“Neither a borrower nor a lender be.” -Shakespeare
Again with the banks??
Well, here we are again, thinking about potential bank problems becoming the country’s problems. Maybe we thought we were done with this after 2009, but the failure of a mid-sized bank in California called SVB has us all thinking about our country’s relationships with the lending industry. Again.
I speak from personal experience. The first 13 years of my working life was spent as a banker catering to small and mid-sized companies for a great institution, Mark Twain Banks. In my time there I met great clients, had wonderful colleagues and learned how the world really worked. Much of the knowledge I impart to people today is based on my time in the banking industry. Heck, some of my banker colleagues are still friends!
The United States and its citizens have always had a love-hate relationship with banks and debt. Early on there was much controversy about whether we even needed banks and debt:
“A national debt, if not excessive, will be to us a national blessing.” – Alexander Hamilton
Thomas Jefferson had a different take on borrowing: “I sincerely believe that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity under the name of funding is but swindling futurity on a large scale.”
Andrew Jackson, who knew something about fighting, was no big fan of banks: “The bank, Mr. Van Buren, is trying to kill me. But I will kill it!”
Banking and lending were disorganized and wild during the 19th century. After the country was subject to boom/bust cycles for decades, Congress in 1913 established the Federal Reserve System to oversee banks in the United States. The idea was to provide standardization and confidence to the country’s financial system. While The Fed, as it came to be known, certainly had its trials and tribulations (ever heard of the Great Depression?), what it produced was some order and consistency to borrowing and lending. The product of the last 110 years of this system was spectacular, consistent growth.
But this growth was not without its pain. It has been said with accuracy that every financial crisis since the founding of this country has been one caused by excessive debt. The crises have not always been caused by the same type of debt (junk bonds and third-world debt in the ‘80s, savings and loan crisis in the ‘90s, sub-prime loans in the ‘00s, etc.), but it has been a consistent story: financial crises usually are caused by bad loans of one kind or another.
“Don’t let your mouth write no check that your tail can’t cash.” -Bo Diddley
This does not mean loans are bad. Very few of us could buy a home or car without debt. Almost no company can exist or grow without loans of some kind. Countries (like ours) cannot provide anywhere near the level of societal support without the use of debt. You show me somebody who has never used debt of any kind, and I will show you a person who doesn’t really participate in our economy. “Self-made” billionaires, middle-class folks, and users of payday loans all engage in debt of some kind.
What gets countries, companies, individuals and their banks in trouble is not debt alone. It is debt beyond the means to repay it. Now it’s easy to lecture: “don’t get into too much debt!” It’s a lot harder to define what is “too much.”
“Blessed are the young for they shall inherit the national debt.” - Herbert Hoover
Does the United States have too much debt? The current national debt is approximately $31 trillion dollars. You can’t even get your head around that big of a number, so don’t try. A more interesting question is who loaned the United States $31 trillion? Well, frankly, mostly it was loaned by ourselves to ourselves! Of the $31 trillion, about $17 trillion is owned by US citizens like you and me. Another $7 trillion is owned to other parts of our own government, which is also essentially ourselves. Lastly, about $7 trillion is owned by foreign individuals or foreign governments.
“If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem.” - J. Paul Getty
The national debt is a lot of money, for sure. But if we owe ourselves a lot of money, maybe we can handle it. After all, it’s not like US citizens are going to “foreclose” on our own country. The debt we owe to foreigners is a bigger problem, and that alone might be too much debt. If you owe someone else a lot of money, you will need to be sensitive to their concerns. That’s sobering. Nonetheless, as J. Paul Getty says, if we owe that much money to foreigners, who has the bigger problem, us or the foreigners whom we owe?
"Before borrowing money from a friend, decide which you need most." - American Proverb
Companies get in trouble when they have too much debt. People who run companies decide to borrow so they can purchase equipment, make payroll, or expand their operations. The bank must decide whether to make the loan, because if the company defaults on a loan and goes out of business, the bank still must pay back depositors. This tension makes it crucial the banks don’t make too many bad loans. A bank starts to have real trouble when their bad loans get close to 1% of the total…they must be right 99% of the time! I’m not right 99% of the time about anything. Banks must be almost perfect when it comes to deciding who gets your money.
Yes, the companies make the mistakes, but their banks take our money and promise to lend it out prudently. If the companies fail, we still expect the bank to make good on our deposits. Virtually all the time they do, but a few banks don’t make the right decisions. Andrew Jackson again, speaking to bankers:
“When you won, you divided the profits amongst you, and when you lost, you charged it to the bank.” (Or, like SVB, they charged it to the FDIC!)
Nevertheless, we need banks and investors to take risk. Without lenders, you don’t get Google or solar farms or new vaccines. Companies don't hire workers or invent new products. Nothing moves. Taking the right amount of risk is a hard thing to define, and bankers are always trying to figure out which risks are good ones, and which are bad. Bankers are essential to everything.
"If you think nobody cares if you're alive, try missing a couple of car payments." - Earl Wilson
How much debt can an individual handle? Personal debt is riskier than company or country debt simply because individuals are all unique and have a varying range of knowledge, intelligence, morality, attention and diligence. This is why lenders to individuals (mortgage companies, credit card companies, payday lenders, etc) rely on providing standardized products to large numbers of people. They can use known trends to ensure they’ll get repaid by most of them.
There are also strong protections for individuals when they borrow money: disclosures, limits on lenders, bankruptcy laws, etc. Protections are designed to insert confidence into the banking system: lenders need to be confident they can get their money back (see the “99%” above) and borrowers need to be confident they won’t be ruined if circumstances mean they cannot repay. The vast majority of the time, this arrangement works well and our country prospers.
What can we conclude about banks and lenders? It is true that the birth of every financial crisis is born from bad debt. One way or another, people, companies, governments and banks will make choices that fail, and those have real costs to our economic well-being.
However, if we don’t find ways to get money from savers to those who will use the money to grow, we are doomed. If you individually are afraid the bank will lose your money, you may be thinking rationally. However, if everybody is afraid all the banks will lose all the money, then our economy stops. Confidence in the system is the cornerstone of our economy.
We need to have faith in our financial system and banks, and the way banks earn that faith is to make sure we watch them. It’s a never-ending task. I don’t want to hear any time soon about how bank regulation should be loosened! Banks are too important to allow them to exceed the speed limits; nothing good happens when banks fail.
“A bank is a place that will lend you money if you can prove you don’t need it.” Bob Hope