(Analysis) There has been a lot of content in different media outlets about how many homeowners are underwater – when the money that they still owe on their mortgage is more than their home’s current market value. Less attention has been paid to a similar phenomenon among banks here in the US: when the money set aside to cover losses on bank loans is not enough to cover the bad loans.
The chart shows the percent of total bank assets that are held by banks whose money set aside to cover losses exceeds the total value of bad loans. It fell dramatically with the increase of bad loans during 2007-8, and it has a long way to go before it returns to levels reported before this time. As banks increasingly claim poor credit quality among loan applicants as a reason for denying approval on new loans, it is important to realize that the poor quality of their outstanding loans is most likely a real reason for credit tightening in the US. Poor lending decisions in the run-up to the financial crisis still determine financial decisions today, contributing to the ongoing poor economic performance in the US.
This poor situation among US banks is limiting the federal reserve’s ability to influence the real economy. Policy analysts rightly identify that with interest rates currently at or near zero, there is much less room to stimulate the real economy through monetary policy. Left unsaid in much of the analysis about monetary policy is why near-zero interest rates are failing to stimulate an economy stuck in a weak recovery: the banks in the US are still underwater.
Workers and their families have a keen interest in making sure that banks can never again sink the whole economy by making risky loans for short-term gain. Labor and working families should closely follow the debates about financial regulation in order to make sure that there are no last-minute deals that favor the financial industry.