The Government Should Study the Prudent Man Rule

By: Daniel Aaronson & Lee Markowitz | Fri, Apr 24, 2009
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The Prudent Man Rule directs trustees to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested. Plainly stated, the Prudent Man Rule is about managing financial affairs responsibly.

In contrast to the Prudent Man Rule, the Federal Reserve and the Treasury Department have been making a public push to force banks to lend under the disguise of keeping businesses and the economy moving forward. Claims have been made that without credit, companies cannot fund working capital, pay employees or invest in their businesses. However, forcing banks to lend in the middle of a deep recession will not lead to improvements in the economy, but will create even greater problems in the future.

Many banks have reported first quarter earnings this week. Two banks whose strategies contrast are Comerica and US Bancorp. In Comerica's earnings release on April 21, 2009, credit deterioration was similar to that of other banks. However, unlike many banks, loan balances have declined for the last 4 quarters. In the release Comerica stated:

Commercial and industrial loan growth has slowed sharply in all 10 previous post-World War II recessions, with actual loan outstandings falling in eight of those recessions, in inflation-adjusted terms. Companies have reduced their borrowings out of appropriate caution during this recession, as well. As a result, we have seen reduced loan demand across our geographic markets.

Comerica's assertion is logical. The government should not be pushing banks to use what are already thin levels of capital to extend new loans in the worst economic environment since the 1930's. Nonetheless, US Bancorp stated the following in its first quarter earnings release also on April 21, 2009:

Strong average loan growth of 19.6 percent (11.1 percent excluding acquisitions) over the first quarter of 2008, driven by:

The growth at US Bancorp is similar to loan growth at many large banks, indicating many banks are executing the government's mandate.

In addition to hoping that new loans can support the US economy, the Federal Reserve Chairman and Treasury Secretary have become more vocal about the prospects for the economy in hope of providing support to all asset prices from real estate to stocks. However, it is rapid loan growth by banks, such as US Bancorp, that is creating new concerns for the stock market and economy. Shareholders should ask 1) why is it necessary to distinguish that the commercial loan growth is "principally in high quality" corporate loans, rather than always 100% high quality and 2) if loan demand shrinks during a recession and retail sales are currently falling who is US Bancorp lending to at such a rapid pace?

The government is trying everything it can to improve the economy and to improve the banking system with the end goal of supporting stock and real estate prices. Yet new credit card and home equity loans are not what the economy nor the banking system needs to fix its problems. Instead of taking the tough medicine and fighting excessive credit, the government is breaking the Prudent Man Rule.

Continental Capital Advisors, LLC is not long or short shares of Comerica Incorporated nor US Bancorp.

 


 

Author: Daniel Aaronson

Daniel Aaronson
Continental Capital Advisors, LLC

Continental Capital Advisors, LLC was formed to offset the destruction of wealth caused by the global devaluation of currencies by central banks. The name Continental Capital symbolizes the 1775 US Currency, "the Continental", which was backed by nothing and quickly became devalued.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Comments within the text should not be construed as specific recommendations to buy or sell securities. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities. Certain statements included herein may constitute "forward-looking statements" with the meaning of certain securities legislative measures. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the above mentioned companies, and / or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Any action taken as a result of reading this is solely the responsibility of the reader.

Copyright 2009-2012 © Continental Capital Advisors, LLC

Author: Lee Markowitz

Lee Markowitz CFA
Continental Capital Advisors, LLC

Continental Capital Advisors, LLC was formed to offset the destruction of wealth caused by the global devaluation of currencies by central banks. The name Continental Capital symbolizes the 1775 US Currency, "the Continental", which was backed by nothing and quickly became devalued.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Comments within the text should not be construed as specific recommendations to buy or sell securities. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities. Certain statements included herein may constitute "forward-looking statements" with the meaning of certain securities legislative measures. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the above mentioned companies, and / or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Any action taken as a result of reading this is solely the responsibility of the reader.

Copyright 2009-2012 © Continental Capital Advisors, LLC

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