Posted on 11/06/2001 9:48:11 AM PST by Dems_R_Losers
When the Federal Open Market Committee meets today it won't be arguing over whether we are in recession. The economy is weaker today than at any time since 1982. It will almost certainly end the meeting by voting to reduce interest rates again. This will bear the same results as all the previous rate cuts this year: none.
Interest rate reductions alone are not enough to jump-start this economy. We need to make sure cheaper credit reaches the companies that need it. Credit rationing, not interest rates, is the real problem with the economy.
The Fed's monetary stimulus has been hijacked by the bank regulators. These credit highwaymen aren't bad guys, they are just doing their jobs. The Treasury Department's Office of the Comptroller of the Currency (OCC), which is charged with regulating federally chartered banks, has a different agenda from the Fed. Its job is to protect bank capital, period. It does so with an army of bank examiners, who wield the blunt instrument of credit rationing inside banks. For more than a year, these regulators have been diverting bank reserves into Treasury securities instead of business loans, in hopes of restoring bank capital that was damaged by technology lending. Companies that rely on banks for working capital have been sucking air.
To restore growth we need a functioning banking system. This will require a level of coordination the Treasury and the Fed have seldom achieved. But the current consensus for growth could give President Bush the political Roto-Rooter he needs to clear out the conduit.
This problem didn't start on Sept. 11. For more than a year U.S. banks have been closed for business lending. The story reads a lot like the real-estate blowout of the early 1990s that ended with Resolution Trust Corp. auctions, except this time it was undisciplined technology investments that did us in. In the three years leading up to 2000, commercial banks loaned enormous sums of money to telecom, cable and technology companies to finance capital-spending programs. These loans weren't backed by assets, but were based on projections that all three sectors would have sales growth rates several times that of the economy for many years to come.
Last summer it became clear that sales growth would not meet those heady projections. Instead of the 14% growth projected by analysts for telecoms this year, for example, actual sales will shrink. Companies without revenues don't make interest payments. And so by the fall of 2000, OCC teams were forcing regional banks to downgrade loans and reduce business lending.
Here's the catch. The loans to technology companies were generally unrecoverable. The tech firms had spent the funds on current operating expenses or to purchase assets with lots of goodwill but little resale value. So the banks turned to the one place they could get money back: reducing the revolving credit facilities of their small business customers.
I got a personal glimpse of all this last October, when a team of bankers visited our office to inform us their bank had decided to reduce the credit rating of, as well as cash-flow loans to, one of the private companies we own, in preparation for a bank examiner audit the following week. Our loan went from a "five" to a "six" on their 10-point internal risk management system, which meant the company could no longer use its acquisition credit line. This caused the company to halt discussions with an acquisition target and to book the costs incurred up to that point as current expenses.
Other companies had it worse, with reduced revolving credit facilities and increased fees. Some companies, under pressure from their banks to raise equity capital, have been forced to sell control in an illiquid equity market. Others have been forced into filing for bankruptcy protection or liquidation.
Deprived of working capital, U.S. companies have been trying to shrink their way to solvency, by reducing inventory, stretching vendors and laying off workers. This has created the sharpest drop in industrial output in 20 years.
Ironically, when the Fed became alarmed at the shrinking economy and began to cut interest rates in January, the bank examiners, who report to a different master, tightened further. The business loan market is far tighter today than it was then. Two years ago banks were willing to lend a good company four to five times Ebitda, or earnings before interest, taxes, depreciation and amortization. Today banks quote a market of just over two times Ebitda but money is not, in fact, available even at that level.
A further irony is that although banks have refused to lend to businesses, they have been throwing money at the consumer through mortgage and equity credit lines. This has produced a two-speed economy that has left many companies unable to produce products or to ship orders for lack of working capital. Stimulating consumer spending won't solve this problem; we need a functioning bank market.
The last period of nonprice credit rationing was the 1990-92 credit crunch. It caused tremendous damage to the economy and cost the first President Bush his re-election bid. It ended only after the RTC had finished its auctions and the property and banking markets had stabilized.
The lesson of that experience -- that the economy is only as healthy as its balance sheet -- is as true today as it was a decade ago. Unless the current Bush administration takes steps to restore bank lending to small businesses and heal the asset markets now, the economy will stay weak.
The White House can do three things to put the economy back on sound footing.
First, it should bring the Fed and the Comptroller of the Currency together to coordinate efforts to restore bank lending. This can be done very quickly and would not require new legislation.
Second, it should introduce legislation to transfer the regulation of federally chartered banks from the Treasury to the Fed, which would make monetary policy function more smoothly and prevent future credit-crunch situations.
Third, the White House should make it clear to Congressional Democrats that the price for support of their huge spending projects is fast action on a lower capital-gains tax rate and further action to lower marginal income tax rates, both of which would increase asset market values and improve bank capital.
Forceful action to Roto-Rooter the business loan pipeline is one thing we can do to make the economy grow again.
Mr. Rutledge is chairman of Rutledge Capital, a private equity investment firm in New Canaan, Conn., and a former economic adviser to the Reagan administration.
In the three years leading up to 2000, commercial banks loaned enormous sums of money to telecom, cable and technology companies to finance capital-spending programs. These loans weren't backed by assets, but were based on projections that all three sectors would have sales growth rates several times that of the economy for many years to come.
Last summer it became clear that sales growth would not meet those heady projections. Instead of the 14% growth projected by analysts for telecoms this year, for example, actual sales will shrink. Companies without revenues don't make interest payments. And so by the fall of 2000, OCC teams were forcing regional banks to downgrade loans and reduce business lending.
This is how the Clinton administration artificially pumped up the economy in the late 1990s to help stave off impeachment. It has been obvious to me since early last year that something fishy was going on, I just couldn't figure out what it was. Clearly the White House was giving orders to the bank regulators to pump as much capital as possible into the tech sector. Eventually even the Clinton-appointed bank regulators realized they were headed off a cliff and started tightening up lending standards. This instantly reduced the book value of thousands of highly leveraged companies. As in all such tightenings, the regulators got carried away and now even legitimate businesses cannot borrow money. Clinton himself couldn't have cared less, he avoided impeachment and knew he would be long gone by the time the true impact of the tightening was felt.
The really bad news is that most of the heads of the bank regulatory agencies are Clinton holdovers, and there are dozens of bureaucrats in these agencies that were hired in the last 8 years.
Aldrich speaks from the grave.
In fact, banking on "future sales" is exactly what EVERY new company does. Virtually no new venture has assets. Berry Gordy started Motown Records with $500 and no assets. C. W. Post was broke when he started Post cereals.
What happened? The telecom markets STOPPED growing. But why? There was no demand for faster, and better, information. There certainly is no glut here, where I can't even get past a 56k Modem. No, what happened is that you have a "knot in the hose." You have flowers that need the water at one end (new companies) and you have plenty of water at the other (new technologies in rapid data transmission, computerized video, MP3 technology) but there is a blockage in delivering the info. This is---and there are different explanations, I'll admit---because the Baby Bells have the technology, but not the authority, to open their wire to digital info; and the local telecoms have the authority, but not the wire.
There is also a massive shortage of VENTURE capital, which the author seems to confuse with the "money supply." WE DO have a deflation in the money supply, but even before this there was a drying up of telecom venture capital---likley due to the factors I mentioned above.
What he's arguing for is a reduction in reserve requirements. Banks can't lend money no matter how appealing the marginal rates if they are at their reserve limits. As many are approaching reserve limits, they are becoming more discriminatory in their lending.
Lower rates won't encourage borrowing nearly as much as monetary expansion. Many corps would borrow at much higher rates if they could get their loans approved; their loans would be more often approved if banks had more discretionary funds.
Have financial problems? Borrow money and spend your way out of them. No problema.
I have an alternative suggestion to giving the Fed more authority -- disband it.
Good idea, but wrong country. The Fed will disband us, before they allow themselves to go under.
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