Washington & Wall Street: Fed Easing Hurting Housing, Banks

Just before the Thanksgiving holiday, the Federal Deposit Insurance Corporation released financial data for all federally insured banks as of the end of the third quarter of 2013.  The Quarterly Banking Profile, which is an important publication that provides a comprehensive summary of financial results for all FDIC-insured institutions, was also released.  The “Quarterly,” as it is known in banking circles, is essential reading for analysts who follow the US economy.  

The FDIC data confirms that the Fed’s policy of “quantitative easing” or QE is rapidly becoming a net negative for job growth, consumer income and the US economy overall.  The data also suggests very strongly that QE is hurting, rather than helping, the US housing sector and the financial institutions that make mortgage loans.  None of this is good for the US economic outlook.

Chief among the data points to be noted is that net interest expense, which is the money paid to depositors at banks, continues to fall.  While all banks earned about $118 billion in interest income last quarter, they paid just $13 billion to depositors, a graphic example of the “financial repression” used by the Fed to subsidize the US banking industry.  Via QE, the Fed is subsidizing all banks to the tune of over $100 billion per quarter in artificially depressed interest cost and income to depositors of all stripes.

Prior to the 2007 financial crisis, total interest expense for all US banks was over $100 billion every three months and interest income was almost $200 billion.  In order to maintain the net interest margin for banks at +/- $100 billion per quarter, the Fed is robbing US savers, including companies, investors and the elderly, of almost the same amount each quarter in badly needed income.  This data graphically illustrates the deflationary nature of current Fed interest rate policies and why Janet Yellen and the Federal Open Market Committee need to raise interest rates soon.

The FDIC Quarterly notes that most major loan categories showed modest increases, one key category – namely residential housing – did not.  The FDIC’s report presents a stark picture:

“Apart from 1-to-4 family residential real estate loans, all major loan categories registered growth in the quarter. Auto loans increased by $10.6 billion (3.2 %), while credit card balances rose by $6.8 billion (1 %). Real estate loans secured by multifamily residential properties increased by $8.1 billion (3.3 %), and loans to states and municipalities increased by $7.5 billion (7.3 %). In contrast, home equity lines of credit fell by $10.9 billion (2.1 %), while balances of other 1-to-4 family residential real estate loans declined by $13.7 billion (0.7 %). At major mortgage lenders, originations of 1-to-4 family residential real estate loans were $136.8 billion (30.1 %) lower than in in the previous quarter, while sales were down $114.7 billion (23.8 %).”

The FDIC confirms what the major banks have been telling investors for months (and what we have discussed in this column), namely that credit creation in the 1-4 family housing market is plummeting.  As the flow of mortgage refinancing transactions drops and the number of loans for home purchases rise only modestly, the net flow of loans for the housing sector is declining fast. This is one reason why many analysts, including your humble blogger, are predicting a slowdown in home price appreciation in 2014.   

At the same time as lending to the housing sector is slowing, banks are reporting a vast increase in cash balances deposited with the Federal Reserve Banks, another illustration of how QE is not helping to stimulate either jobs or consumer spending.  Cash balances piling up at the Fed are not available to help fuel new or existing businesses or grow jobs.

The decline in both first and second lien mortgage loans for 1-4 family homes held in bank portfolios is a very worrisome development.  Not only does it suggest that the US real estate sector is deleveraging at an accelerating rate – even as loan default rates and distressed loan balances also fall -- but is also calls into question whether or not Fed policy is actually making matters worse via QE.  Keep in mind that housing is one of the key transmission mechanisms for Fed interest rate policy.  When you see credit creation and credit balances for housing shrinking, that is a really bad sign.

The final data point we’ll look at this week is the impact of interest rate volatility on bank earnings, something we saw back in July and August after Fed Chairman Ben Bernanke held his now infamous June 19 press conference.  The FDIC notes that net operating revenue—the sum of total noninterest income and net interest income— for all US banks declined by $6.1 billion (3.6 %) from third quarter 2012. Noninterest income was $4.7 billion (7.4 %) lower, as income from sale, securitization, and servicing of 1-to-4 family mortgage loans at major mortgage lenders fell by $4 billion (45.2 %).  Noninterest income from changes in the fair values of financial instruments was $2.2 billion (54.6 %) lower than a year ago.

All of these decreases in bank earnings were caused by the market reaction to Chairman Bernanke’s ill-advised press conference this past June.  The huge move in US Treasury yields (and the related downward move in securities prices) caused big losses to banks and investors alike.  In the mortgage markets, the losses were magnified 2-3x and caused big problems for banks and non-banks alike as hedging strategies were shown to be inadequate.  Indeed, the market reaction several months ago to the hint of a change in QE by Chairman Bernanke shows that current Fed policy is adding risk and volatility to financial markets – something for fans of Janet Yellen to ponder in the days and weeks ahead.  


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