Applauding BNY Mellon’s Move on Excess Cash Balances
Posted by Jason Apollo Voss on Aug 6, 2011 in Blog | 2 comments
Late Thursday night there was a potentially important development in terms of righting the U.S. economic ship. Bank of New York Mellon (BNY Mellon) moved to charge extra fees on its clients that hold more than $50 million in cash deposits with the bank.
Why is this significant? As I have been tracking on the blog for some time (see last year’s “It’s Chickens That Sit On Eggs” and more recently “Cash On Balance Sheets Is Big Concern“), U.S. corporations are not spending their profits. Instead they are socking away extra cash in large commercial banks, like BNY Mellon.
In business school they teach you as a business executive that you should always be in search of the highest possible return vs. risk on your assets. That U.S. corporations cannot find something better to do with their money than earning ~1% is a sign of many bad things:
- They don’t have new growth areas that they feel will generate greater than 1% in returns.
- They don’t feel that their own stocks are worth buying in a stock repurchase program.
- They don’t feel that their own debt is worth paying off with the excess cash.
- They don’t feel that shareholders can do better on their own if they paid out that cash in the form of stock dividends.
I have been talking privately about this problem with friends and family for many, many months. One solution that I felt would help, but would never, ever, ever see the light of day was the U.S. government (or state governments) passing a one time “excess cash” tax. That would lead to businesses freeing up some of those massive cash amounts. That would pump money into the economy and hopefully prime the pump, especially now that the U.S. government is tapped out from issuing more debt.
The Wall Street Journal is reporting that BNY Mellon’s decision is being driven by the fact that they don’t have assets in which they themselves can invest their customers’ cash. WSJ reporters also state that the fastest growing U.S. bank asset this year is cash, having grown 83% (up by $890 billion) to $1.98 trillion! By comparison, consumer loans are reported to have only grown 0.2%, or up by $1.7 billion. That is a 1,000x difference in absolute dollar amount!
It is believed that other commercial banks may follow suit. I hope that they do. Effectively, this would put in place the very tax for which I have been hoping. That would result in a large amount of economic stimulus and hopefully jump start the economy. Yes, it’s possible that it could also jump start inflation, but I would gladly trade a couple of points of inflation at this points for a couple of points of gross domestic product growth (GDP), or a couple of points of improvement in the unemployment rate.
I will continue to monitor this situation as this is one of those “little” stories that has the potential to be the “big” story.
Jason
The unspent cash problem strongly agrees with the description of the liquidity trap from my Macro Econ 101 class. The story behind the liquidity trap is that central bank money supply injections fail to stimulate the economy because the interest rate that market “wants” is effectively less than zero. I haven’t heard you mention this term by name in this blog, perhaps because Keynes theory is only taken seriously in certain circles who largely have a liberal political bias; yet, here we have evidence of at least one market player effectively imposing a negative interest rate on savings!
Keynes theory (from which I believe the liquidity trap concept originated) prescribes dramatically increased government spending to get the economy moving specifically on the premise that interest rates can’t go lower than zero. In this view, fees or taxes on savings could serve as practical alternatives to government spending by enabling negative effective interest rates to manifest. On the other hand, the zero lower-bound may prove to be non-negotiable with the market whose players can always pull their cash out of the banking system entirely. (Uh oh!)
It’s unlikely that BNY Mellon is imposing fees to improve systemic economic prospects; rather, they are trying to turn a profit in a market of flat returns. If this trend toward extra savings fees develops and is able to jump start demand by side-stepping the zero lower bound, then all power to it! However, if it doesn’t work, it may be but a preview of coming deflation. (Not good at all!)
Hi Stephen,
First, thanks for your continued loyalty to the blog. Second, thanks for your comment.
You certainly eat your financial “Wheaties!” Ah yes, the “liquidity trap,” is exactly what we stand at the precipice of experiencing. Economists, who tend to be more quantitatively driven, usually focus on the machinations that you describe. Yet, the underlying problem is why isn’t the cash being spent? The answer is that return vs. risk looks bad to businesses. And even deeper down into the foundations (if I remember you are an engineer) is the idea that there is a pervasive lack of innovation or innovative ideas in the economy. Ultimately that is not tenable in the long run.
You are right to point out that BNY Mellon’s decision is certainly not driven by charitable interest. In fact, in their statement they said that they themselves had no place to invest the cash that was piling up in its commercial accounts.
What I consider to be pathetic in this entire situation is the increasing paralysis of U.S. businesses. There are many and varied uses for cash. For me, as a shareholder, if the business I am invested in has no project on hand worth investing cash in, they ought to engage in a share buyback. Alternatively, if the motivation is to hold cash to insure against an uncertain economic landscape – i.e. minimize business risk – why not deleverage your business by buying back your debt in the open market or utilizing debt covenants to call your bonds? I consider this to be a risk fearing business leaders best use of that cash right now since Interest is a certain and unavoidable payment lest you want a default event. Yet, businesses are not delevering their balance sheets. The last option for gods sakes is to pay out that cash to your owners as a dividend. Even if it is tax inefficient – the usual justification for not paying dividends – I can think of lots of places I would place cash right now to earn better than 1%.
At the heart of the liquidity trap is human choice and all of the frailties associated with human choice. Businesses could certainly be spending that cash, but their leaders are nervous. And so we sit with intransigent unemployment and a stagnating economy. Ugh!
Deflation is definitely a bad thing, especially in the modern information age when consumers can easily track where there are bargains and therefore always await a price cut.
Lastly, in the wake of the BNY Mellon decision other banks, looking to improve profitability, are likely to follow suit. Effectively, the commercial banking sector will do what I have hoped for awhile – to make holding cash an expense (your negative interest rates described above). The situation you describe – of businesses pulling out of the banking system altogether just isn’t going to happen. If the economy is a body and money the blood, banks are the circulatory system. It is just about impossible to avoid banks in the modern world. There is no corporate mattress large enough to stuff away $3 trillion worth of cash, but there are projects, share buybacks, debt calls and dividends that are large enough.
Great statement SE!
Jason