Newspaper article THE JOURNAL RECORD
Interest Rate Gap Next Threat to Banking Industry
By Dave Skidmore
WASHINGTON _ Federal regulators are on the lookout for the next threat to the nation's banks now that a threear wave of commercial real estate losses appears to be receding.
Ironically, they are finding it in the very same conditions that led to higher bank profits this year: the wide gap between longrm and shortrm interest rates.
Banks are paying as little as 3 percent on passbook savings accounts and collecting more than double that on longrm mortgages and securities. That leads to profits. But when interest rates rise and banks are forced to pay out more on deposits, those profits can disappear and even turn into losses.
"The gain from low interest rates is temporary," said Santa Fe, N.M., consultant Roger J. Vaughan, cothor of a new study warning of rising bank failures. "If interest rates rise, then all of the gains can be wiped out overnight."
As President Bush and senior administration officials reassure the public, top regulators are quietly advising banks to protect themselves against an inevitable increase in interest rates.
A new round of interestte related losses, coming on top of the commercial real estate problems, could push up the failure rate and increase the chances taxpayers will have to bail out the Federal Deposit Insurance Corp.
So far this year the banking news has been good. From January through June, banks earned record profits of $15.7 billion, up from $10.2 billion a year ago. But about threearters of the improvement can be attributed to the spread between long and short rates, now at a 20-year high, according to the FDIC.
The risky strategy of profiting from interestte differentials is called lending long and borrowing short. It means lending money for a long period at a fixed rate, such as a 30-year mortgage, and financing that loan with funds borrowed for a short time, such as a 90-day certificate of deposit.
Shortrm rates skyrocketed above 20 percent in the early 1980s. S Ls were stuck with lowte mortgages from the 1970s, but had to pay increasingly higher rates on their deposits. It was the first step in a decadeng debacle.
Now many banks have increased their homertgage portfolio. And they're also buying interestte sensitive mortgagecked securities and Treasury notes and bonds. …