Spread in Rates Sets Off a Wave of Bank Bashing : Economy: What they pay savers and charge borrowers is the issue. Fed Chairman Greenspan is not alone in his criticism.
With unemployment at 7.8% and the recovery on the ropes, some new economic culprits may be coming into focus: the nation’s bankers.
Although the Federal Reserve has eased credit sharply in an effort to get the economy rolling, businesses and consumers are increasingly complaining that banks are not passing the savings onto them.
Returns paid by banks to savers on certificates of deposits or passbook accounts have fallen to the lowest levels in more than 20 years, but the rates banks charge customers for auto, personal and mortgage loans have not dropped nearly as much. So while the discount rate--the rate the Fed charges member banks--stands at 3%, interest on bank credit card charges--the most common loan to consumers--have stayed above 18% on average.
“Rates paid to depositors have dropped faster and harder than loan rates,” said Hugo Ottolenghi, editorial director of Bank Rate Monitor, a North Palm Beach, Fla.-based publication that tracks interest rates. “Broadly speaking, since rates peaked in 1989, consumers have seen savings rates go down by two-thirds, while loan rates have gone down by one-third, if at all.”
The stubbornly high consumer lending rates have ominous implications for the economic recovery, especially since lower interest rates are about the only economic lever available to a government already running a $400-billion annual deficit.
In testimony before congressional committees Tuesday and Wednesday, Federal Reserve Chairman Alan Greenspan said that by keeping loan rates high banks have contributed to the economy’s anemic performance. He said their reluctance to lower interest rates has been a factor in keeping the money supply abnormally low and continuing the credit crunch.
But Greenspan also said banks have been driven to follow this policy to improve their capital positions following a devastating period of loan losses, particularly in real estate and loans to Third World countries, that caused hundreds of banks to fail in recent years.
A consequence of this, obviously, is to create a “significant slowdown in lending,” he told the Senate Banking Committee on Tuesday.
While this may be bad for consumers, businesses and the economy, it has clearly been a boon for banks.
“Banks are enjoying historically high margins,” said James J. McDermott Jr., president of Keefe, Bruyette & Woods, a New York-based firm that specializes in bank analysis. In the first quarter, he said, the average “spread” for big banks--the difference between what they paid for deposits and earned on assets--jumped to 4.23% from 3.86% a year earlier.
That pattern is replicating itself this week as banks report sharply higher second-quarter earnings. BankAmerica Corp., for example, posted second-quarter earnings of $240 million, as its spread hit 4.56%. Other factors contributing to the bank earnings surge include savings in non-interest expenses, such as cuts in personnel, and stable or lower loan losses.
“With spreads like that, it’s easy to fall into bank bashing,” McDermott said.
And that is precisely what a growing number of depositors, borrowers and consumer groups are doing.
“These rates they are paying are so crappy I’ve had to drop my health insurance,” complained Norm van Hall, a retired investor in La Habra.
“My rate from Bank of America has gone from 7% to 5% to 3%--and, meanwhile, they are jacking up my fees,” added Kendis Rochlen Moss, a Los Angeles television writer.
Borrowers are also unhappy. “How is the economy supposed to get going if the banks refuse to pass along their savings?” asked Gary A. Butts of Whittier, who is fuming over the 11.75% rate Santa Fe National Bank is charging him on a personal loan that is pegged to the bank’s higher-than-market prime rate.
“They have no incentive to reduce it,” complained Butts, an attorney and retail florist. “They are making bucks right and left.”
Consumer groups also join in the attack.
“Consumers are being forced to pay for banks’ poor lending decisions of the 1980s,” charged Steve Brobeck, executive director of the Consumer Federation of America. “They’re being paid next to nothing for deposits, and they’re being asked to pay extortionate credit card rates, and auto and mortgage rates that are far above savings rates.”
But are the bank bashers justified? Or are higher bank profits merely part of the cyclical recovery in an industry that until recently was awash in loan losses and runaway expenses, and is under regulatory pressure to bolster its capital?
Do the stubbornly high rates on consumer loans--especially, on credit card loans that the least financially sophisticated consumers must resort to--mean that banks are gouging? Or are the high rates simply a reflection of the riskier lending environment of the 1990s, as bankers contend?
It is a touchy issue. “We have typically declined to discuss our pricing strategy,” said Richard Beebe, a spokesman for BankAmerica Corp. “We will not discuss or rationalize it.”
Beebe said that while credit card rates remain fixed at 19.8%, BankAmerica did cut fixed auto and home equity loan rates by about a quarter of a percentage point July 6, just three days after cutting the rates paid on CDs and money market accounts, also by a quarter point.
Officials of the American Bankers Assn., an industry lobbying group in Washington, deny that banks are profiteering. “There is a definite trend downward for consumer loans, though not necessarily in direct proportion to the decreases in deposit rates,” said James Chessen, the organization’s chief economist.
“Interest rates on adjustable-rate loans such as home equity loans and adjustable-rate mortgages are down dramatically,” he added. Indeed, mortgage rates have fallen significantly. Rates on 30-year fixed mortgages are near 8% on average nationwide and adjustable-rate mortgages are even lower. Both are expected to drop further in the coming weeks.
But such drops are less apparent in other areas. If personal loans and credit card loan rates remain “up there,” Chessen continued, it is because of higher debt loads among consumers, historically high delinquencies and record bankruptcies, including what he called “fraudulent and abusive” bankruptcy filings.
But the most important reason that banks have kept their lending rates high, observers said, is to bolster or rebuild capital accounts depleted by loan losses.
“I wouldn’t call it a windfall, because banks really needed this spread. The industry’s earnings were very fragile coming into the ‘90s,” said Warren G. Heller, research director at Veribanc Inc., a bank research firm.
“There is nothing improper about what is happening now,” McDermott added. “We view it as part of the normal recovery pattern.”
Economists say that while banks may be enjoying wider than usual spreads this year, market forces will soon begin to reassert themselves. “Banks are going to have to shave (loan) rates, pretty much across the board,” said David M. Jones, chief economist of Aubrey G. Lanston & Co., a government securities firm.
Even regulators acknowledge privately that bankers may not have much choice but to keep rates on consumer loans high to bolster their profit margins and capital. “Look, we’re the ones who have been exhorting the industry to build capital,” said one federal regulatory official, who asked to remain anonymous.
Indeed, Veribanc estimates that of the $10.02 billion in effective net income the banking industry posted in the first quarter, about 75% went to bolster industry balance sheets and meet regulatory requirements.
Many economists also challenge the assumption that the economy would bound ahead if bank lending rates were reduced as much as deposit rates have been reduced.
“The last thing consumers want to do is to add more debt when they’re still suffering from the debt overhang of the 1980’s,” Jones said. “Who is going to go out and borrow when he or she reads in the paper about absolutely secure middle-management jobs disappearing in droves?”
In this respect, the current economic dilemma resembles in some respects the economic crisis of the Great Depression when, according to economist Herbert Barchoff, “the prime rate went to 1%, with no cure.”
“When you are out of work or afraid of losing your job, you do not take on debt,” added Barchoff, former president of the Council of Economic Advisers. “Nor will entrepreneurs borrow even very cheap money unless there is a market.”
As a result, said Jones, a noted Fed watcher, “no matter what the Fed does, they are pushing on a string. They have created a favorable rate environment for debt restructuring, they have kept us out of depression. But in terms of a vigorous recovery, there’s not much more the Fed can do.
“History is not kind,” Jones added. “We spent the decade of the ‘80s having a party and took on debt at an excessive rate. It will simply take time to unwind those excesses.”
* MAIN STORY: A1
Interesting Rates
The gap between what banks pay consumers for their deposits and what banks charge consumers for loans has widened markedly since April, 1989, when rates hit their cyclical high. Rates for fixed-rate credit cards have actually gone up in the period.
What banks pay consumers
3rd Quarter, 1992*
One-year CD: 3.90%
Money market account: 3.25%
What banks charge consumers
3rd Quarter, 1992*
Credit card: 18.45%
Personal loan: 16.28%
New car loan: 9.84%
* As of July 17
Source: Bank Rate Monitor
