Greenspan Says Banks Failing to Pass on Fed Cuts

In a rare jawboning of the private sector, Federal Reserve Board Chairman Alan Greenspan said Wednesday that commercial banks have failed to pass on to customers the full benefits of the Fed’s long series of interest rate cuts, using the reductions to improve their profits instead.

The Fed has cut rates 23 times in the last three years, but banks have kept the rates they charge their customers relatively high to strengthen their balance sheets and recover from the worst banking crisis since the Great Depression, Greenspan said.

In testimony before the subcommittee on domestic monetary policy of the House Banking, Finance and Urban Affairs Committee, Greenspan suggested that the unwillingness of banks to encourage borrowing by further reducing interest rates is stunting the recovery and making it more difficult for the Fed to influence the economy.

Asked whether he believes that banks have been slow to pass on rate cuts to customers, Greenspan, a cautious policy-maker who frequently avoids direct answers to such controversial questions in congressional hearings, responded directly and forcefully. “Yes, I do,” he said.

“I think they were so traumatized by (the banking crisis), which created huge threats to their capital positions and (their) viability, that (the effects of the crisis) have not worn off yet, “ Greenspan said. “That is, the balance sheets are all very materially improved, but they are still extraordinarily sensitive about (lending).”

Following Greenspan’s remarks, senior Fed officials were quick to add that the central bank does not believe bankers are deliberately “profiteering.”

Rather, Fed officials said, the nation’s commercial bankers are responding to pressure from regulators and Congress to improve their sickly balance sheets. To do that, they are taking advantage of the wide spread between the low interest rates they pay depositors for money and the rates they charge borrowers.

“I don’t think they are conspiring” to keep rates artificially high, said one senior Fed official after Greenspan’s testimony. “There are a lot of pressures for bankers to be well capitalized today, and one way to do that is to widen the (interest rate) spread.”

While banks agree that their balance sheets need improving, they say that loan rates are coming down.

Greenspan, a Bush appointee and lifelong Republican who has pushed through a series of dramatic rate cuts under White House prodding in recent months, has seemed increasingly frustrated that the Fed’s actions have not led to more lending and a stronger recovery.

Statistics on bank lending rates support Greenspan’s assertions that commercial banks are not fully passing along the Fed’s rate cuts to their customers.

While the Federal Reserve has cut its benchmark federal funds rate five percentage points from 8.25% in the first quarter of 1990 to 3.25% today, the prime rate banks charge their best corporate customers has fallen just four percentage points, from 10% in early 1990 to 6% now, according to the WEFA Group, an economic forecasting firm based in Bala-Cynwyd, Pa. The federal funds rate, which is determined by the Fed, is the rate commercial banks charge each other for overnight loans.

Senior Fed officials noted Wednesday that the spread between the federal funds rate and the prime rate has rarely stayed so wide for as long as it has during the current economic cycle. “The point is, the spread has been persistently large this time,” said one Fed official.

At the same time, banks have taken advantage of the Fed’s actions by lowering the rates they offer depositors more than they have cut the rates they charge borrowers.

For example, commercial banks have slashed the rates they offer on six-month certificates of deposit from an average of 8.3% in the first quarter of 1990 to 3.5% today, according to the WEFA Group. Yet one-year adjustable rate mortgages have fallen only about half as much, from an average of 8.47% in early 1990 to 5.69% this month, according to the WEFA figures.

“The banks just haven’t lowered rates as fast as the Fed,” said WEFA economist Alan Levenson. “They have kept these spreads wide, close to historic levels.”

The result: Bank lending activity is down, but bank profits are soaring. Bank lending in the first quarter of 1992 totaled $2.035 trillion, down from $2.089 trillion during the first quarter of 1991, according to the American Bankers Assn.

But the banking industry reported profits in the first quarter of this year of $7.5 billion, up from $5.5 billion during the same period last year, the ABA said.

“The rate spread certainly has helped our profits,” said James Chessen, the ABA’s chief economist. “Given what banks have been through recently, anything we can get is good.”

But the industry’s actions have prompted many customers to pull their money out of the banking system and put it into mutual funds and other investments, making it more difficult for the Federal Reserve to monitor and direct economic activity, Greenspan and other Fed officials say.

Greenspan admitted that he is puzzled by the economy’s unresponsiveness to steps taken by the Fed.

“Based on the experience over the past three or four decades, most forecasters would have predicted that a reduction of the magnitude seen in short-term interest rates during the past three years would, by now, have been associated with a far more robust economic expansion,” Greenspan said Wednesday.

The Fed’s inability to spur the economy is especially troubling at a time when the White House and Congress have been unable to use tax and budget policy to do the job, analysts noted.

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