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Promoting Responsible Banks

 1 July 2011

I've been thinking for the past several weeks that the slow economic recovery is due to the two bailouts.  I'll make that full argument in a different article.  One of the points I will be making in that argument is that the government gave the banking industry the tool to save the economy and instead most of them used it to protect their own wealth.  But I can't believe every bank was so self centered so I propose in this article we ask the government to rank banks based on how well they contributed to promoting recovery.  Then we should have the government structure the taxes banks pay based on this recovery ranking.  The government should base the rate banks pay for borrowing fed funds on the stewardship the bank showed when given these public benefits.

I know I've written this before but I believe much of the housing crisis would have been avoided if the banks had aggressively acted to refinance house at these historically low interest rates.  At this point in time there every home loan should have an interest rate of 5.5% or less.  And the majority of the home loans should be in the 4's. There should be no loans with an interest rate at or above 6%.  These last assertions are doubly true for people that have had loans for more than 4 years and have always made their payments.   My contention is if the banks refinanced aggressively then there would not be nearly as many houses in foreclosure, housing prices would not have fallen as dramatically, many average households would have a significant amount more spending money.      

Lets look at an example.  Suppose a family has a $200,000 mortgage with an interest rate of 7.5%.  The payment for principle and interest on that loan is about $1,400 (actual $1,398.43).  If that family is able to refinance at 4.5% the principle and interest is about $1,000 (actual $1,013.37).  This is $400 a month extra this family has to "stimulate" the economy or if this family had a lose of income due to the economy this is $400 they don't have to find in order to make ends meet.  That is they are less likely to default on the loan due to bad finances. This also improves this family's attitude about owning the house making it much less likely they will "walk away" from a house that is "underwater".   That is they are more likely to pay their mortgage even if they owe more than the house is worth.  With fewer houses going into foreclosure housing prices would have stabilized and the housing industry would have recovered more quickly.

Now it is almost a crime that we have millions of home owners who made every payment on their home loans for years and years and yet the banks have not gone out and ensured these people were cut into the deal the government gave the banks.  If a person had been making all the payments on their house the banks should have refinanced the outstanding balance with very few fees, with no house appraisal and with no income verification.  If the majority of banks had taken this socially responsible course of action this country would have been out of this recession at least two years earlier.  As a side bar this would have also given them an opportunity to clean up some of the paperwork problems - that is they would have original mortgage paperwork.  

I suspect there are banks out there that have been more aggressive in helping out the economy than the banking industry as a whole.  The government should go out and find these banks and help them gain the prominence in the banking sector they deserve.  First they would have to set criteria on how many loans should have been easily refinanced to the lower rate.  Then they should give the banks ratings on how well they fulfilled their social obligation.  Once that is completed they would institute financial rewards base on these ratings. 

One means the Federal government could use to do this is to make sure when Federal Reserve loans money to these banks these banks are eligible for rates lower than those banks that did not earn a high rating in helping the economy.  These banks should get first dibs at federal money in the fed funds market.  They could even get better commissions on bond sales.   The second means the Federal government should use is the tax code.  Banks should pay a significantly higher tax rate on the gross receipts of home loans whose interest rates are greater than 6%.  This tax rate should get steeper and steeper depending on how high the interest rate is and the length of time homeowners have paid this high rate successfully.  There are also cases where homeowners had adjustable mortgages and could pay the mortgage at the lower rate but could not pay the mortgage at the higher rate.  If the market rate of mortgages was at or lower than this persons original rate and the bank did not refinance because the house was underwater then the bank's income as a result of obtaining this house in foreclosure should be set at the entire appraised value of the home at the time the loan was made. 

The Federal government was aggressive in trying to help the economy.  I personally believe the bailouts lengthened the time to recovery --- but that is a different article.  Given that we as a country chose the bailout method then we should reward those banks that chose to participate as a partner.  We can do this by making sure these socially responsible banks are rewarded financially and given greater status in the banking industry as compared to those banks that during this time of crisis concentrated more on improving their bottom line.