Rising interest rates are impacting borrowers across the nation. The Federal Open Market Committee decided to raise the federal funds rate by 75 basis points in its June, July and September meetings, the largest increases in three decades. Additional increases are expected to come later this year in an attempt to slow demand.
These market conditions present significant potential challenges for community institutions and their commercial borrowers. To weather themselves against the looming storm, community bankers should take proactive steps to safeguard their portfolios and support their borrowers before issues arise.
During uncertain market conditions, it’s even more critical for banks to keep a close pulse on borrower relationships. Begin monitoring loans that may be at risk; this includes loans in construction, upcoming renewals, loans without annual caps on rate increases and past due loans. Initiating more frequent check-ins to evaluate each borrower’s unique situation and anticipated trajectory can go a long way.
Increased monitoring and borrower communication can be strenuous on lenders who are already stretched thin; strategically using technology can help ease this burden. Consider leveraging relationship aggregation tools that can provide more transparency into borrower relationships, or workflow tools that can send automatic reminders of which borrower to check in with and when. Banks can also use automated systems to conduct annual reviews of customers whose loans are at risk. Technology can support lenders by organizing borrower information and making it more accessible. This allows lenders to be more proactive and better support borrowers who are struggling.
Technology is also a valuable tool once loans is classified as special assets. Many banks still use manual, paper-based processes to accomplish time consuming tasks like running queries, filling out spreadsheets and writing monthly narratives.
While necessary for managing special assets, these processes can be cumbersome, inefficient and prone to error even during the best of times — let alone during a potential downturn, a period with little room for error. Banks can use technology to implement workflows that leverage reliable data and automate processes based directly on metrics, policies and configurations to help make downgraded loan management more efficient and accurate.
Fluctuating economic conditions can impact a borrower’s ability to maintain solid credit quality. Every institution has their own criteria for determining what classifies a loan as a special asset, like risk ratings, dollar amounts, days past due and accrual versus nonaccrual. Executives should make time to carefully consider evaluating their current criteria and determine if these rules should be modified to catch red flags sooner. Early action can make a world of difference.
Community banks have long been known for their dependability; in today’s uncertain economic landscape, customers will look to them for support more than ever. Through strategically leveraging technology to make processes more accurate and prioritizing the management of special assets, banks can keep a closer pulse on borrowers’ loans and remain resilient during tough times. While bankers can’t stop a recession, they can better insulate themselves and their customers against one.
Amid mounting regulatory scrutiny, heightened competition and rising interest rates, senior bank executives are increasingly looking to replace income from Paycheck Protection Program loans, overdrafts and ATM fees, and mortgage originations with other sources of revenue. The right capital markets solutions can enable banks of all sizes to better serve their business customers in times of financial uncertainty, while growing noninterest income.
Economic and geopolitical conditions have created significant market volatility. According to Nasdaq Market Link, since the beginning of the year through June 30, the Federal Reserve lifted rates 150 basis points, and the 10-year Treasury yielded between 1.63% and 3.49%. Wholesale gasoline prices traded between $2.26 and $4.28 per gallon during the same time span. Corn prices rose by as much as 39% from the start of the year, and aluminum prices increased 31% from January 1 but finished down 9% by the end of June. Meanwhile, as of June 30, the U.S. dollar index has strengthened 11% against major currencies from the start of the year.
Instead of worrying about interest rate changes, commodity-based input price adjustments or the changing value of the U.S. dollar, your customers want to focus on their core business competencies. By mitigating these risks with capital market solutions, banks can balance their business customers’ needs for certainty with their own desire to grow noninterest income. Here are three examples:
Interest Rate Hedging
With expectations for future rate hikes, many commercial borrowers prefer fixed rate financing for interest rate certainty. Yet many banks prefer floating rate payments that benefit from rising rates. Both can achieve the institution’s goals. A bank can provide a floating rate loan to its borrower, coupled with an interest rate hedge to mitigate risk. The bank can offset the hedge with a swap dealer and potentially book noninterest income.
Commodity Price Hedging
Many commercial customers — including manufacturers, distributors and retailers — have exposure to various price risks related to energy, agriculture or metals. These companies may work with a commodities futures broker to hedge these risks but could be subject to minimum contract sizes and inflexible contract maturity dates. Today, there are swap dealers willing to provide customized, over-the-counter commodity hedges to banks that they can pass down to their customers. The business mitigates its specific commodity price risk, while the bank generates noninterest income on the offsetting transaction.
International Payments and Foreign Exchange Hedging
Since 76% of companies that conduct business overseas have fewer than 20 employees, according to the U.S. Census Bureau, there is a good chance your business customers engage in international trade. While some choose to hedge the risk of adverse foreign exchange movements, all have international payment needs. Banks can better serve these companies by offering access to competitive exchange rates along with foreign exchange hedging tools. In turn, banks can potentially book noninterest income by leveraging a swap dealer for offsetting trades.
Successful banks meet the needs of their customers in any market environment. During periods of significant market volatility, businesses often prefer interest rate, commodity price or foreign exchange rate certainty. Banks of all sizes can offer these capital markets solutions to their clients, offset risks with swap dealers and potentially generate additional income.
Is your bank promoting financial literacy and wellness within the communities you serve?
The answer to that question may be the key to your bank’s future. For many community financial institutions, promoting financial wellness among historically underserved populations is directly linked to fostering resilience for individuals, institutions and communities.
Consider this: 7 million households in the United States didn’t have a bank account in 2019, according to the Federal Deposit Insurance Corp.; and up to 20 million others are underserved by the current financial system. Inequities persist along racial, geographical and urban lines, indicating an opportunity for local institutions to make an impact.
Many have already stepped up. According to the Banking Impact Report, which was conducted by Wakefield Research and commissioned by MANTL, 55% of consumers said that community financial institutions are more adept at providing access to underrepresented communities than neobanks, regional banks or megabanks. In the same study, nearly all executives at community institutions reported providing a loan to a small business owner who had been denied by a larger bank. And 90% said that their institution either implemented or planned to implement a formal program for financial inclusion of underserved groups.
Technology like online account origination can play a critical role in bringing these initiatives to life. Many forward-thinking institutions are actively creating tools and programs to turn access into opportunity — helping even their most vulnerable customers participate more meaningfully in the local economy.
One institution, 115-year-old Midwest BankCentre based in St. Louis, is all-in when it comes to inclusion. The bank partnered with MANTL to launch online deposit origination and provide customers with convenient access to market-leading financial products at competitive rates.
Midwest BankCentre has also committed $200 million to fostering community and economic development through 2025, with a focus on nonprofits, faith-based institutions, community development projects and small businesses for the benefit ofr historically disinvested communities. The bank offers free online financial education to teach customers about money basics, loans and payments, buying a home and paying for college, among others.
Midwest BankCentre executives estimate that $95 out of every $100 deposited locally stays in the St. Louis region; these dollars circulate six times throughout the regional economy.
In a study conducted in partnership with Washington University in St. Louis, researchers found that Midwest Bank Centre’s financial education classes created an additional $7.1 million in accumulated wealth in local communities while providing critical knowledge for household financial stability.
“When you work with a community banker, you are working with a neighbor, friend, or the person sitting next to you at your place of worship,” says Danielle Bateman Girondo, executive vice president of marketing at Midwest BankCentre. “Our customers often become our friends, and there’s a genuine sense of trust and mutual respect. Put simply, it’s difficult to have that type of relationship, flexibility, or vested interest at a big national bank.”
What about first-time entrepreneurs? According to the U.S. Bureau of Labor Statistics, approximately 33% of small businesses fail within 2 years. By year 10, 66.3% have failed.
Helping first-time entrepreneurs benefits everyone. Banks would gather more deposits and make more loans. Communities would flourish as more dollars circulate in the local economy. And individuals with more paths to economic independence would prosper.
For Midwest BankCentre, one part of the solution was to launch a Small Business Academy in March 2021, which provides practical education to help small businesses access capital to grow and scale.
The program was initially launched with 19 small businesses participating in the bank’s partnership with Ameren Corp., the region’s energy utility, with a particular focus on the utility’s diverse suppliers. And 14 small business owners and influencers participated in the bank’s partnership with the Hispanic Chamber of Commerce of Metro St. Louis. Midwest BankCentre teaches small businesses how to “think like a banker” to gain easier access to capital by understanding their financial statements and the key ratios.
Efforts like these might explain why, according to the Banking Impact Report, 69% of Hispanic small business owners and 77% of non-white small business owners believe it’s important that their bank supports underserved communities. Accordingly, non-white small businesses are significantly more likely to open a new account at a community bank or credit union: 70%, compared to 47% of white small businesses.
This can be a clear differentiator for a community bank: a competitive advantage in a crowded marketplace.
For today’s community banks, economic empowerment isn’t a zero-sum game; it’s a force multiplier. With the right strategies in place, it can be a winning proposition for the communities and markets within your institution’s sphere of influence.
There’s been an increasingly common refrain from bank executives as the United States moves into the second half of 2022: Risk and uncertainty are increasing.
For now, things are good: Credit quality is strong, consumer spending is robust and loan pipelines are healthy. But all that could change.
The president and chief operating officer of The Goldman Sachs Group, John Waldron, called it “among — if not the most —complex, dynamic environments” he’s seen in his career. And Jamie Dimon, chair and CEO of JPMorgan Chase & Co., changed his economic forecast from “big storm clouds” on the horizon to “a hurricane” in remarks he gave on June 1. While he doesn’t know if the impact will be a “minor one or Superstorm Sandy,” the bank is “bracing” itself and planning to be “very conservative” with its balance sheet.
Bankers are also pulling forward their expectations of when the next recession will come, according to a sentiment survey conducted at the end of May by the investment bank Hovde Group. In the first survey, conducted at the end of March, about 9% of executives expected a recession by the end of 2022 and 26.6% expected a recession by the end of June 2023. Sixty days later, nearly 23% of expect a recession by the end of 2022 and almost 51% expect one by the end of June 2023.
“More than 75% of the [regional and community bank management teams] we surveyed [believe] we will be in a recession in the next 12 months,” wrote lead analyst Brett Rabatin.
“[B]anks face downside risks from inflation or slower-than-expected economic growth,” the Federal Deposit Insurance Corp. wrote in its 2022 Risk Review. Higher inflation could squeeze borrowers and compromise credit quality; it could also increase interest rate risk in bank security portfolios.
Risk is everywhere, and it is rising. This only adds to the urgency surrounding the topics that we’ll discuss at Bank Director’s Bank Audit & Risk Committees Conference, taking place June 13 through 15 at the Marriott Magnificent Mile in Chicago. We’ll explore issues such as the top risks facing banks over the next 18 months, how institutions can take advantage of opportunities while leveraging an environmental, social and governance framework, and how executives can balance loan growth and credit quality. We’ll also look at strategic and operational risk and opportunities for boards.
In that way, the uncertainty we are experiencing now is really a gift of foresight. Already, there are signs that executives are responding to the darkening outlook. Despite improved credit quality across the industry, provision expenses in the first quarter of 2022 swung more than $19.7 billion year over year, from a negative $14.5 billion during last year’s first quarter to a positive $5.2 billion this quarter, according to the Federal Deposit Insurance Corp.’s quarterly banking profile. It is impossible to know if, and when, the economy will tip into a recession, but it is possible to prepare for a bad outcome by increasing provisions and allowances.
“It’s the opposite of ‘blissfully unaware,’” writes Morgan Housel, a partner at the investment firm The Collaborative Fund, in a May 25 essay. “Uncertainty hasn’t gone up this year; complacency has come down. People are more aware that the future could go [in any direction], that what’s prosperous today can evaporate tomorrow, and that predictions that seemed assured a few months ago can look crazy today. That’s always been the case. But now we’re keenly aware of it.”
The automotive sector is a vital part of the US economy, accounting for 3% of the country’s gross domestic product. But the increasing demand for electric vehicles (EVs) and evolving battery and fuel cell technology means it is experiencing incredible disruption. These ripple effects will be felt across the entire automotive value chain.
Three years ago, EVs represented just 2% of all new car sales in the U.S. A year later, it doubled to 4%. In 2021, it doubled again to 8%; this year, it’s forecast to double yet again to 16%. We can only expect this trend to continue. For example, California regulators unveiled a proposal in April to ban the sale of all new vehicles powered by gasoline by 2035, as the state pushes for more EV sales in the next four years.
How will these transition risks — which includes changing consumer demand, policy and technological disruption — impact the creditworthiness of the 18,000 new-car dealerships, 140,000 used-car dealerships and 234,700 auto repair and maintenance centers across the country? What are the implications for the banks that lend to them?
Some of the world’s largest automotive brands have published bold commitments that will hasten their transformation and the industry’s shift. Last year, Ford Motor Co. announced that it expects 40% to 50% of its global vehicle volume to be fully electric by 2030, while General Motors Co. plans to exclusively offer electric vehicles by 2035.
But these commitments won’t just impact the Fortune 500 companies that are making them – businesses of all sizes, across the automotive value chain, will be affected. To stay in business, these firms will need to update their supply chains and distribution models, invest in new technologies, processes, people and products. In some cases, they may even potentially need to build an entirely new brand.
Banks will have an important role to play in funding much of this transition.
The pool of potential borrowers is getting bigger. Opportunities for banks don’t just exist in being a partner for helping automotive businesses transition — there is also a growing number of new automotive businesses and business models designed for the net-zero future that will require funding as they scale. Tesla isn’t even two decades old but last year, it produced more than 75% of U.S. all-electric cars. With growing consumer demand for EVs, the need for more EV charging stations is also rising. The global market for EV charging stations is estimated to grow from $17.6 billion in 2021 to $111.9 billion in 2028, according to Fortune Business Insights.
Electrify America, ChargePoint, and EVgo are brands that didn’t exist 15 years ago because they didn’t need to. How many more businesses will be born in the next five, 10 or 15 years, which will need loans and investments to help them scale? This is an opportunity worth billions a year for banks — if they have the foresight to anticipate what’s coming and take a forward-looking view.
The Smaller the Detail, the Greater the Value
Currently, most climate analyses work at a broad sector level, looking no deeper than the sub-sector level. This provides some indication of a bank’s exposure, but such a broad view lacks the insight needed to really understand the impact and trends at the individual borrower level.
To get a true grasp on this opportunity, banks should look for solutions that include financial forecasts and credit metrics at the borrower level across several climate scenarios and time horizons. Institutions can directly input these outputs into their existing risk rating models to drive a climate-adjusted risk rating and apply them across the full credit lifecycle, from origination and ongoing monitoring to conducting portfolio level scenario analysis.
Throughout the pandemic, banks enjoyed a unique opportunity to rebuild public trust and goodwill that was lost during the financial crisis 12 years earlier. Climate change is another chance, given that sustainability will be the growth story of the 21st century. With the right technological investments, strategic partnerships and data, banks have an opportunity to be one of the protagonists.
OakNorth will be diving deep into the challenges and issues facing the automotive value chain in an upcoming industry webinar on June 16, 2022, at 1 p.m. EST. Register now at https://hubs.li/Q01bPN1v0.
Say goodbye to the Goldilocks economy, where moderate growth and low inflation sustained us for years. Our global economy and social norms have careened from crisis to crisis over the last 24 months. The world has faced down a pandemic, unprecedented restriction of interpersonal interactions, and disruption of worldwide supply chains. And yet the world economy is booming.
Opinions vary about the reality, root cause, and associated solutions for inflation and low unemployment. But what’s critical is that the growing expectation of future inflation is a self-fulfilling prophecy, and that it stresses the systems for retaining and motivating employees.
Inflation simply is another type of disruption, albeit one that impacts companies and employees at nearly every level. Higher input costs lead to lower corporate margins. Higher costs of goods lead to lower individual savings rates (i.e., margins).
People costs are rising, too. Thinking about people cost as in investment allows strategic discussion about maximizing return. The good thing about people investments relative to say, commodity costs, is that cost levers are largely in corporate control and the tradeoffs can be managed. We view it as an imperative to consider changing pay strategy to reflect the reality of a world where the dollar does not go as far.
Companies and boards should think about how well pay strategy addresses four needs:
Need 1: Is our pay/reward strategy about more than dollars and cents?
Employees have far more choices for employment at this time and can command dollars from multiple places and roles. It is worthwhile to think hard about culture — what makes your culture unique, what people value in their roles, and what might be missing — and then build incentives and reward systems that support those activities in balance with financial performance.
Need 2: Does the pay strategy create the right balance of stability and risk?
Adapting pay programs to be more “risk-off” in the face of a highly uncertain external environment may be appropriate. Think about employees as managing to a “total risk” equation. When the expectation was that corporate growth was close to a given, then the risk meter could accommodate taking more risks to earn potentially more money.
Need 3: Are we making the best possible bets on our top talent?
Paradoxically, it might be a time to take more talent risk by digging deep to find your best people and providing them with differentiated rewards, visibility and responsibility. This is the heart of performance management, and it can always improve. The increased risk comes from investing more in fewer people. What if the assessment turns out to be incorrect or if someone leaves? Managing this risk versus avoiding it is the path to success.
Need 4: How are we sure performance in the face of a more volatile outside world is being rewarded?
This is the most “structural” of the needs. Elements to consider would include:
Higher merit budgets
More modest annual incentive upside and downside
Incorporation of relative measurement into incentive programs
Rationalization of equity participation and limitations to a smaller group as needed
Designation of equity awards based on overall dilution or shares awarded versus dollar amounts
Each of these needs has material tactical considerations that require much discussion about implementing, communicating and managing change. But unlike other major costs, rising people costs present an investment opportunity for increased returns rather than just a hit to the bottom line.
One word seems to encapsulate concerns about banker attitudes’ toward risk in 2022: complacency.
As the economy slowly — and haltingly — normalizes from the impact of the coronavirus pandemic, bankers must ensure they hew to risk management fundamentals as they navigate the next part of the business cycle. Boards and executives must remain vigilant against embedded and emerging credit risks, and carefully consider how they will respond to slow loan growth, according to prepared remarks from presenters at Bank Director’s Bank Audit & Risk Committees Conference, which opens this week at the Swissotel Chicago. Regulators, too, want executives and directors to shift out of crisis mode back to the essentials of risk management. In other words, complacency might be the biggest danger facing bank boards and executives going into 2022.
The combination of government stimulus and bailouts, coupled with the regulatory respite during the worst of the pandemic, is “a formula for complacency” as the industry enters the next phase of the business cycle, says David Ruffin, principal at IntelliCredit, a division of QwickRate that helps financial institutions with credit risk management and loan review. Credit losses remained stable throughout the pandemic, but bankers must stay vigilant, as that could change.
“There is an inevitability that more shakeouts occur,” Ruffin says. A number of service and hospitality industries are still struggling with labor shortages and inconsistent demand. The retail sector is grappling with the accelerated shift to online purchasing and it is too soon to say how office and commercial real estate will perform long term. It’s paramount that bankers use rigorous assessments of loan performance and borrower viability to stay abreast of any changes.
Bankers that remain complacent may encounter heightened scrutiny from regulators. Guarding against complacency was the first bullet point and a new item on the Office of the Comptroller of the Currency’s supervisory operating plan for fiscal year 2022, which was released in mid-October. Examiners are instructed to focus on “strategic and operational planning” for bank safety and soundness, especially as it concerns capital, the allowance, net interest margins and earnings.
“Examiners should ensure banks remain vigilant when considering growth and new profit opportunities and will assess management’s and the board’s understanding of the impact of new activities on the bank’s financial performance, strategic planning process, and risk profile,” the OCC wrote.
“Frankly, I’m delighted that the regulators are using the term ‘complacency,’” Ruffin says. “That’s exactly where I think some of the traps are being set: Being too complacent.”
Gary Bronstein, a partner at the law firm Kilpatrick Townsend & Stockton, also connected the risk of banker complacency to credit — but in underwriting new loans. Banks are under immense pressure to grow loans, as the Paycheck Protection Program winds down and margins suffer under a mountain of deposits. Tepid demand has led to competition, which could lead bankers to lower credit underwriting standards or take other risks, he says.
“It may not be apparent today — it may be later that it becomes more apparent — but those kinds of risks ought to be carefully looked at by the board, as part of their oversight process,” he says.
For their part, OCC examiners will be evaluating how banks are managing credit risk in light of “changes in market condition, termination of pandemic-related forbearance, uncertainties in the economy, and the lasting impacts of the Covid-19 pandemic,” along with underwriting for signs of easing structure or terms.
The good news for banks is that loan loss allowances remain high compared to historical levels and that could mitigate the impact of increasing charge-offs, points out David Heneke, principal at the audit, tax and consulting firm CliftonLarsonAllen. Banks could even grow into their allowances if they find quality borrowers. And just because they didn’t book massive losses during the earliest days of the pandemic doesn’t mean there aren’t lessons for banks to learn, he adds. Financial institutions will want to carefully consider their ongoing concentration risk in certain industries, explore data analytics capabilities to glean greater insights about customer profitability and bank performance and continue investing in digital capabilities to reflect customers’ changed transaction habits.
The coronavirus pandemic laid bare the struggles of average Americans — middle class and lower-income individuals and families. But these struggles are an ongoing trend that Karen Petrou, managing partner of the consulting firm Federal Financial Analytics, tracks back to monetary policy set by the Federal Reserve since the financial crisis of 2008-09.
In short, she says, the Fed bears some of the blame for the widening wealth gap, which sees the rich getting richer, the poor getting poorer and the middle class slowly disappearing. And that’s an existential threat to most financial institutions.
“The bread and butter of community banks — urban, rural, suburban — is the middle class and the upper-middle class, as well as the health of the communities [banks] serve,” Petrou explains to me in a recent interview. Even for banks focused on more affluent populations, the health of their communities derives from everyone living and working in it. “When you have a customer base that is really living hand to mouth,” she says, “that’s not a growth scenario for stable communities, or of course, [a bank’s] customer base.”
A lot of digital ink has been spilled on inequality, but Petrou’s analysis — which you’ll find in her book, “Engine of Inequality: The Fed and the Future of Wealth in America,” is unique. She explores how misguided Fed policy fuels inequality, why it matters, and how she’d recraft monetary policy and regulation. And she believes the future is bleak for banks and their communities if changes don’t occur.
Her ideas have the attention of industry leaders like Richard Hunt, CEO of the Consumer Bankers Association. “She’s not what I’d consider an activist or someone who has an agenda,” he says. “She is purely facts-driven.”
Central to the inequality challenge is the ongoing low-rate environment. We often talk about the Fed’s dual mandates — promoting maximum employment and price stability — but Petrou points out in her book that setting moderate rates also falls under its purview.
Low rates have pressured banks’ net interest margins for over a decade, but they’ve squeezed the average American household, too. Petrou writes that these ultra-low rates have failed to stimulate growth. They’ve also “made most Americans even worse off because trillions of dollars in savings were sacrificed in favor of ever higher stock markets.”
The Fed’s preoccupation with markets over households, she says, benefits the most affluent.
Low interest rates, as we all know, lower the returns one earns on safer investments, like money market accounts or certificates of deposit. That drives investors to the stock market, driving up valuations. Excepting a brief blip early in the pandemic, the S&P 500, Dow Jones Industrial Average and Nasdaq have all performed well over the past year, despite high unemployment and economic closures.
However, stock ownership is concentrated in the hands of a few. As of the fourth quarter 2020, the top 1% hold 53% of corporate equity and mutual fund shares, according to the Federal Reserve; the bottom 90% own 11% of those shares. Most of us would be better off, Petrou concludes, earning a safe, living return off the money we manage to sock away.
More than 60% of middle-class wealth is tied up in their homes; pension funds account for another 17%. Those have been underfunded, “but even underfunded pensions have a hope of paying claims when interest rates are enough above the rate of inflation to ensure a meaningful return on investment,” she writes.
And while homes account for a huge portion of middle-class wealth, home ownership has actually declined over the past two decades among adults below the age of 65, according to a Harvard University study. The supply of lower-cost homes has dwindled, and banks are reticent to make small mortgage loans, which are costly to underwrite. And for those who already own a home, prices still haven’t reached the levels seen before the financial crisis — in real dollars, they’re not worth what they once were.
And homes aren’t a liquid asset. Middle class Americans used to hold more than 20% of their assets in deposit accounts, but that’s declined dramatically. All told, low interest rates severely punish savers, who actually lose money when one adjusts for inflation.
Average real wages haven’t budged in decades — but the costs for everything else have risen, from medical expenses to childcare to education and housing. So, what’s paying for all that if savings yield little and incomes are stagnant? Debt. And a lot of it, at least for the middle class, whose debt-to-income ratio has grown to a whopping 120% — almost double what it was in 1983. For the top 1%, it’s more than halved, to 35% of income.
Middle class households were in survival mode before the pandemic hit, explains Petrou.
“All of the Fed’s monetary-policy thinking is premised on the view that ultra-low rates spur economic growth, but most low-cost debt isn’t available to lower-income households, and most middle-income households are already over their head in debt,” she writes. “Monetary policy has failed in part because the Fed failed to understand America as it bought, saved and borrowed.”
Debt can be wonderful; it can build businesses and make buying a home possible for many. But that dream is disappearing. Coupled with the regulatory regime, low interest rates have changed traditional banking, explains Petrou. Financial institutions are forced to chase fee income, found in wealth management and similar products and services. And lending to more affluent customers makes better business sense.
Petrou wants the Fed to gradually raise rates to “ensure a positive real return.” Combined with other factors, rising rates would “make saving for the future not just virtuous, but successful,” she writes, “giving families with growing wages in a more productive economy a better chance for wealth accumulation, intergenerational mobility, and a secure retirement.”
It won’t fix everything, but it will help middle and lower-income families save for their homes, save for college and even pay down some of that debt.
Petrou is clear — in her book and in my interview with her — that the Fed isn’t ill-intentioned. But the agency is ill informed, she believes, relying on aggregate data that doesn’t reflect a full picture of the economy.
“The economy we’re in is not the one in which most of us grew up,” she says, referring to the baby boomers who form the majority of bank boards and C-suites. The top 10% hold a much greater share of wealth, and that share is growing. The things that many boomers took for granted, she says, are increasingly unattainable, or require an unsustainable debt burden.
College tuition offers a measurable example of how much things have changed. Adjusted for 2018-19 dollars, baby boomers paid an average $7,719 a year to attend a four-year public college, according to the U.S. Department of Education. Generation Z is now entering college paying roughly 2.5 times that amount — contributing to the growing volume of student loans.
“Assuming that [the economy] works equitably because there’s a large middle class means that banks will make strategic errors, misunderstanding their customers and communities,” Petrou tells me. “And that the Fed will make terrific financial policy mistakes.”
Bank boards and executive teams face a number of risks in these challenging times. They may need to adapt their strong internal controls in response, as Mandi Simpson and Sal Inserra — both audit partners at Crowe — explain in this short video. You can find out more about the audit and accounting issues your bank should be addressing in their recent webinar with Bank Director CEO Al Dominick, where they discuss takeaways from the adoption of the current expected credit loss model (CECL) and issues related to the pandemic and economic downturn, including the impact of the Paycheck Protection Program and concerns around credit quality.
The economic picture in mid-August – while mixed – does not offer a strong argument in support of a depression redux. U.S. gross domestic product declined at an annual rate of 32.9% in the second quarter, but the situation seems to have gradually improved since then.
Unemployment in July stood at 10.2% — down from the scary heights of 14.7% in April, which was largely the result of a nationwide lockdown.
The Federal Reserve Bank of Atlanta keeps track of economic growth through its GDPNow tracker, which is not an official forecast but instead a real-time estimate based on current data. Through Aug. 7, the model was indicating that U.S. gross domestic product would grow at a seasonally adjusted annual rate of 20.5% in the third quarter.
That brighter outlook reflects the economic rebound that began in June when a number of states began reopening their economies by relaxing social distancing requirements.
But will that modest rebound last? A surge in coronavirus cases in June and July forced hard-hit states, including Texas, Arizona and California, to re-impose restrictions on certain businesses.
There is growing concern that the nascent economic rebound has begun to falter. The $600 weekly unemployment subsidy from the federal government expired on July 31; Republicans and Democrats in Congress have been unable to agree on another comprehensive relief package. Initial jobless claims have gradually declined since peaking in May, but states and municipalities that have been hurt by lower tax revenue may be forced to begin laying off public employees if they don’t receive aid from Washington.
The driving factor behind the economy’s ups and down is, of course, the Covid-19 pandemic. There were over 5 million reported cases in the U.S. through August 14, although the rolling seven-day national average has declined for the last several weeks. Few economists believe the economy will fully recover until an effective vaccine has been widely distributed.
To this non-economist, it seems we could be in for a recession even worse than the Great Recession more than a decade ago (would we call this one the Greater Recession?), but not necessarily another Great Depression. At least not yet.
In May, I interviewed former Federal Reserve Vice Chairman Alan Blinder, who now teaches economics at Princeton University. The problem with trying to predict a depression, according to Blinder, is the lack of an agreed-upon definition.
He thinks a depression would be “something like an economy that is in decline for at least a year and a half, probably two, and then climbs out of the hole relatively slowly. That is a worst case scenario for what’s going on now. I don’t believe that will happen, but the more important codicil to the sentence is, I don’t know what’s going to happen.”
I think one reason for this growing obsession with the idea of an oncoming depression is that the Great Depression left a deep emotional scar on the American psyche that remains fresh 90 years later.
We’ve all seen the grainy black and white photos of desperate people — including Dorothea Lange’s iconic shot of Florence Owens Thompson, known as “Migrant Mother.” But there are so many others: bread lines, soup kitchens and empty stares.
On Oct. 19, 1987 — what would become known as Black Monday — the Dow Jones Industrial Average dropped 22.6% and the Nasdaq market essentially froze. I was writing for a financial magazine in New York at the time and the following day, all the writers and editors met for a regularly scheduled story conference. This was the biggest market collapse since the crash of 1929, which we all recognized was the harbinger of the Great Depression. We sat around the table, slack-jawed and numb.
There was a lot of black humor, but it had an edge. Everyone was a little unsettled.
Five months into the pandemic, I think we’re all depressed — which partly explains our morbid fascination with the idea of another Great Depression. I’m not saying it’s going to happen, but the thought of it is so frightening that we can’t get it out of our heads.
Let me end this on a (hopefully) funny note. When I searched “Are we in a depression?” I found a long list of articles including, at the very end, this one: “The 10 Worst Foods for Depression.”
So here’s my advice. Lay off the potato chips and have an apple instead. And maybe an apple a day will keep another Depression away.