US commercial banks face enormous risks at this time due to their high concentration of real estate related risk. The lessons we can learn from them are applicable to our financial future as well.
Banks serve a tremendous purpose in this world.
They take in individual’s deposits and pool them together to lend them to businesses or individuals who need the capital for a business opportunity they have. This business opportunity could be a company that wants to expand or an individual who wants to buy a home.
The more that people save, the more money that is in the banking system and this increased money leads to more loans and more economic growth. This growth is natural and healthy because people’s savings represent capital they could use in the future for more purchases. Thus, when a business borrows more money and invests that capital to be able to manufacture more goods it is a smart decision because people already have more money saved to spend on these goods.
This becomes a healthy circular formula that is summarized as such: “higher savings” leads to “more loans to businesses” which leads to “more business investment” which leads to “great consumer choices” and of course more jobs are created along the way which further fuels the economy forward.
Well, most of us are aware that the rate of US savings was actually negative last year, meaning we spent more than we made. This is down from saving 7.5% of our salaries only 30 years ago. So we see that this current economic boom has not been built upon by people’s savings.
On the other hand, economies also grow when interest rates are set artificially low as they were set in the US. These low rates spurred the real estate bubble to new, incredible prices never before seen in the US and the world. And the amazing thing is that there is no economic justification for these high home prices outside of the herd mentality thinking that prices will keep going up.
Well, we have passed that point and are now seeing decreasing prices and increasing inventories of homes available for sale.
The problem with banks is that they get caught up in the herd mentality as well, increasing the amount of money they lend for people to buy homes. And not only that, they are doing so in a riskier and riskier fashion using adjustable rate mortgages.
Currently, US commercial banks face incredible risks because over 60% of their total earning assets are mortgage-related!!! Let me repeat that, over 60% of US commercial bank’s assets are mortgage related – a postwar record high.
As a result of the above risks faced by banks any problems happening in the real estate market would have strong negative ramifications for the US banking system. As an example, the Japanese banking system was crippled after the boom of the 1980’s when they concentrated much of their capital in real estate. Japan spent the following 14 years in an economic doldrum and is now just beginning to see the light of day.
Now that interest rates are going up, and will continue going up, people who used adjustable mortgages are feeling the pinch of increasing monthly mortgage payments. As a result, foreclosure rates are up 38% over last year and bank’s bottom lines are feeling this pinch.
Billionaire Warren Buffet recently said that he has been studying recent bank balance sheets and is very concerned about the growing number of defaults on their books.
The point is that even though banks aren’t prepared and well diversified it means that you should be even more so! How to prepare yourself is discussed in detail in the recently issued eReport entitled “Recession – How To Survive and Thrive”.