There’s Method in Warren Buffett’s Madness

Warren Buffett’s loyal followers are wondering what got into the Oracle of Omaha when he told CNBC  that this is “a great time to be in banking”, praised Wells Fargo’s massive earning power, and said that the government doesn’t need to provide capital to or nationalize banks.

Although some critics dismissed Buffett’s statements as biased because he owns large stakes in Wells Fargo and U.S. Bancorp, he may be dead right.

Buffett was talking about lending, and it’s the “spread” that counts – the difference between the interest rates banks charge for the loans they make and the rate they pay to borrow that money.  When the Federal Reserve makes deep interest rate cuts, spreads widen and loans become more profitable.  The Fed funds rate is so low right now that Wells Fargo is borrowing cheaply and profiting handsomely on the loans it makes.

Although banks do need to recapitalize, they currently are saving money by cutting dividends paid to investors.  Every dollar they make goes into recapitalization.  With stricter government oversight, banks are required to operate more efficiently.  The irony is that these conditions are almost identical to what helped the nation recover from its last banking crisis during the 1990 – 1991 recession.  In fact, the banks 19 years ago were in worse shape than they are today; yet they were not nationalized or put into receivership.  Once the Fed cut interest rates, banks’ lending policies became more conservative, and they eventually recovered.  The same scenario could play out this time around.