Saving For The Perfect Storm

Some banking regulators are beginning to admit the errors made in the early part of this decade that have resulted in the extreme severity of the current economic downturn.  One area that is rearing its ugly head is the inadequacy of loan loss reserves by the largest financial institutions.  As loans were being made at a frenzied pace, the reserves for the inevitable losses associated with those loans were not increased.  The Wall Street Journal reported yesterday that John Dugan, the U.S. Comptroller of the Currency, made the following admission.

He noted that the record profits of the banking industry at the beginning of this decade weren't coupled with an appropriate increasing in reserving. Instead, Dugan said, the ratio of loan loss reserves to total loans actually fell even though bank executives had to know that record profits couldn't last forever.  "Stated differently, rather than being counter cyclical, loan-loss provisioning has become decidedly pro-cyclical, magnifying the impact of the downturn," Mr. Dugan said.

Like many American consumers, the banks themselves were guilty of spending freely by making bad loans and not saving for a rainy day - or, in today's case, saving for the perfect storm.