Gross to Bernanke: You’re creating the lending crunch

September 6, 2012, 1:00 PM UTC

Bill Gross

FORTUNE — The main point of the Federal Reserve’s efforts to drive down interest rates is to boost borrowing. So if Fed Chairman Ben Bernanke’s plan ends up doing just the opposite – causes banks to close up shop instead of handing out more cash – that would be a major problem.

But that’s what bond-guru Bill Gross worries could be the end result of the Fed’s controversial quantitative easing bond buying programs, which Bernanke looks more and more to likely to launch a new round of this fall. In his monthly letter to investors, Gross, who is the co-founder of asset management firm Pimco and the manager of the largest mutual fund in the world, says the Fed’s policies have made borrowing so cheap it may not make sense for banks to lend anymore.

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Take Bank of America (BAC). Currently, the bank is paying bond investors 3.99% when it borrows money for 10-years. Yet, the average rate for a 30-year fixed mortgage was recently 3.53%. Which means borrowing to make home loans, which is in theory what a bank does, no longer makes sense for Bank of America, unless it wants to lose money.

That’s not exactly how it works. Banks get a good deal of the cash they lend out from depositors, to which they pay little or no interest. What’s more, most lenders don’t hold onto mortgages. Instead, they sell them to Fannie Mae or Freddie Mac, which can borrow at lower rates, and pocket a fee.

But even interest-free savings accounts cost banks money. They have to build branches, pay tellers, run computer systems and set up ATM machines in order to attract depositors. And as interest rates fall to historic lows, the spread between those fixed costs, which don’t drop with interest rates, and what a bank can make lending becomes very thin.

According to data recently released by the Federal Deposit Insurance Corp., banks’ net interest margins, which represent the spread between what banks pay to get money and what they make when they lend it out, has shrunk to 3.5% from a recent high of 3.8% in the beginning of 2010. That’s below a near 30-year average of 3.6%. The current net interest margin is even smaller for large banks, at 3.4%, which again reflects how costly it is to have all those branches.

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The result: Any further drops in interest rates, which is what Bernanke seems to want, won’t cause banks to lend more. Instead, Gross thinks, banks will lend less, closing up branches and removing the ATMs that are costing them so much money to run.

“For the current shipwreck perhaps we have the Fed and other central banks to blame,” Gross wrote to investors.

Gross’ point is good. Bank profits could very well turn out to be the flaw in Bernanke’s plan. But it’s not the only way it could go. Last week, for instance, New Jersey’s largest independent bank, and one of the nation’s most conservative lenders, Hudson City Bancorp (HCBK) was forced to sell out to a rival. The bank said low-interest rates were making it tough for the bank to turn a profit. Before selling, though, executives drew up a plan to hire 200 loan officers and dramatically increase lending. The plan was eventually nixed, but you could see how another bank in a similar situation, making less money per loan, could decide to make more loans to make up the bottom line difference. If enough banks take that route, Bernanke gets what he wants, more lending.

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Indeed, there seems to be no sign that banks are pulling back on lending. According to Birinyi Associates, the dollar amount of total loans outstanding at commercial banks is only 2.8% below the August 2008 all-time high, and is the highest level it’s been in four years. What’s more, it’s not clear that falling profitability ever causes banks to cut lending. For instance, bank net interest margins fell by 21% between 2002 and 2007. Yet bank lending rose 52% during that period.

Gross argues if banks were to boost lending anyway, despite lower profits, banks would be taking on more risk than they would be getting compensated for. But that hasn’t stopped banks in the past.

So the question is whether banks, and regulators, have learned their lesson. If not, Bernanke could end up fixing one credit bubble with another.