The Economy by Peter R. Crabb: Federal investment in banks stays risky long after crisis

PETER R. CRABB, professor of finance and economics at Northwest Nazarene University in Nampa.May 29, 2013 

Peter Crabb

The federal government is getting a return on its investment, but like a good mutual fund manager it should sell because the risks are too high.

The return on some of the financial industry bailout money comes in the form of dividends from two of the largest financial institutions in the world - mortgage servicing firms Fannie Mae and Freddie Mac. Earlier in May, Fannie Mae announced a record annual profit for 2012 and plans to send the U.S. Treasury Department a dividend check for $59.4 billion. Freddie Mac said it will send the Treasury $7 billion.

In the spring of last year the Federal Housing Finance Agency said it would operate these formerly private banks under conservatorship through at least the end of 2012. The financial giants remain state-run today despite an improving housing market and record profits.

It may even be the case that the housing market is overextended. As reported in the Idaho Statesman on May 17, U.S. home prices rose almost 11 percent in March of this year compared to a year earlier. This is the fastest increase since 2006 and much faster than the rate of growth in average incomes.

Perhaps the government itself is fueling another housing bubble. The government also keeps a big stake in the banking industry despite growing profits.

The number of government-owned banks is on the decline, but more than four years after the financial crisis the government can't seem to get out of the banking business. U.S. taxpayers have an equity interest in more than 150 banks, including $42 million in three Idaho banks - Intermountain Community Bancorp, Idaho Bancorp, and Syringa Bancorp.

Profits in the financial sector have been rising for some time now. The Federal Deposit Insurance Corporation reports that U.S. commercial banks as a group earned more than $130 billion in 2012, an 18 percent increase over 2011.

But all is not equal in the banking industry. More than 92 percent of the industry's profits go to only 9 percent of the institutions. Big banks are beating their smaller rivals by a large margin.

For example, Idaho has about 16 local commercial banks with 2012 profits of only $28 million, which equates to around 0.5 percent return on assets. Meanwhile, the largest 9 percent of institutions nationally are earning more than 1 percent on assets as a group.

In 2010 Congress passed and the president signed the Dodd-Frank Act, which was designed to protect U.S. taxpayers from having to bail out banks again. But a relatively small number of banks keep getting bigger, making the whole industry more vulnerable to any economic downturn.

Testifying before Congress this month, Stanford economist John Taylor pointed out that under Dodd-Frank, big banks appear "to be enjoying a huge subsidy on their borrowing costs due to market expectations of bailouts. This expectation of bailout of some creditors increases the risk of financial instability."

The risks present before the financial crisis of 2007-09 remain with us today. Thanks to continued government subsidies, housing prices are inflated and more bank bailouts are possible.

U.S. taxpayers should tell their mutual fund manager to sell.

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prcrabb@nnu.edu

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