There have been lots of suggestions for what the Obama Administration’s next move in getting the economy back on track should be. Some, like Paul Krugman, are pushing for another big stimulus plan. I’ve also seen proposals for WPA-style jobs programs.
There are also some who think that the best thing that the federal government could do for the economy is balance the budget. Others who think that doing nothing at all would be the most help.
I think that there is one important task to which President Obama’s economics team should devote all of their energies to the exclusion of everything else: getting the banks lending again. Consider the graph above. Clearly, bank lending in the United States has suffered in the last couple of years and is a primary cause of the slowdown in economic activity. While there is room for a healthy skepticism on the effectiveness of spending as fiscal stimulus I don’t know that anybody disputes bank lending as a means for helping an economy grow.
It has proved an elusive objective. TARPs I and II and the Geithner plan were all attempts at putting the banks back on a sound footing. None of the attempts worked and for a very good reason: the banks have behaved rationally. The preponderance of the “toxic assets” that started the whole snowball rolling remain on the banks’ books. The banks have reluctant to take any of the offers proffered to deal with them because to take any of them would be to acknowledge what lousy shape they’re in. The banks need to rebuild their capital.
To that end the Federal Reserve has been lending banks money at, essentially, an interest rate of 0 and the banks have been investing the money, much of it overseas, in the full confidence that the federal government will continue to bail them out and it’s less risky than making loans in the current uncertain economic climate.
None of the alternatives that present themselves are particularly appealing. Standing firm in a refusal to give the banks additional aid should they need it is unlikely in the extreme, too politically risky. Raising interest rates is more likely to slow the current level of growth than it is to induce the banks to lend.
Punishing the banks for investing rather than lending will not only be met with resistance (as the recent movements in the stock markets should suggest) but will only induce them to lend in the most indirect of manners. As long as they can make more money by investing than by lending, they’ll invest.
Assuaging the bankers’ worries about the prospects of future regulation or taxes might help a little but it would confirm the suspicions of some that the White House is more concerned with Wall Street than with Main Street and recent remarks from President Obama have been somewhat along the opposite lines.
The dilemma in which the White House finds itself now is a primary reason that I thought that the federal government should be viewing the big banks with an eye to liquidating them rather than trying to keep them afloat a year ago. Now a year has passed and the banks are doing much as they were a year ago only doing it without the air of panic that was so evidence last year.
BTW, the Senate may be poised to present the president with another defeat that hasn’t much been remarked upon. It is now being suggested that Ben Bernanke may not be reconfirmed as Fed Chairman. I see no coherent way that one can simultaneously make the case that Bernanke and the Obama Administration saved the economy from collapse and that he should not be confirmed. He’s either a hero or a goat. He cannot be both at once. And, if he is not responsible for saving the economy, it’s a lot more difficult to argue that the Obama Administration has been successful on that front, either.
If the problem is lending why not fire up the old Small Business Administration model and lend directly from government to business?
The small banks are still lending at least, that is, when the regulators let them. It’s the big banks that aren’t lending and the sums that are involved would probably be politically difficult.
What is the proof that there is demand for that lending? There have been suggestions that there is no real demand yet.
“He’s either a hero or a goat. He cannot be both at once.”
Sure he can. He made many mistakes that lead to the crisis. Once it occurred, he recognized it and acted fairly appropriately. That is possible in almost any job. It is his positive response after the crisis that is keeping him, maybe, in his position, not his acts before the crisis. If you want I can give you zillions of examples of this goat and hero thing. Very common in sports. Certainly common in the OR.
Steve
Not from a sales standpoint. Selling a candidate is no different than selling soap. It’s either the greatest or it sucks.
Obviously, I recognize that reality is more nuanced than that. But like sales politics is a different sort of reality.
I don’t think that’s quite the right question. It’s axiomatic that demand and price are inseparable. I know that the cost of borrowing has increased by a number of measures over the last couple of years so a decrease in demand is what would be expected. Consequently, I would say there are several questions. First, why has the cost of borrowing remained high relative to the banks’ costs? Second, how many borrowers that are actually reasonably qualified are being turned away?
I’ve suggested a few possible answers to the first question in the body of the post. I’m not sure how one would go about determining the answer to the second question.
To answer the second question – dig a little deeper – there is a lack of financial intelligence in terms of hard data. Too many banks can’t effectively roll-up their data to understand their situation to effectively know their risk. This is an issue at the fed as well. There is plenty of data warehouse technology to develop summary reports based on hard data. Instead they use an array of “models” of what is happening. For example if a big bank is not able to understand its derivative risks, nor can they (and the Fed) really gather and process risks in the banking system and economy at large then there is not way to get it going again without stimulus. Banks are unable to really know how much risk in dollars to take on or fully gauge the level of risk they have with those dollars. The big rating agencies (now clearly discredited) are of no help to them either. This system worked because times were relatively good and they could use their models and bits of data as a crutch and get a few key ratings to sign on. Now, when you really need hard data, its just not out there. That leaves two key things 1) the government puts a large amount of money out there 2) The Fed needs to build a solid data system that links to the banks in real time and rolls up the data to assess risks across the national debt inventory – it can be done – some banks have parts of it already in place. Todays data imaging tools – like Cognos or Hyperion need to be applied to the data. Then we can work with actual data, and have the confidence to loan and borrow with the “knowledge” rather than “a rating”
That’s an excellent comment, Chris. As I’ve written here a couple of times before I think that modelling per se was a serious part of the problem. Model creation for big banks is a sufficiently narrow field that the banks tended to be highly incestuous in terms of personnel which resulted in a tendency for the banks to operate in lock step which would make peaks higher and valleys lower.
I like Chis’ idea. Anecdotally, people on the big econ boards are not reporting that banks are rejecting loans, but we need real data. I still think that the San Francisco Fed report showing that consumers stop spending and retrench at a debt ratio of 120%-130% is relevant. It is unclear to me at what levels we can expect the consumer to come back.
Steve
Yes because the worked oh so well in the past.
(Here the hint: WPA workers…are still unemployed according to official statistics.)
Yeah, they thought that back during the Gread Depression as well, the tax increase under Hoover were disasterous.
Beats the first two positions, IMO.
And for TARP I, the money was used for things the original legislation did not intend. It was supposed to be used to buy up the toxic assets the banks have. Instead it was used to buy up stock and given to Government Motors. Then it was followed with politically motivated micro-managing so that many banks couldn’t wait to give the money back.
We have basically put ourselves in the same place the Japanese did about 20 years ago or so. We have zombie banks and the government keeps pumping cash into them lest they fail and cause even more problems for the economy and the politicians lose their precious power.
Right, and with the prospect of higher taxes, more regulation, higher labor costs why start a small business or expand an existing one? Creating an environment of greater uncertainty was a stupid, stupid move by Team Obama. Cap-n-Trade, Health Care, growing public debt, expiration of the Bush tax cuts….its not a pro-business environment.
I also like Chris’ idea. More information allows for better decision making. To the extent that information is hidden or private then you have more problems with incentives. But that brings up back to toxic assets. How much are they really worth? If the banks let people look really closely then they are back to revealing how much trouble (or not) they are really in.
And I’ll add that our benevolent Dear Leaders (aka the government) don’t want us to know this kind of stuff. Remember TARP? Why were healthy banks taking money (albeit reluctantly)? To keep people from learning which banks were in the shit, and pulling deposits, closing accounts and moving to those banks/financial entities that weren’t in the shit. When even our great and wise leaders are willing to dupe us rubes….what chance does good honest reform have?