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closeThe International Monetary Fund’s recent estimate of losses resulting from the credit crises is $1 trillion. You can find higher estimates. At least one firm estimates the loss to be $2 trillion.
A trillion dollars is enough to have serious impacts. The Bear Sterns, Countrywide and IndyMac debacles are well known. The IndyMac failure was accompanied by panic when IndyMac’s depositors conducted a run that continued after the Federal Deposit Insurance Corporation took over the bank.
Extraordinary uncertainty characterizes the current financial crisis. Because of how loans were packaged for sale, no one knows where all the troubled loans are, and falling home prices put more loans at risk daily. Consequently, financial institutions’ stock values are down across the board. The markets have yet to sort out the strong institutions from the weak ones. Small banks, big banks, non-banks, all financial institutions have seen declining stock prices.
When markets can’t distinguish between good banks and bad banks, local economies can suffer.
So far, financial institutions have failed because they were holding bad mortgage loans — lots of them. Local banks, by contrast, are in the business of lending to local businesses. Very few local banks hold significant residential mortgage portfolios. When they do hold mortgage loans, it is usually with the intent of selling them. It is possible that a buyer has reneged on a purchase commitment, either explicitly or by technicalities. These would represent small amounts, unlikely to threaten a bank’s survival.
Local banks could have large investments in, or loans to, troubled institutions, but this is also very unlikely. Small banks tend to be very careful about diversifying their investment portfolios.
There are other ways local banks could be impacted by the real estate/credit crunch. They may have invested large amounts in now weak construction loans. This would lead to real estate owned, nonperforming loans or classified loans. They may have unsecured loans to people whose source of income was real estate activity. These problems represent secondary impacts. They could put individual banks in trouble, but that is unlikely. They are really more akin to the normal risk of a bank getting into trouble with imprudent lending, with a somewhat higher loss probability.
The local impacts of the financial crises will be felt by decreased lending. Regulators always overreact to financial crises. I’m convinced that the regulatory response to the 1990s S&L crisis contributed to both the length and depth of the recession.
Regulators are doing it again. Like the markets, they are unable to distinguish between good and bad banks, and regulators are pressuring all banks. This pressure, combined with the natural instincts of bankers to increase caution in uncertain economic times, affects the availability of funds that local small businesses need to grow.
Credit for small businesses is becoming less available. The Federal Reserve publishes the Quarterly Senior Loan Officer Survey. Its report on the July survey, issued Aug. 11, shows that banks have been tightening lending standards to small business since the beginning of 2007. Most recently, 65.3 percent of surveyed banks reported tightening standards in the July survey.
Credit has also become more expensive. According to the July survey, 61.5 percent of surveyed banks have increased the cost of credit lines to small businesses while 71.1 percent have increased the spread they charge small businesses.
When small business can’t access capital, local economies suffer. California and San Luis Obispo County have their own issues. The combination of those issues and tight lending standards could mean we are in for a few interesting quarters.
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