U.S. News

Fed Move May Signal End to Easy Bank Profits

Graham Bowley and Eric Dash|The New York Times

Federal Reserve to Wall Street: The days of easy money — and, just maybe, easy profits — are numbered.

New York Stock Exchange (NYSE)
Oliver P. Quilla for CNBC.com

News on Thursday that the Fed would raise the interest rate that it charges banks for temporary loans was seen by lenders as a sign that their long, profitable period of ultralow rates was coming to an end.

The move suggested that policy makers believed the nation’s banks had healed enough to withdraw some of the extraordinary support that Washington put in place during the financial crisis. And, while all those bailouts stabilized the banking industry, it was low rates from the Fed that helped propel banks’ rapid recovery.

Even though the Fed had telegraphed its intention to raise the largely symbolic discount rate, the timing of the move, coming between scheduled policy meetings, caught some economists by surprise. Stocks and bonds sank in after-hours trading, suggesting Friday could be an anxious day for the markets.

“This is a victory lap by the Fed,” Zach Pandl, economist at Nomura Securities, said. “It is a signal that the Fed is very confident in the health of the banking system. Fundamentally, these actions are a sign of policy success.”

Since the crisis, the Fed has nursed banks back to health with extraordinarily low rates. Banks have been able to borrow money cheaply and put it to work in lucrative ways, whether using the money to make loans at higher rates or to trade in the markets.

The difference between short- and long-term interest rates is near a record high, presenting a profitable opportunity for banks. The difference between two- and 10-year Treasury rates, for instance, is about 2.9 percentage points. Buoyed by such policies, banks’ profits — and banking stocks — have rocketed over the last year.

Many economists said banks were no longer borrowing in large amounts from the Fed using the discount rate, and so the move on Thursday was, in a sense, purely technical.

But it was a sign that the threat of a collapse in financial markets — so real just a year and a half ago — had dissipated. Some economists said that, with unemployment high and the economy growing slowly, the Fed would not be raising the more important benchmark interest rates for some time.

Market Reaction to the Fed

“This does not say anything about interest rates, but it does say something about what has happened on the ground, that the financial industry is not under same stress as it was previously,” Frederic S. Mishkin, a professor at Columbia and a former member of the Fed’s board of governors, said.

Others countered that the move at least brought forward the moment when interest rates would begin to rise again — and put an end to the banks’ period of easy money.

Louis V. Crandall, chief economist at Wrightson ICAP, said it demonstrated “a willingness to entertain an early start to the real business of retreating from the Fed’s very accommodating stance.”

Unnerved by this prospect, at least in the short term, the bond market fell after the Fed’s announcement, driving up the yield on 10-year Treasury notes about seven basis points, or seven-hundredths of a percentage point, to 3.8 percent.

Stock futures also fell in after-hours trading. Financial shares were particularly hard hit, with shares of big banks like JPMorgan Chase and Bank of America each falling about 1 percent.

The uncertainty over what the Fed will do next, and when, is a big worry for bankers.

“It creates real havoc in managing a bank when you have to ride through these cycles when interest rates change rapidly,” said Douglas J. Leech, the chairman and chief executive of Centra Bank, in Morgantown, W.Va.

Many banks are still coping with bad mortgages and other loans. “This poses a new threat,” Mr. Leech said.

Rising interest rates will invariably squeeze banks’ profit margins and reduce the value of some lenders’ own investments. Taken together, those developments will hurt banks’ bottom lines, a particular worry for the many small and midsize banks that are struggling to cope with the weak economy.

Many banks have tried to prepare for an inevitable rise in rates by locking up customers’ deposits, which provide a stable source of funding for loans. Centra, for instance, began extending the term of its certificates of deposits to 16 months, from 12 months, last year. The bank also began offering low-rate loans that it can reset at higher rates in 18 months, in case, as Mr. Leech expects, interest rates rise.