An Intelligence Test for Bankers

It’s a good day for robbing a bank – they’ve got money for a change!

How fast the bankers redeemed themselves…just a few months ago, we were making jokes about them:

“What do you say to a banker who has lost his job on Wall Street?”

“Uh…can I have fries with that?”

But now they’re geniuses again. And they can prove it…just look at their pay stubs!

And if there’s any fear that these dumbbells might blow themselves up again, you can forget it. They’ve got the full faith and credit of the United States of American behind them. Here’s the latest from Associated Press:

“The watchdog overseeing the federal government financial bailout says the government’s maximum exposure to financial institutions since 2007 could total nearly $24 trillion, or about $80,000 for every American.

“The whopping amount compiled by the inspector general for the $700 billion Troubled Asset Relief Program takes into account about 50 initiatives and programs set up by the Bush and Obama administrations as well as by the Federal Reserve.

“Many of the programs are backed by collateral and the $23.7 trillion represents the gross, not net, exposure that the government could face. No one has suggested that the full amount, in fact, will be used.”

It takes our breath away. The feds are squandering money faster than we can keep up with it. Each time we think we’ve got it measured – the total doubles.

Twenty-four trillion is real money. It’s getting close to two full year’s worth of the entire output of the United States…

Is there any wonder Americans’ hate bankers? They are chiselers and scalawags…making huge profits for themselves when the getting was good…and then whining for the protection of Uncle Sam when their own debt bombs blow up on them.

But hatred for bankers is cyclical. It follows the credit cycle.

Of course, bankers are always rogues and idiots. No doubt about that. But sometimes we like them and sometimes we don’t. In the movie, It’s a Wonderful Life, Jimmy Stewart plays the sort of banker we like. His bank made money the old fashioned way – by helping its clients finance houses and businesses. That’s what bankers do on the upside of a credit cycle.

The business model is remarkably simple. So simple even a banker can get it. You borrow from depositors at one rate. And you lend to borrowers (who are also depositors, usually) at a higher rate. What could go wrong?

Well…that’s what makes bankers bankers. They manage to mess it up.

Messing it up is pretty simple too. Deposits are a cost. Loans are a revenue stream. The more you lend, the more you make. Naturally, bankers have a tendency to lend too much. As the quantity increases, quality decreases. The most creditworthy borrowers get their money first. By the end of the cycle, borrowers are marginal…such as the people who got subprime loans in 2004-2007. They were often people without jobs…without assets…and with no fixed addresses.

Bankers lend too much in a predictable rhythm – at precisely the wrong time. They work with numbers and put on a good show. But when it comes to lending, they are all heart. Give them a good boom and they are ready to believe it will last forever. Booms raise asset prices. People borrow to expand and take advantage of the boom-like conditions. Bankers lend for the same reason – to take advantage of customers’ willingness to borrow. So, they are inevitably drawn to lending most at the height of a boom…that is, just before it turns into a bust.

To this tendency towards self-destruction, you can add in the modern finance industry’s delightful innovations – such as its leveraged derivative instruments. Making these available to bankers is like inviting a dipsomaniac for the weekend and leaving the liquor cabinet unlocked; it’s asking for trouble.

But everybody loves bankers in the boom stage. They make it possible to buy houses…expand businesses…and become upstanding, slavish citizens. A man without credit might be a freethinker or even a troublemaker. But give him a mortgage and he will show up for work on Monday and vote in the next election.

In small towns, bankers are leading citizens. They sit on the boards of hospitals and churches. They write letters to the editor of the local paper. They contribute to political campaigns, often keeping an eye open…hoping their state senator dies so they will have a chance to take his place. People ask their opinions and are careful not to offend them. They play roughly the same role…and hold roughly the same status of the local priest. The priest reveals the mysteries of holy orders. The banker reveals to the locals the mysterious truths of economics. When the going is good, he tells them it is because of their hard work, thrift and discipline. When the going is not so good, he shuts up.

When the cycle turns, bankers are pariahs. Nobody hates a banker like someone deep in debt. And at the end of a credit expansion, people are more deeply in debt than ever. The poor banker has to stay at home and draw the drapes, pretending to have gone to Florida for the winter…or to be out of town on business.

Now you can see why busts are so important. They are like an intelligence test for bankers. The dumb and the greedy are eliminated. That is, unless the government steps in to save them.

Just a few months ago, Americans despised bankers. Could it be that the cycle has reversed itself so quickly? Are they now revered again? Are mommas once again urging their babies to grow up and be bankers?

We don’t think so.

Our guess is that they will be chumps and schmucks for years to come. And we’ve got 20 trillion reasons why. Yes, that’s the difference between what Americans owe bankers at the bottom of the credit cycle and what they owe them at the top. The debt cycle has just crested with an all-time high reading of debt/GDP of 370%. It will take many years of paying that debt down…and/or inflating it away…before Americans like bankers again.

The big question in our minds is this: how will that debt get reduced? Will Americans actually pay it down? Or will inflation come to their aid?

And what will happen to the trillions of dollars’ worth of debt the feds are adding? The latest report from Congress estimates deficits as far as the eye can see…even to the year 2020, when they are supposed to be still 7% of GDP – or about $1 trillion. What will happen when this bubble in public debt blows up?

We wish the answer were easier. Two years…or even one year…ago, we could look ahead and see what was coming with a fair measure of confidence. There was clearly a bubble in housing and the financial sector. Surely it would pop.

Now, we look through the glass darkly…

The bubble has popped. The government as responded as we thought it would. The markets have bounced, as we thought they would.

But now what? We’re waiting for the next leg down. If we’re right…stocks will fall hard as investors realize that there will be no quick recovery.

And then… our visibility is poor… but the feds are bound to come back with Stimulus II. It will probably involve quicker-acting tax cuts. And it will probably cause more jitters in the bond market…and eventually, rising inflation levels.

When? How much? Hard to say…

Until tomorrow,

Bill Bonner
The Daily Reckoning