
forced the U.S. to allocate nearly $100 billion to bail out the
S&Ls and set aside a $70 billion credit line for cleaning up the
banks. To prevent such a disaster from happening again, Congress
and the Bush Administration fired off a barrage of tough new
banking standards. But when federal regulators began enforcing
the new rules with an iron fist, many banks and borrowers
started to howl. Last year the Bush Administration ordered
regulators to ease up, but so far, most bankers remain fearful
that any laxity on their part will bring regulatory punishment
or even closure. "The weaker banks want to spend more time
trying to clean up their balance sheets than making new loans,"
says Verne Istock, vice chairman of Detroit's NBD bank.
Gun-shy bankers have gone beyond just turning down new
applicants. They have also cut the credit lines of current
customers. American Crane Co. of Wilmington, North Carolina, a
thriving manufacturer and exporter of mobile crane gear, ran
into that problem when its bank cut the firm's $10 million
credit line by $1 million. Then one of American's important
distributors was forced to shut down completely when another
bank decided to cancel that company's credit line entirely.
"Banks are just not giving us the breathing room we need," says
American CEO Bob Cumming. "The banks themselves will not talk
about what is happening, but they are closing down perfectly
good businesses."
The credit crunch has hit some regions particularly hard,
notably the Northeast and the West. California's 460 banks took
a bad hit when property values nose-dived. Nearly 60% of the
bank loans in the state were backed by real estate, in contrast
to an average of 46% for the U.S. "No one is even going to a
bank here because they know how hard it is to get a loan," says
Goldinger. "The loan demand is there, but people are so tired
of being turned down."
Are American banks stable enough to be lending again? The
issue of the industry's health came into the spotlight once more
last week when Ross Perot suggested during the last
presidential debate that the U.S. banking system is in worse
shape than the government cares to admit. "Right after Election
Day this year, they're going to hit us with a hundred banks .
. . a $100 billion problem," he declared. The candidate was
referring to a new regulation taking effect Dec. 19 that
requires regulators to crack down on banks whose net worth, or
capital, is less than 2% of assets. Regulators at the Federal
Deposit Insurance Corp. quickly rebutted Perot's remarks,
contending that only about 80 weak institutions (total assets:
$30 billion) out of America's 12,000 banks will fall below the
2% level. Moreover, only those banks that show no progress
toward boosting their capital will be taken over, regulators
said.
For the industry as a whole, the outlook seems to be
getting brighter, with many banks actually thriving. The total
level of bank capital, their cushion against losses, is at its
highest since 1966. Despite the weak economy, problem loans have
shrunk nearly 6% so far this year. Total bank profits zoomed to
a record $15.5 billion in the first half of the year, up from
$11.1 billion in the same period two years ago.
If earnings are swelling, why aren't banks willing to take
more chances on lending? One reason is that the current
interest-rate structure has provided them with a rare
opportunity to make a sure-thing return, which banks are
exploiting. They can get money from depositors at only 3%
interest, then turn around and invest it in riskless medium-term
Treasury securities that earn about 6%. The three-point spread
is almost pure profit, with few administrative costs. In the
past 12 months, lenders have increased their holdings of
Treasury bills and notes 23%, to $630 billion, while their
portfolio of business loans dropped 4%, to $594 billion.
While those strong profits have pleased bank executives
and shareholders, the manner in which they were earned has
infuriated the White House and the Federal Reserve. "The banks
were not put into the business to take deposits and stick them
into government securities," says Deputy Treasury Secretary John
Robson. "Banking is not supposed to be a risk-free sport.
Frankly, it is time for banks to step up to the plate and start
lending again."
Bankers, for their part, complain that the biggest factor
inhibiting new lending is the huge regulatory net Washington has
thrown over the entire industry. "The banking system is
currently overmanaged and controlled by regulators," says Joe
Belew, president of the Consumer Bankers Association, a national
group of retail banks. "If you squeeze out the risk factor, you
also squeeze out a number of debatable lending opportunities.
Only people with perfect records will then get the upper hand.
But few of us have perfect records." Nor do banks relish the
thought of having federal examiners constantly looking over
their shoulder. "When you're sitting here with regulators who
are coming down and telling you to downgrade everything that
isn't lily white, you have a problem," says Don McWhorter,
president of Ohio-based Banc One.
The new regulations have forced banks to be highly
conservative in judging loans. Lending officers are required to
carry out far more documentation, a costly and time-consuming
process. They now routinely want business borrowers to provide
personal guarantees, sometimes even with their homes as
collateral. And if the value of that collateral falls below the
outstanding balance of the loan, then bankers may have to
classify the debt as being in default -- even though the
borrower may have been faithfully making payments.
Lenders have also witnessed the spectacle of seeing S&L
executives thrown into jail. This has heightened the fear among
bankers and board directors, as well as among their accountants
and attorneys, that they could face criminal liability if a
loan goes bad and imperils the bank. "There is a real fear
among lenders," says Lawrence Hunter, chief economist of the
U.S. Chamber of Commerce, "that a bad business decision in this
day and age stands the risk of becoming criminal activity."
As the banking industry recovers, its attitude about
lending needs to swing back from hypercaution to moderation.
This trend could be hastened if government would take another
look at its banking regulations and find ways to relax the
rules, and restore the risk-taking function of banks, without
endangering the health of the FDIC. With interest rates so low,
a batch of new loans would go a long way toward invigorating
small and medium-size businesses, which are the nimblest sector
of the economy and the most likely to provide new jobs in a
hurry. Until that happens, no matter who gets elected President,
the nascent recovery will be robbed of the oxygen it needs to
grow.