Wounded banks: Only game left

Banks have become the only game in town for most businesses and consumers looking for loans, and that’s why the government is gearing up for what could be the most expensive bank bailout ever.

Entire trillion-dollar markets for securitized loans have frozen or collapsed in the past 18 months, including parts of the corporate debt market known as commercial paper, private mortgages, auto loans, student loans and credit cards. The result: Banks are often the only lenders still able to satisfy critical credit needs.

“We’ve wiped out the investment banking system. We’ve frozen the commercial paper markets, and virtually all the asset-backed markets … are virtually out of existence or frozen,” said Martin Regalia, chief economist at the U.S. Chamber of Commerce. “So banks are once again the only game in town.”

Treasury Secretary Timothy Geithner is scheduled to present the administration’s plan for shoring up banks further Tuesday, using a combination of capital infusions, government guarantees and outright purchases of souring loans through a “bad bank” to help major banks deal with accumulating losses on their loan portfolios.

Before last fall’s financial crisis, banks provided only $8 trillion of the roughly $25 trillion in loans outstanding in the United States, while traditional bond markets provided another $7 trillion, according to the Federal Reserve. The largest share of the borrowed funds - $10 trillion - came from securitized loan markets that barely existed two decades ago.

People seeking to buy homes and refinance mortgages since the fall of 2007 have found loans harder to obtain because of the collapse of nearly all but the conventional market for 30-year loans.

Students bound for college started finding financing more difficult a year ago as the market for securitized student loans dried up, while car buyers, small businesses and credit card customers all have seen their usual credit sources evaporate more recently.

Perhaps the most acute shortage of credit is being felt by businesses, which before September got less than a third of their loans from banks. Most businesses preferred to take advantage of the better interest rates and terms offered in securities markets, where they could tap into cheap funding from abroad. For short-term loans of one to six months, businesses went to the commercial paper market, while they secured funding for long-term projects and investments in the corporate bond market.

But the bond market for months has been largely closed or prohibitively expensive to all but businesses with top credit ratings. Portions of the commercial paper market have entirely shut down and may not come back. Moreover, some of the major investment banks that used to underwrite and market those loans have gone out of business.

“It’s hard for banks to suddenly take up all this other slack, because it requires a certain expertise to make good loans and service those loans,” said Mr. Regalia. “They don’t have the back office at this point.”

Many legislators in Congress complain that banks aren’t lending, and cite that as an excuse to vote against further bank bailout funds. Their constituents are angry that banks seemingly are not meeting their needs despite massive cash infusions from the Treasury Department. But Mr. Regalia said these critics are wrong.

“Banks are lending more, but 70 percent of the system isn’t there anymore,” he said. “They’re doing their jobs. They’re being careful. But at the same time, the rest of the system has so collapsed that we’re still woefully short of credit.”

The Federal Reserve since September has stepped into the void to try to revive collapsed securities markets, starting with the commercial paper market. The Fed, using its own resources and seed money from the $700 billion Treasury bailout program, for several months has been buying top-rated three-month commercial paper. Under a similar program, this month it will start purchasing securities backed by student loans, auto loans, credit cards and small-business loans.

Fed Chairman Ben S. Bernanke noted recently that the Fed’s commercial paper program is having modest success at reviving that market. The Fed’s presence as a buyer in the market seems to have assuaged worries that companies won’t be able to roll over their debt when their paper comes due. He said he hopes the program to revive the securities market for consumer and small-business loans will work the same way.

“If the program works as planned, it should lead to lower rates and greater availability of consumer and small-business credit. Over time, by increasing market liquidity and stimulating market activity, this facility should also help to revive private lending,” he said.

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