Why allowing banks to increase shareholder dividends is a bad idea

Right now the quarterly dividend on a Bank of America share is only a penny and the Federal Reserve said they should stay there. Following a round of stress tests, the Fed told the biggest banks they were fit enough to increase payouts to shareholders. However Bank of America was the exception. The fragile economic recovery leads some industry experts to question the Fed’s decision, which weakens banks in the event of a double dip. Article source – Why allowing banks to boost shareholder dividends is a bad idea by MoneyBlogNewz.

Fed tells Bank of America no

In January Bank of America told the Federal Reserve it wanted to initiate a rise in shareholder dividends in the second half of 2011. The quarterly dividend would have to go up 8 cents which would be about 20 percent of earnings. Because of the decision Bank of America made to lose $2.24 billion past year purchasing Countrywide in 2008 during the housing industry drop, the Fed told the bank not to do it. There has also been pressure from investors to get B of A to purchase back bad mortgage securities. These were sold before the meltdown began. After the green light from the Fed, JPMorgan Chase, Wells Fargo and U.S. Bancorp quickly announced dividend hikes. Now Bank of America has a plan to give a new proposal to the Fed. This will take place before June is over.

Why would banks increase dividends for shareholders?

The argument Wall Street banks have said that it would be bad to stop a rise in dividends. This is because the economy would not be able to expand without the banks being able to raise equity in the future. banks are able to lose equity however get more investors by paying shareholder dividends. Bankers are not that interested in equity though. They just want leverage to use. banks fund over 95 percent of investments in debt taking other people's money although corporations like Google use equity to get funded. banks stay away from equity because their executives and shareholders make big money on leverage as long as the financial services sector is healthy. banks become more liable for risks when they have more equity too. They do not count on taxpayers to bail them out when things go bad while instead decreasing default risk.

Possibility of another bailout

The Fed had a difficult time with highly leveraged banks in the financial crisis. There are some that disagree with the Fed permitting shareholder boosts. They thing the boosts should not happen until the economy is stronger. Simon Johnson of the New York Times compared a highly leveraged bank to buying a house with a minuscule down payment on a mortgage for 98 percent of the purchase price. If home costs rise, the risk pays off. Creditors end up missing out while the borrower loses if they drop. The difference, however, between highly leveraged banks and highly leveraged homebuyers are that the banks have learned they’re too big to fail. There could be a government bailout to help out the banks and take away tax dollars when a leveraged bank fails.

Citations

New York Times

economix.blogs.nytimes.com/2011/03/24/dividends-lost/?emc=eta1

Business Insider

businessinsider.com/how-bank-dividends-help-wall-street–and-hurt-almost-everyone-else-2011-3

CNN Money

money.cnn.com/2011/03/23/news/companies/bank_of_america_dividend/index.htm