2009 February 01 Sunday
Higher Unemployment Will Shake Even Well Run Banks

Peter Eavis of the Wall Street Journal reports that banks expect much higher rates of loan defaults if the unemployment rate hits 10%.

Despite all the pain in the financial sector, bank executives' biggest fear has yet to materialize. Now, it is rearing its ugly head.

Bankers' worst nightmare is the unemployment rate climbing toward 10%, a level at which credit losses could balloon unpredictably because of high defaults among people with previously strong credit histories.

At higher unemployment rates people with high credit scores start defaulting. They have higher incomes and have borrowed more than the lower income people with low credit scores.

Also last week, Kelly King, chief executive of regional bank BB&T, said unemployment of 8% to 8.5% is "kind of manageable," but 9% to 10% would "have a dramatic impact on our scenarios."

Why the trepidation of going above 9%? Take a regular credit-card book. Past data show that a percentage-point increase in unemployment leads to roughly a percentage-point rise in the charge-off rate, the amount of defaulted loans written off at a loss.

But as unemployment exceeds 9%, bankers think charge-offs will start to increase by more than the increase in unemployment. The reason? A high rate could cause an unprecedented wave of defaults among prime borrowers, who tend to have bigger loan balances.

These comments from BB&T's CEO are coming from a bank that did not go hog wild and issue lots of loans to unqualified home buyers. (and unlike, say, the failed Merrill Lynch, the bank didn't go ahead with its bonuses either)

BB&T Corporation, which earned $1.5 billion in net income in 2008, said today that members of its executive team will not receive annual bonuses under its short-term incentive plan.

"We have traditionally set very difficult goals, and although we are among the top performers in the financial industry in 2008, we did not earn a bonus based on our targets," said Chief Executive Officer Kelly S. King. "This has been an extremely difficult economic environment, even for well-capitalized and profitable financial institutions."

BB&T is one of the strongest capitalized financial institutions in the industry. BB&T's Tier I capital ratio, a measure of financial strength and soundness, is 12.0 percent, significantly higher than the government's safety threshold of 6 percent. BB&T's total capital ratio is 17.1 percent, notably higher than the government's minimum ratio to be well capitalized of 10 percent.

Recently retired BB&T former CEO John Allison says the huge banking crisis was caused by US government policies.

Despite what the news media keep saying, capitalism and deregulation were not the causes of the financial meltdown.

Instead, BB&T CEO John Allison pointed the finger at government creations like the Securities and Exchange Commission (SEC), Federal Deposit Insurance Corporation (FDIC) and Fannie Mae and Freddie Mac, the two government-sponsored enterprises that failed last year. Allison was giving a lecture in Washington, D.C. Jan. 29 for the Ayn Rand Center for Individual Rights.

Allison cited a “religious belief in affordable housing” that led the government to institute the Community Reinvestment Act of 1977 (CRA) and later, during the Clinton years, to a huge expansion of Fannie and Freddie.

“In my opinion, I’m certain without Freddie Mac and Fannie Mae we could not have had the magnitude of misinvestment – we’d a had misinvestment but nothing like what we’ve had today,” Allison said.

Coming from Allison, a bank boss who managed to avoid many of the mistakes that many other banks made, this explanation gains credibility. George W. Bush and Karl Rove built upon CRA to make the disaster monumental in scope. Also see how the CRA, by controlling which banks became big, selected for reckless banks to become big.

Update: So will unemployment rise high enough to put the sound banks into trouble? Nouriel Roubini thinks things will get substantially worse.

Even as he wins plaudits for his prescience, Roubini, 50, says worse lies ahead. Banks face bigger credit losses than they realize, more financial companies will require state takeovers and the world economy will keep shrinking throughout 2009, he says.

“The consensus is catching up with me, but it’s still behind,” Roubini said in an interview in Davos. “I don’t know what some people are smoking.”

I am thinking a 3Q 2009 beginning of recovery is looking less likely. The later the recovery starts the higher the unemployment rate will go.

Share |      By Randall Parker at 2009 February 01 09:35 PM  Economics Financial Regulation

Kent Anthony said at February 12, 2015 2:27 AM:

It's 2015. I don't know how others bank accounts are but mine is empty. I am 34 and I still couldn't marry. Who will give hope to me???

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