Banks are increasing their purchases of U.S. government securities to pump up profits while lending to businesses languishes near the lowest levels since credit markets started to freeze almost three years ago.
Holdings of Treasuries and agency debt rose in each of the past five weeks, an increase of $63.2 billion, to $1.5 trillion, according to Federal Reserve data. At the same time, commercial and industrial loans grew less than 1%, to $1.27 trillion, and are down 23% from the record high in October 2008.
Banks are taking advantage of the record gap between their borrowing costs and yields on U.S. debt instead of lending, according to data compiled by Bloomberg. Bank demand for Treasuries is helping cap yields as the government sells record amounts of bonds to finance a budget deficit that exceeds $1 trillion.
"The risk of owning Treasuries is lower than creating loans," said Anthony Crescenzi, a market strategist and money manager at Pacific Investment Management Co. in Newport Beach, Calif., the world's largest bond-fund manager. "There is no clarity on what the capital climates will be domestically or on a global scale, with regulation coming down the pipes, which means banks will be banking their money in safer assets."
The yield on the benchmark 10-year Treasury notes fell 15 basis points last week, to 3.66%, the biggest decline since February, according to BGCantor Market Data. The yield, which rose to 3.69% on Monday, is down from the high this year of 4.01% on April 5.
Banks increased demand at the Treasury's auctions of 10- and 30-year securities in March. They bought a record $2.562 billion, or 12%, of the 10-year notes sold on March 10 and $3.146 billion, or 24%, of the 30-year bonds offered the next day, government data shows. Banks typically contribute less than 1% of the demand for longer maturity debt.
"As long as we are not lending, this is what we will see — the yield grab," said George Goncalves, head of interest rate strategy in New York at Nomura Holdings Inc., one of 18 primary dealers that are required to bid at Treasury auctions. "If you aren't worried about inflation and you don't think demand for lending is going to pick up, then the long end is where you want to be," he said, referring to bonds with longer maturities.
Low yields are helping taxpayers. In fiscal 2009, which ended Sept. 30, the U.S. paid $383.4 billion in interest on its debt, down from $451.2 billion the previous year, Treasury data shows. That was 3.2% of gross domestic product, down from 4.6% a decade earlier, when Bill Clinton was president and the U.S. had a budget surplus.
Financial institutions have little incentive to lend with unemployment hovering near 10% and the difference between the rate on overnight loans among banks and the 10-year Treasury yield at about 3.5 percentage points. That is more than double the average spread of 1.55 percentage point during the past 20 years.
"If you look at the economy, you are either glass half full or glass half empty — lenders are the latter right now," said Keith Leggett, senior economist at the American Bankers Association in Washington. "There isn't a lot of demand from creditworthy borrowers."