Banks buying Treasuries

http://www.bloomberg.com/apps/news?pid=20601087&sid=ab.TUjV2SQNE&pos=5

Banks are increasing 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.

Banks, facing increased regulation after posting $1.78 trillion of writedowns and losses since the start of 2007, 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.

The increase in government debt comes as banks shrink their balance sheets for the first time since the Great Depression, further restricting lending, particularly for small businesses that rely on banks for financing, according to Brown Brothers Harriman & Co.

Buying longer-term debt is 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, according to Michael Cheah, who manages $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey.

Like Japan’s response to the real estate collapse in the 1990s, the U.S. flooded the economy with cash only to see financial institutions sock the money away in bonds instead of making loans. Yields on 10-year Japanese bonds ended last week at 1.27 percent.

“It’s the Japanese movie, just an American version,” said Cheah, who worked for Singapore’s central bank. “The next scene is that after banks buy more and more government bonds it will be very difficult for the Fed to raise interest rates because they will lead to massive losses in the banks and cause them trouble all over again.”