I was alarmed yesterday to see a sitting US senator assume that the Fed Chairman would naturally prohibit banks from paying dividends (or buybacks) under the new administration. The Fed Chair wisely deflected the question and the assertion behind it. For folks unaware of how the stock market works, and specifically bank accounting, let me say that that was a “doozy” moment. Yes, it is true that the vast majority of quantitative easing and Federal Reserve activity over the past 13 years (since the GFC) has gone into the financial markets rather than the real economy. That is not because banks are intentionally not lending, but because the Fed has been burdened with the responsibility of micro-managing the economy, a task for which it is not equipped, neither in terms of statute nor tool kit. Congress seems unaware of that. Further questions to the Fed Chair assumed that he was responsible for pretty much every problem and every solution that this country has. The Fed’s statutory responsibility is to manage aggregate inflation and employment levels. It struggles to achieve either of those goals (especially employment) given that very limited toolset. In the meantime, the legislative branch–including that US Senator–has consistently dodged its responsibilities in regard to crafting responsible economic policy.
But back in regard to bank stocks and their distributions. Stripping banks of their right to pay dividends (or buy back stock) when they have the ability to make such distributions makes them more or less uninvestable. That is because dividends (and share buybacks) are basically the only key measures of a financial institution’s genuine profitability. Bank accounting is unavoidably opaque; banks move money around internally in a way that was not designed to be captured by GAAP accounting. Take away their distributions, and investors are flying blind. That is what has happened in Europe. An article in the FT from a few months ago captured that scenario in Europe.
The article’s headline and sub-headline say it all: “Europe’s banks fear investor flight after dividend bans: Lenders are verging on uninvestable, making it harder to raise capital in the future.”