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Misleading Sentences: Banking Edition

Anthony Randazzo
May 30, 2011, 7:51am

The following sentence led off a HousingWire story on Friday morning:

"Another downturn in home prices could stifle the solid recovery banks have made in the past two years, cutting into profit margins, derailing credit and threatening ratings, according to Standard & Poor's credit analyst Devi Aurora."

But this is how the analyst should have framed the story:

Another downturn in home prices could force banks to take losses on housing investments they otherwise would have suffered without the federal programs that supported them over the past two years.

Well, really there have been about four years where banks should have been taking losses. The first year of losses, starting in mid-2007 through mid-2008 triggered the financial meltdown. Then more losses were felt heading into 2009, but those were largely stemmed by the the TARP bailout, quantitative easing, HAMP and other federal programs. The programs didn't help the overall economy so much as they bought toxic debt away from the banks and gave them cheap money to invest back into government debt earning a stable return, but without boosting any real growth. 

So for the past two years, banks have steadily become profitable again, while unemployment remains high and the housing market struggles along. There are still years worth of supply in the shadow inventory that have to go through foreclosure, and that means more downward pressure on prices. A look at the historical trend in prices also suggests another 7% to 15% drop in housing prices is needed before recovery. And all of that means more pressure on the banks that have—in relative terms—gotten off pretty easy.

Housing price declines mean more potential for demand, more homes sold, and more housing affordability. And if that means some financial institutions take losses on their bad investments, so what? Why should the taxpayer continue to support them? It doesn't mean the government should initiate programs to cause the banks to lose money—like the regulatory burden that Dodd-Frank imposes. But it does mean that if a void of programs results in the banks taking losses then that will be good for the economy long-term because the toxic debt gets removed. If it had been removed a few years ago (by never initiating these programs) we wouldn't be having this discussion now.


Anthony Randazzo is Director of Economic Research


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