The reasons for my saying that bankers as a group are not too smart are threefold. First, they created the mess they are now in. Second, they have allowed themselves to remain stuck unnecessarily in this same mess for a protracted period of time. And third, they have failed to take advantage of the mess when it is time to do so. Let me explain.
1. Creating the mess:
Had bankers been smart, they would not have jumped into the direct path of the financial tsunami they helped create in the first place.
In 2007 and 2008 the interest rates of one-year CDs were somewhere between 4% and 5%, while the interest rates of credit cards often exceeded 20%. Is it possible the credit card holders’ willingness to pay these exorbitant interest rates are a hallmark of financial discipline? Yet numerous consumers maintained a high level of credit card debt. Enjoy now, pay later. Perhaps that is the American way. While the banks were enjoying the lucrative business of credit card lending, they should have realized that many of these very same customers were also buying homes with variable rate mortgages that began with low teaser rates to qualify the borrowers. But when the real interest rate would be kicking in a few years down the road, it would be extremely difficult for them to keep up with the mortgage payments. If they ever lost their jobs, they would be in dire straits. Immediately prior to the bursting of the housing bubble, banks were willing to underwrite mortgages to virtually anyone who could breathe. That’s how they got into this mess in the first place.
2. Remaining stuck in the mess:
Banks not only created their own mess, but also have allowed themselves to be mired in it for much longer than necessary. It was perfectly reasonable to tighten the lending criteria when the home prices were dropping precipitously. But recently prices have been dropping very slowly, signifying the bottom is near, the banks should relax their lending standards to underwrite more mortgages, because at this juncture the risk has been drastically reduced, especially when the lenders are requiring a 20% down payment in home purchases. The value of a homes must further diminish by more than 20% before the lenders will experience any impairment of security in their loans. At the present time, this scenario is highly unlikely. The banks’ overly stringent requirements for making loans has deterred many otherwise qualified borrowers from purchasing homes, thus preventing the home prices to stabilize. This lending inertia is actually the cause for the depression of home prices, leading to more home foreclosures, perpetuating the downward spiral of home values.
3. Failing to take advantage of the mess:
Earlier this month Warren Buffett announced to the world that he was interested in buying up foreclosed single-family homes in bulk, renting them out and holding them for long-term appreciation. He further opined that such an investment might even garner a better return than investments in stocks. If the CEOs of banks were half as smart as Buffett – that is a bit too much to expect perhaps – he would not stand a chance of acquiring the foreclosed homes. Why? The banks are already in possession of a great number of undervalued properties, so why can’t they follow Warren’s game plan, rent them out to generate cash flow, hold them for appreciation and liquidate them when the time is right, instead of selling them now? But will the banks do that? Most likely not. Bankers as a group are not known for their brilliance, although when it comes to charging all sorts of fees such as late fees, transfer fees and administration fees, they can get plenty creative.
If bankers were smart, they would heed the advice of Warren Buffett and treat the foreclosed properties on the books as valuable assets to be retained, rather than liabilities to be rid of. They would hire real estate professionals to refurbish these properties and rent them out to generate cash flow, as renting is on the rise nationally, instead of selling them to private investment groups which would follow Buffett’s game plan. In my blog entitled healing the American economy with Chinese medicine posted in January of this year, I proposed the government should be the one to purchase the foreclosed homes in bulk. The foreclosed homes are such bargains now that the acquisition of them is truly an investment opportunity, which has been sadly overlooked by cash-rich investors and corporations alike.
If penicillin can be made from molded bread and biofuel can be generated from manure, substantial profits can certainly be achieved by buying foreclosed homes. These bank-owned properties that look like liabilities today will turn out to be valuable assets tomorrow. The future stock prices of banks will rapidly escalate by virtue of such holdings. Hopefully by now they can see their way clear to at least take advantage of the very mess they created.
I am keeping my fingers crossed because bankers ain’t that smart.