BusinessWeek has a terrific story out on how banks are once more gearing up their magic crap-making machines.
The piece focuses on three new products (one of which, payday lending, isn’t exactly new, but more on that later) raising concerns “that banks once again are making dangerous loans to borrowers who can’t repay them and selling toxic investments to investors who don’t understand the risks—all of which could cause blowups in the banking sector and weigh on the economy.”
This is certainly the type of story we need to see right now, especially since these banks are being floated by taxpayers.
First up for BW is a new type of corporate loan that adds the volatility of credit-default swaps to the volatility of floating interest rates—and charges the banks huge fees for the displeasure. The product seems stupid on its face: Raising the interest rates on a company as the cost of insuring against its demise rises, meaning, as BW puts it: “The weaker the company, the higher the interest rates it must pay, which hurts the company further.”
So you’re going to raise interest rates on the companies least able to pay them, thus helping tip them toward defaulting on the loans you’ve given them. What?
One question I have here: Could manipulate the relatively small CDS market for a company in order to hurt its stock?
And this new product comes at a steep cost to corporate borrowers like FedEx, which the mag says would see fees on such a credit line triple or septuple to $3.6 million a month.
But more of a concern is BW’s reporting that some big national banks are getting into payday lending, a predatory practice that charges APR’s of 100’s of percentage points to poor folks. Up to now that’s mostly been the province of sketchy operations in crappy strip malls.
Why are the banks getting in now? I guess they think their reputations can’t go much lower, but it’s also a lesson in unintended consequences. Several states have cracked down on such predatory lending, but big banks like Wells Fargo and U.S. Bancorp aren’t subject to state laws, under the preemption doctrine—an issue Congress ought to take a serious look at.
In the meantime, the press needs to tackle this issue head-on before it metastasizes and gets a patina of legitimacy from your friendly neighborhood national banking corporation.
Finally, BizWeek reports that Wall Street is now offering something called “structured notes,” which are “essentially derivatives,” to mom and pop investors. Uh oh.
The new debt investments offer attractive rates, sometimes guaranteeing double-digit returns for the first couple of years. But when those teaser rates disappear, investors face huge potential losses over the life of the instrument, up to 15 years.
It’s an outstanding job by BusinessWeek to bring this junk to our attention, and its message needs to be amplified. I imagine there are lots of threads to pull on these three products.
Get to it, biz press.
Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR’s business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.