The End Of Private Banking In America?

If you don't think banks are making enough loans to consumers and small businesses right now, just wait until the Congress passes its "cram down" legislation (See Full Story).

As I have said before, the basic business model for banking is fairly simple. They take money in from depositors with the promise of paying interest on that money. Then, they use that money to give out loans to borrowers. The interest income derived from those loans is then used to pay interest to their depositors. In essence, the bank is a lending agent or consolidator between a diverse group of depositors and some group of select borrowers. For that, the banks take a commission; which is their profit.

Now, enter the Democrats in Congress. They believe that people struggling with their mortgages (mortgages that they couldn't really afford in the first place) should have mediation conducted by a Federal bankruptcy judge. That judge, armed with this new legislation, will be able to accomplish what the real estate industry calls a "cram down" of any principal loan amount to a new, much lower level, with lower and much more affordable interest rates.

A "cram down" is simply forgiving any loss in market value that a defaulting homeowner has realized against their original mortgage loan agreement. In essence, a person who bought a house for a high price and who has an equally high mortgage value associated with that home (a.k.a. their principal loan amount), will have a new contract written to match today's lower market value and today's low interest rates. The bank, then, has to eat the difference as a loss. For the delinquent homeowner, it is nothing but a win-win situation. They walk away with a new loan amount and a monthly mortgage that is, in many cases, more than halved. For the bank, they will have sustained losses in the 5 to 6 figure range for each home that is being crammed down on them.

The Democrats argue that this will keep people in their homes. And, it will have no cost to the tax payers. Also, the value of all homes will be maintained because there won't be any empty and foreclosed homes in our neighborhoods.

If only these people understood either business, or banking, or the real estate market!

Every time you financially benefit one group of people in some legislative or court action, you disadvantage others. In a "cram down," you are forcing banks into accepting severe losses. At the very least, those losses will result in reduced interest rates to all their depositors. In those formerly hot real estate markets, many banks won't be able to sustain all the losses that are being forced upon them and the FDIC will have to come in and takeover those banks. The savings of some people, those who exceed the current FDIC insurance levels, can and will sustain heavy losses. Federal funds, from the taxpayers, will be used to square the accounts of remaining depositors through FDIC insurance. So much for no cost to the taxpayers!

If a bank remains solvent while still sustaining tremendous losses, they are not going to be inclined to make any more moderate-to-high-risk loans for fear that some other Federal Judge, at some time in the future, will cram some more losses down on them. This will only exacerbate the current tight credit conditions that already exist in this country. It absolutely will insure that there won't be a recovery from this recession. Further, the value of homes in the real estate market will continue to decline because there won't be any loans available to drive the demand that is very much needed to clear all the existing inventory in what is already an oversupplied housing market.

Apparently, our Congress and Mr. Obama don't seem to understand that it is a lack of home buyers and not necessarily the number of foreclosed homes that is driving home prices down.

Additionally, if a bank sustains heavy losses but remains in business, it is likely to lose depositors because they won't be able to pay adequate or competitive interest rates on their checking/savings accounts. People will move their money elsewhere and, ultimately, those banks will fail as a result of runs on their deposits. Once again, Federal (FDIC) insurance money will have to be used in taking over another bank. And, once again, that's taxpayer money; just in case our Congress doesn't know.

This whole mess could result in a complete collapse of our private banking system. The net-net will ultimately be a Federally operated banking system with all the losses, the pitfalls, the inefficiencies, and all the lack of creativity of our current United States Post Office. God help us all!