Published in El Nuevo Herald on March 02, 2012
Among the major problems affecting the world economy is the performance of banks. Closely linked to the activities of a capitalist market, the banking sector, in both U.S. and Europe, has been undermined its volume of operations, mainly in their ability to lend.
For a long period of moderation, 1985-2006, banks profits were coming expressed by the difference between their lending and deposit rates. That is, banks charge higher interest on loans they grant, that by having to pay interest to savers for the money they place in them. Since banks have greatly reduced its loan portfolio in the U.S., they have had to propose innovative ways to generate revenue, such as a $ 6.00 fee for people, no customers, who redeem a check in their offices. They have also increased the discounts for using debit cards to other networks unaffiliated to the issuer bank.
Banks typically use a significant portion of public deposits to generate income. Regularly, they placed those funds in the capital market to earn higher interest rates in the short term. They also make other investments in diverse businesses such as real estate. Perhaps the most decisive factor in this current financial crisis is that banks have increased too much its assets while its capital has remained virtually unchanged. In other words, banks have continued to use public money to acquire more and more properties. And this exponential increase of their assets has been to satisfy the appetite of its shareholders, who naturally seek a greater return on their investment. Now, why is so important that banks increase their capital too? Because if there is a drop in the capital market, the bank would have resources to absorb that loss without investors and savers are affected, even though the existence of deposit insurance protection, which is very limited.
Banks regularly, when they have many assets, they make bond issues secured or guaranteed by other assets. These bonds raise funds from the public but commit the bank issuing such bond, who have to pay the face value of this document at its due date. In 2007, the rating agency Standard and Poor's and Moody's awarded the highest category (AAA) to many bond issues considered as Collateralized Debt Obligation (CDO). With this high rating, which virtually guaranteed the payment of these bonds at maturity, investors turned to the market by purchasing the bonds that turned out to be mostly a fiasco because the guarantees they had, were more than 50% mortgages finishing in foreclosure. This is part of the famous "toxic debt" held by banks and perhaps the main reason that drove the economic crisis, that also could be called the biggest mistake known in economic history. To compensate for this error, it can be argued that it was difficult to predict the collapse of the real estate market. However, one could also say that all bubbles burst, and this was a housing bubble.
The current crisis has many sides and in it the role of banks is essential. Recently the Obama administration reached an agreement for $ 25,000 million with the Banking Association through which, the most important banks holding mortgages, provide loan modifications to customers whose debts exceed the present value of their homes. Many questions will arise concerning unemployment, income or credit history. However, decisions must be made to prevent the collapse of the economy. The Government is trying to create jobs in U.S. instead of in China. It is trying to be more benevolent or modify the Credit Bureaus. The trading is becoming more transparent. The banks in turn are limiting salaries and juicy bonuses to their executives to be thus higher dividends from its shares.
Even facing this crisis, with medium-term solutions, banks and financial system will do well, by overcoming market failures, but emphasizing once again that the best known system is Capitalism, where toughness and interest are the gear that moves the machinery generating productive jobs and prosperity.
BENJAMIN F. DeYURRE
Economist and Journalist
For a long period of moderation, 1985-2006, banks profits were coming expressed by the difference between their lending and deposit rates. That is, banks charge higher interest on loans they grant, that by having to pay interest to savers for the money they place in them. Since banks have greatly reduced its loan portfolio in the U.S., they have had to propose innovative ways to generate revenue, such as a $ 6.00 fee for people, no customers, who redeem a check in their offices. They have also increased the discounts for using debit cards to other networks unaffiliated to the issuer bank.
Banks typically use a significant portion of public deposits to generate income. Regularly, they placed those funds in the capital market to earn higher interest rates in the short term. They also make other investments in diverse businesses such as real estate. Perhaps the most decisive factor in this current financial crisis is that banks have increased too much its assets while its capital has remained virtually unchanged. In other words, banks have continued to use public money to acquire more and more properties. And this exponential increase of their assets has been to satisfy the appetite of its shareholders, who naturally seek a greater return on their investment. Now, why is so important that banks increase their capital too? Because if there is a drop in the capital market, the bank would have resources to absorb that loss without investors and savers are affected, even though the existence of deposit insurance protection, which is very limited.
Banks regularly, when they have many assets, they make bond issues secured or guaranteed by other assets. These bonds raise funds from the public but commit the bank issuing such bond, who have to pay the face value of this document at its due date. In 2007, the rating agency Standard and Poor's and Moody's awarded the highest category (AAA) to many bond issues considered as Collateralized Debt Obligation (CDO). With this high rating, which virtually guaranteed the payment of these bonds at maturity, investors turned to the market by purchasing the bonds that turned out to be mostly a fiasco because the guarantees they had, were more than 50% mortgages finishing in foreclosure. This is part of the famous "toxic debt" held by banks and perhaps the main reason that drove the economic crisis, that also could be called the biggest mistake known in economic history. To compensate for this error, it can be argued that it was difficult to predict the collapse of the real estate market. However, one could also say that all bubbles burst, and this was a housing bubble.
The current crisis has many sides and in it the role of banks is essential. Recently the Obama administration reached an agreement for $ 25,000 million with the Banking Association through which, the most important banks holding mortgages, provide loan modifications to customers whose debts exceed the present value of their homes. Many questions will arise concerning unemployment, income or credit history. However, decisions must be made to prevent the collapse of the economy. The Government is trying to create jobs in U.S. instead of in China. It is trying to be more benevolent or modify the Credit Bureaus. The trading is becoming more transparent. The banks in turn are limiting salaries and juicy bonuses to their executives to be thus higher dividends from its shares.
Even facing this crisis, with medium-term solutions, banks and financial system will do well, by overcoming market failures, but emphasizing once again that the best known system is Capitalism, where toughness and interest are the gear that moves the machinery generating productive jobs and prosperity.
BENJAMIN F. DeYURRE
Economist and Journalist
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