Why U.S. banks still aren’t lending

By Dean Foust

updated 1:05 p.m. ET Oct. 26, 2008

Ann Arbor Commerce Bank should be in the mood to lend money. Smack in the middle of an affluent college town, the community bank has largely been spared the economic angst roiling the rest of Michigan and the U.S. The bank, which has $360 million in assets, didn't make many risky loans, so losses are low and capital is plentiful. But in recent months the bank has politely referred some customers to other lenders. Says CEO Richard Dorner: "Capital is tight, and we're preserving ours."

The defensive crouch that Dorner and other bank executives have adopted is creating a quandary for Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson, and other Washington policymakers who are trying to get credit flowing freely across the economy.

The government is reaching deep into its pockets to stimulate the credit markets, most recently with a plan to inject $250 billion into big banks. But while there are small signs of improvement — notably a modest drop in the rate banks charge one another to borrow money — the initiatives are being blunted by banks' reluctance to loosen their purse strings. Right now the modest uptick in lending is coming mostly from panicked companies drawing down existing lines of credit rather than new loans.

Simply put, banks are hoarding cash, and the influx of government money won't necessarily change their plans. That's the case with Citigroup, which has shrunk the size of its balance sheet by 13 percent over the past year and plans to cut even further. "We're not going to treat [the money from the government] like a windfall and back off of the measures that we have under way to get the company fit," Citigroup Chief Financial Officer Gary Crittenden told analysts recently.

Depressed credit market until 2010
The industry may be hunkering down for a while. In a recent survey by data firm Reuters LPC, 40 percent of lenders and loan investors said they didn't expect the credit climate to improve significantly until 2010, after the worst of the recession has passed. "Lending won't start until everyone agrees the bottom has been reached," Richard M. Kovacevich, chairman of San Francisco-based Wells Fargo told BusinessWeek in an interview with Maria Bartiromo.

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Some contraction is not only unavoidable but desirable. After all, the economy is going through a natural cleansing as borrowers leveraged to the hilt work down their debt.

The markets will eventually find the right equilibrium — but that could take months, or even years. "We have kind of a chicken-and-egg problem" that no bank will lend until others do so first, says Marvin Goodfriend, an economist at Carnegie Mellon University and former research director at the Federal Reserve Bank of Richmond.

It doesn't help that some of the government's own bank examiners may be browbeating firms to stockpile cash. Industry experts contend these field staffers, who are assigned banks to watch over on a day-to-day basis, believe they're graded only on whether their institutions fail or not — a mindset that makes them overly cautious in the current environment.

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