Friday, August 30, 2013

This Week in Bank Failures

The Cyprus-inspired deposit flight that swept across the major countries of Europe this year also took its toll on American banks. About $50 billion in deposits walked out the door in the second quarter. That’s not a huge sum of money compared to the scale of the banking system or the national economy — it’s about one day of national income — but that it happened at all is telling. For one thing, the expected large-scale movement of money from European banks to American banks never happened. Of course, it did happen to some extent, but it was washed away by local deposit flight. People have to weigh the interest income they earn on bank deposits against the political risk of their deposits being partly nationalized. The daily interest earnings on $50 billion of deposits is about $300,000, so it’s not as if people have a strong incentive to keep as much money as they can in the bank. Banks need deposits, though. Deposit flight eats into banks’ capital positions, so that even a 1 percent decline in deposits forces a bank to make business plan adjustments to compensate. Banks automatically raise some loan interest rates when deposits decline, because that means they have less money to lend and can’t make so many new loans. There has been speculation this week that banks might have to raise interest rates on deposit accounts to reverse the trend of deposit flight, but that would cut into banks’ already thin profit margins. Interest rates on deposit accounts would have to be raised drastically, to something more than 1.25 percent, to get consumers’ attention, and for that to happen, banks would have to raise their loan interest rates. Central banks, though, have been trying to keep interest rates low. Central bank policy has had strikingly little effect on the lending side of the balance sheet, but it did prompt banks to lower deposit interest rates to near zero — until now, at least. If banks began to ignore central bank policy on the deposit side too, that would be unprecedented and might mark the end of the monetary policy era.

Republicans are weighing the merits of a government shutdown in October. I know they are serious about a shutdown as a political strategy because of the questions I answered today in a partisan public opinion survey. The questions the pollster asked me were designed to gauge the level of political support or resistance Republicans can expect from businesses if they close the government for varying lengths of time — one day, one month, six months. How quickly after a government shutdown would a hiring freeze go into effect? How long before the layoffs start? The answers should be obvious enough, even without a survey. Businesses don’t like shutdowns of any kind, whether the cause is a war, a hurricane, or a wildcat strike. Money stops flowing — never good for business. It is especially problematic for banks when this happens. If there is a government shutdown, expect to see a rush of emergency Fed lending to keep the banks from being the early victims. If the shutdown were to last for months, though, there would not be much the Fed could do. Previous government shutdowns, especially in California, have led to large-scale experiments with quasi-money, but that could be disastrous, causing widespread business failures, if it were attempted as a workaround during an extended shutdown in Washington. Instead of winging it on funny-money and faith, businesses will approach an October shutdown with a great deal of caution. As an example, thousands of businesses will furlough workers in advance as a precaution, just as they did at the beginning of the year.

It is a holiday weekend in the United States, reason enough not to shut down any banks tonight. Enjoy your weekend!