Some banks stuff the mattress

AmEx, led by CEO Ken Chenault, is among the big banks adding to its cash reserves lately.

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NEW YORK (Fortune) -- Stressed out or not, some of the nation's biggest banks are awash in cash.

American Express (AXP, Fortune 500), Bank of America (BAC, Fortune 500), Goldman Sachs (GS, Fortune 500) and Morgan Stanley (MS, Fortune 500) are among big institutions that reported a sharp rise in their holdings of cash and easy-to-sell securities in the first quarter.

The banks, all of which have received taxpayer funds under the Treasury's Troubled Asset Relief Program, are under pressure to boost lending as the economy slumps.

But with debt markets still unsettled and investors eager to get out from under the thumb of Congress, these banks -- all of which were buffeted in last fall's market unrest -- have been stuffing money under the mattress instead.

"It's still a dangerous environment," Goldman Sachs finance chief David Viniar said in a conference call this month. "And, as you know and you've heard us say many times, there is nothing more important than liquidity in this dangerous environment."

Goldman said global core excess liquidity -- a measure of the firm's access to instant cash -- surged to $164 billion in the quarter ended March 27, up from $111 billion in the fourth quarter.

The rise was even more dramatic at Bank of America, where cash on hand soared to $173 billion at the end of the first quarter from $33 billion at year-end. CEO Ken Lewis, whose Charlotte-based bank recently acquired the troubled broker-dealer Merrill Lynch, called the shift "very expensive in the short term but well worth the cost in the long term."

Morgan Stanley had more than $150 billion invested in cash or cash-equivalents, such as three-month Treasury bills that recently yielded a puny 0.09%. That's almost a quarter of its balance sheet -- which means the brokerage firm holds twice as much in cash as it did a year ago.

"Although this creates a noticeable drag to our earnings," finance chief Colm Kelleher said, "we believe that maintaining a strong liquidity position is currently the most prudent approach."

That's because holding cash can ease fears that a bank will be brought down by an inability to borrow money in the markets -- the so-called run on the bank that brought down Lehman Brothers last fall. That concern persists despite the alphabet soup of federal plans that give banks access to government money.

Funding questions are more acute for firms such as Goldman and Morgan, which didn't become bank holding companies until after last fall's market plunge and haven't typically depended on deposits -- a low-cost source of funds for traditional banks. Big deposit gatherers such as JPMorgan Chase (JPM, Fortune 500) and Wells Fargo (WFC, Fortune 500) haven't felt the need to mention their liquidity in recent press statements.

But even consumer banks such as BofA, SunTrust (STI, Fortune 500) and another recent convert to bank holding company status, American Express, are adding cash.

AmEx, which boosted its liquidity position to $25 billion from $13 billion in the fourth quarter, said it plans to hold enough cash to pay off all its debt maturities for the coming year.

BofA said its big cash position means it could operate for more than two years without raising new money in the markets -- up from a year and half at the end of 2007.

Cash is especially handy now, with regulators having spent the last month compiling the stress tests whose results are being shared with banks this week.

Federal officials said on a conference call with reporters last week that one part of the test checked banks' capacity to withstand a shock as severe as the one that froze credit markets last September.

Firms such as Goldman, Morgan Stanley and American Express -- all of which have said they want to repay TARP funds as soon as practicable -- are also trying to show investors that they can wean themselves from government support, even if markets remain unsettled.

While the banks are building up cash to reassure investors, observers note that it can be tough in a recession to find other uses for the money, given consumers' focus on rebuilding their own depleted savings.

"Liquidity allows the banks to lend if they can find borrowers who can pay them back," said Gary Townsend, a former bank analyst who now runs Hill-Townsend Capital in Chevy Chase, Md. "That's the big challenge right now, because the risk-adjusted returns are as big as we've seen in a couple of decades."

Indeed, SunTrust chief James Wells said in a conference call last week that part of the bank's rising liquidity -- it hit $6 billion at the end of the first quarter, up 14% from a year ago -- is attributable to the fact that "demand remains weak for loans to higher quality borrowers."

Given the unpredictability of how the government has dealt with troubled banks ranging from Bear Stearns and Lehman Brothers to Washington Mutual and Wachovia, some investors see the hoarding as a rational response -- regardless of how it might play in Washington.

"At this point, the marginal value of $1 is worth much more in passing the stress test than being lent out," said Eric Falkenstein, a former bank executive and hedge fund manager. "Until the Fed/Treasury stops threatening the banks with imminent dilution based on some unarticulated capital sufficiency test, it would be foolish to lend more money."