Fed move to green light shareholder dividend boost problematic

Bank of America stockholders will only make a penny per share this year, so says the Federal Reserve. Based on the outcomes of the latest stress tests, the Fed has set several big banks free to raise shareholder dividends, but Bank of America is still in detention. The fragile economic recovery leads some industry experts to question the Fed’s decision, which weakens banks in the event of a double dip. Post resource – Why allowing banks to boost shareholder dividends is a bad idea by MoneyBlogNewz.

Fed throttles Bank of America dividends

The Federal Reserve heard from Bank of America that it wanted to, in the second half of 2011, to boost shareholder dividends in January. The quarterly dividend would have to go up 8 cents which would be about 20 percent of earnings. According to analysts, the Fed forbid Bank of America from doing so because of the bank’s exposure in the housing sector after buying out Countrywide in 2008, a decision that cost it $2.24 billion last year. Investor groups have also been pressuring B of A to purchase back billions in bad mortgage securities the bank foisted on them before the meltdown. Dividend increases were declared by JPMorgan Chase, Wells Fargo and U.S. Bancorp after getting permission from the Fed. The Fed could be getting a revised version of the dividend plan by June from Bank of America.

Why would banks boost dividends for shareholders?

The economy won’t be able to grow without increasing dividends helping banks raise more equity in the future, Wall Street banks argue. By paying shareholder dividends, banks attract investors however lose equity. Bankers disdain equity and love leverage. While a company like Google is funded almost entirely by equity, the average bank lives on other people’s money, funding more than 95 percent of investments with debt. Equity is something banks don't need because leverage makes executives and shareholders lots of money. This is assuming there is health in the financial sector. banks become more liable for risks when they have more equity too. They don't count on working class individuals to bail them out when things go bad while instead decreasing default risk.

Fed decision risks another bailout

There were many highly leveraged banks noticed during the financial crisis. The Fed was worried about this. There are some that disagree with the Fed allowing shareholder increases. They thing the boosts shouldn't take place until the economy is stronger. Sometimes individuals will purchase a home with a small down payment and a mortgage that is 98 percent of the purchase price. This is compared to the leveraged bank by Simon Johnson of the New York Times. It ends up being a good risk with a rise in the home price. Both the creditor and borrower are part of the risk. A drop will hurt both of them. The main difference, however, between highly leveraged banks and highly leveraged homebuyers are the banks have learned they’re too large to fail. Having a leveraged bank fail doesn't mean anything. Working class individuals will end up paying for it to be okay.

Articles cited

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