Bailed Out Banks Are Helping to Keep Treasury Rates Low

Banks are buying Treasuries like mad it seems due to a dearth of corporate bonds and restrained growth of their loan portfolios. Sounds like a good time to issue debt if you are a top rated corporate. Also, this is a result of banks being defensive, with substantial growth in deposits net of loans since they are restraining their loan growth. But with treasury returns so low, one has to imagine that at some point banks switch to being more aggressive on the loan growth front once they have more confidence in the value of their balance sheets and deposits keep rolling in due to Americans finally saving more. All-in-all, to me this a good sign that our financial system is healing itself.

U.S. lenders bailed out by the government are returning the favor by stepping up purchases of Treasuries, helping to temper a rise in borrowing costs.

Bank holdings of U.S. government securities are up 15.6 percent from a year ago, almost double the average annual growth rate of about 8 percent since the Federal Reserve began tracking the data in 1973, according to the Greenwich, Connecticut-based trading and research firm MKM Partners LP. Purchases may accelerate as lenders look for places to park rising deposits as sales of federal agency debt of companies such as Fannie Mae and corporate bonds slow.

“We expect demand to shift to Treasuries, given low net supply in corporates,”Srini Ramaswamy, a fixed-income strategist at New York-based JPMorgan Chase & Co., the second- biggest U.S. bank, wrote in a report July 24. The firm’s models “suggest that bank purchases of corporates and mortgage-backed securities will be small relative to the growth in deposits net of loans, which have been growing at a rate of roughly $29 billion per month.”

Nevertheless, there is a potential scary side to this in that it resembles what happened with Japan during their “lost decade” of growth.

It’s also reminiscent of Japan, where banks increased their holdings of government bonds to record levels during the country’s so-called lost decade of economic stagnation that began in the 1990s. By the end of 2005, government bonds made up 18.2 percent of Japanese bank portfolios, up from 7.5 percent in 1998, while loans as a percentage of holdings slid to 55 percent from 63 percent, according to Citigroup.