Low Interest Rates Do Not Mean Easy Money

I was listening to my wake-up radio station this morning, catching the 6:30a.m. news as usual and waiting for the business commentator who follows the sports. Now, I'm sure this guy is well-received in some circles - I mean, the radio station must pay him, right? - but to me his comments are almost always some voodoo interpretation of some tidbit he's spotted in The Globe & Mail prior to going on air.

Today was no exception, when he talked about Bank of Canada's 0.75% interest rate reduction benefiting some people (variable-rate mortgage holders and line-of-credit users for example) but he was pretty certain the central bank erred because in his opinion there is now a big risk of re-creating another credit bubble right before our eyes 'by lending lots of low-cost money to people who don't qualify for loans and can't pay them back' i.e. sub-prime mortgages or similar. What a dope. It doesn't matter a whit how low rates are if no one is lending and if no one can afford to borrow. I couldn't take it any more - grabbed my cell phone from beside the bed and called the station's talkback line with the dual objective of setting him straight and venting a little too.

The fact is, regardless of interest rates set by the central bank, or more relevant - by the big banks at the retail level - the banks simply aren't lending to anybody unless there are existing commitments or platinum-plated collaterals, and even then maybe not. Why? Well, one good reason is the banks' priority is to shore up their capital bases - i.e. conserving cash - which means i) not lending at all, or ii) demanding much higher levels of collateral from customers, or iii) by demanding much higher interest rates from customers, or iv) all the above.

One personal experience from last week is related to my Mom's move to a retirement condo. Mom is moving to a retirement-specific condo building. In order to finance the move in a convenient manner, Mom has lots of assets but asked her bank to loan her $60,000 for 90 days, with her $127,000 GIC they were holding (not her only assets at that bank) as collateral.

The first anomaly was, the request had to be forwarded to head office. Then - more than two days later - the loan was denied flat - for no quoted reason. The capper came when my brother, acting for my Mom, asked the bank to then liquidate the GIC so she could complete the condo transaction and the personal banking manager said to the effect of 'No, you can't liquidate your GIC' even though it is clearly redeemable any time. All of our jaws dropped simultaneously. To make the rest of the story short, my brother, a lawyer, invited the banker to discuss the legality of denying my Mom access to her deposited assets. The banker caved and cashed the GIC. We are still flabbergasted at the actions of that bank.

I really believe the bank's actions in this matter, when extrapolated to a Canada-wide bank-wide context - send the message that it is absolutely focused on preserving its capital, not lending to anyone unless they truly have to, and making sure none of their branch officers make lending decisions that erode their capital positions. No kidding - their investment arm clearly screwed up so big on sub-prime & ABCPs they have to do something to remain on a even keel.

The next case is a well-heeled professional friend whose business-only line-of-credit was coming up for annual renewal. His business is solid as a rock, and growing, and has substantial deposits at his bank, at least three times the amount of the line-of-credit, which he has never drawn against. This time around on the annual renewal, the bank asked him for all his personal statements, including his wife's, and an inventory of everything they have invested, before the bank would consider renewing the business line-of-credit. My friend is pissed off and the bank is adamant. In times of easy credit that would be deemed idiotic and totally unnecessary. In these times of the credit-crunch, it's business as usual.

Of course, when the central bank dropped interest rates by 0.75%, everyone expects the chartered banks to do the same, right? Wrong, and for the second time this year. The banks are absolutely intent on improving their overall loan performance and the way to do that is to levy higher interest charges wherever possible. So when the central bank drops the rate 0.75%, customers simply do not get the whole benefits.

The newspapers are full of reports where banks wouldn't lend (the BCE buyout is such a classic example) to their ultimate relief. Their capital bases are all-important these days.

One of the major objectives - even demands - of central bakers when forwarding billions of bailout dollars is that banks must make loans available, hence keeping the economy moving. The banks' actions couldn't be further from meeting those demands. Truth is, the banks are seizing up the credit markets in a selfish and vain attempt to forestall their own troubles and in the process are paving the road to economic hell for us all.

Don't believe me? Go apply for a loan. Good luck - let me know how it goes.