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Why Vilifying the Banks Matters


The relationship between the public and the financial services industry has turned downright ugly.

Editor's Note: This content was originally published on the Buzz & Banter (click for a free trial).

When does an industrialist become a robber baron? Or a savvy businessman become a profiteer? Or a banker become a "fat cat"? At what point does success become privilege?

While these questions may seem silly, economic history suggests that they're far from immaterial.

In his Buzz & Banter earlier today, Sean Udall wrote "While I don't like seeing the banks continually vilified my bank thesis is only changed on a huge FASB mistake…"

While I would like to share his optimism regarding the banks, I'd offer that vilification matters.

For as long as banks have existed, the industry has suffered from a perception problem. From the money changers in the temples to Mr. Potter in It's a Wonderful Life, banks and bankers have been reviled. To me, it's inherent to the business. A borrower's current gratification, pardon the pun, is mortgaged for the future. The moment a loan is made, an obligation is born.

But of late, what has always been a tenuous relationship between the general public and the financial services industry has turned particularly ugly. From "reprehensible" subprime lending activities to "obscene" post bailout earnings, the current perception is that our banks have unduly profited from the customers and the nation these firms supposedly serve.

At its core, it's a violation of public trust.

Unfortunately, it's this same public trust that serves as the foundation for our banking industry. As inherent middlemen, banks must trust a borrower's willingness to repay a loan as much as depositors must trust the banks. Failure in either direction creates catastrophe.

In the 1930s, it was the breakdown in depositor confidence that led to bank runs, and ultimately the creation of the FDIC*.

In contrast, what appears to be happening in this crisis is a breakdown in borrowers' willingness to repay loans. In increasing numbers, those who can are opting for "strategic default" or bankruptcy.

What's striking to me, however, is the tight correlation that appears to be forming between our rising societal view of the banks as villains and strategic defaults. And my fear is that the more we demonize lenders, the more we invite not just underwater borrowers but also financially able borrowers to opt for default.

As recent history shows, the financial health of our banks and our economy are entwined. And unfortunately, the more credit defaults rise (whether out of borrowers' inability or unwillingness to pay), the more our nascent economic recovery is jeopardized.

Many would like to believe that we can have it all: Vilification and distrust of the banks as well as improving credit quality and a growing economy.

I just don't see how that works.

*As an aside: History suggests that there was the same deterioration in the relationship between borrowers and lenders in the 1930s. What's interesting to me, though, is that it would appear that the deterioration manifested itself in depositor runs, as depositors sensed what was coming and saw a need to get out of its way. With FDIC deposit insurance, most current-day depositors have no reason to worry. I believe that ultimately, this crisis will determine whether FDIC insurance is sufficient to prevent bank runs altogether, or merely delay their timing.
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Position in SPY, SRS, and JPM.
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