Business Insider

Peter Crabb: How uncertainty hinders bank lending and slows the economy's recovery

The party of 2009 is over. But we could get a nice Christmas present for 2010.

Since the U.S. economy was in a recession for most if not all of 2009, many would not have considered it a party. But for the stock market, 2009 was the best of times.

Stock prices, as measured by the Dow Jones Industrial Average, are up 13 percent over the past year but unchanged for the calendar year 2010. Meanwhile, investors in U.S. Treasury bonds have earned more than 10 percent since the start of 2010 year compared with 9.5 percent since August of last year.

It can now be said that the stock market rally of 2009 was more a response to too much selling in 2008 than a vote of confidence for economic growth in 2010. The better return for bond investors this year indicates great concerns for the global economic outlook.

Stock and commodity prices have been very volatile and mostly unchanged over the summer while significant gains are being made in government bonds. Prices for bonds in the U.S., Europe, the U.K. and Japan are all rising.

Bond markets do better in times of greater risk and uncertainty. Government bonds are often referred to as “safe haven” investments.

In response to the weak economic outlook, policymakers are considering further monetary stimulus. Monetary stimulus is any action of the U.S. Federal Reserve designed to encourage spending and investment.

On Aug. 10, the policy-making arm of the Fed, the Federal Open Market Committee, issued a statement that economic output and employment is slowing. The committee said it will maintain interest rates for banks near zero percent for “an extended period.”

But if banks can get money at a cost near zero, why are they not lending it out like crazy? The answer: too much uncertainty.

In his most recent testimony to Congress, Fed Chairman Ben Bernanke said committee members think uncertainty is currently “greater than normal.” Speaking at a Boise Metro Chamber of Commerce luncheon last week, John Stumpf, CEO of Wells Fargo & Co., confirmed that uncertainty is high with his customers. Stumpf argued that businesses are unwilling to invest, and therefore borrow, because of uncertainty over some taxes and regulations.

Banks themselves are facing greater uncertainty. Yes, the president signed a comprehensive financial reform bill, but banks will not know for another few months if their toughest regulatory requirement will change.

The hardest requirement placed on banking institutions is that of capital. The capital requirement is the amount of actual investment funds the banks must hold compared with what they can borrow.

The required capital ratio for banks is set at the international, not national, level. The Basel Committee on Banking Supervision at the Bank for International Settlements in Basel, Switzerland is a cooperative group of central banks responsible for determining the appropriate level of capital.

Wells Fargo and U.S. Bank are currently operating under what is called the Basel II Framework. Under this agreement banks must have a total capital ratio no lower than 8 percent.

Last week, the Basel Committee indicated the ratio will rise. The committee said there “are clear net long-term economic benefits from increasing the minimum capital and liquidity requirements from their current levels in order to raise the safety and soundness of the global banking system.” Unfortunately, the committee won’t release the details of this proposed increase in capital requirements until a meeting of G-20 heads of government in November.

No wonder banks aren’t lending more. Why increase lending now if they will only be required to invest more in support of these loans three months from now?

With all the unanswered questions about the economy and financial regulations the markets, both stock markets and job markets will remain in a funk. Perhaps we will know more come Christmas.

Peter R. Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.