Why you should worry when banks hoard cash

Dear A-Letter Reader,

Banks are holding a lot of cash these days… over $1 trillion according to the latest estimate. It’s a trend that’s been accelerating for the most part, despite the stock market’s intense rally over the course of the last year.

Here’s why it’s troubling…

Excess Reserves Skyrocket in the wake of Lehman’s Failure

There are two reasons why banks are stuffing their vaults with money…

The first is that the pendulum on risk management has swung to ultra-conservative levels. You see, a few years ago, at the height of the economic boom, banks were lending to anyone who asked for money. You could buy a million-dollar home via a so-called “NINJA” loans— meaning No Income, No Job.

And we all saw how that trend ended.

So it makes sense that the banks are now asking for everything short of a DNA sample to make sure that any new loans they write will be completely repayable. And with their books still packed with “toxic” loans from the freewheeling bubble era, banks would rather keep the cash in the vault than reinvest the profits by offering more loans.

But the second reason is the real kicker—it’s the growing problem in commercial real estate (CRE), which we’ve been reporting on for the past year as markets have rallied and shrugged off the information…

The days of commercial refinancing are at hand.

Specifically, the type of commercial real estate loans that were being made while everyone was becoming a realtor and learning to ‘flip’ houses. Despite the extra $1 trillion in cash held at banks, there’s actually $1.4 trillion in CRE loans that are going to reset in the next four years.

And dollars to donuts says some of them won’t qualify for refinancing. Many will be refinanced on existing terms, irrespective of the decline in cash flow and value of the property—extending and pretending on both sides that some of the destroyed value still exists, or will again someday.

But don’t take my word for it. Elizabeth Warren, head of the Congressional Oversight Panel overseeing TARP funds, had this to say about the banks, “We’re seeing banks that don’t want to lend because they see every dollar that comes in the door and say I’ve got to hold on to it to try to fill my commercial real estate hole or else I will be gone.”

Obviously, some banks will be more affected than others—particularly those with a high CRE exposure. These banks are the next downleg in the ongoing credit-crunch.

The best and most profitable course for banks is usually to expand their loan portfolio. Right now, they’re not doing that. And there’s a stark possibility of further contraction when CRE loans come due. Add all that up and it’s “Watch out below!” for America’s weary banking system.

Stay Sovereign and Stay Short!

Andrew Packer

Editor of The Credit Crunch Short Report

Source: Sovereign Society