Bernanke Recovery, Updated Trickle Down Economics - 7 / 29 / 09

The real question is why the markets are moving up. And the answers are telling. It's my view that cheap capital does not create opportunities for businesses to borrow or obtain growth financing, the type of 9,10, or 11% money that allows them to compete in new markets, or compete better in old markets. Standard loans of that nature are offered by Banks to their most stable, near risk free customers. Asset backed 9% money is excellent business for the top tier banks. These banks, who have been made custodians of our economy by the US government do not know how to lend or take risks on businesses the way they used to.

Financial institutions newly fattened on tax payer funds have no intention of using government provided funds to extend new loans to their existing or new customers. But these are the loans traditionally needed to jump start the economy. Instead they loan money to private equity managers and private lenders who have huge amounts of cash on the books, and permit the banks to hypothecate the risk to these private funds that seek to earn 20% annually. These private funds can't afford to lend at a few percent above what they are borrowing at. They charge 14% interest plus 20% of the loans value in equity. That's what a growth loan looks like these days in a best case scenario. What companies can afford to pay that?

Here's an anecdotal conversation I have recently had with a Tier 1 bank middle market lending officer (who happens to be a close friend of mine) that explains how the Bernanke / Geithner stimulus package really works.

Me - "We just acquired a company that needs some growth capital. It's a 15 year old business with revenues of $22.0 million, and $4.5 million in EBITDA. Currently it has a $5.0 million note on the books from a tier 2 bank. They have assets recently valued at $30.0 million. Shareholder equity is greater than $9.0 million. They would like to borrow an additional 3 million and refinance the $5.0 million into a single $8.0 million note."

Banker - "Well, I don't think its for us. Too risky. I but I could introduce you to 3 private lenders who would definitely give you a proposal."

Me - "How do you know these lenders?"

Banker - "We lent the money to them."

Now I understand that this conversation was held with a single bank, but I have received a similar response from at least one other top tier bank (Wells Fargo) and 2 mid tier banks. Banks don't want to take lending risk. They want to make easy money.

One way they do this is to acquire or build a good trading floor. This trading floor uses a portion of the capital on the banks books to trade / invest in equity, commodities, and secondary debt to generate profits for the shareholders. In good years they pull in 30% on the money - that's a great business. Margins on this type of business are terrific, even after paying high salaries. In a bad year the trading floor covers its costs. Rarely do they lose money. They have access to prime brokerage products. Prime Brokerage products rarely lose value. So why would banks do anything more than proprietary investments and lending to other lenders?

Given this model, for the Bernanke / Geithner stimulous package to work banks need to have enough cheap capital that they are inclined to trade a portion of it and in so doing put money into the capital markets creating buying and upside. This is what has caused the equity markets to rise, not value building in the economy. The real hope here is that the equity markets rise enough and remain at new highs long enough to entice IPO and secondary investors to return to the equity markets. Equity investments are the only reasonable money available to growing companies. And I believe that Bernanke and Geithner know this to be the case. Which is why the US government makes whatever announcements it can make to sustain or improve the equity market's performance. And it is also why the stimulus package will take a very long time to work.

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Bradford van Siclen