The Financial Industry's Corporate Profits

The U.S. banking system has been healing since its near-death experience in late 2008. After Lehman Brothers went belly up, a major hemorrhage of liquidity nearly took out several other big banks and financial companies.

Despite this trauma, after three years the financial industry has roared back quite strongly. The most direct evidence of this is in the bottom line – i.e., corporate profits. Not only have they rebounded, but they have shot up to an all-time high in 2010. Profits in 2011 will likely match last year’s figure.

The problem now is that the banks are holding on to these profits and not redeploying them back into the economy. For the real estate industry, the credit standards continue to remain very tight despite exceptionally low default rates among recent homebuyers of the past three years. The high aggregate of default rates is just the legacy impact of problem mortgages that were originated during the housing bubble years and that are still working their way through the pipeline.

Banks are claiming that there are uncertain regulatory rules from the Dodd-Frank legislation as a justification for the necessity of holding on to the extra cash. There is a certain validity to that argument, since there are several ‘blank’ pages in the Dodd-Frank bill where the rules are not yet set in stone and will be finalized in the future. But the extra cash holding could also be due to the steady income stream that is present in the current, less-competitive banking industry. Economic textbooks say fewer firms mean easier tacit collusion in raising prices for consumers.

As for jumbo mortgages, which do not carry the government-backing of FHA or Fannie and Freddie, the interest rates are notably higher. The average 30-year jumbo mortgage rate was 4.81 percent in late September, versus the conforming mortgage rate of 4.05 percent. On a $500,000 mortgage, the difference in mortgage rates is the difference in a monthly mortgage payment (principal and interest only) of $225 per month.   From October on, over 600 counties across the country will face a lower loan limit, and some consumers in these communities may be forced to pay higher mortgage rates because they will be pushed over into the jumbo loan classification.   In other words, some consumers will be forking over extra money to banks that are already flush with cash. It is worth remembering that these private banks are not purely private like small business owners.

In a free market system, effective firms survive and thrive while the ineffective or detrimental ones face destruction. But in the history of the banking industry, big banks somehow do not face the market test. The big banks, not uncommonly, are able to squeeze out taxpayer money to help support themselves in times of crisis. Given this unique bank relationship to taxpaying consumers, it is a pity that consumers are asked to pay more on their mortgages.  A quick policy change that would help consumers would be (1) raise the mortgage loan limit and (2) a moratorium on paying interest on the money the banks park at the Federal Reserve in order to encourage lending to the economy. In conjunction, the Dodd-Frank bill should also be thoroughly revisited page by page to remove any obstacles to sound lending.