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Banking: U.S. Banks Pull Back on Europe Lending, Survey Shows

U.S. banks tightened their standards for loans to European banks and fewer relaxed lending standards to businesses in the third quarter, the Federal Reserve said Monday.

The Fed’s quarterly senior-loan-officer survey, based on 51 domestic banks and 22 U.S. branches of foreign banks, showed that about two-thirds of banks that make loans to their European counterparts had tightened standards for those loans in the July-to-September quarter, reflecting growing uncertainty in financial markets over Europe’s sovereign-debt crisis.

“Many domestic banks indicated that the tightening was considerable,” the Fed said about lending to European banks. The central bank added a set of special questions about lending to Europe to the survey, conducted in early October. About half of the domestic banks in the survey said they make loans or extend credit lines to European banks.

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Credit Suisse to Hand Over Account Data

ZURICH—Credit Suisse Group AG will hand over names of clients suspected of dodging U.S. taxes, intensifying the campaign by U.S. authorities to pressure Swiss banks into turning over Americans with hidden accounts.

Credit Suisse said Tuesday that it will hand over account information to Swiss tax authorities in response to a request from the U.S. Internal Revenue Service. The bank, Switzerland’s second largest by assets, declined to comment on the number of names or when it would submit the information. The Swiss tax authority will examine the details and allow clients the chance to appeal, after which it would give the names to the IRS. That process could take several months.

The IRS’s request stems from a months-long investigation into allegations that Credit Suisse bankers helped scores of Americans evade taxes. Early this year, the U.S. indicted two current and three former Credit Suisse bankers; they have denied wrongdoing. In July, the U.S. Justice Department notified Credit Suisse that the bank itself was a formal target of a criminal investigation into allegations that it helped U.S. citizens avoid paying U.S. income tax.

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A Short Banking History of the United States

We are now in the midst of a major financial panic. This is not a unique occurrence in American history. Indeed, we’ve had one roughly every 20 years: in 1819, 1836, 1857, 1873, 1893, 1907, 1929, 1987 and now 2008. Many of these marked the beginning of an extended period of economic depression.

How could the richest and most productive economy the world has ever known have a financial system so prone to periodic and catastrophic break down? One answer is the baleful influence of Thomas Jefferson.

Jefferson, to be sure, was a genius and fully deserves his place on Mt. Rushmore. But he was also a quintessential intellectual who was often insulated from the real world. He hated commerce, he hated speculators, he hated the grubby business of getting and spending (except his own spending, of course, which eventually bankrupted him). Most of all, he hated banks, the symbol for him of concentrated economic power. Because he was the founder of an enduring political movement, his influence has been strongly felt to the present day.

Consider central banking. A central bank’s most important jobs are to guard the money supply — regulating the economy thereby — and to act as a lender of last resort to regular banks in times of financial distress. Central banks are, by their nature, very large and powerful institutions. They need to be to be effective.

Jefferson’s chief political rival, Alexander Hamilton, had grown up almost literally in a counting house, in the West Indian island of St. Croix, managing the place by the time he was in his middle teens. He had a profound and practical understanding of markets and how they work, an understanding that Jefferson, born a landed aristocrat who lived off the labor of slaves, utterly lacked.

Hamilton wanted to establish a central bank modeled on the Bank of England. The government would own 20% of the stock, have two seats on the board, and the right to inspect the books at any time. But, like the Bank of England then, it would otherwise be owned by its stockholders.

To Jefferson, who may not have understood the concept of central banking, Hamilton’s idea was what today might be called “a giveaway to the rich.” He fought it tooth and nail, but Hamilton won the battle and the Bank of the United States was established in 1792. It was a big success and its stockholders did very well. It also provided the country with a regular money supply with its own banknotes, and a coherent, disciplined banking system.

But as the Federalists lost power and the Jeffersonians became the dominant party, the bank’s charter was not renewed in 1811. The near-disaster of the War of 1812 caused President James Madison to realize the virtues of a central bank and a second bank was established in 1816. But President Andrew Jackson, a Jeffersonian to his core, killed it and the country had no central bank for the next 73 years.

We paid a heavy price for the Jeffersonian aversion to central banking. Without a central bank there was no way to inject liquidity into the banking system to stem a panic. As a result, the panics of the 19th century were far worse here than in Europe and precipitated longer and deeper depressions. In 1907, J.P. Morgan, probably the most powerful private banker who ever lived, acted as the central bank to end the panic that year.

Even Jefferson’s political heirs realized after 1907 that what was now the largest economy in the world could not do without a central bank. The Federal Reserve was created in 1913. But, again, they fought to make it weaker rather than stronger. Instead of one central bank, they created 12 separate banks located across the country and only weakly coordinated.

No small part of the reason that an ordinary recession that began in the spring of 1929 turned into the calamity of the Great Depression was the inability of the Federal Reserve to do its job. It was completely reorganized in 1934 and the U.S. finally had a central bank with the powers it needed to function. That is a principal reason there was no panic for nearly 60 years after 1929 and the crash of 1987 had no lasting effect on the American economy.

While the Constitution gives the federal government control of the money supply, it is silent on the control of banks, which create money. In the early days they created money both through making loans and by issuing banknotes and today do so by extending credit. Had Hamilton’s Bank of the United States been allowed to survive, it might well have evolved the uniform regulatory regime a banking system needs to flourish.

Without it, banking regulation was left to the states. Some states provided firm regulation, others hardly any. Many states, influenced by Jeffersonian notions of the evils of powerful banks, made sure they remained small by forbidding branching. In banking, small means weak. There were about a thousand banks in the country by 1840, but that does not convey the whole story. Half the banks that opened between 1810 and 1820 had failed by 1825, as did half those founded in the 1830s by 1845.

Many “wildcat banks,” so called because they were headquartered “out among the wildcats,” were simple frauds, issuing as many banknotes as they could before disappearing. By the 1840s there were thousands of issues of banknotes in circulation and publishers did a brisk business in “banknote detectors” to help catch frauds.

The Civil War ended this monetary chaos when Congress passed the National Bank Act, offering federal charters to banks that had enough capital and would submit to strict regulation. Banknotes issued by national banks had to be uniform in design and backed by substantial reserves invested in federal bonds. Meanwhile Congress got the state banks out of the banknote business by putting a 10% tax on their issuance. But National banks could not branch if their state did not allow it and could not branch across state lines.

Unfortunately state banks did not disappear, but proliferated as never before. By 1920, there were almost 30,000 banks in the U.S., more than the rest of the world put together. Overwhelmingly they were small, “unitary” banks with capital under $1 million. As each of these unitary banks was tied to a local economy, if that economy went south, the bank often failed. As depression began to spread through American agriculture in the 1920s, bank failures averaged over 550 a year. With the Great Depression, a tsunami of bank failures threatened the collapse of the system.

The reorganization of the Federal Reserve and the creation of the Federal Deposit Insurance Corporation hugely reduced the number of bank failures and mostly ended bank runs. But there remained thousands of banks, along with thousands of savings and loan associations, mutual savings banks, and trust companies. While these were all banks, taking deposits and making loans, they were regulated, often at cross purposes, by different authorities. The Comptroller of the Currency, the Federal Reserve, the FDIC, the FSLIC, the SEC, the banking regulators of the states, and numerous other agencies all had jurisdiction over aspects of the American banking system.

The system was stable in the prosperous postwar years, but when inflation took off in the late 1960s, it began to break down. S&Ls, small and local but with disproportionate political influence, should have been forced to merge or liquidate when they could not compete in the new financial environment. Instead Congress made a series of quick fixes that made disaster inevitable.

In the 1990s interstate banking was finally allowed, creating nationwide banks of unprecedented size. But Congress’s attempt to force banks to make home loans to people who had limited creditworthiness, while encouraging Fannie Mae and Freddie Mac to take these dubious loans off their hands so that the banks could make still more of them, created another crisis in the banking system that is now playing out.

While it will be painful, the present crisis will at least provide another opportunity to give this country, finally, a unified banking system of large, diversified, well-capitalized banking institutions that are under the control of a unified and coherent regulatory system free of undue political influence.

Could the U.S. central bank go broke?

While that day seems distant now, some economists and market analysts have even begun pondering the unthinkable: could the vaunted Fed, the world’s most powerful central bank, become insolvent?

Almost by definition, the answer is no.

As the monetary authority, the central bank is the master of the printing press. It can literally conjure up money at will, and arguably did exactly that when it bought about $2 trillion of mortgage-backed securities and U.S. Treasuries to push down borrowing costs and boost the economy.

The Fed’s unorthodox steps helped it generate record profits in 2010, allowing it to send $78.4 billion to the U.S. Treasury Department. But its swollen balance sheet leaves the central bank unusually exposed to possible credit losses that could create a major headache at a time of increasing political encroachment on the Fed’s independence.

Asked about the issue of potential losses during congressional testimony on Friday, Fed Chairman Ben Bernanke suggested the risks were minimal. If liabilities on the Fed’s balance sheet were to exceed its assets, it would only be so because of rising interest rates in the context of a thriving economy, he suggested.

“Under a scenario in which short-term interest rates rise very significantly, it’s possible that there might come a period where we don’t remit anything to the Treasury for a couple of years. That would be I think a worst-case scenario,” Bernanke said. Customarily, the Fed submits surplus profits from its operations back to the Treasury’s coffers.

But the Fed’s newfangled policy steps and the potential for credit losses raises, for some experts, the prospect that the Treasury may actually be forced to “recapitalize” the Fed — economist-speak for what others might call a bail-out.

That would be a strange role reversal given the Fed’s efforts to ease monetary policy by buying the Treasury’s debt, and it could raise a political firestorm from lawmakers who believed all along the Fed was putting taxpayer money at risk.

A PAUPER ON PAPER

Varadarajan Chari, an economics professor at the University of Minnesota and a consultant to the Minneapolis Fed, says that at some point during its exit from easy monetary policies, the Fed actually may go broke — at least on paper.

“The most obvious exit strategy is, when inflation starts to pick up, to stop and reverse asset purchases,” he said. “That’s likely to include requiring the Fed in an accounting sense to see a significant accounting loss.”

The Fed now holds just over $1 trillion in Treasuries, Chari noted, and if inflation rose by a couple of percentage points, it would dent the value of those holdings by about 10 percent, leaving the Fed with a $100 billion loss.

“I’m sure it will have some negative political fallout,” Chari said. “But not economic consequences. Their ability to print money means it (insolvency) doesn’t mean anything.”

Many economists argue that the potential cost to the taxpayer from the Fed’s policies is far smaller than the threat of a prolonged period of economic stagnation that would result from a less proactive approach.

With the U.S. unemployment rate at 9.4 percent and only tentative signs that businesses are beefing up hiring, Fed officials, including Chairman Bernanke, see a duty to prevent a further deterioration of economic conditions — and have signaled a readiness to use all the tools at their disposal.

Last November, as the economic recovery appeared to falter, the Fed said it would buy a new round of $600 billion in Treasury securities through June of this year. That’s on top of the $1.7 trillion in Treasuries and mortgage-backed securities it had purchased in response to the financial crisis.

Still, the pitfalls of the Fed’s approach are almost as numerous as the lending facilities it undertook to stem the crisis. Perhaps most daunting, the Fed’s purchases of Treasury debt and mortgage-backed securities have effectively turned it into a mammoth investor — a thoroughly undiversified one.

“The biggest risk is losses on its portfolio on long-term debt if inflation rises,” said Alan Meltzer, a Fed historian and economics professor at Carnegie Mellon University in Pittsburgh.

QUANTITATIVE TEASING

That threat is already apparent in the Fed’s latest round of bond buying, or so-called quantitative easing. According to calculations by Reuters Insider credit analyst Ed Rombach two weeks ago, the average duration of the Fed’s new portfolio of bonds is just under 5 years, and every 1-basis-point rise in 5-year to 6-year Treasury yields results in a loss of about $65 million.

The Fed is sitting on paper losses of about $2.3 billion on the purchases of U.S. Treasuries it made from November 12 until late last week, according to an analysis by Reuters Insider.

The Fed is also vulnerable to losses through its so-called Maiden Lane portfolios, a collection of investments it acquired when it brokered J.P. Morgan Chase’s takeover of a floundering Bear Stearns and bailed out failed insurer AIG.

The portfolio will likely generate losses, according to many analysts. Still, the total Maiden Lane portfolio amounts to just $66 billion, a small slice of the Fed’s growing pie of securities.

For most Fed officials, a concern over credit losses would be a luxury compared with the risk they see as predominant: that the economy will not grow quickly enough to return more than 14 million unemployed Americans to work, and inflation so low that it leaves the country exposed to possible deflationary shocks.

“The risks are worthwhile given that the economy would be in the toilet if the Fed never did anything to expand its balance sheet,” said Michael Feroli, chief economist at JP Morgan and a former New York Fed staffer.

Feroli does not believe asset sales will be a primary avenue for the Fed’s exit. Indeed, Bernanke appears to think the ability to raise interest rates on bank reserves might prove the most effective way to withdraw stimulus. But even that tool is not without its mechanical difficulties.

The problem lies in the basic workings of fixed income. By definition, bond prices decline when their yields or interest rates go up. That means that as the economy recovers and pushes inflation higher, the Fed will move to increase interest rates, pushing down the value of its giant bond portfolio.

“What would the international reaction be if the Fed suddenly had to go and be recapitalized?” said Bob Eisenbeis, chief monetary economist at Cumberland Advisors and a former head of research at the Atlanta Fed. “I don’t think that would bode well for Treasuries, or for the dollar, or anything else. It would be embarrassing.”

What You Need to Know about Banking

When it comes to choosing a bank, consider both convenience and cost. Some charge flat monthly fees; others charge a fee for each check written and each deposit made. Some charge if you go below the minimum balance, use a live teller, use another bank’s automated teller machine (ATM), make an account balance inquiry, have your canceled checks returned to you each month, or close your account. Most charge for bouncing checks, placing a stop payment on a check, and using your overdraft protection.

Reconcile your checkbook monthly and review your credit card statements for errors. Scam artists are finding new ways to target these two areas and if you’re not alert, you could get taken for a ride.

Review your banking habits, identify the services that are most important to you, compare fees for those services between several different banks, and then choose the bank that

fits your needs for the best price. If you use ATM machines to withdraw cash from your account on a weekly basis, for example, you wouldn’t want to choose a bank that offers free checking but charges a hefty fee for ATM transactions. You may decide to use a traditional brick-and-mortar bank in your neighborhood or an Internet bank in cyberspace.

In today’s world, you’ve got a few options when it comes to banking. One such option is to pick a credit union over a traditional bank. Banks are owned by investors; credit unions are owned and controlled by customers, who are members. Credit unions are nonprofit organizations and return surplus earnings to members by lowering interest rates on loans, increasing interest rates on deposits, or offering free or low-cost services.

The most basic requirement for any bank or credit union you choose is that it must be insured and fully backed by the U.S. government. This ensures that your account will be protected for up to $100,000, or $250,000 for retirement accounts. For credit unions, the National Credit Union Association (NCUA) provides coverage. Banks may be covered by the Federal Deposit Insurance Corporation (FDIC).